Securities and Exchange Commission v. Lek Securities Corporation et al
Filing
355
OPINION AND ORDER: The SEC's October 5, 2018 motion to exclude Begelman's testimony is granted. (Signed by Judge Denise L. Cote on 4/8/2019) (jca)
Case 1:17-cv-01789-DLC Document 355 Filed 04/08/19 Page 1 of 14
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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SECURITIES AND EXCHANGE COMMISSION,
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Plaintiff,
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-v:
:
LEK SECURITIES CORPORATION, SAMUEL
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LEK, VALI MANAGEMENT PARTNERS d/b/a
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AVALON FA, LTD., NATHAN FAYYER, and
:
SERGEY PUSTELNIK a/k/a SERGE
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PUSTELNIK,
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Defendants.
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:
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17cv1789 (DLC)
OPINION AND ORDER
APPEARANCES
For plaintiff Securities and Exchange Commission
David J. Gottesman
Olivia S. Choe
Sarah S. Nilson
U.S. Securities and 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
Case 1:17-cv-01789-DLC Document 355 Filed 04/08/19 Page 2 of 14
DENISE COTE, District Judge:
This Opinion addresses the motion of plaintiff U.S.
Securities and Exchange Commission (“SEC”) to exclude expert
testimony based on the report of Roger Begelman (“Begelman”),
offered by defendants Lek Securities Corporation (“Lek
Securities”) and Samuel Lek (“Lek; and together with Lek
Securities, the “Lek Defendants”).
For the following reasons,
the SEC’s motion is granted.
On March 10, 2017, the SEC sued the Lek Defendants, Avalon
FA Ltd. (“Avalon”), Nathan Fayyer, and Sergey Pustelnik
(together with Avalon and Fayyer, the “Avalon Defendants”),
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 brought claims for violations of several provisions
of the Securities Exchange Act of 1934 (the “Exchange Act”) and
the Securities Act of 1933 (the “Securities Act”).
The SEC’s
claims against the Lek Defendants are principally for aiding and
abetting the Avalon Defendants’ violations of Sections 10(b) and
9(a) of the Exchange Act and Section 17(a) of the Securities
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Act.
See SEC v. Lek Sec. Corp., 276 F. Supp. 3d 49, 57-58
(S.D.N.Y. 2017).
Following the close of discovery, on October 5, 2018, the
SEC moved to exclude Begelman as an expert at trial.
On October
5, the SEC also moved to exclude the testimony of four other
experts that the defendants intend to call as rebuttal expert
witnesses to the SEC’s experts, Terrance Hendershott and Neil
Pearson.
The Lek Defendants’ motions to exclude testimony by
Hendershott and Pearson, and the SEC’s motions to exclude
testimony from the four rebuttal expert witnesses offered by the
defendants were addressed in two recently filed Opinions.
See
SEC v. Lek Sec. Corp., No. 17cv1789(DLC), 2019 WL 1304452
(S.D.N.Y. Mar. 21, 2019) (the “March 21 Opinion”); SEC v. Lek
Sec. Corp., No. 17cv1789(DLC), 2019 WL 1198599 (S.D.N.Y. Mar.
14, 2019) (the “March 14 Opinion”).
A detailed recitation of the factual and procedural
background to this motion, including descriptions of the two
market manipulation schemes alleged by the SEC -- a layering
scheme and a Cross-Market Strategy -- is provided in the March
14 Opinion.
In brief, layering involves placing non-bona fide
limit orders on one side of the market in order to influence a
trader’s ability to execute favorable trades on the opposite
side of the market.
3.
See Lek Sec. Corp., 2019 WL 1198599, at *2-
The March 14 Opinion also describes the legal framework for
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addressing a Daubert motion.
Familiarity with the March 14
Opinion is assumed; it is incorporated by reference.
I. Summary of Begelman Report
Begelman’s expert report, dated March 16, 2018, purports to
evaluate Lek Securities’ compliance and surveillance practices
in light of industry standards.
The substance of the report is
divided into four sections.
