In the Courts

The individual defendants at issue in Carson, former CCI employees, were charged with FCPA and Travel Act violations. The defendants demanded that the government provide them with the entire CCI database and all documents related to the CCI internal investigation. They argued that, as a result of the plea agreement, the CCI materials were “within the government's possession, custody, or control” under Federal Rule of Criminal Procedure 16(a)(1)(E) based on CCI's plea agreement.

The defendants relied heavily on Judge Lewis Kaplan's decision in United States v. Stein, 488 F.Supp.2d 350 (S.D.N.Y. 2007). In Stein, the court held that defendants could force the government to produce materials in KPMG's possession based on the broad language of KPMG's plea agreement. There, the government had argued to quash the defendants' subpoena to KPMG in part on the grounds that it could simply request those documents from KPMG under its plea agreement.

Judge Selna found that the CCI plea agreement was too narrow for the Stein logic to apply. The court also found Stein inconsistent with Ninth Circuit precedent on Rule 16 obligations. Further, the court found that the defendants had not shown that the documents that they requested, particularly the entire database, were material to their defense. The proper method of obtaining them would be through subpoena to CCI.

Separately, the court also refused to produce certain CCI charts summarizing other evidence that CCI had provided to the government, over which CCI claimed attorney work product protection. The court noted that CCI had a “Confidentiality and Non-Waiver Agreement” with the government that preserved CCI's privilege and evidenced CCI's intention to keep the documents confidential.

Rules for Measuring Loss In Securities Fraud Not Applicable to Criminal Fraud Sentencing

The Ninth Circuit, in an opinion by Judge Milan D. Smith, remanded a defendant's case for resentencing, but declined to apply the standard set out by the Supreme Court for securities fraud cases to loss calculations in criminal sentencing. United States v. Berger, 2009 WL 4141478, *1 (9th Cir. Nov. 30, 2009).

Richard I. Berger had been the President, CEO and Chairman of the Board of Craig Consumer Electronics (“Craig”). Due to Craig's loan facilities, Berger and others were required to provide regular reports on the status of the company's assets. In order to increase their borrowing capacity, Berger and others falsified these certifications to hide the fact that the company lacked sufficient funds. Thereafter, Berger again misrepresented Craig's financial condition in statements and reports to the SEC during the company's initial public offering. Ultimately, an audit revealed accounting irregularities that lead to restatement of earnings for several years. The company's stock eventually lost more than 80% of its value and was delisted from Nasdaq. The company ultimately filed for bankruptcy.

Berger was tried and convicted on a number of counts of bank and securities fraud. After an initial appeal and remand, he was sentenced to 97 months in prison. The District Court reached that sentence in part based on its calculation of the loss to Craig's banks and the loss to its shareholders. The court found that Berger's fraud resulted in a loss of $3.14 million to the banks and calculated the loss to shareholders as $2.1 million. To find the shareholder loss, the court adopted a method suggested by the government. It identified the average drop in share price of other companies after they had reported accounting regularities to the market. The court then applied that drop (26.5%) to the value of Craig's initial public offering to calculate the loss.

On appeal, the Ninth Circuit found that the lower court erred in applying this calculation method. The defendant had argued that the District Court erred in calculating the shareholder loss in part because it did not apply the standard outlined by the U.S. Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). In Dura Pharmaceuticals, the Supreme Court held that a plaintiff asserting a securities fraud claim under 15 U.S.C. ' 78j(b) and 78u-4 must prove that the public disclosure of the fraud caused the shareholder to suffer loss. Thus, a plaintiff cannot sustain a claim just by showing that he purchased the stock at an inflated price; he must also show he suffered an actual loss when the fraud was disclosed and the share price dropped.

Two other Circuit Courts had applied the Dura Pharmaceuticals analysis to the criminal sentencing calculation of the amount of loss caused in criminal securities fraud cases. The Ninth Circuit, however, found that the primary rationale behind the Dura Pharmaceuticals decision did not apply in criminal cases. Specifically, the Dura Pharmaceuticals court relied on the notion that Plaintiff has not necessarily suffered loss at the time of purchase and that he was required to prove some actual economic loss caused by the fraud. In contrast, in the criminal sentencing context, the court is concerned not with a particular person's loss but loss to society as a whole. Thus, there could be general loss even without proving the specific drop in stock price.

In addition, the court found that the Sentencing Guidelines specifically allowed for calculation of a loss by overvaluation. Thus, application of Dura Pharmaceuticals ran contrary to the Guidelines. Rather than apply Dura Pharmaceuticals, the Ninth Circuit relied on its prior decision in United States v. Hicks, 217 F.3d 1038 (9th Cir. 2000), to find that “the defendant's sentence [must be based on the] harm that resulted from the acts or omissions of the defendant.”

In this matter, the lower court had erred by assuming that there had been a loss to shareholders rather than relying on evidence that there was an actual loss. Specifically, the District Court simply determined what an average loss would have been and assumed that the loss caused by defendant would have been the same. The error was particularly acute in this case where the stock had stopped trading prior to the public disclosure of the fraud. As a result, the court had not established that there was a loss to shareholders caused by the fraud. The court vacated the sentence and remanded for re-sentencing.

