United States v. Finnerty, No. 07-1104 (2d Cir. 2008)

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07-1104-cr United States v. Finnerty 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT August Term, 2007 (Argued: June 13, 2008 Decided: July 18, 2008) Docket No. 07-1104-cr - - - - - - - - - - - - - - - - - - - -x UNITED STATES OF AMERICA, Appellant, - v.DAVID FINNERTY, Defendant-Appellee. - - - - - - - - - - - - - - - - - - - -x Before: JACOBS, Chief Judge, POOLER, Circuit Judge, RESTANI,* Judge. The government appeals from a judgment of acquittal 31 entered in the United States District Court for the Southern 32 District of New York (Chin, J.), setting aside the jury 33 verdict in a securities fraud prosecution against a New York 34 Stock Exchange specialist who engaged in interpositioning. 35 We affirm. * The Honorable Jane A. Restani, Chief Judge of the United States Court of International Trade, sitting by designation. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 LAUREN GOLDBERG, Assistant United States Attorney, United States Attorney s Office for the Southern District of New York, New York, NY (Michael J. Garcia, United States Attorney, on the brief, Anirudh Bansal and Celeste Koeleveld, Assistant United States Attorneys, of counsel), for Appellant. FREDERICK P. HAFETZ, Hafetz & Necheles, New York, NY (Tracy Sivitz, on the brief), for Defendant-Appellee. DENNIS JACOBS, Chief Judge: In this securities fraud case, the government appeals 20 from a judgment of acquittal entered by the district judge 21 following a jury s guilty verdict. 22 Finnerty, 474 F. Supp. 2d 530 (S.D.N.Y. 2007) (Chin, J.). 23 Defendant-Appellee David Finnerty was a specialist at the 24 New York Stock Exchange ( NYSE ) who engaged in the practice 25 of interpositioning --the arbitrage of the gap between 26 customers orders to buy and sell stock--to the benefit of 27 his firm s account and (via compensation) himself. 28 issue on appeal is whether the government proved that 29 Finnerty s conduct was deceptive. 30 31 See United States v. The sole Because it did not, the judgment of acquittal is affirmed. 32 2 1 2 BACKGROUND This case is one of several arising from an 3 investigation into the practices of specialists on the NYSE 4 trading floor. 5 specialists fielding competing bids and offers for stock in 6 the 2,800 listed companies. 7 of the specialist firms as follows: 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 The NYSE operates as an auction market with We recently described the role Each security listed for trading on the NYSE is assigned to a particular [specialist] Firm. To execute purchases and sales of a particular security, buyers and sellers must present their bids to buy and offers to sell to the specific Specialist Firm assigned to that security. The primary method of trading on the Exchange occurs through the NYSE s Super Designated Order Turnaround System, which transmits orders to buy and sell to the Specialist Firm electronically. The orders appear on a special electronic workstation often referred to as the display book. Each Specialist Firm has a computerized display book at its trading post that permits the Firm to execute orders for the market. 24 In re NYSE Specialists Sec. Litig., 503 F.3d 89, 92 (2d Cir. 25 2007). 26 specialists trade for the proprietary or principal 27 account of their own firm. 28 In addition to executing trades for NYSE customers, In 2002, the NYSE opened an investigation into improper 29 trading by specialists. 30 practices: interpositioning and trading ahead. 31 specialist engages in interpositioning when he prevent[s] The investigation focused on two 3 A 1 the normal agency trade between matching public orders and 2 instead interpose[s] himself between the matching orders 3 in order to generate profits for the principal account--in 4 other words, when the specialist acts as an arbitrager by 5 taking a profit on the spread between the bid price and the 6 ask price of customers orders. 7 trades ahead when he trades for his own account before 8 undertaking trades for public investors. 9 practices implicate two NYSE rules. Id. at 93. A specialist Id. These 10 NYSE Rule 104 allows for a proprietary trade when it is 11 reasonably necessary to permit [a] specialist to maintain a 12 fair and orderly market, and otherwise prohibits such 13 dealings. 14 when the specialist has knowledge of any particular 15 unexecuted customer s order to buy (sell) such security 16 which could be executed at the same price. NYSE Rule 92(a) prohibits a proprietary trade 17 18 The Indictment 19 In 2006, Finnerty was charged with three counts of 20 securities fraud. 