On September 20, 2019, in its second significant criminal fraud-related decision this month,1 the Second Circuit reversed a district court’s grant of a new trial to a residential mortgage backed securities (RMBS) trader, Michael Gramins. The ruling is significant because, among other things, it attempts to clarify Second Circuit law on the types of evidence that may bear on materiality in a fraud case.
RMBS are typically bought and sold by sophisticated financial institutions.2 Because RMBS are not traded on an exchange, “investors looking to transact in RMBS must contact registered broker-dealers . . . to find interested buyers or sellers or transact directly with [the] broker-dealers from the broker-dealers’ own accounts."3 Such RMBS broker-dealers make money based on the difference, or “spread,” between the price at which counterparties were willing to sell RMBS to the broker-dealer and the price at which other counterparties were willing to buy RMBS from the broker-dealer.4 As a matter of agency law, “the broker-dealer in these transactions acts solely in its own interest as a principal."5
The last several years saw a series of prosecutions in the District of Connecticut against RMBS traders at broker-dealers. In these cases, the government alleged that the defendants lied to their counterparties about the price at which they had acquired RMBS they were selling, the price at which they could sell RMBS they were acquiring, and/or the source of the RMBS, i.e., whether it was coming from the broker-dealer’s own inventory or whether the broker-dealer had acquired it from another party. Through these misrepresentations, the defendant-traders sought to increase the spread, and hence their profits. A central issue in these prosecutions was whether the alleged misrepresentations were “material,” i.e., whether there was “a substantial likelihood that a reasonable investor would find the . . . misrepresentation important in making an investment decision."6
Before Gramins, the government’s success in these cases had been limited. In United States v. Litvak, 808 F.3d 160 (2d Cir. 2015) (“Litvak I”), the Second Circuit vacated an RMBS trader’s securities fraud convictions. Litvak I held that the trial court had improperly excluded the defendant’s expert testimony that RMBS market participants, such as Litvak’s counterparties, followed their own valuation procedures, and that, as such, a broker’s statements about pricing were immaterial to the decision to buy or sell a bond at a particular price. However, the Second Circuit held that testimony from a counter-party that Litvak’s misrepresentations were “important” to them (“point of view testimony”) precluded a finding of immateriality as a matter of law and remanded the case for a new trial.
A jury again convicted Litvak, but the Second Circuit again vacated the conviction. See United States v. Litvak, 889 F.3d 56 (2d Cir. 2018) (“Litvak II”). Litvak II held that the district court erred by admitting a counterparty’s point of view testimony that Litvak had been acting as his “agent” (and not as a “principal”)—which was wrong as a matter of agency law. The court reasoned this testimony prejudiced Litvak by incorrectly suggesting that Litvak and the counter-party were in a fiduciary-type relationship. The government elected not to try Litvak a third time and dismissed the charges.
In between Litvak I and Litvak II, a jury convicted Gramins, an RMBS trader at another broker-dealer, of conspiracy to commit securities fraud and wire fraud. After Litvak II, however, the district court granted Gramins a new trial. The district court found that testimony from one of Gramins’ counterparties ran afoul of Litvak II, by “strongly impl[ying],” if not explicitly stating, that he (erroneously) believed he and Gramins were in an agency relationship and that Gramins had corresponding duties of loyalty and honesty to him.7 In its recent decision, the Second Circuit reversed the grant of a new trial, reinstating the conviction. The Second Circuit analyzed the counter-party’s testimony, found that it did not “erroneously claim an agency relationship with Gramins,” either explicitly or implicitly, and that, even if the testimony was improperly admitted, any error was harmless in light of other evidence of Gramins’ guilt.8
Gramins contains several important takeaways in the area of materiality. First, Gramins reinforces that “point-of-view” testimony from a defendant’s counter-party that the defendant’s alleged misstatements were “important” to them “can constitute sufficient evidence of materiality to support a conviction for securities fraud."9 Gramins, along with Litvak I, Litvak II, and the Second Circuit’s decision earlier this month in United States v. Johnson, demonstrate the difficulty of establishing, at least as a matter of law, the absence of materiality merely because a transaction involved sophisticated parties who may have done their own independent diligence.
Second, however, Gramins also reiterates Litvak II’s holding that such point-of-view testimony “must fall ‘within the parameters of the thinking of reasonable investors in the market at issue,’” and that “erroneous” or “idiosyncratic” point-of-view testimony should be excluded.10 Thus, in light of Gramins, courts should still give defense counsel broad leeway in attempting to exclude, challenge, or rebut counter-party testimony through, among other things, in limine practice, cross-examination, and testimony from experts or other participants in the market at issue.
More broadly, despite the government’s win in the Second Circuit, it bears noting that, at trial, the jury acquitted one of Gramins’ co-defendants on all counts and acquitted the other co-defendant on all counts except the conspiracy count, on which it failed to reach a verdict. The Second Circuit observed that a distinguishing factor between Gramins and his co-defendants was that Gramins, unlike his co-defendants, had placed deceptive trades shortly after receiving compliance training in the wake of the indictment of Litvak, providing powerful evidence of his consciousness of guilt.11
The favorable appellate result in Gramins may embolden the government to bring similar cases going forward. Our team has a long track record in assisting clients navigate these types of complex issues in these types of cases. If you have any questions or if we can be of assistance in any way, please do not hesitate to reach us.
1 See Client Alert, Second Circuit Affirms Wire Fraud Conviction in Foreign Exchange Trading Case, available at https://www.bakerbotts.com/insights/publications/2019/september/second-circuit-affirms-wire-fraud-conviction-in-foreign-exchange-trading-case.
2 United States v. Gramins, --- F.3d ----, 2019 WL 4554521, at *2 (2d Cir. Sept. 20, 2019).
3 Id. (quotations omitted)).
5 Id. at 3 (emphasis added).
6 Gramins, 2019 WL 4554521, at *10 (quotation omitted).
7 Id. at *9.
8 Id. at **14-18.
9 Id. at *11.
10 Id. at **9, 12 (quoting Litvak II, 889 F.3d at 65) (emphasis added).
11 Id. at 20.
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