In the Courts

Calculation of 'Gain Resulting from the Offense'

On appeal, Mr. Nacchio argued that the district court imposed an improper sentence because it based Nacchio's term of imprisonment on an incorrect calculation of the “gain resulting from the offense” under U.S. Sentencing Guideline ' 2.F1.2. That section provides that insider trading carries a base offense level of 8, which should be increased based on the total gain realized by the defendant. The district court calculated Nacchio's gain based on the total amount he realized from his stock sales. Nacchio argued that the district court's approach resulted in punishment based on the normal appreciation in Qwest's shares after he received the stock options, but before he acted on material, nonpublic information.

The Tenth Circuit reversed the district court, holding that “Mr. Nacchio's gain should be calculated in a manner that is more narrowly focused on producing a figure that reflects, in at least approximate terms, the proceeds related to his criminally culpable conduct (i.e., trading on material, nonpublic information).” Id. at *5. In doing so, the Tenth Circuit considered and rejected the reasoning of United States v. Mooney, 425 F.3d 1093 (8th Cir. 2005) (en banc), which the district court cited as support for its gain analysis. The Tenth Circuit instructed the district court on remand “to adopt a realistic, economic approach (1) that would take into account that Mr. Nacchio's offense did not inhere in his sale of the shares itself, but in the deception intertwined with the sales due to his possession of insider knowledge, and (2) that consequently would endeavor to compute his gain for sentencing purposes based upon the gain resulting from that deception.” Id. at *7.

The Tenth Circuit gave four reasons for its holding. First, it explained that “[t]he plain language of ' 2F1.2 support[ed] the notion that an insider trading defendant's 'gain' should not consist of the total amount that the defendant realized from his or her stock sales, but should be limited more specifically to the gain that resulted from trading with insider knowledge” because the “offense” was not selling stock per se but selling it on the basis of material, nonpublic information. Id. at *8. In short, calculating Mr. Nacchio's term of imprisonment based upon his total gain would result in punishment for otherwise lawful conduct.

Second, the Tenth Circuit concluded that the district court should have excluded from its gain calculation “unrelated market factors” and “the underlying inherent value of the Qwest shares.” Id. at *11. The court explained that there was no evidence that Nacchio's criminal conduct rendered Qwest's stock worthless; the shares would have had value, albeit less value, if his inside information had been known to the public. Nacchio's benefit was limited to that artificial extra value in Qwest's stock price.

Third, the Tenth Circuit looked to civil securities-fraud cases for guidance because “[c]riminal cases have the same 'tangle of factors affecting price' that is found in civil cases.” Id. at *14 (citation omitted). Specifically, it looked to the analysis used to calculate the proper amount of civil disgorgement, which, like the Sentencing Guidelines, sought to identify the value of ill-gotten gains. The court explained that civil disgorgement was based upon “the difference between the value of the shares when the insider sold them while in possession of the material, nonpublic information, and their market value a reasonable time after public dissemination of the inside information” rather than the wrongdoer's total profit. Id. at *13-15 (quotation omitted).

Finally, the court noted that a disgorgement approach was consistent with two policies underlying the Sentencing Guidelines: individualized sentencing that reflected the defendant's specific conduct and the elimination of unwarranted disparities between similarly situated defendants. By focusing on the specific gain attributable to the defendant's specific conduct, a court can craft a sentence that “fully reflects” the defendant's conduct while minimizing the effect of market forces and other factors that otherwise could result in different punishments for similar criminal conduct.

Nacchio's case was remanded to the district court for resentencing “grounded in economic reality” and a disgorgement approach to calculating Nacchio's “gain resulting from the offense.”

Forfeiture Calculation

The Tenth Circuit also held that the district court improperly ordered Nacchio to forfeit the gross value of the stock transactions for which he was convicted rather than the net profit from those transactions. Both the district court's forfeiture order and the appellate court's holding were based upon the courts' interpretation of 18 U.S.C. ' 981(a)(2), which provides for the calculation of the sum of forfeiture.

The district court agreed with the government that the proceeds of Nacchio's crimes should be defined by 18 U.S.C. ' 981(a)(2)(A), which apply to cases involving “illegal goods, illegal services, unlawful activities, and telemarketing and health care fraud schemes.” Under that provision, forfeitable proceeds are any property obtained as a result of the offense and are “not limited to the net gain or profit realized from the offense.” The district court concluded that insider trading was an “unlawful activity” because it was a “specified unlawful activity” under 18 U.S.C. ' 981(a)(1)(C) (incorporating by reference 18 U.S.C. ' 1956(c)(7)) and because securities are commodities, not goods.

Mr. Nacchio argued that the proceeds of his crimes should be defined by ' 981(a)(2)(B), which applied to “lawful goods or lawful services that are sold or provided in an illegal manner.” Under that provision, forfeitable proceeds “means the amount of money acquired through the illegal transactions resulting in the forfeiture, less the direct costs incurred in providing the goods or services.” Nacchio contended that securities were “lawful goods” and that forfeiture was based upon the “illegal manner” in which he sold those securities.

