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United States v. Finnerty

February 21, 2007

UNITED STATES
v.
DAVID FINNERTY, DEFENDANT.



The opinion of the court was delivered by: Chin, D.J.

OPINION

In this case, defendant David Finnerty, a former specialist on the New York Stock Exchange, was convicted of securities fraud by a jury on October 26, 2006. He moves for a judgment of acquittal under Rule 29(c) of the Federal Rules of Criminal Procedure or, alternatively, for a new trial under Rule 33.

The Government proved at trial that Finnerty engaged in interpositioning: instead of matching pending buy and sell orders, Finnerty repeatedly traded for his firm's proprietary account, buying stock from one customer and selling it to another, making a profit from the slight differences in pricing. The issue presented is whether the Government proved that Finnerty engaged in fraudulent or deceptive conduct within the meaning of the securities laws.

I hold that the Government did not, for the evidence at trial did not establish that Finnerty's customers were misled or defrauded or otherwise deceived. Accordingly, Finnerty's motion pursuant to Rule 29(c) is granted and the jury's verdict is set aside. The Court will enter a judgment of acquittal. In addition, pursuant to Rule 29(d)(1), in the event that the judgment of acquittal is later vacated or reversed, I conditionally grant defendant's motion for a new trial.

STATEMENT OF THE CASE

I. The Facts

Construed in the light most favorable to the Government, see United States v. Hamilton, 334 F.3d 170, 179 (2d Cir. 2003), the evidence at trial showed the following:

A. Finnerty

Finnerty was employed by Fleet Specialist, Inc. ("Fleet"), as a New York Stock Exchange ("NYSE") specialist beginning in approximately 1996. (Tr. 11, 1022).*fn1 Between 1999 and 2000, Finnerty was the specialist for Celera Genomics Group ("CRA") and PE Biosystems ("PEB"). (Id. at 1029). From September 2000 until April 2003, Finnerty was the specialist for General Electric ("GE") -- one of the most heavily traded stocks on the NYSE -- and perhaps Fleet's most prestigious stock. (Id. at 25, 59, 1029). Indeed, Finnerty was so successful as a specialist that he would, on occasion, be interviewed by CNBC about the market, and was featured in newspaper articles about the NYSE. (Id. at 462-63, 1199, 1249; DXs 700, 8000C).

B. NYSE Specialists

Typically, purchases and sales of stocks on the NYSE are executed through a specialist who works on the floor of the exchange. (Tr. 17). Each stock that is traded on the NYSE is assigned to a specific specialist, and the specialist is the only person on the floor who trades the stock of a particular company. (Id.). To buy or sell a particular stock, buyers and sellers must first present their bids or offers to the specialist assigned to that stock. (Id. at 18).

Purchase and sell orders are presented to a specialist in two ways. First, the order may be conveyed orally by a floor broker on the floor of the exchange at the specialist's post. (Id. at 18, 227-28). Second, an order may be transmitted to the specialist electronically using the NYSE's "Super Designated Order Turnaround System" (the "Super DOT"). (Id. at 18-19, 227-28). Orders transmitted this way appear on a computer screen known as the "display book." (Id. at 19, 228-29).

After receiving the order, a specialist can fill it in two ways. A specialist is generally required by NYSE rules to match any open buy orders from one customer with any open sell orders from another customer. (Id. at 1035-36). Specialists are permitted, however, to execute trades on a "principal" or "dealer" basis when such a trade is necessary to maintain a fair and orderly market. (Id. at 26-27, 1030, 1036-37). For example, if there are no matching buy and sell orders in a given price range at a given time, specialists are authorized to execute a purchase or sale by selling stock from or buying stock for the specialist's proprietary account. (Id. at 26-27, 1036-37).

