Sec. & Exch. Comm'n v. Lek Sec. Corp.

• Decision Date: 25 August 2017
• Docket Number: 17cv1789 (DLC)
• Citation: 276 F.Supp.3d 49
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. LEK SECURITIES CORPORATION, Samuel Lek, Vali Management Partners d/b/a Avalon FA LTD, Nathan Fayyer, and Sergey Pustelnik a/k/a Serge Pustelnik, Defendants.
• Court: U.S. District Court — Southern District of New York

276 F.Supp.3d 49

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,

v.LEK SECURITIES CORPORATION, Samuel Lek, Vali Management Partners d/b/a Avalon FA LTD, Nathan Fayyer, and Sergey Pustelnik a/k/a Serge Pustelnik, Defendants.

17cv1789 (DLC)

United States District Court, S.D. New York.

Signed August 25, 2017

For the Securities and Exchange Commission: David J. Gottesman, Robert A. Cohen, Olivia S. Choe, Sarah S. Nilson, U.S. Securities and Exchange Commission, 100 F Street N.E., Washington, DC 20549.

For Lek Securities Corporation and Samuel Lek: Steve M. Dollar, David B. Schwartz, Norton Rose Fulbright US LLP, 1301 Avenue of the Americas, New York, New York 10103.

For Lek Securities Corporation and Samuel Lek: Kevin J. Harnisch, Norton Rose Fulbright US LLP, 799 9th Street N.W., Suite 1000, Washington, DC 20001–4501.

OPINION AND ORDER

DENISE COTE, United States District Judge

Broker-dealer Lek Securities Corporation ("Lek") and its principal Samuel Lek (collectively "the Lek Defendants") have moved to dismiss the securities fraud action filed against them by the Securities and Exchange Commission ("SEC"). The SEC alleges that these defendants participated in unlawful layering and cross-market manipulation schemes.

In their motion to dismiss, the Lek Defendants do not contend that the complaint's allegations lack sufficient detail to give them fair notice of the SEC's theory of wrongdoing. Instead, they principally argue that neither the layering nor the cross-market trading described in the complaint can constitute market manipulation in violation of federal securities laws. They are wrong. For the following reasons, the motion to dismiss is denied.

BACKGROUND

The following facts are taken from the complaint. Lek is a New York based registered broker-dealer. It provides foreign trading firms, including co-defendant Vali Management Partners d/b/a Avalon FA LTD ("Avalon"), with access to U.S. securities markets. The conduct at issue in this case occurred in large part through trading in the Avalon account at Lek ("Avalon Account"). Samuel Lek is Lek's Chief Executive Officer and Chief Compliance Officer.

Samuel Lek supervised his co-defendant Sergey Pustelnik ("Pustelnik"), who referred foreign customers to Lek, including Avalon. Pustelnik later became a registered representative at Lek and worked on the Avalon Account. He received commissions and other payments from Lek on Avalon's trades through Lek.

Pustelnik is also alleged to be an undisclosed control person of Avalon. Pustelnik was significantly involved in Avalon's management and operations and shares in Avalon's revenue or profits with Avalon's principal Nathan Fayyer ("Fayyer"), who is also a named defendant in this action.

Avalon is a foreign day-trading firm that uses mostly foreign traders based in Eastern Europe and Asia to conduct its trading. Avalon is not registered with the SEC. Fayyer is Avalon's sole disclosed owner and director. During the relevant period, Fayyer oversaw Avalon's trade groups and had authority to restrict or terminate their trading in the Avalon Account.

The SEC's allegations concern two schemes to manipulate U.S. securities markets. The first scheme involved Avalon's use of a trading strategy typically referred to as "layering" or "spoofing." The second was a cross-market manipulation scheme. Together, Avalon's layering and cross-market manipulation activity generated profits of more than $28 million.

Lek also profited significantly from commissions and other fees it earned from Avalon's layering and cross-market manipulation activity. Between 2012 and 2016, Avalon produced more commissions, fees, and rebates for Lek than any other customer.

I. The Layering Scheme

In the alleged layering scheme, Avalon placed "non-bona fide orders" through Lek to buy or sell stock with the intent of injecting false information into the market about supply or demand for the stock. The complaint characterizes non-bona fide orders as orders that Avalon did not intend to execute and that had no legitimate economic reason. Avalon placed these orders to trick and induce other market participants to execute against orders that Avalon did intend to execute for the same stock on the opposite side of the market, which the complaint describes as its bona fide orders. Through this scheme, Avalon obtained more favorable prices on the executions of its bona fide orders than otherwise would have been available. Between December 2010 and September 2016 Avalon engaged in hundreds of thousands of instances of layering, involving hundreds of securities traded on U.S. exchanges. The complaint describes three specific instances of layering in detail.

