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Kenneth Mahaffy

Other New York Federal Exonerations
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In August 2005, a federal grand jury indicted six stock traders on conspiracy and fraud charges, accusing them of agreeing to share confidential information to make profitable trades.

The indictment named Kenneth Mahaffy and Timothy O’Connell, of Merrill Lynch; David Ghysels, Jr., of Lehman Brothers; and Robert Malin, Linus Nwaigwe, and Keevin Leonard of A.B. Watley, a day trading firm.

According to the charges, Merrill Lynch and Lehman had internal communication systems with devices known as “squawk boxes.” During the day, traders transmitted internal communications (known as squawks) that included pending client orders for specific blocks of particular securities, but did not disclose client names.

The purpose of exchanging the information via the squawk boxes was to find a fellow broker with a client who would take up the other side of the trade so that the firm could make commissions on both ends of the transaction and not expose the trades to external market fluctuations.

The indictment alleged that Mahaffy, O’Connell, and Ghysels placed telephone receivers next to the squawk boxes. These open lines were connected to traders at Watley, who could hear the proposed trades. Then, according to the indictment, traders at Watley placed trades of their own in anticipation of the trades being executed at Merrill Lynch and Lehman.

Through this practice, known as “frontrunning,” Watley traders got more attractive prices for trades they executed for themselves than the trades executed at Merrill Lynch and Lehman. The indictment alleged that if a Watley trader learned that a Lehman customer was intending to make a large purchase of a particular stock—large enough that the price of the stock would rise—the Watley trader bought shares of that stock prior to the Lehman customer purchase and then, after the stock price rose, cashed in for a profit.

The prosecution contended that the conspiracy flourished due to the use of confidential information that was transmitted through the squawks to Watley.

In 2007, the defendants went to trial in U.S. District Court for the Eastern District of New York in Brooklyn. Numerous employees of the all three firms testified and described how the transactions occurred. Several employees of the stock brokerages testified that the information transmitted over the squawk boxes was confidential.

The defense sought to show that the information was not confidential. On cross-examination, the defense elicited testimony that the firms did not train brokers on proper use of squawks or client order information in general. The firms lacked policies that specifically addressed how squawks should be treated or that expressly delineated squawked information as confidential. Defense evidence showed that the squawks were broadcast throughout firm offices including to non-employee visitors and that brokerage supervisors were aware that the defendants were transmitting squawks outside of the offices.

In May 2007, the jury acquitted the defendants of 38 of 39 counts but was unable to reach a unanimous verdict on the remaining count of conspiring to commit securities fraud. The judge declared a mistrial and the defendants went to trial a second time in 2009.

On April 22, 2009, after two days of deliberation following a three-week retrial, the jury reported that it was unable to reach a unanimous verdict. The trial judge urged the jury to continue deliberating and a day later, it convicted the defendants of conspiring to commit securities fraud. Malin was sentenced to four years in prison, Leonard was sentenced to two years and 10 months in prison, and Mahaffy was sentenced to two years in prison. O’Connell, Nwaigwe and Ghysels were sentenced to probation.

While the convictions were being appealed, the U.S. Securities and Exchange Commission began administrative proceedings against Mahaffy. In December 2009 and January 2010, 30 investigative depositions, taken as early as December 2004, were turned over to Mahaffy’s defense lawyers. After examining the depositions, all six defendants filed a motion for a new trial contending that the deposition witnesses testified that the squawked information was in fact not confidential—contrary to what those same witnesses had testified to at the trials.

The trial judge, although critical of the prosecution for failing to disclose the information, denied the motion for a new trial and concluded that the jury still would have convicted the defendants even if the concealed information had been presented.

In August 2012, the Second Circuit U.S. Court of Appeals vacated the convictions of all six defendants and ordered a new trial. The appeals court found that the depositions contained sworn testimony that the information transmitted on the squawk boxes was not confidential.

The court pointed to emails exchanged by prosecutors. Several weeks before the first trial, Sandeep Satwalekar, the primary SEC staff attorney investigating the case who conducted almost all of the SEC depositions and who was cross-designated as a special Assistant U.S. Attorney and sat at the prosecution table during the trial, “emailed two of his colleagues on the trial team, (Assistant U.S. Attorneys) Michael Asaro, the lead prosecutor, and Sean Casey, the Deputy Chief of the Business and Securities Fraud Unit. He specifically cautioned them that portions of at least one of the deposition transcripts contained “possible evidence that should be turned over to the defense” under the rule based on the U.S. Supreme Court case of Brady v. Maryland, which requires disclosure of exculpatory evidence to the defense.

“This is the last time I will bring this possible Brady issue up, but look over this excerpt when you get a chance. Tell me whether this requires some disclosure to defense counsel,” the email said.

The appeals court said that the prosecutors in the first trial knew of the 30 transcripts and chose not to disclose them and that a different team of prosecutors at the second trial also knew about the transcripts and chose not to disclose them, opting to rely upon the decision of the prosecutors at the first trial.

The depositions contained “sworn SEC testimony from senior members of the brokerage firms that squawked information was not confidential or treated as such,” the court said.

The court noted that after the first trial ended with 38 counts of acquittal and a hung jury on a single securities fraud conspiracy count, and the jury in the second trial convicted only after being temporarily deadlocked. “We have little confidence,” the court said, “that the result would have been the same had the government complied with its…obligations and disclosed the SEC transcripts.”

“In light of the government’s mishandling of material exculpatory and impeaching material, we wonder whether the government will choose to subject the defendants to yet a third trial,” the court said.

In fact, there was no third trial. The prosecution entered into deferred prosecution agreements of varying lengths—from several months to several years—under which the charges would be dismissed if the time passed and the defendants were not arrested or charged with other misconduct.

O’Connell completed his term in September 2013, and the charge against him was dismissed in December 2013. Ghysels completed his term in December 2013, and the charge against him was dismissed on January 17, 2014. Nwaigwe completed his term in February 2015, and the charge against him was dismissed on February 17, 2015. Leonard completed his term in March 2016, and the charge against him was dismissed. Mahaffy completed his agreement in March 2017. Malin’s agreement expires in March 2018.

– Maurice Possley

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Posting Date: 4/28/2017
State:Fed-NY
County:(Eastern)
Most Serious Crime:Fraud
Additional Convictions:
Reported Crime Date:2003
Convicted:2009
Exonerated:2017
Sentence:2 years
Race:Caucasian
Sex:Male
Age at the date of crime:47
Contributing Factors:Perjury or False Accusation, Official Misconduct
Did DNA evidence contribute to the exoneration?:No