Pursuant to NYSE Rule 104, specialists are under an affirmative obligation to buy or sell stock on a principal or dealer basis when necessary to maintain a "fair and orderly" market, i.e., to minimize any actual or anticipated short-term imbalance between supply and demand. (Id. at 54). Similarly, specialists are obliged to refrain from purchasing or selling securities on a principal or dealer basis when not necessary to maintain a fair and orderly market. (Id. at 26-27, 1030, 1036-37). This negative obligation generally precludes specialists from executing trades on a principal or dealer basis when there are matching public orders to buy and sell. (Id.). In other words, specialists are prohibited from "interpositioning" or engaging in DOT arbitrage -- i.e., trading on their own accounts between existing investor orders (thereby earning a profit on the discrepancy in prices) when there are buy and sell orders that can be matched. (Id. at 1035).

C. The Clerks

On the floor of the exchange, clerks assist the specialist by executing trades at the specialist's direction. (Id. at 219). There are two categories of clerks: backup clerks and front line clerks. (Id. at 20-21). The backup clerk runs errands, gets coffee and lunch, and does administrative paperwork -- all the while learning to operate the display book. (Id.). The front line clerk stands next to the specialist at the panel, and carries out the specialist's orders to execute trades. (Id. at 21). A specialist is typically someone who has worked his way up from a backup clerk. (Id. at 20). Finnerty, for example, began as a clerk in 1986 and finally became a specialist in 1996. (Id. at 25, 1022).

At trial, the Government called three clerks -- Philip Finale, Douglas Lange, and William Ottesen. Finale, who clerked for Finnerty in GE for approximately six months (Tr. 217), testified that even when there were orders that could be paired off, Finnerty would sometimes direct him to trade for the principal account ahead of either the buyers or sellers, and subsequently trade for the principal account on the opposite side (id. at 295-97). In doing so, Finnerty would sell at a higher price than he bought, and earn a profit for the principal account. (Id.).

On his first day on the job, Finale questioned Finnerty about trading for the principal account when public orders could be matched. (Id. at 308). Finale knew that these trades were improper (id.), and that a specialist has an obligation to always place the public first (id. at 252). Nonetheless, Finnerty replied by telling Finale to go ahead with the trades. (Id. at 308-10).

In early December 2002, Finnerty learned that there would be an investigation by the NYSE into DOT arbitrage. (Id. at 411-12). Finnerty informed Finale about the investigation, and directed Finale to start pairing off the DOT orders -- which he promptly did. (Id. at 412).

In April 2003, Finnerty approached Finale on the floor of the exchange the day before Finale was to testify before the NYSE regarding the investigation. (Id. at 417-18). Finnerty told Finale that Finale should not "say anything to incriminate [Finnerty], because it's going to incriminate [Finale] also." (Id. at 418).

Lange, who clerked for Finnerty for one day while filling in for another clerk, testified that Finnerty directed him to trade for the principal account when public orders could have been matched. (Id. at 629, 641-42). Lange also testified that he felt "uneasy" about conducting these trades, and informed the head clerk that he hoped he would never have to clerk for Finnerty again. (Id. at 641-42).

Ottesen, who clerked for Finnerty approximately eight to ten days (id. at 921), also testified that he executed trades for the principal account rather than match orders at the direction of Finnerty (id. at 925-27). Ottesen felt that these trades were improper, and he also questioned Finnerty the first time Finnerty directed him to execute these trades. (Id. at 935). Finnerty responded by pointing to his badge, indicating to Ottesen that these trades were permissible because he said it was. (Id. at 935-36).

D. The Exception Reports

Dr. Roken Ahmed testified that the NYSE created exception reports that identified all the interpositioning trades in Finnerty's assigned stocks. (Id. at 724-25). These exception reports were generated by a computer algorithm. (GX 2100, 2102-2104, 2109, 2111-2118). Three types of exception reports were created: (1) customer disadvantaged, where the principal account earned a profit; (2) customer advantaged, where the principal account incurred a loss; and (3) break-even, where the principal account neither profited nor lost. (Tr. 729-30).

