The opinion of the court was delivered by: Denny Chin, D.J.
Defendants David Finnerty and Thomas Murphy, Jr., move to dismiss the Indictments against them, arguying that the facts as alleged in the Indictments do not, as a matter of law, make out a violation of 15 U.S.C. § 78j(b) ("Section 10(b)") and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. They further argue that the Indictments should be dismissed because due process prohibits criminal prosecution of the alleged conduct.
In the alternative, defendants move to strike certain language from the Indictments, and also move to inspect the instructions given by the prosecution to the grand jury. For the following reasona, the motions are granted in part and denied in part.
The facts, as alleged in the Indictments, 05 Cr. 393 and 05 Cr. 397, are as follows:
Finnerty and Murphy were employed by Fleet Specialist, Inc., as New York Stock Exchange ("NYSE") specialists from about 1996 and 1993, respectively, and during all times relevant to the Indictments. (Finnerty Indict. ¶ 2; Murphy Indict. ¶ 2).*fn1 With limited exceptions, purchases and sales of securities on the NYSE had to be executed through a specialist who worked on the floor of the exchange. (Finnerty Indict. ¶ 3; Murphy Indict. ¶ 3). To effectuate purchases and sales of particular securities, buyers and sellers had to first present their bids to buy, or offers to sell, to the specialist assigned to that security. (Id.).
Orders to purchase or sell could be presented to a specialist in one of two ways. First, the order could be conveyed orally by a floor broker on the floor of the exchange at the specialist's post. (Id.). Second, an order could be transmitted to the specialist electronically using the NYSE's "Super Designated Order Turnaround System." Orders transmitted this way would appear on a computer screen that was referred to as the "display book." (Id.).
After receiving the order, a specialist could fill it in one of two ways. A specialist was generally required by rules of the Securities and Exchange Commission ("SEC") and the NYSE to match any open buy orders from one investor with any open sell orders from another investor. (Finnerty Indict. ¶ 4; Murphy Indict. ¶ 4). These are referred to as "agency" or "broker" orders because the specialist is simply acting as an agent who matches orders of willing buyers and sellers. (Id.). In certain limited circumstances, however, specialists were permitted to execute trades on a "principal" or "dealer" basis, when required to do so to maintain a fair and orderly market. (Finnerty Indict. ¶ 5; Murphy Indict. ¶ 5). For example, if there were no matching buy and sell orders in a given price range at a given time, specialists were authorized to execute a purchase or sale by selling stock from the specialist's proprietary account, or by buying stock and holding it in that account. (Id.).
In addition to executing purchase and sale orders, specialists were responsible for reporting to the public the prices at which stocks were being bought and sold. (Finnerty Indict. ¶ 6; Murphy Indict. ¶ 6). Because of their position, specialists had access to certain material information -- such as advance knowledge of the price parameters of all open orders --and accordingly were subject to certain rules and obligations to prevent them from taking unfair advantage of investors. (Id.). Pursuant to NYSE Rule 104, specialists were under an affirmative obligation to buy or sell stock on a principal or dealer basis when necessary to maintain a "fair and orderly" market, e.g., to minimize any actual or anticipated short-term imbalance between supply and demand. (Finnerty Indict. ¶ 8; Murphy Indict. ¶ 8). Similarly, specialists were obliged to refrain from purchasing or selling securities on a principal or dealer basis when not necessary to maintain a fair and orderly market. (Finnerty Indict. ¶ 9; Murphy Indict. ¶ 9). This negative obligation generally precluded specialists from executing trades on a principal or dealer basis when there were matching public orders to buy and sell. (Id.). In other words, specialists were prohibited from "trading ahead" or "interpositioning" -- trading on their own accounts ahead of or between existing investor orders.*fn2 (Id.).
The Indictments allege that Finnerty and Murphy engaged in schemes of trading ahead and interpositioning that resulted in purchasing and selling securities for their proprietary accounts at advantageous prices, to the detriment of the investing public. Because their compensation was based in part on the profitability of their proprietary accounts, each stood to benefit financially from the alleged scheme. (Finnerty Indict. ¶ 15; Murphy Indict. ¶ 15). Finnerty is alleged to have engaged in approximately 40,000 instances of interpositioning and trading ahead, and Murphy more than 9,000. (Finnerty Indict. ¶ 16; Murphy Indict. ¶ 16). The Indictments allege that this conduct violated Section 10(b).
I discuss the three motions before Court: (a) the motion to dismiss the Indictments, (b) the motion to strike certain allegations from the Indictments, and (c) the motion to inspect the grand jury instructions.
Defendants move to dismiss the Indictments, arguing, inter alia, that (1) the facts as alleged do not state an offense of securities fraud in violation of Section 10(b) and Rule 10b-5; and (2) due process prohibits criminal prosecution of this conduct. I discuss the arguments in turn.
1. Section 10(b) and Rule 10b-5
Section 10(b) forbids (1) the "use or employ[ment] . . . [of] any . . . manipulative or deceptive device," (2) "in connection with the purchase or sale of any security," (3) in contravention of" Securities and Exchange Commission ("SEC") "rules and regulations." 15 U.S.C. § 78j(b); see also Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341 (2005). Section 10(b) seeks "to prevent fraud, whether it is 'a garden type variety of fraud, or present[s] a unique form of deception. Novel or atypical methods should not provide immunity from the securities laws.'" United States v. Russo, 74 F.3d 1383, 1390 (2d Cir. 1996); see also Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir. 1984) ("The purpose of § 10(b) and Rule 10b-5 is to protect persons who are deceived in securities transactions."). Thus, the statute should be construed "'not technically and restrictively, but flexibly to effectuate its remedial purposes.'" SEC v. Zandford, 535 U.S. 813, 819 (2002) (quoting Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 151 (1972)).
SEC Rule 10b-5, which was promulgated pursuant to Section 10(b), contains three parts, and makes it unlawful:
(a) to employ any device, scheme, or artifice to defraud,
(b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or
(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with ...