Bond trader could face nine years in prison in rare criminal prosecution

Jesse Litvak was ecstatic.

It was March 31, 2010, and the mortgage bond trader at Jefferies & Co. had just persuaded Michael Canter, head of securitized assets at from giant asset manager Alliance Bernstein, to bite on the purchase of millions of dollars in mortgage bonds.

Litvak messaged the good news to his boss, William Jennings and wrote that he misrepresented the prices Jefferies had paid for the bonds and could get Canter to pay even more.

“Boom!” replied Jennings.  

With another phone call and a couple of clicks on his computer, Litvak completed the $27 million sale, which earned him and Jefferies a $50,000 commission.

Or at least that’s what Canter thought.

Thanks to Litvak’s lies about the bond prices, which cost Jefferies less than he claimed, the actual commission was a whopping $650,000.

Litvak’s giddiness over that one sale would later came back to haunt him: The money that Alliance Bernstein used to buy the bonds came from U.S. taxpayers, bailout money approved by Congress in 2008 to help spur investment in mortgage bonds after the financial crisis.

After Canter learned of the subterfuge, Litvak, 39, was fired by Jefferies and charged in January 2013 with defrauding the federal government’s Troubled Asset Relief Program (TARP) — by misrepresenting bond prices to six firms using TARP funds to buy bonds — and stealing more than $6 million. He was found guilty of securities fraud on March 7 after a weeklong trial. His sentencing is scheduled for July 23 at the U.S. District Court in New Haven, Connecticut.

Jennings was also forced to resign from the company in February, though no charges have been filed against him.

If prosecutors get their way, Litvak, who denied the charges, could receive up to a nine-year prison sentence and pay a $5 million fine. The Securities and Exchange Commission (SEC) is preparing to smack him with civil penalties, which could include an additional $1 million in fines.

Jefferies & Co. agreed in March to pay $25 million in fines and restitution in a nonprosecution agreement with the U.S. attorney’s office and with the SEC.

Its success with the Litvak case has given the Justice Department a much needed shot in the arm amid criticism that it failed to criminally prosecute any of the high-ranking bank officials blamed for instigating the 2008 fiscal crisis that brought the country to its economic knees.

While Litvak, a managing director on the mortgage bond trading desk at Jefferies, would never be mistaken for any of the investment bankers who created the toxic subprime mortgage bonds that sparked the crisis, prosecutors said he is nevertheless a symbol of Wall Street’s immense greed.

They were quick to point out during his trial, for example, that Litvak earned more than $18 million in commissions during his four years at Jefferies, money that bought him, among other things, a Manhattan apartment and a six-bedroom home in the Hamptons.

“Jesse Litvak lied to his customers to boost profits,” said Assistant U.S. Attorney Jonathan Francis during the trial. “That is fraud, and that is a crime."

The probe has since widened to other brokers and banks, including JPMorgan Chase and the Royal Bank of Scotland, which placed several bond traders on leave while the banks’ leaders anxiously awaited further action by federal prosecutors, the SEC and a relatively new agency born from the fiscal crisis, the Office of Special Inspector General for the Troubled Asset Relief Program (SIGTARP).

Signed into law in October 2008 by then-President George W. Bush, TARP provided billions to prop up ailing firms such as AIG as well as to help banks resume lending and buy mortgage bonds at a time when few were being sold.

SIGTARP was created to police the TARP funds and investigate and prosecute white collar crime associated with the misuse of that money. 

It was to SIGTARP that the U.S. Treasury Department referred Alliance Bernstein’s Canter to after he called to report Litvak’s behavior. Unbeknownst to Litvak, Canter purchased the bonds with TARP money. 

Unlike other federal regulators, SIGTARP is a law enforcement agency that holds the same investigative power as the FBI. Since its creation, SIGTARP has been credited with recovering more than $5 billion in restitution to the government and to victims such as Alliance Bernstein, which received $2.2 million as part of an agreement with Jefferies.

The agency, along with the Department of Justice, has been criticized for failing to prosecute anyone else, something Litvak’s attorneys have questioned.

But SIGTARP has opened windows into the secretive world of mortgage bond trading, in which buyers and sellers are forced to trust the word of hundreds of traders like Jesse Litvak.

“It’s a very opaque business, and the whole market is built on it,” said Christopher Kennedy, a managing director at MountainView Capital.

During the trial, investigators produced transcripts of messages, or chats, that Litvak regularly conducted with other brokers and investors via his Bloomberg desktop terminal that laid bare his lies to his clients, often flattering them as if he were talking with old college buddies. 

While his defense attorneys argued that Litvak was merely playing an established Wall Street game with experienced investment professionals, the electronic trail revealed a culture at Jefferies in which lying about bond prices was accepted and even encouraged.

The same trail led investigators to the other banks, which were subsequently subpoenaed to produce chat and phone transcripts from their brokers. The ongoing investigation has led many Wall Street banks, including Deutsche Bank, Goldman Sachs and JPMorgan, to take action and warn their brokers against using chat rooms or, if they do, to refrain from writing or saying anything during recorded phone calls that could later be construed as a liability.

“It’s a different ballgame,” said Frank Pallotta, a former banker at Morgan Stanley and Goldman Sachs. “Given what happened to the country as a result of the financial crisis, including the loss of millions of homes and jobs, the public has zero tolerance for fraud, especially from Wall Street.”

While prosecutors maintain the Litvak case isn’t over and the investigation into other banks and brokers is continuing, other government agencies are trying to bring the hidden world of mortgage bond sales out into the public.

The Financial Industry Regulatory Authority is working on a plan to publish bond prices on its trade reporting and compliance engine (TRACE), which aside from mortgages, publishes the pricing of most other bond sales. And SEC Chairwoman Mary Jo White is using the Litvak case to ready her a plan to call for more transparency in the bond market.

A former U.S. attorney in New York who gained fame prosecuting organized crime, White said that she wants to bring mortgage bond pricing “out of the shadows” and is proposing the creation of a database that, like TRACE, would require brokers to report their trades. The plan is in its infancy, but her argument is simple: Litvak’s fraud never would have occurred if investors had access to the real bond prices. (Canter discovered he had been duped 18 months after buying the bonds when an associate of Litvak’s inadvertently emailed Canter the actual bond prices.)

As for Litvak, his supporters have sent hundreds of letters in an attempt to lobby U.S. District Judge Janet C. Hall to ignore prosecutor’s calls for a nine-year sentence and agree to the 14-month prison sentence sought by his attorneys. Many cite Litvak’s middle-class Colorado upbringing, his education at Emory University and the fact that he has two young children, one of whom is a special-needs child.

Prosecutors remain unmoved.

“Litvak’s offenses were born of greed, arrogance and a disdain for traditional notions of honesty and fair play,” wrote U.S. Attorney Dierdre M. Daly in her July 8 sentencing memorandum. “[The court] should impose a sentence that reflects the predatory nature, the life of privilege and opportunity that he squandered by committing them and the vital need to deter similar behavior in an industry where, according to the defense, broker-dealers have turned fraud into business as usual.”