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A N 8 D 8 B 18 AR CE www. NYLJ.com SIN Volume 262—NO. 100 Thursday, November 21, 2019 White-Collar Crime Expert Analysis Materiality and Admissibility of Evidence In Criminal Securities Fraud Cases

ateriality is a critical, often underscores the importance of deter- hotly contested, issue in mining how most effectively to counter criminal securities fraud government claims of materiality in prosecutions. In addition securities fraud cases. to arguing that particular Mstatements were not false, or that par- RMBS and Materiality ticular statements were believed to be By And RMBS are generally bought and sold true, a defendant commonly argues Elkan Jonathan S. in large blocks, worth millions of dol- Sack that the statements at issue were not Abramowitz lars, by sophisticated financial institu- material to a reasonable investor, and tions, such as hedge funds and insur- thus do not give rise to a violation of defrauding buyers and sellers of RMBS ance companies. They are not traded the securities laws. by misrepresenting the prices at which on exchanges like equities, and prices Materiality—and the related issues a purchase or sale could be effected, of transactions are not posted contem- of how the government seeks to prove and thereby increasing the profit to poraneously. Consequently, market materiality, and how the defense seeks participants lack verifiable informa- to counter proof of materiality—lies The decisions in each case tion regarding prior trades. Prospec- at the heart of a series of important, turned on whether evidence tive buyers and sellers do business closely related Second Circuit deci- through dealers who seek to find the sions, beginning with United States v. relating to materiality was other side of proposed transactions, Litvak, 808 F.3d 160 (2d Cir. 2015) (Lit- properly excluded or admitted or who buy for, or sell from, their own vak I), continuing with United States v. at trial. inventory of RMBS. Dealers often have Litvak, 889 F.3d 56 (2d Cir. 2018) (Litvak more information about market con- II), and concluding most recently (in the dealers. The decisions in each case ditions than buyers and sellers, who September 2019) with United States v. turned on whether evidence relating commonly look to dealers for “market Gramins, 939 F.3d 429 (2d Cir. 2019). In to materiality was properly excluded color” regarding supply and demand. each of these cases, the defendants— or admitted at trial. Dealers are compensated primarily dealers in residential mortgage-backed In this article, after generally dis- through the “spread” or “margin” in securities (RMBS)—were accused of cussing materiality in the context of a transaction—that is, the difference RMBS trading, we analyze the evidence between the price at which the seller that was excluded and admitted by sells, and the buyer buys. In transact- Elkan Abramowitz and Jonathan Sack are members of Morvillo Abramowitz Grand Iason & the district court and explore the ing with buyers and sellers, dealers act Anello. Mr. Abramowitz is a former chief of the crimi- link between the substantive issue as principals, not as agents of either nal division in the U.S. Attorney’s Office for the South- (whether statements are material) side of a trade. ern District of New York. Mr. Sack is a former chief of and the evidentiary issue (whether Beginning in 2013, the Department the criminal division in the U.S. Attorney’s Office for the Eastern District of New York. Joshua Bussen, given evidence fairly tends to prove of Justice pursued charges against an associate of the firm, contributed to this article. or disprove materiality). This analysis RMBS dealers who allegedly made Thursday, November 21, 2019 false statements in order to widen statements to buyers and sellers. The found Litvak guilty of one (out of 10) the spread on transactions and inflate defense argued that sophisticated buy- counts of securities fraud, and the their profits—including the Litvak and ers and sellers of RMBS did not attach district court sentenced Litvak to the Gramins prosecutions noted above, real importance to the dealer’s report same term of incarceration as after the and another prosecution, United States of a counterparty’s negotiating posi- first trial—two years. The defendant v. Demos, No. 16cr220 (AWT) (D. Conn. tion. Rather, buyers and sellers made appealed, and the Court of Appeals 2016), which resulted in an acquittal decisions to buy or sell based almost reversed the conviction again. at trial. The materiality issue was pre- exclusively on their own complex pric- In Litvak II, the problem was not the sented starkly because the defendants ing models. exclusion of proffered