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Buyers Beware: Jury Rules Bond Traders Can Lie to their Customers

Jesse Litvak, a former bond trader at Jeffries Global Investment Banking (“Jeffries”), was arrested and charged with securities fraud in 2013 for selling bonds to customers while lying about the price he himself had previously paid for the bonds. Litvak was initially convicted in 2014 for fraud and sentenced to two years in prison. However, after appealing, the Court decided that he should have the opportunity to explain his case to a jury. A federal jury in New Haven, Connecticut rendered a verdict on his case in January 2017, and he will be sentenced at the end of April.

Litvak sold bonds comprised of residential mortgage backed securities (“RMBS”) which are financial products comprised of pools of residential mortgage loans created by banks and packaged together based on different structuring of credit, prepayment risk, principle payment, and interest payment, and then packaged into securities and traded on the open market. When trading these bonds, Litvak habitually lied about when he had purchased the bonds and what prices he paid for them. For example, Litvak would tell a customer that he had bought bonds for $73.00 each earlier that day, and sell them to the customer for $73.25 the same day. In reality, Litvak had purchased the bonds for $71.00 several days prior, and had been shopping them around to institutional buyers to whom he could unload them for as high a price as possible.

Litvak’s defense is as follows: lying to his customers is not fraud, because fraud requires the lies be material, and lying about the price he paid for bonds is not material to the buyers’ pricing mechanisms in structuring a trade. Some analysts of the case have termed this defense a ‘used car salesman defense’ playing off the perception that used car salesmen bend the truth, and therefore assertions made about a cars previous condition and prices paid are not material to the buyer’s objective valuation of the car.

According to Litvak and his defense team, the only information that a reasonable investor should care about is the value of the securities based on their independent valuation models and market conditions such as the bonds’ liquidity and pre-payment/default risk. In other words, the only information material to investors is that of the securities current determined value, not historical prices that others paid.

Litvak has several mitigating circumstances that bolster his defense: most buyers of blocks of RMBS directly from a Jeffries bond trader such as Litvak are highly sophisticated institutional investors themselves, and purchase blocks of bonds in excess of $20 million. As such, they have teams of quantitative analysts who conduct extensive due diligence to determine whether the asking price is competitive. If the buyers’ sophisticated computer pricing models greenlighted a buy of the securities at the price Litvak was asking, it is immaterial whether or not he lied about historical prices of the bonds in question. Additionally, Litvak had no fiduciary duty or suitability obligations when making these sales to other sophisticated institutional investors.

A federal jury in New Haven, Connecticut acquitted Litvak on 9 out of 10 counts, finding his defense persuasive. This verdict has several implications for litigation in the securities industry, the most obvious being that juries can be unpredictable when it comes to cases involving complex financial transactions – nearly all analysts predicted the jury would find Litvak guilty and despise the notion of condoning lying in financial transactions. However, jurors apparently bought the testimony of the defense’s expert witness who testified that aspects of bond trading are akin to playing poker and bluffing, agreeing that the lies were immaterial. This ruling may also open up new avenues of defense for individuals accused of securities fraud, as it implies that certain industry practices or norms—such as the expectation that your bond trader may be lying to you–create assumptions that absolve misrepresentations from being material.

Lax & Neville LLP has nationally represented small broker-dealers, financial services professionals and securities industry companies in regulatory matters and securities-related and commercial litigation. Please contact our team of attorneys for a consultation at (212) 696-1999.