Millionaire Prudential Broker Dodges SEC Suit
(CN) - Securities regulators failed to allege wrongdoing with regard to the millions a former top Prudential Securities broker made from "market timing," the 2nd Circuit ruled.
As a licensed broker for Prudential, Frederick O'Meally traded on behalf of money managers at hedge funds using a mutual-fund strategy called market timing from 1994 to 2003.
The strategy exploits brief discrepancies between the stock prices used to calculate share values once daily and the prices at which those stocks are actually trading in the meantime.
Because the method, which is legal, entails many short-term trades, however, long-term investors suffer from increased transaction fees and difficulty maintaining liquidity and investing in long-term assets.
The Securities and Exchange Commission sued O'Meally and some colleagues years later, alleging that O'Meally traded in 60 funds that forbid market timing.
Regulators said O'Meally ignored orders from Prudential and the funds to stop market timing, and masked his activity when any funds blocked his efforts by switching up financial-adviser and customer-account numbers.
Market timing allegedly made O'Meally one of Prudential's top traders, as he earned about $3.8 million from January 2001 to September 2003 alone.
At trial, O'Meally introduced evidence showing that the funds' policies were unclear. One example O'Meally gave was that at least one PIMCO fund allowed market timing, despite a restriction in its prospectus, while others chose not to stop trading with Prudential because of the size of its business.
As for the multiple financial-adviser numbers, O'Meally said he used them to share business-generation credit with brokers or to let clients track their trades without accessing the trades of others. Prudential even invested in a computer system to better process his strategy, he said.
The jury rejected the SEC's claims of intentional misconduct, but found that O'Meally did violate certain sections of the Securities Exchange Act by negligent conduct as to six of the funds.
The Southern District of New York sustained the jury's verdict, and rejected O'Meally's argument that the SEC presented no expert evidence to show an applicable standard of care.
Faced with a $60,000 penalty and disgorgement of nearly $445,000 in fees he earned, plus prejudgment interest, O'Meally appealed. The 2nd Circuit in Manhattan reversed Monday, saying the case against O'Meally must be dismissed.
"Here, it cannot be said that expert testimony was necessary, or that what an expert could say would be useful," Judge Dennis Jacobs wrote for a three-judge panel. "The only evidence adduced was of deliberate acts that were carefully executed, profitable and legal. The SEC did not propose how O'Meally's conduct might have been sloppy or ill-calculated. Negligence was not referenced in the opening or closing arguments. It was first brought to the jury's attention in the charge itself--without useful guidance. Given the lawful nature of the trading technique, the absence of bad faith, the inconsistent practices, and the mixed signals from the funds (and Prudential), expert testimony could not have cured the central problem: the jury could not do more than speculate as to how a broker in O'Meally's position breached a standard of care (whatever it might be said to be)." (Parentheses in original.)
The court also tossed claims that O'Meally negligently strayed from Prudential's orders.
"While the firm's ostensible policy was to comply with the letters sent from the funds, it encouraged its traders to interpret such instructions in the narrowest sense, so that only the specific [financial advisor] FA and customer numbers expressed in the letters were to be blocked; and otherwise, it was business as usual," Jacobs wrote. "The SEC offered nothing to contradict this evidence, and produced no evidence that O'Meally continued to trade on the specific numbers in the block notices. Unsurprisingly, Prudential's legal and compliance teams - and O'Meally's supervisors - all approved of his practices. No reasonable juror could have found O'Meally liable under this theory."