21 while he was employed by Fleet Specialists, Inc. between 22 1999 and 2003, Finnerty caused approximately 26,300 23 instances of interpositioning, resulting in illegal profits The superseding indictment alleged that 4 1 to his dealer account of approximately $4,500,000, and 2 approximately 15,000 instances of trading ahead, resulting 3 in approximately $5,000,000 in customer harm. 4 indictment charged that Finnerty thus engaged in a 5 fraudulent and deceptive course of conduct, in violation of 6 15 U.S.C. §§ 78j(b) and 78ff and 17 C.F.R. § 240.10b-5. 7 Count One charged Finnerty with carrying out this fraud 8 while he was the specialist responsible for trading in the 9 stock of General Electric, from September 2000 through early The 10 2003; Count Two, while specialist for Applera Corp.-Celera 11 Genomics Group, from November 1999 through February 2002; 12 and Count Three, while specialist for PE Biosystems, from 13 November 1999 through September 2000. 14 15 Pretrial Rulings 16 Finnerty moved to dismiss the indictment on the ground 17 that interpositioning is neither deceptive nor manipulative 18 and therefore does not constitute securities fraud. 19 20 21 22 23 24 25 26 27 In relevant part, the Securities Exchange Act of 1934 makes it unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange-. . . 5 1 2 3 4 5 6 7 8 9 10 11 12 13 15 U.S.C. § 78j ( § 10(b) ). 14 thereunder, makes it unlawful 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Rule 10b-5, promulgated for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5 (1995). 39 The district court granted Finnerty s motion in part, 40 but let stand the allegations based on subsections (a) and 41 (c) of Rule 10b-5. The court reasoned that the NYSE rules 6 1 obligate specialists to place the interests of their public 2 customers above their own ; that Finnerty made a profit for 3 [himself], and subordinated the interests of the trading 4 public below [his] own ; and that this practice deceive[d] 5 the trading public, as investors believed that [specialists] 6 were working to match orders, first and foremost, and that 7 [specialists] traded for their own proprietary accounts only 8 to maintain a fair and orderly market. 9 Finnerty, 2006 WL 2802042, at *4 (S.D.N.Y. Oct. 2, 2006). 10 United States v. The district court ruled that the indictment failed to 11 state a violation of subsection (b) of Rule 10b-5 because it 12 did not identify any statements that were misleading or were 13 made misleading by Finnerty s omission. 14 government argued that no such showing was required under a 15 line of Second Circuit cases that allows for omission 16 liability based on implied misrepresentations where a 17 securities dealer charges excessive markups when selling 18 securities. 19 that unlike securities dealers, specialists do not actively 20 solicit customers, nor do they hang[] out [their] 21 professional shingle. 22 Lynch & Co., 147 F.3d 184, 192 (2d Cir. 1998)) (alteration 23 in original). 24 with their customers, the court concluded that the Id. Id. at *6. The Rejecting that theory, the court reasoned Id. (quoting Grandon v. Merrill Because of the dealers direct relationship 7 1 situations are quite distinct, and that the excessive 2 markup cases were inapposite. Id. 3 4 Proof at Trial 5 At trial, the government narrowed its case. It did not 6 undertake to prove trading ahead; it focused exclusively on 7 interpositioning. 8 owed a fiduciary duty to public customers. 9 accordance with the pretrial rulings, it did not try to 10 11 It did not try to prove that Finnerty And, in prove a violation of subsection (b). The government called three former NYSE clerks, who 12 testified that Finnerty directed them to execute 13 interpositioning trades for the principal account ahead of 14 (and to the detriment of) existing public orders. 15 the clerks, Philip Finale, testified that just before he was 16 scheduled to testify before the NYSE investigation, Finnerty 17 pulled him aside and whispered: don t say anything to 18 incriminate [me], because it s going to incriminate [you] 19 also. 20 One of The government displayed graphics showing the sequence 21 of keystrokes that compose an interpositioning trade. 22 NYSE managing director testified about the computer codes 23 used to generate exception reports, which identify 8 An 1 instances of interpositioning and trading ahead.2 2 summary charts of that data showed 26,283 instances of 3 interpositioning trades under Finnerty s watch. 4 those instances, Fleet s principal account profited-- 5 yielding a total of $4.5 million. Several In 95% of 6 Joseph DiPrisco, who served as Fleet s CFO during the 7 relevant period, testified that individual profitability 8 was one factor that determined a specialist s bonus. 9 generally paid a specialist 15 to 20% of his profits. 