Bringing Sentencing Sanity to Operation Malicious Mortgage

Credits against “loss” include: 1) the “fair market value” of property returned or services rendered to victims before the offense was detected or the defendant should have known it was about to be; and 2) amounts victims recover from selling collateral or its fair market value at sentencing. See, e.g., United States v. Weidner, 437 F.3d 1023, 1047-48 (10th Cir. 2006) (error to calculate intended loss without considering value of collateral pledged to secure increased line of credit); United States v. Williams, 292 F.3d 681, 686 (10th Cir. 2002) (“[W]e have upheld a finding of intended loss of an entire loan amount where ' the defendant intended to permanently deprive the lender of security by concealing pledged collateral ' Nevertheless, '[t]he security of [a] loan is a valid consideration in evaluating a defendant's realistic intent and the probability of inflicting loss.'”). In a Ponzi scheme, however, one victim's gains do not offset the losses of another.

Loss Calculation

The Guidelines provide some guidance, but “do not present a single universal method of loss calculation ' nor could they, given the fact-intensive and individualized nature of the inquiry.” United States v. Zolp, 479 F.3d 715, 718 (9th Cir. 2007). The Ninth Circuit's ruling in United States v. Crandall, 525 F.3d 907, 912 (9th Cir. 2008) may be useful in OMM cases because it emphasizes that ' 2B1.1 should not be “applied mechanically” and endorses a “realistic, economic approach to determine what losses the defendant truly caused or intended to cause.” In Crandall, where victims purchased illegally converted condominiums, the sentencing court erred by not reducing “loss” by the value of the properties, because it was “improbable from a realistic, economic perspective that the 'condominiums' had no value to the victims ' even though the units may have been difficult or impossible to resell.” See also United States v. Leonard, 529 F.3d 83, 92-93 (2d Cir. 2008) (error not to reduce “loss” by investments' value, even if victims would not have purchased them but for fraud and there was no ready resale market). The court posited several possible ways to calculate loss in real estate frauds: a “fair market appraisal” to determine actual loss, the “cost of repair” where properties can be brought up to par, and “gain” ' defendants' gain over their outlay. Crandall, 525 F.2d at 914.

'Volatile Nature'

The Crandall court also commented on the “volatile nature of the real estate market,” which it characterized as “wholly independent of Defendants' culpability.” While this did not help the defendants ' they were denied the benefit of the properties' eventual appreciation ' the implication that a defendant is not responsible for market swings could be useful in OMM sentencings. Where victims' losses reflect a market decline or other intervening factors, the full extent of losses may exceed what was “reasonably foreseeable,” or the client's actual intent, at the time of the fraudulent conduct. See United States v. Confredo, 528 F.3d 143 (2d Cir. 2008) (defendant entitled to show he subjectively intended less loss than aggregate face amount of fraudulent loan applications); United States v. Rutkoske, 506 F.3d 170 (2d Cir. 2007) (court must consider factors other than fraud that might have contributed to stock price decline when determining loss), cert. denied, 128 S. Ct. 2488 (2008); United States v. Olis, 429 F.3d 540, 545 (5th Cir. 2005) (defendant responsible only for losses caused directly by offense conduct).

Foresight or Intent

How is reasonable foresight or intent established in hindsight? One key may be the historic performance of the relevant market. If history is a guide, the full extent of today's real estate foundering was not “reasonably foreseeable” in many areas. In some of the FBI's “top 10″ states, home prices were on a long-term upswing before late-2005, or even later. The rate of decline in national residential real estate prices for the First Quarter of 2008 was the highest in 20 years, and the foreclosure rate on sub-prime loans had decreased continuously between late-2001 and early-2005. Local unemployment rates may have been unforeseeable given historic or proximate trends in an area.

Some mortgage scam players thought everyone would profit, or reasonably underestimated the losses that occurred in the wake of falling home values and escalating default rates. While a witting participant in a double mortgage fraud will be tagged with at least the face value of second mortgages, was the full extent of first mortgagees' losses reasonably foreseeable given the contemporaneous value of the collateral? A Detroit borrower who exaggerated income reasonably might not have foreseen being laid-off and defaulting; there may have been little reasonably foreseeable loss from inflating Florida appraisals given the historic trend of home prices in the Sunshine State; an underwriter in most OMM hot spots reasonably might have failed to appreciate the full risk of approving unqualified buyers given the unprecedented recent leap in default rates.

A regional real estate or lending expert may validate the reasonableness of rosy expectations or the unforseeability of actual losses. Would regional statistics support the reasonableness of a client's belief that real estate would always be profitable, or underestimation of the riskiness of loans? Building on applicable data, the defense may credibly argue that a client's sentence should not be based on the portion of victims' losses that was not reasonably foreseeable or intended at the time of an offense under ' 2B1.1, cmt. n. 3(A). See also Id., cmt. n. 19(C) (departure where offense level “under this guideline substantially overstates the seriousness of the offense”).