In the first section, Begelman states that “[i]ndustry and
regulatory standards for the supervision and compliance
obligations on a broker-dealer, such as Lek [Securities], are
based on a reasonableness standard.”
He briefly describes Lek
Securities’ role as a broker-dealer and provides a few highlevel comments about Lek Securities’ compliance practices.
For
example, he notes that Lek Securities processed approximately 1
million orders per day.
He explains that, “like most modern
broker-dealers,” Lek Securities used both automated systems and
manual post-hoc reviews to support its compliance, supervision,
and surveillance efforts.
In the second section of the report, Begelman describes
what are, in his view, some of the difficulties that brokerdealers face when trying to surveil for manipulative layering in
the equities markets.
He provides three descriptions of
layering -- one from 2010 and two from 2012 -- from the
Financial Industry Regulatory Authority (“FINRA”) or the SEC.
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Begelman opines that the regulatory descriptions are inadequate;
he complains that broker-dealers “have received little guidance
from regulators concerning what constitutes layering and how to
detect it.”
To the extent regulators have provided guidance,
Begelman opines that such guidance would be difficult to
implement.
For example, he asserts that, because legitimate
strategies can involve trading on both sides of the market and
many market orders are cancelled, “simply looking for two-sided
markets that also involve cancelled orders would not be
particularly informative.”
He also asserts that, to the extent
layering turns on the intent of the trader, broker-dealers
“typically ha[ve] limited knowledge of a trading client’s
proprietary strategies.”
In the third section of the report, Begelman asserts that
“broker-dealers typically undertake an incremental process of
adjusting their compliance regime” in response to new types of
manipulative trading.
The remainder of the section then
provides a narrative description of times at which Lek
Securities adjusted configurations of its Q6 Layering Control
system, the surveillance system it used to detect market
manipulation.
For example, after Lek Securities first
implemented the Q6 Layering Control system on February 1, 2013,
Begelman explains that Lek Securities relaxed Avalon’s controls
at the “parent” level and implemented new controls at the “sub5
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account” level.
He asserts that such “revisions and updates to
compliance programs” are “common” in the securities industry.
He concludes that Avalon’s Q6 Layering Control system, together
with its back-end review of certain trading, were “consistent
with a compliance framework to prevent potential manipulative
trading.”
In the fourth section of his report, Begelman provides a
narrative of Lek Securities’ communications with various
regulators.
He describes several instances in which Lek
Securities requested guidance from regulators about how to
configure its controls to prevent layering.
He notes that while
Lek Securities continued to receive inquiries from regulators
regarding potentially manipulative trading within Avalon
accounts, Lek Securities received “no additional input from
FINRA or other exchanges as to what its settings [on the Q6
Layering Control system] should be.”
Begelman explains that
this “leads him to conclude” that Avalon’s settings were not in
conflict with regulators’ communications.
The fourth section of the report further describes Lek
Securities’ decision in 2016 and 2017 to implement a “new
restriction preventing a trader from entering more than 4 orders
on one side of the market at any time.”
Begelman explains that
Lek Securities implemented this control by utilizing newlyissued cross-market reports from FINRA.
6
He asserts that Lek
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Securities’ implementation of the new control was “precisely the
sort of action that a compliance department should undertake in
such circumstances.”
Begelman concludes that Lek Securities’
“compliance, surveillance, and risk controls were consistent
with the industry standard.”
II.
The Motion to Exclude
The SEC moves to exclude Begelman’s expert testimony.
The
SEC contends that Begelman is unqualified to provide the expert
opinions contained in his report.
It also contends that
Begelman’s report provides little more than a narrative of Lek
Securities’ compliance practices and that it is unhelpful to the
jury.
The SEC is correct and its motion is granted.
To testify as an expert witness, an individual must be
“qualified as an expert by knowledge, skill, experience,
training, or education.”
Fed. R. Evid. 702.
“To determine
whether a witness qualifies as an expert, courts compare the
area in which the witness has superior knowledge, education,
experience, or skill with the subject matter of the proffered
testimony.”
United States v. Tin Yat Chin, 371 F.3d 31, 40 (2d
Cir. 2004); see also Lek Sec. Corp., 2019 WL 1198599, at *13-14.