10 Finally, the government introduced into evidence Fleet 11 Finnerty s testimony before the NYSE, in which Finnerty 12 admitted that he and his clerks could trade for the 13 principal account only when necessary to maintain a fair and 14 orderly market, and only when the public customers 15 subsequently received the same or a better price than the 16 principal account received. 17 Finnerty called Dr. Patrick Conroy, who testified that 18 Finnerty s 26,283 alleged acts of interpositioning 19 represented only .94% of the total trades executed by 20 Finnerty during the relevant time period. 2 The managing director testified to the following definition of an interpositioning trade: If two orders, a buy order and a sell order[,] are present at the same time, and the specialist instead of executing them against each other trades separately with each of them, that would be an interpositioning exception. 9 1 The jury rendered a guilty verdict on all three counts. 2 3 Post-trial Rulings 4 The district court granted Finnerty s post-trial motion 5 for a judgment of acquittal on the ground that the 6 government failed to prove that interpositioning 7 constituted a deceptive act within the meaning of the 8 federal securities laws because it did not provide proof of 9 customer expectations. United States v. Finnerty, 474 F. 10 Supp. 2d 530, 542 (S.D.N.Y. 2007).3 11 considered that, in a securities fraud prosecution, the 12 government generally must present proof of what customers 13 think they are getting ; otherwise, a juror has no way of 14 concluding whether customers were deceived by a defendant s 15 conduct. 16 customer expectations is an element of the crime that the 17 Government must establish for a conviction under 10b-5, the 18 district court concluded that the very definition of 19 deceptive calls for some showing of what the investing 20 public expected. 21 Id. at 539. The district court Without holding that evidence of Id. The government appeals. 3 In the alternative, the district court ruled that a new trial was warranted based on several evidentiary issues. Because we affirm the judgment of acquittal, we do not review the alternative grant of a new trial. 10 1 2 DISCUSSION We review the grant or denial of a judgment of 3 acquittal de novo, and we apply the same standards governing 4 the sufficiency of the evidence as are applied by a district 5 court. 6 2006). 7 of acquittal only if after viewing the evidence in the 8 light most favorable to the prosecution, no rational 9 factfinder could have found the essential elements of the United States v. Temple, 447 F.3d 130, 136 (2d Cir. Thus, we will affirm the district court s judgment 10 crime beyond a reasonable doubt. 11 U.S. 307, 319 (1979). Jackson v. Virginia, 443 12 13 14 I Section 10(b) of the 1934 Act prohibits the use of any 15 manipulative or deceptive device or contrivance in 16 connection with the purchase or sale of securities. 17 language of § 10(b) gives no indication that Congress meant 18 to prohibit any conduct not involving manipulation or 19 deception. Santa Fe Indus. Inc. v. Green, 430 U.S. 462, 20 473 (1977). The government has abandoned on appeal any 21 claim of market manipulation. 22 Finnerty say or do that was deceptive? 23 24 The So the question is, what did The government admits that Finnerty made no misstatement. The government told the jury that the real 11 1 issue in the case was whether David Finnerty directed the 2 interpositioning trades and whether he did it intentionally 3 and with the intent to defraud. 4 theory of non-verbal deceptive conduct. This was, in essence, a 5 Conduct itself can be deceptive, and so liability 6 under § 10(b) or Rule 10b-5 does not require a specific 7 oral or written statement. 8 v. Scientific-Atlanta, 128 S. Ct. 761, 769 (2008). 9 the concept of deception may be, it irreducibly entails Stoneridge Inv. Partners, LLC Broad as 10 some act that gives the victim a false impression. 11 not accomplished by deception (e.g., physically taking and 12 carrying away another s property) is not fraud absent a 13 fiduciary duty. 14 Brokerage Customer Sec. Litig., 2007 WL 2694469, at *8 15 (S.D.N.Y. Sept. 13, 2007) (Lynch, J.) (internal citation 16 omitted). 17 Theft In re Refco Capital Markets, Ltd. The government has identified no way in which Finnerty 18 communicated anything to his customers, let alone anything 19 false. 20 favorable to the government, the government undertook to 21 prove no more than garden variety conversion. 