Former brokers at Merrill Lynch, Citigroup and Lehman Brothers Holdings Inc. won a reversal of their convictions for tipping day traders to confidential data on their internal "squawk boxes," after an appeals court said prosecutors withheld critical evidence.
The U.S. Court of Appeals said prosecutors in Brooklyn, New York, failed to disclose until after the trial 30 deposition transcripts taken by the U.S. Securities and Exchange Commission, some of which would have supported the defense of ex-Merrill Lynch broker Kenneth Mahaffy Jr. and others.
Such "violations obscure a trial's truth-seeking function and, in so doing, place criminal defendants at an unfair advantage," a three-judge panel wrote today in ruling that prosecutors violated a legal duty to turn over exculpatory information.
It's unclear whether prosecutors will seek to retry the defendants, who were convicted at a 2009 trial of conspiracy after their first trial ended in hung jury on that count. The first trial, in 2007, resulted in an acquittal on the other 38 counts.
"In light of the government's mishandling of material exculpatory and impeaching material, we wonder whether the government will choose to subject the defendants to yet a third trial," the New York-based appeals court said.
Robert Nardoza, a spokesman for U.S. Attorney Loretta Lynch in Brooklyn, said prosecutors will review the ruling and consider options. Prosecutors have previously called information in the transcripts irrelevant.
Andrew J. Frisch, an attorney for Mahaffy who discovered the SEC transcripts four days after his client was sentenced to two years in prison, said he was "ecstatic" with the decision.
Mahaffy, who remained free pending the appeal, was prosecuted "for a benign practice historically condoned and encouraged by the industry," Frisch said in a statement.
Mahaffy was one of three brokers convicted of conspiring to sell day traders access to internal squawk boxes, which brokers used to discuss pending trades by their banks. Three former day- trading executives at New York-based A.B. Watley Group Inc. were also convicted. Their convictions were reversed as well.
Prosecutors argued at the trial that the brokers helped the Watley traders engage in "front-running" by holding their phone receivers up to their squawk boxes and transmitting the squawks. This allowed the Watley traders to buy and sell shares at more attractive prices than would have been available once the squawked orders were executed.
In return, Watley placed "wash trades" with the brokerages, buying and selling the same security at the same price and paying commissions to the brokers, prosecutors said.
The defense argued at the trials that the information broadcast wasn't confidential. The SEC transcripts, in which brokerage officials testified that the squawked information wasn't confidential, backed the defense, the appeals court said.
"The withheld SEC testimony strongly suggests that the brokerage firms did not treat squawked block order information as confidential," the court said.
Separately, the panel found that the lower-court judge didn't properly instruct the jury on the law.
"There were many SEC deposition testimony transcripts that were directly related to the issues at trial that should have been disclosed and weren't," Susan Wolfe, a lawyer for David Ghysels Jr., who worked at now-bankrupt Lehman Brothers, said in an interview.
Yuangchung Lee, the attorney for Timothy O'Connell, who worked at Merrill Lynch, didn't immediately return a call for comment on the ruling. Merrill Lynch is now a unit of Bank of America Corp.
Mahaffy worked at Merrill Lynch and Citigroup's Smith Barney unit.
Also winning a reversal were Robert Malin, the former president of Watley; Keevin Leonard, who was a supervisor of proprietary trading there; and Linus Nwaigwe, a former Watley compliance director. Each was sentenced to prison.
John Nester, an SEC spokesman, didn't immediately return a call seeking comment.
The case is U.S. v. Mahaffy, 09-cr-5349, U.S. Court of Appeals for the Second Circuit (New York).
By David Glovin and Christie Smythe