By Dan Ivers
Law360, New York (May 19, 2014, 12:52 PM ET) — The Second Circuit on Monday reversed a negligence verdict against a former Prudential Securities Inc. broker in a case brought by the U.S. Securities and Exchange Commission, saying the evidence used to find him guilty of intentionally engaging in illegal market activity was insufficient.
The three-judge panel found that Frederick O’Meally could not be liable for negligence claims related to his participation in market timing — which involves the frequent buying and selling shares of the same mutual fund to exploit perceived inefficiencies in their pricing — because while the practice is technically against Prudential policy, the company often made exceptions to the rules.
“As the SEC points out, no exception was made specifically for O’Meally; but our focus is on the reasonableness of O’Meally’s conduct, and if the funds were making exceptions for others, it was not unreasonable for O’Meally to believe he could engage in market timing as well,” the ruling said.
The panel also noted that Prudential’s own compliance and legal departments approved O’Meally’s activity on more than one occasion, striking a crucial blow to the SEC’s argument that he had acted in bad faith.
In asking the appeals court for a reversal, O’Meally asserted that since the SEC built its case solely around accusations of intentional fraud, the jury was not entitled to decide whether there was any negligent deviation from the industry standard of due care.
While a jury found him liable only on negligence and only with respect to six of the 60 mutual funds he traded in, he was ordered to disgorge $444,000 and pay a $60,000 fine. The jury rejected arguments from the SEC that alleged he had committed fraud by engaging in market timing.
While not necessarily illegal, mutual funds often prohibit the practice because it can dilute investors’ shares. Along with three other Prudential brokers, the SEC alleged that O’Meally persisted in market timing for his hedge fund clients even after the mutual funds he traded in demanded he stop.
He then allegedly masked the transactions by opening large numbers of new accounts with dozens of broker identification numbers, the SEC claimed, inducing the mutual funds to process trades they wanted no part of.
A former senior vice president at Prudential who was among its top 10 brokers, O’Meally was the only one of the four SEC targets not to settle.
Andrew J. Frisch, an attorney for O’Malley, said the decision was vindication after more than a decade of fighting for his client.
“Fred cannot get back the 11 years trying to prove that what he did was appropriate, but he goes forward from today knowing that he was right,” he said.
SEC spokesperson Christina D’Amico said the agency was reviewing the decision.
U.S. Circuit Judges Dennis Jacobs, Guido Calabresi and Rosemary S. Pooler sat on the panel for the Second Circuit.
O’Meally is represented by Andrew J. Frisch, Jeremy B. Sporn and Amanda L. Bassen of the Law Offices of Andrew J. Frisch and Jonathan A. Harris of Harris O’Brien St. Laurent & Chaudhry LLP.
The SEC is represented by Jeffrey A. Berger, Michael A. Conley and Jacob H. Stillman, on behalf of SEC general counsel Anne K. Small.
The case is U.S. Securities and Exchange Commission v. O’Meally, case number 13-1116, in the U.S. Court of Appeals for the Second Circuit.
–Additional reporting by Andrew Scurria. Editing by Katherine Rautenberg.