The Expert's Examiner


SEC v. LEK SECURITIES CORP., No. 1:17-cv-01789 (S.D. N.Y., 3/14/19)
April 9, 2019

Analyzing the proffered testimony of five experts and weighing the reliability and relevance factors laid out in Daubert, the Court rules on motions to disqualify and motions in limine. The SEC brought this enforcement action in March 2017 against the Lek Defendants and the Avalon Defendants. The Avalon Defendants are accused of manipulating the securities market through trading conducted at Lek Securities. Avalon is a foreign-based day trading outfit with traders "largely based in Eastern Europe and Asia." The Court has previously enjoined the Avalon Defendants and denied a motion to dismiss by the Lek Defendants. Pending before the Court are summary judgment motions and cross-motions to exclude expert testimony; in this Opinion, the Court deals with the latter set of motions.

The SEC's first expert witness, Terrence Hendershott, analyzes limit orders, cancellations, and executions made by the Avalon traders over a six-year period for evidence of "layering." Layering concerns the placement of "visible limit orders" that are intended, not for execution, but to create the appearance of activity in the market and to influence the orders of other investors. Expert Hendershott first isolated those layering "loops" that met certain reliability standards and then tested them further with a Cancellation Analysis, Position Analysis, NBBO Movement Analysis, and Realized Spread Analysis.

Defendants' expert, David J. Ross, reminds the Court that specific manipulative intent is required for a 1934 Act violation and that Mr. Hendershott's data only identifies patterns in the aggregate, not in any particular layering loop. His conclusions are also "suspect," because the applied ratios behind his conclusions are arbitrary and unsupported by authority. Mr. Ross further cites a FINRA oversight report that found far fewer suspect loops, thus indicating that the Hendershott methodology is "flawed." The defense also proffers the expert report of Alan Grigoletto, who uses the Ross data findings to form his opinions about the Hendershott report. He also defends the masking of one's trading intentions as quite natural in competitive markets.

Defendants also offer Haim Bodek in rebuttal to the SEC's Hendershott. The Court terms Mr. Bodek's report "difficult to understand" plus it purports to opine on the law. He also contends, from his analysis of the Avalon trading, that it follows a mix of subtle trading strategies (exploratory trading, market impact, scalping, and quasi-market making), designed to inform liquidity and timing decisions, thus enabling Avalon to take "speculative positions at sensible price points."

The SEC's second expert witness, Neil Pearson, analyzed two data sets for evidence of cross-market trading strategies, whereby traders manipulate stock prices in order to profit from the artificial impact on the price of the option derivative. Expert Pearson first defined the trading "loops" or patterns that could be suspect -- which constituted 95% of Avalon's options trading -- and then narrowed the criteria to develop reliable examples of the cross-market trading strategy. To that group of 636 loops, he applied seven further analyses to assure consistency with the cross-market strategy.

Experts Ross, Grigoletto, and Bodek all proffered testimony discrediting the Pearson analyses. The Court describes those in detail and then discusses, in turn, the relevance and reliability of the five experts' expected testimony. Ultimately, the Court rejects the challenges to the SEC experts, Hendershott and Pearson. Experts Ross, Grigoletto, and Bodek, are either fully disqualified (Bodek) or permitted to testify only in very limited fashion.

 (ed: *This is a marvelous, albeit lengthy, examination of conflicting and opposing expert testimony on a complex trading matter and an in-depth analysis of the criteria a court applies in weighing the admissibility of expert testimony. Judge Cote's understanding of the securities markets and her ability to present (and clearly comprehend) the trading strategies and the expert analyses at issue informs her analyses impressively. **The role of the expert in presenting a manipulation case, especially to a jury, is   pivotal. That Avalon-Lek have struck out on virtually all three of their experts bodes ill for their chances at trial.)

Download opinion