Deceptively Simple

United States v. Finnerty, No. 07-1104-cr (2d Cir. July 18, 2008) (Jacobs, Pooler, CJJ, Restani, J)

The New York Stock Exchange functions, essentially, as an auction market. Specialist firms are designated to facilitate the auction of a particular stock by processing the bids to buy and offers to sell it. Specialists also trade for their own firm’s accounts. “Interpositioning” occurs when the specialist interposes himself in the middle of public trades to make a profit for the firm. It is prohibited by NYSE rules.

Defendant Finnerty engaged in thousands of instances of interpositioning, making $4,500,000 in profit for the firm’s account, and thereby inflating his bonus. He was charged with, and convicted of, three counts of securities fraud. After trial, the district court granted his motion for a judgment of acquittal, holding that the government failed to prove that interpositioning was a “deceptive act” under securities law because the government did not “provide proof of customer expectations.” The government appealed, and the circuit affirmed.

Securities law prohibits any “manipulative or deceptive device or contrivance” in connection with the purchase or sale of securities. The government did not argue that there was any market manipulation here, arguing only that Finnerty’s actions were deceptive. It agreed that he made no misstatements, however, arguing that he engaged in “non-verbal deceptive conduct.” While conduct can be deceptive, it “irreducibly entails some act that gives the victim a false impression.”

Here, the government identified “no way in which Finnerty communicated anything to his customers, let alone anything false.” Rather, what he did was a “garden variety conversion.” Even if some customers might have understood that NYSE rules prohibit specialists from interpositioning and that those rules “amount to an assurance (by somebody) that interpositioning will not occur,” here there was no evidence that this understanding was “based on a statement or conduct by Finnerty.” Thus, he did not commit securities fraud.

Nor was his ability to take advantage of his position by itself deceptive; “not every instance of financial unfairness” constitutes securities fraud absent proof of manipulation, a false statement, a breach of duty to disclose, or deceptive communicative conduct. Finally, the evidence of consciousness of guilt could not overcome this problem. Finnerty clearly knew that he had violated an NYSE rule, and tried to cover it up. But this does not establish securities fraud, either.