Trading in Opaque Markets and Compliance

The Commission settled two failure to supervise cases with Nomura Securities International, Inc. In the Matter of Nomura Securities International, Inc., Adm. Proc. File No. 3-19248 (July 15, 2019); In the Matter of Nomura Securities International, Inc., Adm. Proc. File No. 3-19249 (July 15, 2019). The cases are substantially similar. Each is based on the trading tactics used by the firm’s traders in what are essentially opaque markets. The first centered on trading residential mortgage backed securities or RMBS during the period January 2010 to November 2013. The traders were Ross Shapiro, Michael Gramins and Tyler Peters. The Order alleges that the “three Nomura RMBS traders misled or lied to investment advisers and other fund managers that were trading RMBS . . .” about the prices and compensation involved in the transactions.

The second alleges that traders James Im and Kee Chan “misled or lied to investment advisers and other fund managers that were trading CMBS [commercial mortgage backed securities] . . .” about the prices and other matters. Each Order alleges that the firm failed to reasonably supervise the traders. Each proceeding was settled with a series of undertakings and the entry of an order censuring the firm for failing reasonably to supervise within the meaning of Exchange Act Section 15(b)(4)(E). In the first, Nomura will pay customers $20,704,337. In addition, the firm will pay disgorgement of $16,329,650 and prejudgment interest of $3,792,300. The firm will also pay a penalty of $1 million. Those amounts are satisfied by paying the customers. In the second the firm will pay customers $4,275,035. In addition, the broker will pay disgorgement of $1,133,5000, prejudgment interest of $242,609.67 and a penalty of $500,000. Again, those a mounts will be satisfied by paying the customers.

The picture of a few rogue traders painted by the two Orders cited above contrasts sharply with that presented by a detailed examination of the actions. These cases were part of a larger prosecutorial effort by the USAO and the SEC focused on trading in opaque markets such as those involving RMBS and CMBS. The cases began with the actions against Jeffries & Co. head trader Jesse Litvak. U.S. v. Litvak, No. 13-CR-00019 (D.Conn. Filed Jan. 25, 2013); SEC v. Litvak, Civil Action No. 3: 13-CV-00132 (D. Conn. Filed Jan. 28, 2013). The two groups of cases involving traders at Numora followed: U.S. v. Shapiro, No. 15-cr-00155 (D. Conn. Filed Sept. 3, 2015); SEC v. Shapiiro, Civil Action No. 15-cv-07045 (S.D.N.Y. filed Sept. 8, 2015); SEC v. Im, Civil Action No. 1:17-cv-0313 (S.D.N.Y. Filed May 17, 2017). Each of these cases is built on the kind of trading that is the lynchpin of the two failure to supervise actions settled by the broker-dealer this week with the SEC.

Litvak became the model for the resolution of the criminal charges. Initially, Mr. Litvak was found guilty by a jury. That conviction was overturned, however. The Second Circuit Court of Appeals concluded that the district court errored by excluding expert testimony regarding the nature of the markets and securities being traded. Specifically, the excluded witnesses would have testified that the markets were complex, opaque and inefficient. Perhaps more importantly, the professional traders that populated the markets use complex systems and models to evaluate potential transactions which essentially made any statement by Mr. Litvak not relevant. When the testimony was admitted at retrial Mr. Litvak was found not guilty on all but one count. That count was later reversed on appeal and then dropped by the government. The Commission dismissed its case against Mr. Litvak.

The defendants in Shapiro modeled their defense on the second Litvak trial. Testimony was developed from various traders regarding the opaque nature of the markets and the manner in which the sophisticated traders that participate in those venues execute transactions. The testimony also established that the firm compliance department was more than aware of the wild west type tactics used by traders. Again, the jury largely refused to convict, returning not guilty verdicts on virtually all counts. The few remaining counts are pending.

Finally, the Commission filed Im. The U.S. Attorney’s Office chose not to file a parallel criminal case. Kee Chan, named as a defendant along with James Im, settled on filing, consenting to the entry of a permanent injunction based on Securities Act Section 17(a). He also agreed to pay disgorgement of $51,956, prejudgment interest of $11,757 and a penalty of $150,000. The action is pending as to Mr. Chan. Similarly, the Commission’s action in Shapiro is still in litigation. Mr. Shapiro settled, consenting to the entry of a permanent injunction based on Exchange Act Section 10(b) and agreeing to pay a penalty of $200,000. The case is set for trial on January 17, 2020.

The history of these cases raises significant questions regarding the failure to supervise issues presented in the two Orders cited above which name the brokerage firm as a Respondent. To be sure, the tactics used by the traders are repugnant. At the same time, since the traders relied largely on complex models to make investment decisions, it is questionable at best that the misstatements had any material impact on the trading decisions. If that is true it calls into question the calculation of the sums being paid to investors as well as the disgorgement which is supposed to be ill-gotten gains. Viewed in this context those sums seem to be little more that multiple penalties, a view consistent with that stated by the Supreme Court in Kokesh v. SEC, 137 S.Ct. 635 (2017).

Finally, while the tactics used by the traders clearly cannot be condoned, it seems difficult to conclude that permitting them constitutes failure to supervise since they have no material impact. Yet the conduct described is clearly contrary to every duty of a market professional. Perhaps a better charge is a failure of professionalism, a failure of compliance and permitting a culture that is contrary to any code of ethics.

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