22 government put it during summation, David Finnerty stole 23 from his public customers tens of times a day, sometimes 24 over a hundred times in one day . . . Rather, viewing the evidence in the light most 12 As the The government later 1 analogized Finnerty s conduct to a bank teller who 2 3 4 5 6 7 8 9 10 11 Like a thieving bank teller, the government argued, Finnerty 12 had the motive and the means to profit from 13 interpositioning.4 14 conveyed an impression that was misleading, whether or not 15 it could have a bearing on a victim s investment decision in 16 connection with a security. 17 form of communication by the defendant is always required to 18 prove deception (although that is the template of virtually 19 every case). 20 absent proof that Finnerty conveyed a misleading impression 21 to customers, would pose a risk that the federal power 22 would be used to invite litigation beyond the immediate 23 sphere of securities litigation and in areas already 24 governed by functioning and effective state-law guarantees. 25 Stoneridge, 128 S. Ct. at 771. takes in hundreds of deposits a day and he gives out hundreds of withdrawals, and just once, once every day takes he takes one of those deposits, instead of putting it in the till, he puts it in his pocket. He committed a crime probably less than 1 percent of the time in that example, but does that make it right to steal? Of course it doesn t. But there is no evidence that Finnerty We need not decide whether some To impose securities fraud liability here, 26 4 The government presented this analogy to rebut Dr. Conroy s testimony that Finnerty s interpositioning trades represented less than one percent of his total trades. 13 1 2 3 4 II On appeal, the government presses a number of arguments in support of its prosecution theory. We are unpersuaded. The evidence shows (in the words of the government s 5 brief) that Finnerty, while holding himself out as a 6 specialist obligated to follow NYSE rules and refrain from 7 interpositioning, interpositioned on a massive scale under 8 the guise of maintaining a fair and orderly market. 9 Accordingly, the government argues, a reasonable jury could 10 find that at least some customers were aware of the NYSE 11 rules, would have expected Finnerty to comply with the 12 rules, and were therefore deceived when Finnerty violated 13 them. 14 premises and inferences: (1) brokerage houses are members 15 of the NYSE; (2) as members, brokerage houses know about 16 (and are subject to) the NYSE rules against 17 interpositioning; (3) brokerage houses were customers of 18 Finnerty; so (4) Finnerty s violation of the NYSE rules 19 deceived the brokerage houses. 20 seeks to impose criminal liability based on a background 21 assumption of compliance with NYSE rules. 22 The government relies on the following chain of In essence, the government The government did not make this argument at trial. 23 Moreover, we rejected a similar argument (made by civil 24 claimants) in a statement case decided last term, Lattanzio 14 1 v. Deloitte & Touche LLP, 476 F.3d 147 (2d Cir. 2007). 2 There, shareholders sued the accounting firm Deloitte & 3 Touche based on allegedly false statements in corporate 4 quarterly statements that were neither audited by the firm 5 nor accompanied by its audit opinion. 6 federal regulation obligated Deloitte, as the issuer s 7 outside accountant, to review interim quarterly statements 8 before expressing an audit opinion on a subsequent filing. 9 Id. at 155. Id. at 152-53. A The claim was that an investor (understanding 10 Deloitte s regulatory obligation) would construe Deloitte s 11 silence as its imprimatur on the quarterly statements in 12 question. 13 that Deloitte s mandated review of [the issuer s] quarterly 14 statements associated Deloitte with those statements to such 15 a degree that they became Deloitte s statements, or that the 16 review created a regulatory duty to correct, the breach of 17 which qualifie[d] as a statement under § 10(b). 18 Id. In other words, the shareholders alleged Id. This argument failed because in a statement case like 19 Lattanzio, a party can incur liability [under § 10(b)] only 20 if a misstatement is attributed to it at the time of 21 dissemination. 22 issuer s accountant review interim financial statements 23 supports an understanding among the investing public that 24 such reviews are in fact conducted. Id. It may be that a requirement that an 15 Id. But that was not 1 2 3 4 5 6 7 8 9 10 11 12 13 enough to ground § 10(b) liability in Lattanzio: Public understanding that an accountant is at work behind the scenes does not create an exception to the requirement that an actionable misstatement be made by the accountant. Unless the public s understanding is based on the accountant s articulated statement, the source for that understanding-whether it be a regulation, an accounting practice, or something else--does not matter. Id. (internal citation omitted). The government s argument fails for much the same 14 reason. 