NYSE Specialist Convictons Reversed

July 30, 2008

In a stunning rebuke, the United States Court of Appeals for the Second Circuit reversed the January 25, 2007 securities fraud convictions of former NYSE specialists Michael Joseph Hayward and Michael Stern (United States District Court for the Southern District of New York). The Defendants were charged with illegally trading their firm's proprietary accounts at a time when the government alleged they were obligated to match buy and sell orders as required by NYSE Rule 92(a)(which prohibitrs proprietary trading by specialists when in possesion of knowledge that a particular unexecuted customer order could be executed at the same price).

The prosecution's theory was that the conduct described above violated Section 10(b) of the '34 Act in that it was a "manipulative or deceptive device" in connection with purchase or sale of a publicly traded security. However, since the prosecution conceded that the conduct was not "manipulative," the sole issue at trial and on appeal was whether the proprietary trading was "deceptive."

The appellate court cited its prior ruling in United States v. Finnerty, No. 07-1104, 2008 WL 2778830, at * 1 (2d Cir. July 18,2008): "'deception' . . . irreducibly entails some act that gives the victim a false impression," but the Government "identified no way in which Finnerty communicated anything to his customers, let alone anything false." The appellate court found little in the cases against Hayward and Stern beyond mere violations of NYSE Rules.

In following the trajectory of this case, this author never understood how a violation of that NYSE rule rose to the level of criminal misconduct. Putting aside the ethics of such trading and even conceding that some NYSE rule was violated, far more is needed to remove this conduct from the provincial realm of a self-regulatory organization and launch it into the stratosphere of criminal misconduct. One of the problems with prosecutors sending a message through bully tactics is that the message may get lost in the mail and returned to sender. Such was the case here -- and the message came back with postage due.

A copy of the decision can be read here at: http://rrbdlaw.com/images/2cirNYSE.pdf