Eleventh Circuit: Probation-Only Sentence for HealthSouth Executive Unreasonable

The Eleventh Circuit Court of Appeals, in an opinion by Judge Joel F. Dubina, found that the District Court's sentence of Kenneth K. Livesay was unreasonable in light of the factors outlined in 18 U.S.C. ' 3553(a).

This was not the Eleventh Circuit's first review of the defendant's sentence. The court had already remanded the case for further explanation, then reversed the District Court's sentence as unreasonable, then vacated the sentence (after the U.S. Supreme Court remand). After its most recent sentencing hearing, the District Court found that the defendant's offense level was 28, his criminal history category was I, and his Guidelines sentencing range was 78 to 97 months' imprisonment. The government had moved for a downward departure ' under ' 5K1.1 in light of the defendant's substantial cooperation in the prosecution of others ' and recommended a 20-month sentence. The District Court again (for the third time but now with a different judge) imposed a sentence of 60 months of probation and the government (for the third time) appealed.

The Eleventh Circuit applied the factors laid out in 18 U.S.C. ' 3553(a)(2) to find that a sentence of no jail time did not adequately “reflect the seriousness of the offense, promote respect for the law, or provide a just punishment.” More importantly, the court determined that one of the main considerations in the Sentencing Guidelines was the deterrence of white collar criminals. It found that probation-only sentences were unlikely to deter white collar criminals who could analyze the financial benefits against the risks and easily determine that financial fraud might be worth the risk of no time in prison.

The court also looked to several prior decisions in which it reversed sentences of minimal jail time for HealthSouth executives involved in the same fraud as defendant. In short, the court explained: “We also hold that any sentence of probation would be unreasonable given the magnitude and seriousness of Livesay's criminal conduct.” (emphasis in original). The court vacated the sentence and remanded to the District Court for re-sentencing.

In the Courts was written by Associate Editor Kenneth S. Clark, an associate at Kirkland & Ellis LLP, Washington, DC. Business Crimes Hotline was written by Matthew Alexander, an associate in the same office.

Individual Defendants Cannot Compel Government to Produce Materials in Possession of Cooperationg Former Employer

Judge James V. Selna of the U.S. District Court for the Central District of California denied individual defendants' motion seeking to force the government to produce documents currently in the possession of Control Components, Inc. (“CCI”). United States v. Carson, No. 8:09-cr-00077-JVS (C.D. Cal. Dec. 8, 2009).

CCI had previously pleaded guilty to several FCPA-related violations. Prior to pleading guilty, CCI had conducted a far-reaching internal investigation into the allegations of misconduct. During that investigation, CCI had gathered approximately 75 million pages that were then organized in a database. As a part of its plea and probation, CCI agreed to “cooperate fully” with the government and to disclose all information regarding CCI and corrupt payments “about which the [government] shall inquire.”

The individual defendants at issue in Carson, former CCI employees, were charged with FCPA and Travel Act violations. The defendants demanded that the government provide them with the entire CCI database and all documents related to the CCI internal investigation. They argued that, as a result of the plea agreement, the CCI materials were “within the government's possession, custody, or control” under Federal Rule of Criminal Procedure 16(a)(1)(E) based on CCI's plea agreement.

The defendants relied heavily on Judge Lewis Kaplan's decision in United States v. Stein , 488 F.Supp.2d 350 (S.D.N.Y. 2007). In Stein, the court held that defendants could force the government to produce materials in KPMG's possession based on the broad language of KPMG's plea agreement. There, the government had argued to quash the defendants' subpoena to KPMG in part on the grounds that it could simply request those documents from KPMG under its plea agreement.

Judge Selna found that the CCI plea agreement was too narrow for the Stein logic to apply. The court also found Stein inconsistent with Ninth Circuit precedent on Rule 16 obligations. Further, the court found that the defendants had not shown that the documents that they requested, particularly the entire database, were material to their defense. The proper method of obtaining them would be through subpoena to CCI.

Separately, the court also refused to produce certain CCI charts summarizing other evidence that CCI had provided to the government, over which CCI claimed attorney work product protection. The court noted that CCI had a “Confidentiality and Non-Waiver Agreement” with the government that preserved CCI's privilege and evidenced CCI's intention to keep the documents confidential.

Rules for Measuring Loss In Securities Fraud Not Applicable to Criminal Fraud Sentencing

The Ninth Circuit, in an opinion by Judge Milan D. Smith, remanded a defendant's case for resentencing, but declined to apply the standard set out by the Supreme Court for securities fraud cases to loss calculations in criminal sentencing. United States v. Berger, 2009 WL 4141478, *1 (9th Cir. Nov. 30, 2009).