defense expert conceded that they had made false To support this defense, Litvak testimony, but the admission of testi- statements, with the effect of widen- sought to call an expert witness with mony the government offered to help ing spreads and increasing profits, substantial experience in the RMBS prove materiality. At trial, the district but argued that the false statements market. The expert would have tes- court admitted the testimony of Brian were not material—because the buy- tified that a reasonable RMBS trader Norris, an RMBS trader, who bought ers and sellers made decisions based would not have cared what Litvak said and sold RMBS through Litvak. Norris on internal models and analysis, not about RMBS prices because buyers testified that, when deciding whether based on statements made by dealers and sellers did not use that informa- to buy RMBS and at what price, he in the heat of price negotiation. tion to make decisions; they relied on accepted as true Litvak’s statements In those cases, the test of material- their own internal analysis. The dis- about the price of certain bids, and ity was not at issue. The government trict court excluded the expert tes- that it “absolutely” “[w]ould … have must prove a “substantial likelihood timony as irrelevant, and Litvak was mattered to” him had he known that that a reasonable investor would find convicted of securities fraud. Litvak bought the RMBS at a lower the misrepresentation important in On appeal, the Second Circuit price than he represented to Nor- making an investment decision.” held that the trial court’s decision ris. Litvak, 13cr019, Second Trial Tr. Litvak II, 889 F.3d at 64 (alteration to exclude the expert testimony was 751:20-25. omitted) (quoting United States v. an abuse of discretion and required Central to the appeal was Norris’s Vilar, 729 F.3d 62, 88 (2d Cir. 2013)). a new trial. The court held that the additional testimony that he believed A misrepresentation is important to a jury would have benefited from an Litvak was acting “as an agent” in reasonable investor “if there is a sub- explanation of the complexity of RMBS executing the trades. Id. at 748:11- stantial likelihood that the disclosure trading, which was “particularly true 12, 805:5-15. The defense objected of the omitted fact would have been because” the pricing of RMBS is “more in limine to this testimony, but the viewed by the reasonable investor as complicated”—it “tend[s] to be more district court denied the defendant’s having significantly altered the total subjective, [is] available mainly or objection, holding that “it would be mix of information made available.” only from dealers, and [is] often based highly improper for the government Gramins, 939 F.3d at 445 (quotation on models as opposed to prices from to argue to the jury that Litvak was marks omitted). At issue was whether prior transactions.” Id. The court not- an agent of the counterparties,” but the misstatements during price nego- ed that, had the expert been allowed that the counterparties could “testify[ tiations were material to sophisticated to testify, the jury “could reasonably ] about their perception of the relation- investors. have found that misrepresentations ship between Litvak and themselves” by a dealer as to the price paid for and, “in the course of such testimony, ‘Litvak I’ and ‘Litvak II’ certain RMBS would be immaterial to a they [would be allowed to say] collo- In 2013, Jesse Litvak, an RMBS dealer counterparty that relies not on a ‘mar- quially … that they understood Litvak at Jefferies & Co., was charged with ket’ price or the price at which prior to be their ‘agent.’” Dkt. No. 432, at 4. several counts of criminal securities trades took place, but instead on its While the Second Circuit observed fraud. The government alleged that Lit- own sophisticated valuation methods that evidence of an alleged victim’s vak misrepresented the prices he had and computer model.” Litvak I, 808 subjective state of mind is admissi- paid or would pay for RMBS, result- F.3d at 183. ble to prove an objective fact—here, ing in a larger commission to Jefferies On remand, Litvak was tried a sec- what a reasonable investor would (and, by extension, to Litvak). Litvak ond time. The defendant’s expert have regarded as important—intro- acknowledged that he had made false testimony was allowed, but the jury duction of such testimony has limits, Thursday, November 21, 2019 and the court held that those limits one count of wire fraud, and acquit- court and reinstated Gramins’s con- were exceeded in the second Litvak ted Gramins on all remaining counts. viction. In the Second Circuit’s view, trial. Norris’s testimony was unfairly In post-trial motions, Gramins