15 rules prohibit specialists from interpositioning, and that 16 the rules amount to an assurance (by somebody) that 17 interpositioning will not occur. 18 customers may have expected that Finnerty would not engage 19 in the practice. 20 on a statement or conduct by Finnerty, he did not commit a 21 primary violation of § 10(b)--the only offense with which he 22 was charged. 23 Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994) 24 (holding that in the civil context, § 10(b) does not itself 25 reach those who aid and abet a § 10(b) violation ); Wright 26 v. Ernst & Young LLP, 152 F.3d 169, 175 (2d Cir. 1998) 27 (explaining that under Central Bank, a defendant cannot 28 incur primary liability for a statement neither made by him 29 nor attributed to [him] at the time of its dissemination ); Some customers may have understood that the NYSE As a consequence, some But unless their understanding was based See Central Bank of Denver, N.A. v. First 16 1 Shapiro v. Cantor, 123 F.3d 717, 720 (2d Cir. 1997) 2 ( Anything short of such conduct is merely aiding and 3 abetting, and no matter how substantial that aid may be, it 4 is not enough to trigger liability under Section 10(b). 5 (quoting In re MTC Elec. Techs. Shareholders Litig., 898 F. 6 Supp. 974, 987 (E.D.N.Y. 1995)). 7 Taking a slightly different tack, the government argues 8 that Finnerty s scheme was self-evidently deceptive 9 because he had two critical advantages over his customers: 10 he could see all pending orders to buy and sell a particular 11 stock, and he determined the price ultimately paid. 12 It may be that Finnerty unfairly profited from superior 13 information. 14 unfairness constitutes fraudulent activity under § 10(b). 15 Chiarella v. United States, 445 U.S. 222, 232 (1980). 16 characterizing Finnerty s conduct as self-evidently 17 deceptive is conclusory; there must be some proof of 18 manipulation or a false statement, breach of a duty to 19 disclose, or deceptive communicative conduct. 20 10(b) is aptly described as a catchall provision, but what 21 it catches must be fraud. 22 But not every instance of financial And Section Id. at 234-35. The government points to evidence showing Finnerty s 23 consciousness of guilt: 24 NYSE that he traded ahead of customers only when the public (1) Finnerty testified before the 17 1 received the same or a better price than his principal 2 account did (testimony that was countered by the 3 government s demonstrative chart, which showed that the 4 customer was disadvantaged 95% of the time); (2) clerk 5 Philip Finale testified that Finnerty pressured him to lie 6 about being instructed to execute interpositioning trades; 7 and (3) shortly after Finnerty learned about the NYSE 8 investigation, his rate of interpositioning declined almost 9 to zero. 10 Viewed in the light most favorable to the government, 11 United States v. Iodice, 525 F.3d 179, 182 (2d Cir. 2008), 12 this evidence shows that Finnerty knew he had violated an 13 NYSE rule, and tried to cover it up. 14 NYSE rule does not establish securities fraud in the civil 15 context, Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 16 445 (2d Cir. 1971), let alone in a criminal prosecution. 17 Finnerty may have known that interpositioning was wrong 18 within the context of his employment, and that it put him at 19 risk professionally; but an awareness of peril, a guilty 20 conscience or an impulse to cover one s tracks does not 21 bespeak criminally fraudulent conduct within the context of 22 the securities laws. 23 24 But violation of an Finally, the government cites Basic Inc. v. Levinson, 485 U.S. 224 (1988), for the idea that (in the government s 18 1 words) interpositioning violates common sense notions of 2 fair play and honest dealing in the securities market. 3 Basic Inc. says that under the fraud-on-the-market 4 doctrine, the reliance of individual plaintiffs on the 5 integrity of the market price may be presumed when 6 materially misleading statements have been disseminated 7 into an impersonal, well-developed market for securities. 8 Id. at 247. 9 arises where a civil plaintiff can point to public, However, the Basic Inc. presumption of reliance 10 material misrepresentations that impugned the integrity of 11 a stock s market price. 12 has attributed to Finnerty nothing that deceived the public 13 or affected the price of any stock: no material 14 misrepresentation, no omission, no breach of a duty to 15 disclose, and no creation of a false appearance of fact by 16 any means. Id. at 248. Here, the government 17 18 19 20 CONCLUSION For the foregoing reasons, we affirm the judgment of acquittal. 19

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