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October 14, 2008

DOJ Swings & Misses; SEC On Deck

Specialists Win in Court Again

By Peter Chapman

This summer brought some good legal news for a bunch of ex-New York Stock Exchange specialists. In July and August, federal judges exonerated six former NYSE specialists charged by the U.S. Department of Justice (DOJ) with securities fraud for their roles in the NYSE floor trading scandal in the early years of the decade. The judges' decisions offer hope to several others now facing trial in Securities and Exchange Commission proceedings covering the same charges. (Many also face hearings conducted by the New York Stock Exchange; see related story.)

The U.S. Court of Appeals for the Second Circuit got the ball rolling in July, when it rejected the DOJ's appeal of a ruling by Federal Judge Dennis Chin in February 2007 that found former specialist David Finnerty not guilty of securities fraud.

Finnerty then worked for Fleet Specialist, now Banc of America Specialists, where he traded the stock of General Electric.

After that decision, the three-judge panel then overturned the convictions of two more specialists, Michael Hayward and Michael Stern. Both men had worked at the now defunct Van der Moolen Specialists. Both men had received six-month prison sentences after their 2006 convictions for securities fraud.

Then, in August, Judge Sidney Stein, the judge who originally sentenced Hayward and Stern, vacated the guilty pleas of Joe Bongiorno and Pat McGagh, two more ex-specialists from Van der Moolen. In making his decision, Stein cited the appeals court's decision. Bongiorno and McGagh had pled guilty in 2006 and were sent to jail. Finally, also in August, federal prosecutors dropped charges against former LaBranche specialist and fugitive Freddy DeBoer.

The six reprieves mark an end, after three years, to a futile effort by the DOJ to throw 15 former specialists in jail for breaking NYSE rules covering specialists' negative obligations. Of the 15, the feds managed to send only four to jail. They dropped charges against eight, and three were acquitted.

The beginning of the end came in February 2007, when Chin overturned a jury's conviction of Finnerty. Chin ruled that the DOJ failed to prove fraud because it failed to demonstrate that the specialist deceived anyone.

The judge found that the DOJ proved that Finnerty ignored his negative obligation not to interposition between client orders. But, Chin stated in his final opinion, the DOJ needed to prove that Finnerty's customers "got something different from what they expected." They did not, he concluded. Chin agreed with Finnerty that "the government could not prove that interpositioning was deceptive without showing what the investment public expected."

The validations of Chin's ruling by the appeals court this summer could provide defendants in the SEC's civil case with some ammunition, attorneys say. In April 2005, in conjunction with the DOJ indictments, the SEC charged 20 former specialists with securities fraud. Like the DOJ, the SEC is basing much of its case on the all-encompassing Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Unlike the DOJ, the SEC is also citing Section 17(a) of the Securities Act of 1933, which also covers fraud.

The SEC appears to be having better luck than the DOJ. The regulator has wrung settlements out of Hayward, Stern, DeBoer and two other ex-Van der Moolen traders. They were fined between $75,000 and $300,000 apiece. Hayward, Stern, DeBoer and Gerard Hayes were barred from the industry. The SEC's administrative proceedings got under way last year and are ongoing.

Attorneys tell Traders Magazine the defendants plan to leverage the appeals court's ruling in their cases with the SEC. Like the DOJ, the SEC must prove deceit as well, they note. Unlike the DOJ, though, the SEC need not prove its case beyond all reasonable doubt. The regulator only needs to show that a "preponderance" of the evidence supports its case.

That some of the defendants are settling is not surprising, according to one lawyer. Any fines incurred are likely to be less than their legal bills if they choose to fight the SEC.

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