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

• Decision Date: 14 March 2019
• Docket Number: 17cv1789 (DLC)
• Citation: 370 F.Supp.3d 384
• 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

370 F.Supp.3d 384

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 March 14, 2019

For plaintiff Securities & Exchange Commission: David J. Gottesman, Olivia S. Choe, Sarah S. Nilson, U.S. Securities & Exchange Commission, 100 F Street NE, Washington, DC 20549.

For defendants Lek Securities Corporation and Samuel Lek: Steve M. Dollar, David B. Schwartz, Norton Rose Fulbright US LLP, 1301 Avenue of the Americas, New York, NY 10103, Kevin J. Harnisch, Norton Rose Fulbright US LLP, 799 9th Street NW, Suite 1000, Washington, DC 20001, Ronald D. Smith, Norton Rose Fulbright US LLP, 2200 Ross Avenue, Suite 3600, Dallas, TX 75201.

For defendants Vali Management Partners d/b/a Avalon Fa Ltd., Nathan Fayyer, and Sergey Pustelnik: James M. Wines, Law Office of James M. Wines, 1802 Stirrup Lane, Alexandria, VA 22308, Steven Barentzen, Law Office of Steven Barentzen, 17 State Street, Suite 400, New York, NY 10004.

OPINION AND ORDER

DENISE COTE, District Judge:

This Opinion addresses the motions of defendants Lek Securities Corporation ("Lek Securities") and Samuel Lek ("Lek"; together with Lek Securities, the "Lek Defendants") to exclude expert testimony to be offered at trial on behalf of plaintiff United States Securities and Exchange Commission ("SEC") by Terrence Hendershott and Neil Pearson, and the SEC's motions to exclude testimony from the Lek Defendants' experts David J. Ross and Alan Grigoletto, offered in rebuttal to the Hendershott and Pearson testimony. It also addresses the SEC's motion to exclude the testimony of Haim Bodek, offered by defendants Avalon FA Ltd. ("Avalon"), Nathan Fayyer ("Fayyer"), and Sergey Pustelnik ("Pustelnik"; together with Avalon and Fayyer, the "Avalon Defendants") in rebuttal to Hendershott and Pearson's testimony. Hendershott and Pearson have analyzed patterns of trading at Avalon, which conducted its trading through Lek Securities. For the following reasons, the Lek Defendants' motions to exclude Hendershott and Pearson as trial witnesses are denied; the SEC's motion to exclude Bodek is granted; and the SEC's motions to exclude Ross and Grigoletto are granted in part.

Background

The SEC sued the Lek and Avalon Defendants on March 10, 2017, principally alleging that traders at Avalon engaged in two schemes to manipulate the securities markets and that they did so through trading at Lek Securities, a broker-dealer based in New York. Avalon is a foreign day-trading firm whose traders are largely based in Eastern Europe and Asia. Avalon is not a registered broker-dealer and relies on registered firms like Lek Securities to conduct trading in U.S. securities markets. The SEC contends that Lek reaped significant commissions and fees from Avalon's trading.

The SEC brought claims for violations of several provisions of the Securities Exchange Act of 1934 (the "Exchange Act"). The claims against the Lek Defendants are primarily for aiding and abetting, in violation of Section 20(e) of the Exchange Act, the Avalon Defendants' violations of Sections 10(b), 17(a), and 9(a) of the Exchange Act. See SEC v. Lek Sec. Corp., 276 F.Supp.3d 49, 57-58 (S.D.N.Y. 2017) (" Lek II").

The same day this case was filed, the SEC obtained an ex parte temporary restraining order ("TRO") against Avalon. An Opinion of March 29, 2017 denied Avalon's motion to modify the TRO. See SEC v. Lek Sec. Corp., No. 17cv1789(DLC), 2017 WL 1184318 (S.D.N.Y. Mar. 29, 2017). Avalon thereafter consented to the entry of an injunction against it. An Opinion of August 25, 2017, denied the Lek Defendants' motion to dismiss the claims against them.¹ Lek II, 276 F.Supp.3d at 57.

Following the completion of discovery, the Lek Defendants moved for summary judgment on August 24, 2018. On the same date, they also moved to exclude the testimony and opinions of Hendershott and Pearson, the SEC's expert witnesses. Those motions became fully submitted on November 2, 2018.

On October 5, the SEC moved to exclude all five of the defendants' expert witnesses including Ross, Grigoletto, and Bodek, who the Defendants intend to call as rebuttal witnesses to Hendershott and Pearson. Those motions became fully submitted on November 16.

