Holding

The U.S. Court of Appeals affirmed a district court's acquittal of New York Stock Exchange ("NYSE") floor trader David Finnerty, who was accused of committing interpositioning. The government had argued at trial that Finnerty committed securities fraud by engaging in interpositioning, or improperly stepping in between public buy and sell orders and trading for his own or firm's gain on the difference between the bid and ask prices. Prosecutors said such conduct resulted in illegal profits to his dealer account of approximately $4.5 million. But the U.S. District Court for the Southern District of New York rejected the government's argument, holding that the prosecution failed to prove that Finnerty’s customers were misled, defrauded or otherwise deceived. On appeal, the Second Circuit agreed with the district court's finding, ruling that government’s evidence showed Finnerty knew he had broken NYSE rules and tried to cover it up, but that did not mean he committed criminal fraud.

Detailed Summary

In this securities fraud case, the government appealed from a judgment of acquittal entered by the district court following a jury’s guilty verdict. Opinion, p. 2, citing United States v. Finnerty, 474 F. Supp. 2d 530 (S.D.N.Y. 2007).

Defendant-Appellee Finnerty was a specialist at the NYSE who engaged in the practice “interpositioning” - the arbitrage of the gap between customers’ orders to buy and sell stock - to the benefit of his firm’s account and (via compensation) himself. The sole issue on appeal was whether the government proved that Finnerty’s conduct was deceptive. Id.

In 2006, Finnerty was charged with three counts of securities fraud. The superseding indictment alleged that while he was employed by Fleet Specialists, Inc. between 1999 and 2003, Finnerty “caused approximately 26,300 instances of interpositioning, resulting in illegal profits to his dealer account of approximately $4,500,000, and approximately 15,000 instances of trading ahead, resulting in approximately $5,000,000 in customer harm.” Id., pp. 4-5. The indictment charged that Finnerty thus engaged in a fraudulent and deceptive course of conduct, in violation of 15 U.S.C. §§ 78j(b) and 78ff and 17 C.F.R. § 240.10b-5. Id., p. 5.  After trial, the jury rendered a guilty verdict on all three counts.

The district court granted Finnerty’s post-trial motion for a judgment of acquittal on the ground that the government failed to prove that “interpositioning constituted a deceptive act within the meaning of the federal securities laws because it did not provide proof of customer expectations.” Id., p. 10, citing Finnerty, 474 F. Supp. 2d 530, 542.

The district court considered that, in a securities fraud prosecution, the government generally must present “proof of what customers ‘think they are getting’; otherwise, a juror has no way of concluding whether customers were deceived by a defendant’s conduct.” Id., citing id. at 539.

Section 10(b) of the 1934 Act prohibits the use of any “manipulative or deceptive device or contrivance” in connection with the purchase or sale of securities. “The language of § 10(b) gives no indication that Congress meant to prohibit any conduct not involving manipulation or deception.” Id., p. 11, citing Santa Fe Indus. Inc. v. Green, 430 U.S. 462, 473 (1977).

Applying this law to the evidence presented, the Second Circuit held that the prosecution failed to establish that Finnerty conveyed an impression that was misleading, whether or not it could have a bearing on a victim’s investment decision in connection with a security. Id., p. 13.

“We need not decide whether some form of communication by the defendant is always required to prove deception (although that is the template of virtually every case). To impose securities fraud liability here, absent proof that Finnerty conveyed a misleading impression to customers, would pose “a risk that the federal power would be used to invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees.” Id., citing Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 128 S. Ct. 761, 769 (2008).

Viewed in the light most favorable to the government, United States v. Iodice, 525 F.3d 179, 182 (2d Cir. 2008), the evidence showed that Finnerty knew he had violated an NYSE rule, and tried to cover it up. But violation of an NYSE rule does not establish securities fraud in the civil context, Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 445 (2d Cir. 1971), let alone in a criminal prosecution. Id. p. 18.

“Here, the prosecution attributed to Finnerty nothing that deceived the public or affected the price of any stock: no material misrepresentation, no omission, no breach of a duty to disclose, and no creation of a false appearance of fact by any means.” Id., p. 19.

On the basis of the foregoing, the Second Circuit affirmed the district court’s judgment of acquittal.