The Government submitted various summary charts relating to the number of interpositioning violations in the stocks Finnerty traded. One of the charts showed that, in total -- from November 1999 to April 2003 -- there were 26,283 interpositioning trades in the stocks Finnerty traded where the principal account earned a profit. (GX 1020). The trades resulted in approximately $4.5 million in profit for Fleet's principal account. (Id.). In contrast, during this same period, there were only 130 interpositioning trades where the principal account lost money, and only 1,340 interpositioning trades where the principal account broke even. (Id.). So, approximately 95% of the time where there was interpositioning in the stocks Finnerty traded, the principal account profited. (Id.).*fn2

Another chart submitted by the Government identified the number of daily customer disadvantaged interpositioning trades that occurred for GE from October 1, 2002 through April 11, 2003. (GX 1021). The number of daily interpositioned trades in October and November 2002 was consistently high. (Id.). The interpositioned trades, however, virtually disappeared starting December 5, 2002 -- the day that Fleet announced that the NYSE would be investigating "the practice of buying/selling ahead of DOT Orders by specialists" and that Fleet itself would be investigating DOT arbitrage. (Id.; Tr. 415; GX 75).

E. Screenshots

The Government offered in evidence twenty-seven screenshots, which showed -- virtually keystroke by keystroke --how some of the interpositioning trades were entered into the display book. Finale reviewed the screenshots, and testified that the pattern of trading reflected the types of trades he executed for Finnerty while clerking for him in GE. (Id. at 408-09).

F. Finnerty's Deposition Testimony

Excerpts of Finnerty's testimony before the NYSE in connection with the NYSE's investigation into interpositioning were offered into evidence. (Id. at 1021-38; GXs 9000, 9001).

Finnerty identified the stocks he traded, and explained that the amount he received as a bonus was determined, in part, by the amount of profit he earned for the principal account, i.e., Fleet's overall performance and his performance. (Tr. 1023-24, 1027-30). He stated that he would instruct his clerks to trade for the principal account ahead of public orders if it was necessary to maintain a fair and orderly market, but only if the public orders traded ahead of received the same or better price than the specialist received. (Id. at 1030-32). This, he explained, was "[b]ecause no order should be disadvantaged in price and myself as principal or our firm advantaged." (Id. at 1033).

Finnerty also acknowledged that "as a specialist, you have a fiduciary responsibility to get the best price and a price that -- and you, as principal, cannot participate in a price that is superior for any public orders that you are acting as agent for." (Id. at 1034). He explained that the specialist's negative obligation requires that "when it is possible for a specialist to match up orders, it is his responsibility to do so." (Id. at 1036). He was thus aware that interpositioning was a violation of NYSE rules and Fleet policy. (Id. at 1035).

G. Finnerty's Compensation

Fleet's primary financial officer at the time, Joseph DiPrisco, testified regarding Finnerty's compensation. He stated that specialists were paid a base salary and a bonus, and that the bonus was based, in part, on the profit that a specialist made for the principal account. (Id. at 859). During the period from 1999 to 2002, specialists typically received between 15 and 20% of their trading profits as a bonus. (Id. at 860; GX 1051).

In 2000, Finnerty received two bonuses totaling $2 million. (Tr. 1041; GX 1050). The bonus for the first six months was $700,000, which represented about 2,262% of trading profits. (Tr. 862-63, 1042; GX 1050). The bonus for the next six months was $1.3 million, which represented about 15% of trading profits. (Id.). His base salary that year was $150,000. (Tr. 860).

In 2001, Finnerty also received two bonuses totaling $2.9 million. (Tr. 1042-43; GX 1050). The bonus for the first six months was $1.5 million, which represented about 14% of trading profits. (Id.). The bonus for the next six months was $1.4 million, which represented about 12% of trading profits. (Tr. 1043; GX 1050).

In 2002, Finnerty received two bonuses totaling $1.75 million. (Id.). The bonus for the first six months was $1 million, which represented about 13% of trading profits. (Id.).

The bonus for the next six months was $750,000, which represented about 6% of trading profits. (Id.).

H. The Defense Case

On its case, the defense called one witness, Dr. Patrick Conroy. Dr. Conroy testified that the number of interpositioning violations represented less than 1% of the total number of trades executed by Finnerty as a specialist during the relevant time period, and that the daily average volume of shares traded in GE was far ...


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