Moreover, to be admitted under Rule 702, expert testimony
must be relevant and rest on a reliable foundation.
Daubert v.
Merrell Dow Pharm., Inc., 509 U.S. 579, 597 (1993); United
States v. Williams, 506 F.3d 151, 160 (2d Cir. 2007).
7
An
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expert’s opinion is reliable if it has “a reliable basis in the
knowledge and experience of his discipline.”
at 592.
Daubert, 509 U.S.
An expert’s opinion is relevant if it will “help the
trier of fact to understand the evidence or to determine a fact
in issue.”
Fed. R. Evid. 702.
Expert testimony will be helpful
only if it assists the jury in “comprehending and deciding
issues beyond the understanding of a layperson.”
DiBella v.
Hopkins, 403 F.3d 102, 121 (2d Cir. 2005).
A.
Begelman Lacks Relevant Expertise
Begelman is unqualified to give an opinion about the
adequacy of a broker-dealer’s systems and procedures to detect
and prevent manipulative layering.
Begelman’s experience is
grounded in his work at a wholesale bank; he does not have
relevant experience at a broker-dealer.
As Begelman admitted in
his deposition, he has no experience related to the detection or
surveillance of layering in the equities markets.
Begelman has a Bachelor of Arts in political science from
the University of Vermont and a Juris Doctor from New York Law
School.
He worked as trial counsel for the New York Stock
Exchange from 1988 to 1993.
From 1993 to 2016, Begelman held
positions at Goldman Sachs.
From 1993 to 2008, he was the
Global Head of Control Rooms and Regulatory Reporting; he was
also the Co-Head of the Compliance Surveillance and Strategy
division.
From 2008 to 2016, he was the Co-Chief Compliance
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Officer of GS Bank USA -- the wholesale banking division of
Goldman Sachs.
None of these roles provided Begelman with
experience on the systems used by broker-dealers to detect and
prevent manipulative layering schemes in the equities markets.
Begelman’s experience at GS Bank USA in particular is
inapposite to his proffered testimony.
a broker-dealer.
A wholesale bank is not
The clients of GS Bank USA do not have direct
access to the equities markets through GS Bank USA.
The
regulations that govern GS Bank USA are different from those
that govern a broker-dealer.
While Begelman speculated at his
deposition that GS Bank USA “could have had or may or probably
had a manipulations surveillance,” he admitted that GS Bank USA
did not have surveillance designed to detect layering in the
equities markets.
To the extent GS Bank USA surveils for
“spoofing” or layering in other markets, Begelman acknowledged
that, aside from a five- to ten-minute conversation in 2010, he
had no personal involvement in the design or development of any
such surveillance system.
Begelman’s earlier experience is also insufficient to
qualify him as an expert in this case.
For example, Begelman
asserts he previously worked in divisions at Goldman Sachs that
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largely focused on Goldman Sach’s broker-dealer operations. 1
But
Begelman readily admits in his deposition that his work as
Global Head of Control Rooms and Regulatory Reporting did not
involve detection or surveillance for layering or spoofing in
the equities markets.
And while he asserted that the Compliance
Surveillance and Strategy division addressed spoofing and
layering issues, Begelman was unable to describe in his
deposition any parameters that Goldman Sachs used to detect or
surveil for layering, spoofing, or any other form of market
manipulation.
Likewise, Begelman could not remember whether his
experience at the New York Stock Exchange ever involved
evaluating whether broker-dealers had sufficient systems and
procedures to detect and prevent market manipulation.
Begelman appears to have taken no steps to remedy these
deficiencies in his experience.
As he admitted at his
deposition, Begelman did no research into how other brokerdealers surveil for market manipulation before concluding that
Lek Securities’ layering controls were “consistent with the
industry standard.”
broker-dealers.
He compiled no data; he did not contact any
Nor did Begelman develop an adequate
understanding of Lek Securities’ layering controls prior to
Begelman submitted a supplementary declaration on November 2,
2018 seeking to address deficiencies in his expertise that were
evident from his deposition testimony.
1
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rendering his opinion.
