United States v. Finnerty

07-1104-cr
United States v. Finnerty
1
2 UNITED STATES COURT OF APPEALS
3
4 FOR THE SECOND CIRCUIT
5
6 August Term, 2007
7
8
9 (Argued: June 13, 2008 Decided: July 18, 2008)
10
11 Docket No. 07-1104-cr
12
13 - - - - - - - - - - - - - - - - - - - -x
14
15 UNITED STATES OF AMERICA,
16
17 Appellant,
18
19 - v.-
20
21 DAVID FINNERTY,
22
23 Defendant-Appellee.
24
25 - - - - - - - - - - - - - - - - - - - -x
26

27 Before: JACOBS, Chief Judge, POOLER, Circuit
28 Judge, RESTANI,* Judge.
29
30 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 LAUREN GOLDBERG, Assistant
2 United States Attorney, United
3 States Attorney’s Office for the
4 Southern District of New York,
5 New York, NY (Michael J. Garcia,
6 United States Attorney, on the
7 brief, Anirudh Bansal and
8 Celeste Koeleveld, Assistant
9 United States Attorneys, of
10 counsel), for Appellant.
11
12 FREDERICK P. HAFETZ, Hafetz &
13 Necheles, New York, NY (Tracy
14 Sivitz, on the brief), for
15 Defendant-Appellee.
16
17 DENNIS JACOBS, Chief Judge:
18
19 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. See United States v.

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. The sole

28 issue on appeal is whether the government proved that

29 Finnerty’s conduct was deceptive.

30 Because it did not, the judgment of acquittal is

31 affirmed.

32

2
1 BACKGROUND

2 This case is one of several arising from an

3 investigation into the practices of specialists on the NYSE

4 trading floor. The NYSE operates as an auction market with

5 specialists fielding competing bids and offers for stock in

6 the 2,800 listed companies. We recently described the role

7 of the specialist firms as follows:

8 Each security listed for trading on the NYSE
9 is assigned to a particular [specialist] Firm.
10 To execute purchases and sales of a particular
11 security, buyers and sellers must present
12 their bids to buy and offers to sell to the
13 specific Specialist Firm assigned to that
14 security. The primary method of trading on
15 the Exchange occurs through the NYSE’s Super
16 Designated Order Turnaround System, which
17 transmits orders to buy and sell to the
18 Specialist Firm electronically. The orders
19 appear on a special electronic workstation
20 often referred to as the “display book.” Each
21 Specialist Firm has a computerized “display
22 book” at its trading post that permits the
23 Firm to execute orders for the market.

24 In re NYSE Specialists Sec. Litig., 503 F.3d 89, 92 (2d Cir.

25 2007). In addition to executing trades for NYSE customers,

26 specialists trade for the “proprietary” or “principal”

27 account of their own firm.

28 In 2002, the NYSE opened an investigation into improper

29 trading by specialists. The investigation focused on two

30 practices: “interpositioning” and “trading ahead.” A

31 specialist engages in interpositioning when he “prevent[s]

3
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. Id. at 93. A specialist

7 trades ahead when he trades for his own “account before

8 undertaking trades for public investors.” Id. These

9 practices implicate two NYSE rules.

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.” NYSE Rule 92(a) prohibits a proprietary trade

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.”

17

18 The Indictment

19 In 2006, Finnerty was charged with three counts of

20 securities fraud. The superseding indictment alleged that

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

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.” The

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

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 In relevant part, the Securities Exchange Act of 1934

20 makes it

21 unlawful for any person, directly or
22 indirectly, by the use of any means or
23 instrumentality of interstate commerce or of
24 the mails, or of any facility of any national
25 securities exchange--
26
27 . . .

5
 1 (b) To use or employ, in connection with
2 the purchase or sale of any security
3 registered on a national securities
4 exchange or any security not so
5 registered . . . any manipulative or
6 deceptive device or contrivance in
7 contravention of such rules and
8 regulations as the Commission may
9 prescribe as necessary or appropriate in
10 the public interest or for the protection
11 of investors.
12
13 15 U.S.C. § 78j (“§ 10(b)”). Rule 10b-5, promulgated

14 thereunder, makes it unlawful

15 for any person, directly or indirectly, by the
16 use of any means or instrumentality of
17 interstate commerce, or of the mails or of any
18 facility of any national securities exchange,
19
20 (a) To employ any device, scheme, or
21 artifice to defraud,
22
23 (b) To make any untrue statement of
24 material fact or to omit to state a
25 material fact necessary in order to make
26 the statements made, in the light of the
27 circumstances under which they were made,
28 not misleading, or
29
30 (c) To engage in any act, practice, or
31 course of business which operates or
32 would operate as a fraud or deceit upon
33 any person,
34
35 in connection with the purchase or sale of any
36 security.
37
38 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.” United States v.

