Trading in Opaque Markets: Fraud, Materiality and Compliance

The Shapiro trial

The Shapiro trial began in May 2017; it concluded in early June. Testimony in the case was presented by ten government witnesses, primarily the counterparties or employees of Nomura.

During cross-examination the defense sought to develop testimony reflecting the points presented by the expert witness in Litvak. The testimony included the following:

• Frank DiNucci, a government cooperator who pleaded guilty to conspiracy in the case testified he repeatedly used the same sales tactics as the defendants because he thought they were legal

• Caleb Chao, a co-worker of Mr. Peters testified that in view of his supervisor’s approval he believed the tactics he used, which were like those of the defendants, were appropriate

• Alejandro Feely, another Nomura employee, testified that while he was uncomfortable with the trading tactics, he never thought they were illegal

Other witnesses presented similar testimony, emphasizing that: the trading tactics were never concealed; Nomura’s compliance and legal department never reprimanded any member of the RMBS team for the trading tactics; and until Litvak the only consequence of such tactics was the possible loss of business from a counterparty.

The requests to charge by the defendants were modified after Litvak to conform to those used in that case. On June 15, 2017, following a week of deliberations, the jury returned verdicts of largely not guilty except:

• Mr Gramins was found guilty of conspiracy

• The jury did not reach verdicts on three counts: one for conspiracy as to Mr. Shapiro and one each for securities and wire fraud as to Mr. Gramins.

Post trial motions are in briefing. The SEC’s parallel case is pending.

Im & Chan

Prior to the verdict in Shapiro, the SEC filed an action against Nomura traders James Im and Kee Chan. SEC v. Im, Civil Action No. 1:16-cv-0313 (S.D.N.Y. Filed May 17, 2017). The Commission’s complaint centers on trading in commercial mortgage backed securities or CMBS.

The allegations are substantially similar to those in Shapiro. It alleges that the defendants deliberately misled and lied to customers about:

• The prices Nomura bought or sold the securities

• The bids Nomura made or received

• The compensation the firm obtained for acting as an intermediary (the spread)

• Who owned the securities

Essentially the same pattern was repeated for each trade: 1) The potential buyer would be told the bond could only be secured at a higher price than was actually quoted; and 2) The potential buyer then increased the amount to be paid, increasing the spread for the firm. The pattern reversed for sales.

The SEC’s complaint alleged that the representations by the traders were material to the counterparties. Since the markets were opaque, counterparties relied on the trader for pricing information. Ultimately the misrepresentations generated hundreds of thousands of dollars in ill-gotten profits. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b).

Mr. Chan settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of the provisions cited in the complaint. He also agreed to pay disgorgement of $51,985, prejudgment interest and a penalty of $150,000. In a related administrative proceeding Mr. Chan was barred from the securities business with a right to apply for re-entry after three years. See Lit. Rel. No. 23848 (May 26, 2017).

Mr. Im is litigating the case. Recently he filed a motion to dismiss, presenting essentially the same type of arguments used by the defense in Litvak. The U.S. Attorney’s Office did not bring a parallel criminal action.

The future

The key to these cases was the trading environment. There was no doubt that misrepresentations were made – they were captured in electronic communications. There was also no dispute that the firms had established compliance systems and that they knew and tolerated the trading conduct identified as wrongful by the government.

Whether the USAO has ceded the filed to the SEC after two trial losses is unclear. The SEC is proceeding although the agency have yet to take a case to trial. While neither the USAO nor the SEC fully considered the trading environment as reflected in the claims in the indictments and complaints, it appears to have impacted the view of the jurors. The verdicts make it clear that the jurors carefully evaluated each charge and made thoughtful, considered decisions as evidenced by the split verdicts.

In the future the firms may evaluate their compliance policies and procedures. While the expert testimony in Litvak may well be correct about the trading environment, repeated misrepresentations is not the proper manner in which to conduct business – and it clearly has consequences. Perhaps the end result of these cases is to bring a bit of sunlight into a dark corner of the securities markets, encouraging improvement.