At his deposition, Begelman was unable
to understand or interpret the very documents that he cited in
his report which describe the specific layering controls Lek
Securities applied to particular Avalon sub-accounts.
Although
Begelman could not interpret during his deposition even a single
report of the controls utilized by Lek Securities’ Q6 Layering
Control system, he affirmed that he nonetheless “stand[s] by”
the description given in his report. 2
Begelman’s report is not grounded in data or statistics.
It is not supported by citations to peer-reviewed literature.
It is not based on a comparative study of other broker-dealers’
compliance practices.
The entire report is based on nothing
more than Begelman’s claim to expertise through experience.
Indeed, Begelman cites “[his] experience” as the sole basis for
the majority of the conclusions he offers in his report.
These
include his assertions that Lek Securities’ “compliance,
surveillance, and risk controls were consistent with the
industry standard,” that the Q6 Layering Control system was
implemented “in accordance with” regulatory guidance, and that
In the fourth section of his report, Begelman describes “depth
control” as a “new restriction” that Lek Securities developed in
or around 2016. In his deposition, however, Begelman displayed
significant ignorance of the way in which the “depth control”
feature operates. While not disqualifying, this ignorance is
just one more example of the fact that Begelman’s report does
not reflect any expert knowledge that he possesses.
2
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Lek Securities’ controls were “consistent with . . . [his]
expectations for an agent broker-dealer in surveilling for a
novel form of potential manipulative activity.”
experience provides no basis for this testimony.
Begelman’s
This
deficiency is so extreme that it may not addressed solely
through cross-examination.
Pursuant to the requirements of
Daubert and Rule 702, his report must be excluded because he is
not qualified as an expert in the areas in which he offers
opinions.
B.
Begelman’s Opinions Are Largely Inadmissible
Even if Begelman had relevant expertise, many of his
opinions would still be inadmissible.
The heart of Begelman’s
report is little more than a narrative of Lek Securities’
communications with regulators and its adjustments to the Q6
Layering Control system.
testimony.
This is not admissible expert
Business records and lay witnesses are the
appropriate vehicle for providing such historical evidence to
the jury.
Moreover, few of the issues Begelman addresses in his
report concern issues beyond the ken of a layperson.
A jury
does not need an expert’s assistance to understand when Lek
Securities received guidance from regulators and when it did
not.
As an additional example, Begelman asserts that “revisions
and updates to compliance programs . . . are common in the
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securities industry.”
Although Begelman has sufficient
expertise to draw this conclusion, it is tangential to the issue
of whether Lek Securities developed a sufficiently robust
compliance program.
Moreover, it is obvious and likely
undisputed that a corporation’s response to a new regulatory
issue will involve some calibration and adjustment.
It would
not help the jury for Begelman to alert it of this plainly
common phenomenon.
The SEC’s motion must be granted even though it would
likely be helpful to the jury to hear testimony from an expert
qualified in the design and implementation of broker-dealer
compliance systems.
Such testimony could, theoretically,
provide a description of the industry standard in developing
programs aimed at detecting and controlling for layering,
including by explaining in some detail the challenges faced by
broker-dealers in developing robust compliance systems and
describing with some specificity the features of systems that
broker-dealers commonly employ to detect and prevent layering.
It would likely have been helpful to have an expert compare the
components of Lek Securities’ layering controls to those of
well-regarded broker-dealers in the industry, mapping over time
how the industry responded to the emergence of manipulative
layering in the equities markets and how it upgraded and
improved its compliance programs in response to that improved
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understanding.
Testimony that placed Lek Securities’ compliance
programs in the context of the broker-dealer industry’s broader
compliance efforts could have assisted the jury in assessing the
soundness and rigor of Lek Securities’ programs and its good
faith in adopting them.
Begelman, however, does not -- and
could not -- provide this testimony.
For the reasons set forth
above, his opinions are excluded in their entirety.
Conclusion
The SEC’s October 5, 2018 motion to exclude Begelman’s
testimony is granted.
Dated:
New York, New York
April 8, 2019
________________________________
DENISE COTE
United States District Judge
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