the testimony at issue did not cross prejudicial because it was objectively argued initially insufficiency of evi- the line that was drawn in Litvak II. false in a critical respect. An RMBS dence as to materiality, but after The court found persuasive that at dealer is not an agent of, nor does the Second Circuit’s decision in Lit- Gramins’s trial, Wollman described she owe a fiduciary duty to, the cli- vak II, Gramins added the argument Gramins as a “broker” and said that ent. In light of that falsity, the Second that, through Norris’s testimony, the he was “brokering” trades; he did not Circuit held that if a victim’s testimony government had improperly implied say that was an “agent.” Wollman did is an “idiosyncratic and unreason- that Gramins was acting as an agent. not express an “erroneous or idiosyn- able viewpoint,” it is not “probative According to the defense, Wollman cratic” view of his relationship with of the views of a reasonable, objec- had implied an agency relationship Gramins, and his testimony could be tive investor in the RMBS market.” by testifying that, during RMBS trade regarded as probative of a reasonable Litvak II, 889 F.3d at 69. The govern- negotiations, Gramins was “acting on investor’s view of the materiality of ment argued that any error had been behalf of another counterparty” by the statements. The court held that cured by effective cross-examination “facilitating a trade between [Woll- Wollman’s testimony was relevant, not and a curative instruction to the jury man] and that other counterparty.” unduly prejudicial, and not likely to that Litvak was not an “agent” in these Gramins, 15cr155, Dkt. No. 496, at 6 mislead the jury. transactions. The Second Circuit dis- (citing Trial Tr. 2113:19-2114:9, 2181:6- agreed. Because “Norris’s testimony 10, 2181:16-21, 2271:4-17). In support Conclusion about a perceived agency relationship of this claim, Gramins noted that in a Materiality is a fact-intensive and dif- was the only rational reason for the separate RMBS fraud case (Demos), ficult issue in many criminal securities jury to have convicted appellant on fraud cases. In a series of RMBS fraud that count of securities fraud while In a series of RMBS fraud pros- prosecutions, the Second Circuit has acquitting him on all other counts,” given guidance to prosecutors and the Second Circuit held that the dis- ecutions, the Second Circuit has defense counsel for thinking through trict court’s mistake in admitting the given guidance to prosecutors what evidence may be introduced agency testimony was not harmless. and defense counsel for thinking in support of either side’s material- ity argument. Defendants may offer ‘Gramins’ through what evidence may be competent expert testimony; and the In the Gramins case, the government introduced in support of either government may present the testimo- charged three former RMBS traders side’s materiality argument. ny of victims so long as the victim’s at Nomura Securities International., understanding of legal duties is not including Michael Gramins, with con- the government agreed (before trial) objectively mistaken and so central to spiracy and substantive securities and not to offer any testimony suggesting the case as to be unfairly prejudicial. wire fraud. The underlying conduct that Demos was acting as an agent or The Second Circuit’s RMBS fraud deci- was similar to that in Litvak, and the fiduciary, and the district court prohib- sions provide a framework for future key issue at trial was again materiality. ited the government from using terms litigation over materiality and admis- The government claimed that Gramins that implied an agency relationship, sibility of evidence at trial. made false statements to one of its such as “broker” or “commissions,” witnesses, Joel Wollman, who testified see Demos, No. 16cr220, Dkt. No. 258, that he had “maintained heightened at 1, 4—and in that case, the defendant expectations of truthfulness from his was acquitted. In Gramins, the district broker-dealer” in RMBS trades, but he court, relying on Litvak II, granted did not say that he believed Gramins Gramins’s motion for a new trial in was acting as his agent or fiduciary. light of Wollman’s testimony that had, Gramins, 939 F.3d at 440. The jury in the court’s view, incorrectly implied convicted Gramins on the conspir- that a dealer was acting as an agent. Reprinted with permission from the November 21, 2019 edition of the NEW YORK acy count, failed to reach a verdict The government appealed, and the LAW JOURNAL © 2019 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382 on one count of securities fraud and Second Circuit reversed the district or [email protected]. # NYLJ11202019426533