Litvak was accused of defrauding investors of US$2 million by misrepresenting how much sellers were asking for the securities, or what customers would pay, and keeping the difference for Jefferies. George Canellos, former deputy director of the U.S. Securities and Exchange Commission (SEC), said after Litvak was arrested in January 2013 that his claims were "unfit for a used-car lot."

"The government prosecuted Mr. Litvak for conduct that was not a crime," his lawyers said in the filing. "As a matter of law, Mr. Litvak's statements in the course of negotiations were immaterial, and Mr. Litvak did not possess the requisite intent because there was no evidence that he contemplated harm to the counterparties."

Even as Litvak challenges his conviction, the U.S. is building potential securities-fraud cases against more mortgage-bond traders using his case as a model, according to two people with knowledge of the investigations. No decisions have been made on timing, said the people, who asked not to be named because the investigation is confidential.

More Traders

The government has been looking into the activities of as many as 10 traders who worked at banks including JPMorgan Chase & Co., Royal Bank of Scotland Group Plc, and Morgan Stanley, one of the people said.

Litvak is the first person to be convicted of fraud tied to the Public-Private Investment Program, an initiative that used funds from the Troubled Asset Relief Program bailout to spur investments in mortgage-backed securities after the 2008 financial crisis.

The case raised questions about how much trickery is allowed in trading, as witnesses at his trial testified that his tactics were common.

The appeals court last month granted Litvak bail while he challenges his conviction, saying he raised "substantial" questions of law and fact that are "likely to result" in a reversal.

Litvak was found guilty of securities fraud and making false statements, as well as fraud connected to the Troubled Asset Relief Program. Along with his prison sentence, he was ordered to pay a $1.75 million fine. He had been scheduled to report to prison Nov. 5 to begin serving a two-year sentence when the appeals court granted bail.

The U.S. last month dropped a request for Litvak to pay restitution, saying his victims will be compensated through settlements with Jefferies, which agreed in January to pay $25 million to settle U.S. probes of suspected abuses in the trading of mortgage-backed securities.

Thomas Carson, a spokesman for the U.S. Attorney's Office in New Haven, declined to comment on yesterday's filing.

Litvak wasn't required to disclose Jefferies' profit on a transaction as the firm was a "principal" acting for its own account, buying bonds and selling them at a higher cost, and wasn't an agent acting for a customer's account, his lawyers said in the brief.

"Under industry guidelines, Jefferies could make undisclosed profits of as much as 10 percent for the bonds in the relevant non-inventory trades," according to Litvak's brief. "Jefferies deemed a markup of 4 percent or less to be acceptable without requiring justification to a supervisor, and the markup on each of Mr. Litvak's non-inventory trades was less than 4 percent."

Litvak didn't dispute that he made misstatements, arguing at trial that they weren't material and he didn't think the other parties in the transactions would be harmed because he was selling the bonds at "fully disclosed and agreed upon fair prices" that stayed below Jefferies' threshold for 4 percent profit.

'Broad Swath'

His attorneys argued that Hall excluded a "broad swath" of evidence as irrelevant, including testimony from a former portfolio manager and the former general counsel of the Financial Industry Regulatory Authority, as well as proof that many of the alleged victims profited substantially from the trades.

To prove that Litvak's statements were material, the government was required to show that a reasonable investor would consider omissions or misrepresentations important factors in making a decision to invest, his lawyers said.

Prosecutors' arguments that Litvak's misstatements were material because the other parties would have negotiated harder if they had known Jefferies' real profit "would raise the specter of criminal liability for commonplace conduct in negotiations," his lawyers said.

Under this theory, "garden-variety statements that people make daily in negotiations—that they are not authorized to transact at a higher price, that they need the price to be lower to meet their target, and so on—could support felony charges," Litvak's lawyers said.

"Every car salesman who tells a customer that he cannot lower his price any further because he would earn only a minuscule profit on the sale as it is would be guilty of fraud," Litvak's lawyers said. "All manner of misrepresentations—whether about a trader's monthly quota, about the time pressure on a deal, or about a shared love of a sports team—would qualify."

The government also didn't prove that Litvak intended to defraud the other parties in the negotiations, and Hall didn't inform the jury it needed to find that he "contemplated harm" in order to convict him of securities fraud, his lawyers argued.

The case is U.S. v. Litvak, 13-cr-00019, U.S. District Court, District of Connecticut (New Haven). The appeal is U.S. v. Litvak, 14-2902, U.S. Court of Appeals for the Second Circuit (Manhattan).

–With assistance from Matt Robinson, Jody Shenn and Keri Geiger in New York.

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