Sec. & Exch. Comm'n v. Ginder

• Decision Date: 19 May 2014
• Docket Number: Docket No. 13–1116.
• Citation: 752 F.3d 569
• Parties: SECURITIES and EXCHANGE COMMISSION, Plaintiff–Appellee, v. Jason N. GINDER, Michael L. Silver, Brian P. Corbett, Defendants, and Frederick O'Meally, Defendant–Appellant.
• Court: U.S. Court of Appeals — Second Circuit

752 F.3d 569

SECURITIES and EXCHANGE COMMISSION, Plaintiff–Appellee,

v. Jason N. GINDER, Michael L. Silver, Brian P. Corbett, Defendants,andFrederick O'Meally, Defendant–Appellant.

Docket No. 13–1116.

United States Court of Appeals, Second Circuit.

Argued: Feb. 7, 2014.

Decided: May 19, 2014.

Andrew J. Frisch (Jeremy B. Sporn and Amanda L. Bassen, on the brief), The Law Offices of Andrew J. Frisch, New York, NY, (Jonathan A. Harris, Harris, O'Brien, St. Laurent & Houghteling LLP, New York, NY, on the brief), for Appellant.

Jeffrey A. Berger (Michael A. Conley and Jacob H. Stillman, on the brief), on behalf of Anne K. Small, General Counsel, Securities and Exchange Commission, Washington, D.C., for Appellee.

Before: JACOBS, CALABRESI and POOLER, Circuit Judges.

DENNIS JACOBS, Circuit Judge:

Frederick O'Meally, a broker, traded on his clients' behalf using a mutual-fund trading strategy known as market timing. While market timing is legal, doing it in a deceptive manner (like anything else in securities trading) is not. And many mutual funds have policies that forbid or discourage it. In this civil enforcement action, the Securities and Exchange Commission (“SEC”) alleged deceptive conduct by O'Meally with respect to trading in sixty mutual funds. Specifically, the complaint alleged that O'Meally failed to follow directives issued by the mutual funds and his employer (Prudential Securities) to cease his market timing, and that he used different “financial advisor numbers” when mutual funds blocked trading from the ones he customarily used. The jury found that O'Meally had engaged in no intentional misconduct; but that O'Meally violated Section 17 of the Securities Act of 1933, 15 U.S.C. § 77q, which has no scienter element, with respect to only six of the sixty mutual funds. On appeal, O'Meally argues that the district court erred by: 1) excluding certain evidence as irrelevant; 2) improperly instructing the jury on a good-faith defense; 3) denying his Rule 50 motion seeking judgment as a matter of law based on insufficiency of evidence; and 4) awarding disgorgement and pre-judgment interest. Because we rule on the ground of insufficiency, the other grounds are referenced only incidentally.

The SEC's trial strategy focused entirely on O'Meally acting intentionally. When the jury rejected all claims of intentional misconduct, the district court sustained the jury's verdict on the theory that O'Meally negligently failed to read and heed instructions from his supervisors; yet other theories are argued on appeal. Because the evidence was insufficient to support a verdict against O'Meally under a theory of negligence, we reverse.

BACKGROUND

O'Meally was a licensed broker who worked for Prudential Securities from 1994 to 2003. On behalf of his clients—money managers at hedge funds—O'Meally traded shares of mutual funds using market timing, which is a form of arbitrage. It “ ‘exploit[s] brief discrepancies between the stock prices used to calculate [a mutual fund's] shares' value once a day, and the prices at which those stocks are actually trading in the interim.” ’ SEC v. Ficken, 546 F.3d 45, 48 (1st Cir.2008) (quoting Kircher v. Putnam Funds Trust, 547 U.S. 633, 637 n. 4, 126 S.Ct. 2145, 165 L.Ed.2d 92 (2006)); see also In re Mut. Funds Inv. Litig., 529 F.3d 207, 210–11 (4th Cir.2008) (defining market timing as “mov[ing] in and out of the funds to take advantage of the temporary differentials between the mutual funds' daily-calculated ‘net asset value’ (‘NAV’) and the market price of the component stocks during the course of a day”). Because this strategy entails numerous short-term trades in a fund's shares, it can disadvantage long-term investors by: increasing the fund's transaction costs; impairing the fund's ability to maintain liquidity for share redemptions in the usual course; and limiting the fund's ability to invest in long-term assets. See In re Mut. Funds, 529 F.3d at 211;see also SEC v. Gann, 565 F.3d 932, 935 (5th Cir.2009).

