(Bloomberg) -- The cases struck fear into the hearts of Wall Street bond traders, and with reason. They hinged on a simple argument by prosecutors: Traders’ lies are illegal.
Yet in a matter of hours on Thursday, two of the higher-profile cases -- the bond-market equivalents of trials of the decade -- unraveled for federal prosecutors in spectacular fashion.
The first, involving former Jefferies Group LLC trader Jesse Litvak, was reversed on appeal -- for a second time. The other one, against ex-Cantor Fitzgerald LP managing director David Demos, ended in a not guilty verdict. Together, they marked a humbling turnabout for federal prosecutors and their efforts to pursue charges against traders accused of deceiving clients while haggling over bond prices.
The double-barreled outcomes, coming within two hours of one another, likely brought an end to the government’s five-year crackdown on trader behavior in the bond market.
“When there are sophisticated parties engaged in arms-length deals, then proving fraud may well be impossible,’’ said Peter Henning, a former federal prosecutor and a law professor at Wayne State University in Detroit.
The 36-year-old Demos hugged his lawyer and broke down in tears when a federal jury announced the verdict in Hartford, Connecticut. Prosecutors claimed Demos lied to his customers about the prices at which his company could buy or sell mortgage bonds, boosting the profit his firm earned on a trade and therefore increasing his own bonus.
Speaking outside the courtroom, Demos called the decision “a complete vindication of everything I’ve fought for, my family has fought for and my lawyers have fought for, for the past three years. Bluffing or lying or puffing about your cost in a negotiation was never a crime, is not a crime and should never be a crime.”
Litvak, 43, was the first of more than a half-dozen traders to be charged by U.S. authorities with fraud for lying to clients. His arrest in January 2013 put traders on notice that they could face criminal prosecution for making misrepresentations to customers while negotiating trades, sending shock waves through Wall Street and leading to the resignations and suspensions of dozens of traders as financial firms clamped down on shady sales tactics.
He was convicted twice: once in a 2014 trial that was later reversed on appeal and then again in 2017. As part of its ruling Thursday, the New York-based appeals court ordered him freed from the Florida prison camp where he’s been serving a two-year sentence.
Nomura Holdings Co. warned its traders “DO NOT LIE” in a compliance briefing shortly after Litvak’s arrest, and many traders on Wall Street quit negotiating with customers via emails and texts, which could be collected as evidence against them, and instead began hashing out transactions by voice.
Still, prosecutors accused three Nomura trades of deceiving their customers. Last year, though, a jury in Hartford acquitted them of the vast majority of 27 counts against them, while convicting one of conspiracy and not reaching a decision on several others. A retrial is scheduled for July.
In all of the cases, the traders argued that they were dealing with sophisticated investors who knew not to accept their every sales pitch as gospel. Industry veterans acknowledge traders can be selective with the truth when going back and forth over prices. The question for jurors and the appeals court was, did that cross a legal line?
Jose Baez, Demos’s lawyer, said the verdict and the decision in Litvak’s appeal should put an end to the bond-trading prosecutions.
“Hopefully, today’s double victory not only for David but for Jesse will send a clear message that we’re not accepting this and juries aren’t accepting this,” Baez said after court.
Thomas Carson, a spokesman for the Connecticut U.S. Attorney John Durham, said prosecutors respect the verdict in the Demos case.
Harry Sandick, a partner at Patterson Belknap Webb & Tyler and a former federal prosecutor in Manhattan, said the appeals court made clear that it’s improper to lie about a security, but difficult to prove fraud in a transaction with market-savvy parties.
“The buy side in the bond market is just as sophisticated as the sell side if not more so, and it’s hard to see how people at a major hedge fund, for example, would be misled by what a trader tells them about pricing,” he said.
Traders say they’ve changed their behavior since Litvak’s 2013 arrest. But in the wake of Thursday’s developments, it’s their customers who may have to be careful.
When Eric Marks, a portfolio manager for Ellington Financial LLC, testified against Demos, he may have inadvertently captured the tension inherent in the bond market.
“When my boss trained me,” Marks said, “he told me to always watch out for what people tell you because you have to assume they’re lying to you.’’
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