Again, the Tenth Circuit agreed with Nacchio, holding that he “should be required to forfeit his net profit, rather than the gross proceeds, of his insider trading offenses.” Id. at *20. First, the court concluded that not “every 'specified unlawful activity' laid out as subject to a forfeiture order under ' 981(a)(1)(C) also must be one of the 'unlawful activities' of subsection (A) to which the gross receipts definition of 'proceeds' is applied.” Id. Citing United States v. Kalish, No. 06 Cr. 656 (RPP), 2009 WL 13015, at *7 (S.D.N.Y. Jan. 13, 2009), the Tenth Circuit explained that Congress would have repeated the defined term “specified unlawful activity” had it intended that precise list of conduct and that equating “specified unlawful activity” with “unlawful activities” would render superfluous another part of the statute.

Because the Tenth Circuit concluded that insider trading was not an “unlawful activity” by virtue of being a “specified unlawful activity,” it next considered whether Nacchio's conduct involved “unlawful activity” or “lawful goods” that were sold in an illegal manner. The court concluded that securities generally were lawful and that, under the facts of Mr. Nacchio's case, the shares he sold were goods. It therefore held that “Mr. Nacchio's acts of insider trading involved lawful goods sold in an illegal manner” and that the district court should have applied ' 981(a)(2)(B) to calculate his forfeiture amount as the gross proceeds of his criminal conduct minus his direct costs. The Tenth Circuit thus reversed the district court's forfeiture order.

In the Courts and Business Crimes Hotline were written by Peter A. Farrell and Kenneth S. Clark respectively, both Associates at Kirkland & Ellis LLP, Washington, DC.

Tenth Circuit Holds That Insider Trading 'Gain' Is Limited to the Portion of Profit Attributable to Defendant's Criminal Conduct

In United States v. Nacchio, No. 07-1311, 2009 WL 2343716 (10th Cir. July 31, 2009), the U.S. Court of Appeals for the Tenth Circuit held that a district court's sentencing order relied on an improper calculation of the defendant's “gain resulting from the offense” of insider trading because it was not limited to the gain specifically attributable to his criminal conduct. The Tenth Circuit also held that the district court erred in requiring the defendant to forfeit the gross amount of his criminal stock transactions rather than his net profit from those transactions.

Nacchio is the latest in a series of important district court and appellate opinions regarding the prosecution and conviction of Joseph Nacchio, former CEO of Qwest Communications International, Inc., for insider trading in the shares of his former company. In December 2003, the government obtained an indictment that charged Mr. Nacchio with 42 counts of insider trading for allegedly exercising Qwest stock options on the basis of material, nonpublic information. A jury convicted Nacchio on 19 of those counts and acquitted him of the other 23. The district court sentenced Nacchio to 72 months' imprisonment and two years of supervised release (to run concurrently with his term of imprisonment), and it ordered him to pay a $19 million fine and to forfeit approximately $52 million.

Calculation of 'Gain Resulting from the Offense'

On appeal, Mr. Nacchio argued that the district court imposed an improper sentence because it based Nacchio's term of imprisonment on an incorrect calculation of the “gain resulting from the offense” under U.S. Sentencing Guideline ' 2.F1.2. That section provides that insider trading carries a base offense level of 8, which should be increased based on the total gain realized by the defendant. The district court calculated Nacchio's gain based on the total amount he realized from his stock sales. Nacchio argued that the district court's approach resulted in punishment based on the normal appreciation in Qwest's shares after he received the stock options, but before he acted on material, nonpublic information.

The Tenth Circuit reversed the district court, holding that “Mr. Nacchio's gain should be calculated in a manner that is more narrowly focused on producing a figure that reflects, in at least approximate terms, the proceeds related to his criminally culpable conduct (i.e., trading on material, nonpublic information).” Id. at *5. In doing so, the Tenth Circuit considered and rejected the reasoning of United States v. Mooney , 425 F.3d 1093 (8th Cir. 2005) (en banc), which the district court cited as support for its gain analysis. The Tenth Circuit instructed the district court on remand “to adopt a realistic, economic approach (1) that would take into account that Mr. Nacchio's offense did not inhere in his sale of the shares itself, but in the deception intertwined with the sales due to his possession of insider knowledge, and (2) that consequently would endeavor to compute his gain for sentencing purposes based upon the gain resulting from that deception.” Id. at *7.

The Tenth Circuit gave four reasons for its holding. First, it explained that “[t]he plain language of ' 2F1.2 support[ed] the notion that an insider trading defendant's 'gain' should not consist of the total amount that the defendant realized from his or her stock sales, but should be limited more specifically to the gain that resulted from trading with insider knowledge” because the “offense” was not selling stock per se but selling it on the basis of material, nonpublic information. Id. at *8. In short, calculating Mr. Nacchio's term of imprisonment based upon his total gain would result in punishment for otherwise lawful conduct.