Market timing is not illegal. But mutual funds often endeavor to curb this technique by restricting its use in the trading of their shares. See Gann, 565 F.3d at 934. Many fund prospectuses prohibit market timing, and a number of funds traded by O'Meally sought to halt the practice. Some funds identified transactions associated with O'Meally's financial advisor numbers (hereafter “FA numbers”) and proscribed future transactions using those numbers. Those funds sent O'Meally “block notices” to inform him of these restrictions. See id. at 935 (“A block notice typically informs the broker that he has run afoul of a fund's restrictions and bars specified accounts controlled by the broker from future trades.”). For its part, Prudential supported the funds' efforts with its own policy of compliance with the funds' restrictions.

O'Meally persisted in market timing on behalf of his clients over the objections of the funds and Prudential. When the funds blocked accounts associated with O'Meally, he continued to trade in them under new FA numbers and customer account numbers. These practices permitted O'Meally to mask his activity, and helped O'Meally become one of Prudential's top traders. During the relevant period of January 2001 to September 2003, O'Meally earned approximately $3.8 million from market timing transactions done on behalf of his clients.

The SEC initiated this civil enforcement proceeding against O'Meally and some of his colleagues. The SEC's complaint alleged that O'Meally violated: Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a); Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b); and SEC Rule 10b–5, 17 C.F.R. § 240.10b–5. The SEC's strategy at trial undertook to show that O'Meally knew the clear directives of the funds and his employer, and that he intentionally disregarded those directives, and adopted certain practices designed to conceal his role in such trading.

O'Meally introduced evidence demonstrating that the policies established by the funds were anything but clear due to their inconsistent application. For example, PIMCO Funds permitted at least one of O'Meally's clients to engage in market timing notwithstanding the restriction found in its fund prospectus. In other cases, a fund's salesperson negotiated with Prudential to allow market timing trades without the salesperson notifying the office responsible for enforcing the fund's restrictions. Some funds, despite expressing concerns about market timing, chose not to terminate trading with Prudential because of the size of its business. O'Meally also showed that the use of multiple FA numbers had legitimate purposes, such as sharing business-generation credit among brokers or allowing clients to track their trades without learning of investments by other Prudential clients.

Prudential's internal policy, according to one of its sales associates, was understood to honor a fund's demands only in the narrowest sense: if a block notice referenced a certain account, the notice was read to have no effect as to any other accounts affiliated with the blocked account. Those responsible for overseeing O'Meally's activities at Prudential—his supervisors, the compliance department, and the legal department—approved of his practices. And the firm invested in a computer system capable of processing O'Meally's strategy more efficiently.

O'Meally unsuccessfully tried to proffer evidence that, when the SEC and state attorneys general sued the funds, the settlement agreements recited findings that the funds permitted market timing in their annuity funds. The district court conditionally excluded that evidence as irrelevant, pending O'Meally's showing that the settlement agreements were connected with his own market timing (this proffer is the evidentiary ruling O'Meally has challenged on appeal).

At the close of evidence, O'Meally made a Rule 50 motion for judgment as a matter of law. O'Meally argued that the court should dismiss any claim by the SEC based on negligence because all of the SEC's evidence undertook to show intentional conduct, and no expert evidence was introduced to show an applicable standard of care. The court reserved decision until after the jury reached a verdict.

During deliberations, the jury sent a note to the court asking: “if good faith defense is found by preponderance of evidence, is that [a] complete defense to [the] SEC charges?” Trial Tr., App. at 509. The Court answered “no” and referred the jury to its initial instructions (this supplemental charge is the one O'Meally has challenged on appeal).

In a verdict delivered the next day, the jury found that O'Meally did not violate Section 10(b) of the Securities Exchange Act or Rule 10b–5. With respect to Section 17(a) of the Securities Act, the jury found that O'Meally was not liable for intentional or reckless conduct with respect to any of the sixty mutual funds referenced in the SEC's complaint. However, the jury found that O'Meally did violate Sections 17(a)(2) and (a)(3) by negligent conduct—though as to only six of the sixty mutual funds.¹

O'Meally renewed his Rule 50 motion challenging the sufficiency of evidence regarding negligence. The district court surmised that “[t]he jury's verdict ... might be premised on a finding that O'Meally acted negligently with regard to either [i] the specialized and technical aspects of his job or [ii] the common task of reading and heeding emails from a supervisor.” Memorandum Order, SEC v. O'Meally, No. 06 Civ. 6483, ECF No. 202 at 6 (S.D.N.Y. May 30, 2012). As to O'Meally's argument that negligence could not be established in this case absent expert testimony regarding the duty of care, the court ruled that the jury could have found O'Meally liable under the second form of negligence, which did not require expert testimony regarding the standard of care. Id. at 6–7. Thus, the verdict was ultimately sustained by the district court on the ground that O'Meally...