Richard I. Berger had been the President, CEO and Chairman of the Board of Craig Consumer Electronics (“Craig”). Due to Craig's loan facilities, Berger and others were required to provide regular reports on the status of the company's assets. In order to increase their borrowing capacity, Berger and others falsified these certifications to hide the fact that the company lacked sufficient funds. Thereafter, Berger again misrepresented Craig's financial condition in statements and reports to the SEC during the company's initial public offering. Ultimately, an audit revealed accounting irregularities that lead to restatement of earnings for several years. The company's stock eventually lost more than 80% of its value and was delisted from Nasdaq. The company ultimately filed for bankruptcy.

Berger was tried and convicted on a number of counts of bank and securities fraud. After an initial appeal and remand, he was sentenced to 97 months in prison. The District Court reached that sentence in part based on its calculation of the loss to Craig's banks and the loss to its shareholders. The court found that Berger's fraud resulted in a loss of $3.14 million to the banks and calculated the loss to shareholders as $2.1 million. To find the shareholder loss, the court adopted a method suggested by the government. It identified the average drop in share price of other companies after they had reported accounting regularities to the market. The court then applied that drop (26.5%) to the value of Craig's initial public offering to calculate the loss.

On appeal, the Ninth Circuit found that the lower court erred in applying this calculation method. The defendant had argued that the District Court erred in calculating the shareholder loss in part because it did not apply the standard outlined by the U.S. Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo , 544 U.S. 336 (2005). In Dura Pharmaceuticals, the Supreme Court held that a plaintiff asserting a securities fraud claim under 15 U.S.C. ' 78j(b) and 78u-4 must prove that the public disclosure of the fraud caused the shareholder to suffer loss. Thus, a plaintiff cannot sustain a claim just by showing that he purchased the stock at an inflated price; he must also show he suffered an actual loss when the fraud was disclosed and the share price dropped.

Two other Circuit Courts had applied the Dura Pharmaceuticals analysis to the criminal sentencing calculation of the amount of loss caused in criminal securities fraud cases. The Ninth Circuit, however, found that the primary rationale behind the Dura Pharmaceuticals decision did not apply in criminal cases. Specifically, the Dura Pharmaceuticals court relied on the notion that Plaintiff has not necessarily suffered loss at the time of purchase and that he was required to prove some actual economic loss caused by the fraud. In contrast, in the criminal sentencing context, the court is concerned not with a particular person's loss but loss to society as a whole. Thus, there could be general loss even without proving the specific drop in stock price.

In addition, the court found that the Sentencing Guidelines specifically allowed for calculation of a loss by overvaluation. Thus, application of Dura Pharmaceuticals ran contrary to the Guidelines. Rather than apply Dura Pharmaceuticals , the Ninth Circuit relied on its prior decision in United States v. Hicks , 217 F.3d 1038 (9th Cir. 2000), to find that “the defendant's sentence [must be based on the] harm that resulted from the acts or omissions of the defendant.”

In this matter, the lower court had erred by assuming that there had been a loss to shareholders rather than relying on evidence that there was an actual loss. Specifically, the District Court simply determined what an average loss would have been and assumed that the loss caused by defendant would have been the same. The error was particularly acute in this case where the stock had stopped trading prior to the public disclosure of the fraud. As a result, the court had not established that there was a loss to shareholders caused by the fraud. The court vacated the sentence and remanded for re-sentencing.

Eleventh Circuit: Probation-Only Sentence for HealthSouth Executive Unreasonable

The Eleventh Circuit Court of Appeals, in an opinion by Judge Joel F. Dubina, found that the District Court's sentence of Kenneth K. Livesay was unreasonable in light of the factors outlined in 18 U.S.C. ' 3553(a).

This was not the Eleventh Circuit's first review of the defendant's sentence. The court had already remanded the case for further explanation, then reversed the District Court's sentence as unreasonable, then vacated the sentence (after the U.S. Supreme Court remand). After its most recent sentencing hearing, the District Court found that the defendant's offense level was 28, his criminal history category was I, and his Guidelines sentencing range was 78 to 97 months' imprisonment. The government had moved for a downward departure ' under ' 5K1.1 in light of the defendant's substantial cooperation in the prosecution of others ' and recommended a 20-month sentence. The District Court again (for the third time but now with a different judge) imposed a sentence of 60 months of probation and the government (for the third time) appealed.

The Eleventh Circuit applied the factors laid out in 18 U.S.C. ' 3553(a)(2) to find that a sentence of no jail time did not adequately “reflect the seriousness of the offense, promote respect for the law, or provide a just punishment.” More importantly, the court determined that one of the main considerations in the Sentencing Guidelines was the deterrence of white collar criminals. It found that probation-only sentences were unlikely to deter white collar criminals who could analyze the financial benefits against the risks and easily determine that financial fraud might be worth the risk of no time in prison.

The court also looked to several prior decisions in which it reversed sentences of minimal jail time for HealthSouth executives involved in the same fraud as defendant. In short, the court explained: “We also hold that any sentence of probation would be unreasonable given the magnitude and seriousness of Livesay's criminal conduct.” (emphasis in original). The court vacated the sentence and remanded to the District Court for re-sentencing.

In the Courts was written by Associate Editor Kenneth S. Clark, an associate at Kirkland & Ellis LLP, Washington, DC. Business Crimes Hotline was written by Matthew Alexander, an associate in the same office.