OMM defendants may be threatened with many Guideline upward adjustments, including multiple/vulnerable victims, mass-marketing, derivation of more than $1 million from a financial institution, sophisticated means, abuse of a position or trust or use of special skill, and aggravating role. Are these largely duplicative on the facts? See United States v. Williams, 527 F.3d 1235, 1251-52 (11th Cir. 2008) (abuse-of-trust adjustment applicable only where “victim placed a special trust in the defendant beyond [the] ordinary reliance on the defendant's integrity and honesty that underlies every fraud scenario”); United States v. Jackson, 346 F.3d 22, 26 (2d Cir. 2003) (“Most fraud schemes that obtain more than one half million dollars involve careful planning, some sophisticated techniques, and are extensive.”). Of course, whatever adjustments are piled on, Booker and its progeny may support a lower sentence based on mitigating factors.

Conclusion

Finally, because OMM sentencings touch on our nation's broader economic woes, they carry some risk of retribution. Highlighting the relative insignificance of a client's wrongdoing may keep this in check. A $5-million loss, for example, is a tiny fraction of estimated total annual mortgage fraud losses. See http://www.fbi.gov/hq/mortgage_fraud.htm ($4-6 billion, according to the FBI). It is a drop in the ocean of global losses arising from the U.S. subprime mortgage market (recently estimated to potentially exceed $1 trillion). A stiff sentence will not restore stability in housing prices or confidence in credit markets, or improve the economy ' objectives identified in government press releases accompanying OMM's launch. Most defendants are pikers when viewed against OMM's backdrop, and deserve to be sentenced as “little fish.”

Evan A. Jenness ([email protected]) is a criminal defense attorney whose offices are in Santa Monica, CA.

The DOJ's announcement of “Operation Malicious Mortgage” (OMM) reflects a tidal wave of mortgage fraud prosecutions. Sentencings are rippling through federal courts in the nation's “top 10 mortgage fraud states” ' Florida, Georgia, Michigan, California, Illinois, Ohio, Texas, New York, Colorado, and Minnesota, and other significantly impacted states, including Arizona, Maryland, Utah, Nevada, Missouri, Indiana, Tennessee, Virginia, New Jersey, and Connecticut. See http://www.fbi.gov/publications/fraud/mortgage_fraud07.htm (FBI 2007 Mortgage Fraud Report).

Harsh sentences can be generated by a rote application of the U.S. Sentencing Guidelines in mortgage fraud cases. Everyone from low-level straw buyers to complicit appraisers, account managers, escrow officers and title insurers to mortgage brokers and bankers, underwriters and lawyers may face prison time. In most schemes grouped under the “mortgage fraud” umbrella, sentences will be driven by Guideline Sections 2B1.1(b)(1) (“loss”) and 1B1.3(a) (“relevant conduct”). See also USSG ” 2F1.1 (for frauds predating Nov. 1, 2001); 2S1.1 (money laundering); 2T1.1 (tax evasion).

Challenging the scope of “relevant conduct” should be defense counsel's first line of attack in many cases, because victims' losses may not have resulted from a convicted client's activities or the reasonably foreseeable acts of others in furtherance of jointly undertaken criminal activity under ' 1B1.3. Beyond that, analyzing “loss” in the context of the broader phenomenon of plummeting real estate values, rising unemployment, and sky-rocketing default rates may mitigate the Guidelines' sting. “Loss” under ' 2B1.1 is the greater of the “actual” or “intended” loss. “Actual loss” is the “reasonably foreseeable pecuniary harm that resulted from the offense,” and “intended loss” is pecuniary harm that was intended to result, including harm that was unlikely or impossible. Tangential or non-economic harms, interest or penalties, and prosecution costs are not included. Where the amount of an actual loss “reasonably cannot be determined,” the “gain that resulted” from the offense may be used. See
' 2B1.1, cmt. n. 3(B).

Credits against “loss” include: 1) the “fair market value” of property returned or services rendered to victims before the offense was detected or the defendant should have known it was about to be; and 2) amounts victims recover from selling collateral or its fair market value at sentencing. See, e.g., United States v. Weidner , 437 F.3d 1023, 1047-48 (10th Cir. 2006) (error to calculate intended loss without considering value of collateral pledged to secure increased line of credit); United States v. Williams , 292 F.3d 681, 686 (10th Cir. 2002) (“[W]e have upheld a finding of intended loss of an entire loan amount where ' the defendant intended to permanently deprive the lender of security by concealing pledged collateral ' Nevertheless, '[t]he security of [a] loan is a valid consideration in evaluating a defendant's realistic intent and the probability of inflicting loss.'”). In a Ponzi scheme, however, one victim's gains do not offset the losses of another.

