U.S. appeals court appears receptive to bond trader's fraud appeal

By Jonathan Stempel

NEW YORK, May 13 (Reuters) - A federal appeals court on Wednesday signaled a willingness to overturn part or all of the conviction of a former Jefferies Group Inc trader accused of defrauding investors after the financial crisis by lying about mortgage bond prices.

In weighing Jesse Litvak's appeal in the closely watched case, the 2nd U.S. Circuit Court of Appeals in New York expressed discomfort at adopting a standard for fraud that could broadly limit how people transact on Wall Street, yet also not encourage investors and traders to seek unfair advantages.

Litvak, 40, was sentenced to two years in prison following his March 2014 conviction by a federal jury in New Haven, Connecticut of securities fraud and defrauding the Treasury Department's Troubled Asset Relief Program.

Prosecutors said Litvak's misrepresentations from 2009 to 2011 cheated customers, including participants in TARP's Public-Private Investment Program, helping boost Jefferies' profit by $2.25 million and his own pay, which he thought too low.

Assistant U.S. Attorney Jonathan Francis told a three-judge appeals court panel that while the government was not interested in "criminalizing making money," Litvak had crossed the line.

"This is a broker lying about facts to rip off his customers," Francis said. "Our hope going forward is that people would stop lying, about anything."

But the panel expressed concern about criminalizing too many alleged misrepresentations.

"We're dealing here with big boys," Circuit Judge Barrington Parker said. "I don't see what the limiting principle is in the government's position that would not criminalize the back and forth in how the market operates."

Parker and Circuit Judge Chester Straub also questioned whether the trial judge properly excluded defense testimony from a portfolio manager who was to discuss what investors who trade bonds think about.

Straub also said the Treasury Department did not appear to make specific decisions on or in response to Litvak's trades. The defense had said this would undermine Litvak's conviction for TARP fraud.

Litvak's lawyer Kannon Shanmugam told the panel that any misrepresentations by his client had no material impact because his investors would have known whether he was cheating them.

"This is not a situation in which a counterparty was entirely reliant on Mr. Litvak's word as to the value," he said.

Still, Circuit Judge Susan Carney said misrepresentations could matter to investors.

"It seems to me Mr. Litvak's misstatements," she said, "would affect the price that ultimately would be paid."

A decision by the 2nd Circuit could come this year, and the court has said the appeal raised "a substantial question of law or fact likely to result in reversal." Litvak, a married father of two, is free on bail.

The case could also determine the fate of bond trader Matthew Katke, who in March pleaded guilty to cheating customers at Royal Bank of Scotland Group Plc in a similar case. Katke may withdraw his plea if the 2nd Circuit voids Litvak's conviction.

Jefferies, a unit of Leucadia National Corp, in March 2014 entered a non-prosecution agreement and agreed to pay $25 million to end U.S. probes into its supervision of Litvak and other traders.

The case is Litvak v. U.S., 2nd U.S. Circuit Court of Appeals, No. 14-2902.

(Reporting by Jonathan Stempel in New York; Editing by David Ingram and Richard Chang)