Second, the Tenth Circuit concluded that the district court should have excluded from its gain calculation “unrelated market factors” and “the underlying inherent value of the Qwest shares.” Id. at *11. The court explained that there was no evidence that Nacchio's criminal conduct rendered Qwest's stock worthless; the shares would have had value, albeit less value, if his inside information had been known to the public. Nacchio's benefit was limited to that artificial extra value in Qwest's stock price.

Third, the Tenth Circuit looked to civil securities-fraud cases for guidance because “[c]riminal cases have the same 'tangle of factors affecting price' that is found in civil cases.” Id. at *14 (citation omitted). Specifically, it looked to the analysis used to calculate the proper amount of civil disgorgement, which, like the Sentencing Guidelines, sought to identify the value of ill-gotten gains. The court explained that civil disgorgement was based upon “the difference between the value of the shares when the insider sold them while in possession of the material, nonpublic information, and their market value a reasonable time after public dissemination of the inside information” rather than the wrongdoer's total profit. Id. at *13-15 (quotation omitted).

Finally, the court noted that a disgorgement approach was consistent with two policies underlying the Sentencing Guidelines: individualized sentencing that reflected the defendant's specific conduct and the elimination of unwarranted disparities between similarly situated defendants. By focusing on the specific gain attributable to the defendant's specific conduct, a court can craft a sentence that “fully reflects” the defendant's conduct while minimizing the effect of market forces and other factors that otherwise could result in different punishments for similar criminal conduct.

Nacchio's case was remanded to the district court for resentencing “grounded in economic reality” and a disgorgement approach to calculating Nacchio's “gain resulting from the offense.”

Forfeiture Calculation

The Tenth Circuit also held that the district court improperly ordered Nacchio to forfeit the gross value of the stock transactions for which he was convicted rather than the net profit from those transactions. Both the district court's forfeiture order and the appellate court's holding were based upon the courts' interpretation of 18 U.S.C. ' 981(a)(2), which provides for the calculation of the sum of forfeiture.

The district court agreed with the government that the proceeds of Nacchio's crimes should be defined by 18 U.S.C. ' 981(a)(2)(A), which apply to cases involving “illegal goods, illegal services, unlawful activities, and telemarketing and health care fraud schemes.” Under that provision, forfeitable proceeds are any property obtained as a result of the offense and are “not limited to the net gain or profit realized from the offense.” The district court concluded that insider trading was an “unlawful activity” because it was a “specified unlawful activity” under 18 U.S.C. ' 981(a)(1)(C) (incorporating by reference 18 U.S.C. ' 1956(c)(7)) and because securities are commodities, not goods.

Mr. Nacchio argued that the proceeds of his crimes should be defined by ' 981(a)(2)(B), which applied to “lawful goods or lawful services that are sold or provided in an illegal manner.” Under that provision, forfeitable proceeds “means the amount of money acquired through the illegal transactions resulting in the forfeiture, less the direct costs incurred in providing the goods or services.” Nacchio contended that securities were “lawful goods” and that forfeiture was based upon the “illegal manner” in which he sold those securities.

Again, the Tenth Circuit agreed with Nacchio, holding that he “should be required to forfeit his net profit, rather than the gross proceeds, of his insider trading offenses.” Id. at *20. First, the court concluded that not “every 'specified unlawful activity' laid out as subject to a forfeiture order under ' 981(a)(1)(C) also must be one of the 'unlawful activities' of subsection (A) to which the gross receipts definition of 'proceeds' is applied.” Id . Citing United States v. Kalish , No. 06 Cr. 656 (RPP), 2009 WL 13015, at *7 (S.D.N.Y. Jan. 13, 2009), the Tenth Circuit explained that Congress would have repeated the defined term “specified unlawful activity” had it intended that precise list of conduct and that equating “specified unlawful activity” with “unlawful activities” would render superfluous another part of the statute.

Because the Tenth Circuit concluded that insider trading was not an “unlawful activity” by virtue of being a “specified unlawful activity,” it next considered whether Nacchio's conduct involved “unlawful activity” or “lawful goods” that were sold in an illegal manner. The court concluded that securities generally were lawful and that, under the facts of Mr. Nacchio's case, the shares he sold were goods. It therefore held that “Mr. Nacchio's acts of insider trading involved lawful goods sold in an illegal manner” and that the district court should have applied ' 981(a)(2)(B) to calculate his forfeiture amount as the gross proceeds of his criminal conduct minus his direct costs. The Tenth Circuit thus reversed the district court's forfeiture order.

In the Courts and Business Crimes Hotline were written by Peter A. Farrell and Kenneth S. Clark respectively, both Associates at Kirkland & Ellis LLP, Washington, DC.