This Opinion addresses the motions to exclude Hendershott, Pearson, Ross, Grigoletto, and Bodek. The main threads of the opinions offered by these experts are outlined below, beginning with Hendershott's opinion regarding the phenomenon of layering and Ross, Grigoletto, and Bodek's rebuttals to Hendershott's opinion, followed by an outline of Pearson's opinion regarding the phenomenon of cross-market trading and Ross, Grigoletto, and Bodek's rebuttals to Pearson's opinion.

I. Summary of Hendershott Reports ²

Hendershott analyzed trade orders, cancellations, and executions made by Avalon traders from December 2010 through September 2016 (the "Avalon Trade Data"). The orders analyzed by Hendershott are limit orders, or "instructions to trade at a price that is no worse than the limit price specified by the trader."³

Hendershott analyzed the Avalon Trade Data to determine whether any of Avalon's order and trade activity was consistent with layering. Hendershott defines layering as a trading strategy whereby traders place "visible limit orders ... that they do not intend to execute." They place these orders "to create an artificial appearance of supply or demand to improve the execution of their other orders." Visible limit orders are informative; they are predictive of future price movements. As a result, they can impact trade prices. Among the market participants that rely on data about pending limit orders that are visible to the markets are market makers,⁴ high-frequency traders, and investors that use algorithms to implement their trading strategies, such as institutional investors.

As explained by Hendershott, when engaged in layering a trader will place a greater number of visible limit orders on the side of the market where the trader does not intend for the trades to execute and a smaller number of orders on the side of the market where the trader intends for the trades to execute. For instance, a trader will typically place a large number of buy (or sell) orders without intending for those orders to execute in order to increase the perceived demand (or supply) of the stock and therefore influence the price per share or volume of shares the trader is able to sell. A trader will then place a smaller number of sell (or buy) orders that the trader intends to execute. The trader will then cancel the buy (or sell) orders. The side of the market where the trader places the greater number of orders the trader does not intend to execute is referred to as the "Loud" side. The other side of the market, with the smaller number of orders the trader does intend to execute, is referred to as the "Quiet" side.

Using the methods described below, Hendershott concluded that Avalon's order and execution activity was frequently consistent with layering. Using a series of conservative measures, he identified 675,504 sets of trades consistent with layering over a period from December 2010 to September 2016. This trading resulted in Avalon earning more than $ 21 million in revenue, $ 12 million of which was earned in 2015 and 2016. The Avalon trading that was consistent with layering accounted for more than 45% of Avalon's trading revenue, even though it made up less than 5% of Avalon's trading volume.

A. Identification of Layering Loops

Hendershott applied five criteria to identify groups of orders, cancellations, and executions consistent with layering. First, Hendershott considered only instances where a trader places both buy and sell orders in a single stock, because layering is a strategy that involves a trader placing orders on both sides of the market. Second, Hendershott only considered instances where the orders were entirely resolved through cancellation or execution within 60 seconds, even though it is possible for traders to engage in a layering scheme through transactions that last longer than 60 seconds. The parties refer to these groupings as "Loops."

Third, Hendershott required both the number of visible orders and the number of shares in those orders on the Loud side of a Loop to be greater than both the orders and shares on the Quiet side by at least two to one (the "Order Imbalance").⁵ Approximately 2 million Loops from the Avalon Trade Data met Hendershott's first three criteria.

Fourth, Hendershott eliminated Loops where the ratio of executed shares on the Quiet side to the Loud side was less than three to one (the "Execution Imbalance"), even though the Loud-side shares were more numerous. Hendershott contends that considering only Loops with an Execution Imbalance of at least three to one eliminates trading strategies such as market making from the Loops.

Fifth, Hendershott eliminated Loops if a Loud-side order was placed more than one second after the last Quiet-side execution or cancellation. He reasoned that this was consistent with a layering strategy, which typically involves placing Loud-side orders to achieve favorable execution prices for Quiet-side orders. Hendershott explains that, together, these five criteria create a conservative data set reflecting patterns of layering activity. Applying these criteria yielded a total of 675,504 Loops that Hendershott found to be consistent with layering (the "Layering Loops").⁶ Of those, 663,994 occurred after March 12, 2012.⁷

B. Further Analyses

Having identified Layering Loops, Hendershott then conducted four analyses ("Further Analyses") of all or some of the Layering Loops to evaluate whether the Loops did indeed have characteristics consistent with layering and to eliminate the possibility that the activity had occurred as part of a non-layering...