As described by a trader who later became one of Avalon's trade group leaders in a 2012 email to Samuel Lek, layering is a "special" trading strategy:

For example, the bid and ask of symbol X is 90.09 and 90.14, we put buy orders in 90.10, 90.11, 90.12, 90.13 and so on, then push the price to 90.20, right now the bid and ask is 90.20 and 90.21, we put a big size short order in 90.20 to get a short position, then we cancel all of the buy orders in 90.10, 90.11, 90.12 and so on. And we put sell orders in 90.20, 90.19, 90.18, 90.17 and so on, to push the price to 90.05, then put a big size buy order in 90.05 to cover position, and cancel all of the sell orders.. so we will put hundre[d]s of orders to push stock price and then cancel them.

(Emphasis supplied.)

As described in the complaint, Samuel Lek had ample notice that regulators considered layering a manipulative practice. Indeed, in response to the email quoted above Samuel Lek stated, "regulators have argued that your trading strategy ‘layering’ is manipulative and illegal. This is of concern to us even though I do not agree with their position." Between 2012 and 2016, regulators, exchanges, and other market participants repeatedly notified the Lek Defendants that Avalon may be engaged in manipulative layering through its trading at Lek. In September 2012, the Financial Industry Regulatory Authority ("FINRA") informed Lek that Avalon's trading "appears consistent with a manipulative practice called layering." In July 2013, Bats Global Markets exchange ("BATS") advised the Lek Defendants that it was seeing a "clear-cut cross-market layering strategy" by Avalon, including "1,700 instances [of layering] over the last two days." BATS later sent Lek a letter identifying specific instances of Avalon's layering activity. Following these communications, Lek stopped sending Avalon's orders to BATS and instead routed Avalon's orders to other exchanges and venues. In November 2013, a New York Stock Exchange ("NYSE") Hearing Board found that Lek had violated various exchange rules by, among other things, failing to supervise and implement adequate risk controls for trading strategies including spoofing and layering. The Lek Defendants continued to receive numerous regulatory inquiries and warnings through 2016. Samuel Lek and others at Lek informed Pustelnik of a number of these communications.

Fayyer was also well aware of the regulatory disapproval of layering, or as he sometimes termed it, multi-key trading. He marketed Avalon to prospective traders as one of the few remaining destinations willing to allow layering and touted Avalon's relationship with Lek, one of the only brokers that still permitted layering. For example, in March 2013, Fayyer explained:

the broker is not a cheap one, but this is because they do tolerate and protect us from many issues such as multi-key trading, which is not allowed anywhere pretty much anymore, and other dark pool and scalping strategies which can be described as wash orders by many other firms. So you get what you pay for here.

The Lek Defendants never instituted effective controls to prevent layering from occurring, and quickly relaxed any controls Lek did implement in response to Avalon's, Fayyer's, and Pustelnik's requests. In February 2013, Lek implemented a layering control that would block certain trading through its proprietary Q6 program ("Q6 Control"). The complaint asserts that Q6 Control was "mere window-dressing." Q6 Control was triggered when a trader traded or attempted to trade on both sides of the market with a disproportionate number of orders on one side. The difference in the number of orders between the two sides was referred to as the delta. Q6 Control was initially triggered by a delta of 10. Pustelnik encouraged Lek to relax the Q6 Control for Avalon. On February 6, 2013, Pustelnik urged a Lek officer to increase the delta on the Avalon Account to 75. Within a week of implementing Q6 Control, Lek relaxed the delta on the Avalon Account to 100. At all times thereafter the delta on the Avalon Account remained between 50 and 100.

II. The Cross–Market Manipulation Scheme

In a cross-market manipulation scheme that it began to execute in August 2012, Avalon purchased and sold U.S. stock at a loss to move the prices of corresponding options, so that Avalon could make a profit by trading those options at prices that it would not otherwise have been able to obtain. The profits that Avalon achieved through its options trading more than offset the losses it sustained on its allegedly manipulative trading of stock. The SEC alleges that Avalon engaged in over 600 instances of cross-market manipulation through Lek between August 2012 and December 2015. The complaint describes in detail a specific example of Avalon's cross-market manipulation activity.

The Lek Defendants and Pustelnik were well aware that regulators objected to Avalon's cross-market trading activity as potentially manipulative. For example, within a week of Avalon initiating its cross-market strategy through Lek, FINRA advised the Lek Defendants that it viewed the trading as potentially manipulative. In June 2014, FINRA again requested that Lek "continue to review activity [of the cross-market strategy] and address any potential manipulative activity involving both option and stock...