The 2nd U.S. Circuit Court of Appeals in New York also ordered that Jesse Litvak, the former trader, be retried on some charges, despite a lack of evidence that his misstatements were material to the U.S. government.

Prosecutors said the government was a victim because some of Litvak's customers handled money for the U.S. Treasury Department's Troubled Asset Relief Program, and that his lies impeded efforts to restart the mortgage debt market.

Writing for a 3-0 appeals court panel, Circuit Judge Chester Straub also said the trial judge was wrong to exclude expert testimony on Litvak's behalf with regard to the securities fraud counts, and that this error was not harmless.

But he said "a rational jury could have found that Litvak's misrepresentations were material" to customers, and ordered a new trial on the 10 securities fraud counts.

The defendant was the first person charged under a 2009 law banning major fraud against the United States through TARP.

Tuesday's decision voids his conviction on one TARP fraud count and four counts of making false statements.

U.S. Attorney Deirdre Daly said she was "gratified" that the panel upheld the government's securities fraud theory, and that her office "will proceed with retrying" the securities fraud charges.

"Today's opinion affirms the government's ongoing efforts to investigate and prosecute fraud in the fixed-income markets," Daly said in a statement.

Kannon Shanmugam, a lawyer for Litvak, said: "We're very pleased with today's decision."

The decision could help lawyers representing defendants in two similar criminal cases brought by Daly's office.

On Sept. 8, Daly announced fraud and conspiracy charges against former Nomura Holdings Inc (>> Nomura Holdings, Inc.) traders Ross Shapiro, Michael Gramins and Tyler Peters for cheating their customers.

In the other case, bond trader Matthew Katke pleaded guilty in March to cheating customers at Royal Bank of Scotland Group Plc (>> Royal Bank of Scotland Group plc), but retained the right to withdraw his plea if the 2nd Circuit voided Litvak's conviction.

FRUSTRATING TREASURY NOT ENOUGH

Litvak had been free on bail while he appealed his March 2014 conviction and two-year prison term.

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

In voiding the TARP fraud conviction, Straub found a lack of evidence that Litvak's conduct was "reasonably capable of influencing a decision of the Treasury," even if it was relevant to that agency and frustrated its investment goals.

He also said Chief Judge Janet Hall of the New Haven, Connecticut, federal court, who oversaw Litvak's trial, erred in excluding testimony from Ram Willner, a portfolio manager.

Willner was to testify that investors who negotiate with bond traders like Litvak would widely consider statements from such traders "biased" and often misleading.

Straub said excluding Willner's testimony was unfair to Litvak by making it too hard to rebut testimony that his misstatements mattered to investors with whom he dealt.

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

Marc Mukasey, a lawyer for former Nomura trader Gramins, said: "The government's case has been gutted by the Second Circuit. It's heartening to know that the rule of law still prevails in these days of government overreach."

Lawyers for the other Nomura defendants did not immediately respond to requests for comment. Richard Albert, a lawyer for Katke, said he is reviewing the decision.

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 Dan Grebler)

By Jonathan Stempel