Charged with misrepresenting prices on mortgage-backs that firm traded on "risk principal" basis.

[ by Howard Haykin ]

The SEC on Monday charged a former executive at Jefferies & Co., a NY-based broker-dealer, with defrauding investors while selling residential mortgage-backed securities ("RMBSs") in the wake of the financial crisis so he could generate additional revenue for his firm.  The SEC complaint, filed in federal court in Connecticut, accused Jesse Litvak with arranging trades for customers as part of his job as a managing director on the Jefferies MBS desk.

Profile of Defendant.   Jesse Litvak, 38, a resident of New York City, was associated with Jefferies & Co. from April 2008 to December 2011.  He was a managing director and a trader in Jefferies’ MBS group, working at the firm's Stamford, CT, offices.  As a senior MBS trader at Jefferies,
Litvak arranged trades between buyers and sellers of MBS's and purchased and sold securities for and out of Jefferies’ inventory. The MBS's consisted of both non-agency residential mortgage-backed securities (“RMBS's”) - those issued by non-government institutions - and commercial
mortgage-backed securities (“CMBS's”).  Investors in these securities receive payments from the interest and principal payments on the underlying mortgages.

SEC Findings and Allegations.     As a senior MBS trader for Jefferies, Litvak allegedly committed his misconduct from 2009 to 2011.   The securities he dealt with were illiquid securities, and many of the MBS's that Litvak traded had been discounted significantly since the 2007-2008 financial crisis.  The market for MBS's is opaque - and there is no exchange that shows the buy and sell price for each trade.  Therefore, the buyer of the MBS has no way of knowing or learning the actual price paid by the broker, unless the broker chooses to tell its customer (the truth). 

As an intermediary, Litvak generally purchased MBS from one customer and then sold the same security to another customer.  In those circumstances, Jefferies and Litvak typically were trading the MBS's a riskless, principal basis.  Litvak earned compensation for Jefferies by reselling the MBS's at a higher price and collecting the spread (or difference) between the purchase price and the sale price. The customers were aware that Jefferies was compensated in this way, and the amount and source of the compensation were part of the negotiations around the purchase and sale of the MBS.

By and large, Litvak's customers were funds that invested in MBS's - some of which were created by the U.S. government under a program designed to help strengthen the markets for MBS's during the financial crisis - e.g., Legacy Securities Public-Private Investment Program (“PPIP”) funds established by the U.S. government. Under PPIP, the U.S. Department of Treasury (“U.S. Treasury”) invested in funds advised by private sector fund managers for the purpose of purchasing “eligible assets,” typically debt securities that had been issued prior to 2009 and that had originally been given the highest ratings (such as AAA) by a rating agency.

Misconduct.   Through his alleged deceit, Litvak supposedly generated over $2.7 million in additional revenue for Jefferies.  This increased performance helped improve his own standing at the firm, and helped raised his annual bonuses.  he did so, essentially by misrepresenting the price at which Jefferies had purchased the MBS's before reselling it to the customer and Jefferies compensation for arranging the trade. 

• Litvak would buy an MBS from one customer, and sell it to another customer.
• On some occasions, Litvak to the buyer about the price at which his firm had bought the MBS, enabling him to re-sell the MBS to the other customer at a higher price;  the difference was firm profit.
• On other occasions, Litvak misled the buyer by purporting that he was matching a fictional seller's sell order to the buyer's order, even though, in reality, he was just selling the MBS out of his firm’s inventory at a higher price. 

SEC Charges.   The SEC’s complaint charges Litvak with violating the antifraud provisions of the federal securities laws, particularly Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5, and Section 17(a) of the Securities Act of 1933.

The U.S. Attorney’s Office for the District of Connecticut today announced criminal charges against Litvak.

SEC Staff Credits.   Investigation, which continues, by:  Kerry Dakin, James Goldman, Rachel Hershfang, Kevin Kelcourse of the Boston Regional Office.  Mr. Goldman is a member of Enforcement's Structured and New Products Unit, headed by Kenneth Lench.  SEC litigation will be led by Ms. Hershfang.

For further details, go to:   [SEC PR 13-12, 1/18/13], [SEC Complaint] and [Bloomberg, 1/28/13].