On May 3, 2018, a three-judge panel on the Second Circuit Court of Appeals (“Second Circuit”) vacated former bond trader Jesse Litvak’s conviction on one count of securities fraud, holding that the district court erred in admitting testimony from a counterparty concerning that counterparty’s mistaken understanding of Litvak’s role in the sale of residential mortgage-backed securities (“RMBS”) to it. United States v. Litvak, No. 17-1464-cr (2d. Cir. May 3, 2018). Litvak appealed his 2017 jury trial conviction on one count of securities fraud, arguing that his misstatements to the counterparty—which concerned the price at which Litvak had purchased the RMBS he subsequently sold to the counterparty—were immaterial to a reasonable investor. Further, Litvak contended that the district court erred in admitting portions of testimony from the counterparty’s trader, who erroneously believed that Litvak was acting as the counterparty’s agent in the sale of the RMBS, rather than acting as principal. While the Second Circuit held that a reasonable jury could have found that Litvak’s misstatements were material, it ruled that the district court materially erred in admitting testimony that suggested Litvak owed a fiduciary duty to his counterparty, and that the error was not harmless. Accordingly, the panel vacated the conviction and remanded the case, yet again, to the district court.

Authored by Circuit Judge Ralph Winter, the Second Circuit’s decision marks the latest chapter in the federal government’s prosecution of Litvak, which Shearman & Sterling has covered extensively (please see links below). Litvak was indicted in January 2013 and originally convicted following a 2014 jury trial on ten counts of securities fraud, one count of fraud against the Troubled Asset Relief Program (“TARP”), and four counts of making false statements. Litvak appealed his conviction to the Second Circuit, which in 2015 reversed Litvak’s fraud against TARP and false statement convictions and vacated Litvak’s securities fraud convictions. See United States v. Litvak, 30 F. Supp. 3d 143 (D. Conn. 2014), rev’d in part, vacated in part, 808 F.3d 160 (2d Cir. 2015). Following a re-trial in 2017, Litvak was acquitted on nine of ten counts of securities fraud; however, the jury convicted Litvak on one count of securities fraud related to a single RMBS transaction.

The Second Circuit’s decision focuses first on whether a jury could have concluded that Litvak’s alleged false statements to the one counterparty’s trader were material—a necessary element to show that Litvak committed securities fraud related to the sale of the RMBS. Litvak allegedly misrepresented the price at which he had purchased the RMBS and, accordingly, allegedly misrepresented the profit that Litvak’s broker-dealer employer would make on the sale of that security. Litvak argued that such information was immaterial to his counterparty, since it did not pertain to the underlying value of the RMBS and the counterparty agreed to a purchase price based on information generated by its own internal research and trading algorithms. However, the Second Circuit held that a jury could reasonably conclude Litvak’s misstatements were material, insofar as the broker-dealer’s profit affects the price that the buyer pays for a security. The court explained, “[w]hen the broker-dealer seeks a profit for its role in procuring and selling a security desired by a buyer, the profit becomes part of the price paid by the buyer. The value of the security may be the most important factor governing the decision to buy, but the price must be considered in determining whether the purchase is deemed profitable.” United States v. Litvak, No. 17-1464-cr, *22 (2d. Cir. May 3, 2018).

Underscoring that the materiality standard is an objective standard that considers the views of a hypothetical, reasonable investor, however, the Second Circuit then went on to hold that the district court erred in admitting testimony from Litvak’s counterparty regarding his understanding of Litvak’s role in the RMBS sale. Although it was undisputed at trial that Litvak acted as a principal—not an agent—in the transaction, and even though the district court so instructed the jury, the district court also admitted testimony from the counterparty’s trader, who testified to his mistaken belief that Litvak was acting as the counterparty’s agent and thus owed it a fiduciary duty. Although the government claimed that this testimony as to the counterparty’s mistaken belief was relevant to materiality, the Second Circuit disagreed. As the Second Circuit explained, the materiality standard is based on the beliefs of a reasonable investor, not an “indisputably idiosyncratic and unreasonable viewpoint,” at least absent evidence that Litvak was the source of the counterparty trader’s mistaken understanding. Accordingly, it concluded that the testimony was admitted in error: “It can hardly be the law that the point of view of an investor who is admitted to be wrong . . . is relevant to prove what a reasonable investor, neither confused nor incorrect, would have deemed important.” And particularly given that this was the sole count of conviction, the Second Circuit held that it could not conclude that the testimony did not substantially influence the jury and accordingly vacated Litvak’s conviction.

Prior to the Second Circuit’s ruling, Litvak was sentenced in April 2017 by a federal district court to two years’ imprisonment, a $2 million fine, and three years’ probation, and Litvak had already begun to serve his sentence. He will now be released to await a decision from the government on whether it will seek to bring a third trial.

United States v. Litvak 

Former Bond Trader Jesse Litvak Sentenced To Two Years’ Imprisonment After High-Profile Re-Trial In Securities Fraud Case, Shearman & Sterling Need-To-Know Litigation Weekly, May 2, 2017 

Bond Trader Acquitted Of All But One Securities Fraud Charges In Retrial, Shearman & Sterling Need-To-Know Litigation Weekly, January 30, 2017 

‘Litvak’ Dicta Provides Counsel Fodder for Challenging Proof of Intent, New York Law Journal, April 11, 2016