Loss Calculation

The Guidelines provide some guidance, but “do not present a single universal method of loss calculation ' nor could they, given the fact-intensive and individualized nature of the inquiry.” United States v. Zolp , 479 F.3d 715, 718 (9th Cir. 2007). The Ninth Circuit's ruling in United States v. Crandall , 525 F.3d 907, 912 (9th Cir. 2008) may be useful in OMM cases because it emphasizes that ' 2B1.1 should not be “applied mechanically” and endorses a “realistic, economic approach to determine what losses the defendant truly caused or intended to cause.” In Crandall , where victims purchased illegally converted condominiums, the sentencing court erred by not reducing “loss” by the value of the properties, because it was “improbable from a realistic, economic perspective that the 'condominiums' had no value to the victims ' even though the units may have been difficult or impossible to resell.” See also United States v. Leonard , 529 F.3d 83, 92-93 (2d Cir. 2008) (error not to reduce “loss” by investments' value, even if victims would not have purchased them but for fraud and there was no ready resale market). The court posited several possible ways to calculate loss in real estate frauds: a “fair market appraisal” to determine actual loss, the “cost of repair” where properties can be brought up to par, and “gain” ' defendants' gain over their outlay. Crandall, 525 F.2d at 914.

'Volatile Nature'

The Crandall court also commented on the “volatile nature of the real estate market,” which it characterized as “wholly independent of Defendants' culpability.” While this did not help the defendants ' they were denied the benefit of the properties' eventual appreciation ' the implication that a defendant is not responsible for market swings could be useful in OMM sentencings. Where victims' losses reflect a market decline or other intervening factors, the full extent of losses may exceed what was “reasonably foreseeable,” or the client's actual intent, at the time of the fraudulent conduct. See United States v. Confredo , 528 F.3d 143 (2d Cir. 2008) (defendant entitled to show he subjectively intended less loss than aggregate face amount of fraudulent loan applications); United States v. Rutkoske , 506 F.3d 170 (2d Cir. 2007) (court must consider factors other than fraud that might have contributed to stock price decline when determining loss), cert . denied , 128 S. Ct. 2488 (2008); United States v. Olis , 429 F.3d 540, 545 (5th Cir. 2005) (defendant responsible only for losses caused directly by offense conduct).

Foresight or Intent

How is reasonable foresight or intent established in hindsight? One key may be the historic performance of the relevant market. If history is a guide, the full extent of today's real estate foundering was not “reasonably foreseeable” in many areas. In some of the FBI's “top 10″ states, home prices were on a long-term upswing before late-2005, or even later. The rate of decline in national residential real estate prices for the First Quarter of 2008 was the highest in 20 years, and the foreclosure rate on sub-prime loans had decreased continuously between late-2001 and early-2005. Local unemployment rates may have been unforeseeable given historic or proximate trends in an area.

Some mortgage scam players thought everyone would profit, or reasonably underestimated the losses that occurred in the wake of falling home values and escalating default rates. While a witting participant in a double mortgage fraud will be tagged with at least the face value of second mortgages, was the full extent of first mortgagees' losses reasonably foreseeable given the contemporaneous value of the collateral? A Detroit borrower who exaggerated income reasonably might not have foreseen being laid-off and defaulting; there may have been little reasonably foreseeable loss from inflating Florida appraisals given the historic trend of home prices in the Sunshine State; an underwriter in most OMM hot spots reasonably might have failed to appreciate the full risk of approving unqualified buyers given the unprecedented recent leap in default rates.

A regional real estate or lending expert may validate the reasonableness of rosy expectations or the unforseeability of actual losses. Would regional statistics support the reasonableness of a client's belief that real estate would always be profitable, or underestimation of the riskiness of loans? Building on applicable data, the defense may credibly argue that a client's sentence should not be based on the portion of victims' losses that was not reasonably foreseeable or intended at the time of an offense under ' 2B1.1, cmt. n. 3(A). See also Id., cmt. n. 19(C) (departure where offense level “under this guideline substantially overstates the seriousness of the offense”).

OMM defendants may be threatened with many Guideline upward adjustments, including multiple/vulnerable victims, mass-marketing, derivation of more than $1 million from a financial institution, sophisticated means, abuse of a position or trust or use of special skill, and aggravating role. Are these largely duplicative on the facts? See United States v. Williams , 527 F.3d 1235, 1251-52 (11th Cir. 2008) (abuse-of-trust adjustment applicable only where “victim placed a special trust in the defendant beyond [the] ordinary reliance on the defendant's integrity and honesty that underlies every fraud scenario”); United States v. Jackson , 346 F.3d 22, 26 (2d Cir. 2003) (“Most fraud schemes that obtain more than one half million dollars involve careful planning, some sophisticated techniques, and are extensive.”). Of course, whatever adjustments are piled on, Booker and its progeny may support a lower sentence based on mitigating factors.

Conclusion

Finally, because OMM sentencings touch on our nation's broader economic woes, they carry some risk of retribution. Highlighting the relative insignificance of a client's wrongdoing may keep this in check. A $5-million loss, for example, is a tiny fraction of estimated total annual mortgage fraud losses. See http://www.fbi.gov/hq/mortgage_fraud.htm ($4-6 billion, according to the FBI). It is a drop in the ocean of global losses arising from the U.S. subprime mortgage market (recently estimated to potentially exceed $1 trillion). A stiff sentence will not restore stability in housing prices or confidence in credit markets, or improve the economy ' objectives identified in government press releases accompanying OMM's launch. Most defendants are pikers when viewed against OMM's backdrop, and deserve to be sentenced as “little fish.”

Evan A. Jenness ([email protected]) is a criminal defense attorney whose offices are in Santa Monica, CA.