9 Finnerty, 2006 WL 2802042, at *4 (S.D.N.Y. Oct. 2, 2006).

10 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. Id. at *6. The

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.” Id. Rejecting that theory, the court reasoned

19 that unlike securities dealers, “specialists do not actively

20 solicit customers,” nor do they “‘hang[] out [their]

21 professional shingle.’” Id. (quoting Grandon v. Merrill

22 Lynch & Co., 147 F.3d 184, 192 (2d Cir. 1998)) (alteration

23 in original). Because of the dealers’ direct relationship

24 with their customers, the court concluded that “the

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. It did not try to prove that Finnerty

8 owed a fiduciary duty to public customers. And, in

9 accordance with the pretrial rulings, it did not try to

10 prove a violation of subsection (b).

11 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. One of

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 The government displayed graphics showing the sequence

21 of keystrokes that compose an interpositioning trade. An

22 NYSE managing director testified about the computer codes

23 used to generate “exception reports,” which identify

8
1 instances of interpositioning and trading ahead.2 Several

2 summary charts of that data showed 26,283 instances of

3 interpositioning trades under Finnerty’s watch. In 95% of

4 those instances, Fleet’s principal account profited--

5 yielding a total of $4.5 million.

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. Fleet

9 generally paid a specialist 15 to 20% of his profits.

10 Finally, the government introduced into evidence

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 The district court

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.” Id. at 539. Without holding that “evidence of

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.” Id.

21 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 DISCUSSION

2 “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.” United States v. Temple, 447 F.3d 130, 136 (2d Cir.

6 2006). Thus, we will affirm the district court’s judgment

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

10 crime beyond a reasonable doubt.” Jackson v. Virginia, 443

11 U.S. 307, 319 (1979).

12

13 I

14 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. “The

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. So the question is, what did

22 Finnerty say or do that was deceptive?

23 The government admits that Finnerty made no

24 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.” This was, in essence, a

4 theory of non-verbal deceptive conduct.

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.” Stoneridge Inv. Partners, LLC

8 v. Scientific-Atlanta, 128 S. Ct. 761, 769 (2008). Broad as

9 the concept of “deception” may be, it irreducibly entails

10 some act that gives the victim a false impression. “Theft

11 not accomplished by deception (e.g., physically taking and

12 carrying away another’s property) is not fraud absent a

13 fiduciary duty.” In re Refco Capital Markets, Ltd.

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 The government has identified no way in which Finnerty

18 communicated anything to his customers, let alone anything

19 false. Rather, viewing the evidence in the light most

20 favorable to the government, the government undertook to

21 prove no more than garden variety conversion. As the

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 . . .” The government later

12
1 analogized Finnerty’s conduct to a bank teller who

2 takes in hundreds of deposits a day and he
3 gives out hundreds of withdrawals, and just
4 once, once every day takes he takes one of
5 those deposits, instead of putting it in the
6 till, he puts it in his pocket. He committed
7 a crime probably less than 1 percent of the
8 time in that example, but does that make it
9 right to steal? Of course it doesn’t.
10
11 Like a thieving bank teller, the government argued, Finnerty

12 had the motive and the means to profit from

13 interpositioning.4 But there is no evidence that Finnerty

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. We need not decide whether some

17 form of communication by the defendant is always required to

18 prove deception (although that is the template of virtually

19 every case). To impose securities fraud liability here,

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.

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 II

2 On appeal, the government presses a number of arguments

3 in support of its prosecution theory. We are unpersuaded.

4 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. The government relies on the following chain of

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. In essence, the government

20 seeks to impose criminal liability based on a background

21 assumption of compliance with NYSE rules.

22 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. Id. at 152-53. A

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. 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. Id. In other words, the shareholders alleged

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).” Id.

18 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.” Id. It may be that “a requirement that an

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. But that was not

15
1 enough to ground § 10(b) liability in Lattanzio:

2 Public understanding that an accountant is at
3 work behind the scenes does not create an
4 exception to the requirement that an
5 actionable misstatement be made by the
6 accountant. Unless the public’s understanding
7 is based on the accountant’s articulated
8 statement, the source for that understanding--
9 whether it be a regulation, an accounting
10 practice, or something else--does not matter.
11
12 Id. (internal citation omitted).

13 The government’s argument fails for much the same

14 reason. Some customers may have understood that the NYSE

15 rules prohibit specialists from interpositioning, and that

16 the rules amount to an assurance (by somebody) that

17 interpositioning will not occur. As a consequence, some

18 customers may have expected that Finnerty would not engage

19 in the practice. But unless their understanding was based

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. See Central Bank of Denver, N.A. v. First

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”);

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. But “not every instance of financial

14 unfairness constitutes fraudulent activity under § 10(b).”

15 Chiarella v. United States, 445 U.S. 222, 232 (1980). And

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. “Section

20 10(b) is aptly described as a catchall provision, but what

21 it catches must be fraud.” Id. at 234-35.

22 The government points to evidence showing Finnerty’s

23 consciousness of guilt: (1) Finnerty testified before the

24 NYSE that he traded ahead of customers only when the public

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. But violation of an

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 Finally, the government cites Basic Inc. v. Levinson,

24 485 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. However, the Basic Inc. presumption of reliance

9 arises where a civil plaintiff can point to “public,

10 material misrepresentations” that impugned the integrity of

11 a stock’s market price. Id. at 248. Here, the government

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.

17

18 CONCLUSION

19 For the foregoing reasons, we affirm the judgment of

20 acquittal.

19