Criminal Intent and the So-Called 'Red Flag' Theory

The doctrine of conscious avoidance holds that a perpetrator cannot avoid criminal liability by taking deliberate actions to avoid knowledge of a crime. It thus serves as an alternative method for showing “knowing” conduct. United States v. Stadtmauer, 620 F.3d 238, 255 (3d Cir. 2010) (“[W]illful blindness is a subjective state of mind that is deemed to satisfy a scienter requirement of knowledge.”). For example, in United States v. Kehm, 799 F.2d 354, 362 (7th Cir. 1986), the evidence showed that the defendant set up a company that was used to smuggle drugs, that he arranged for the company to rent a plane that was used for the smuggling operation, but that he left the room when the use of the plane was discussed because “he didn't want to hear about it.” The court held the jury could have properly found that the defendant deliberately avoided direct knowledge of the crime, and thus acted knowingly for purposes of the criminal law.

The basic principal is seemingly straightforward. People who take steps to deliberately remain ignorant of facts establishing the criminality of the enterprise in which they are engaged are just as guilty as the “knowing” participants. The legal theory behind this doctrine, on the other hand, is controversial and not easily articulated or submitted to objective gauges of fairness. The problem is that holding defendants criminally liable for something they did not actually know creates a potential to convict them for negligence or recklessness. Courts have understandably expressed some discomfort with the doctrine. See, e.g., United States v. Nektalov, 461 F.3d 309, 311 (2d Cir. 2006) (“The doctrine of conscious avoidance is indeed susceptible of several well-founded attacks.”); United States v. Alston-Graves, 435 F.3d 331, 340 (D.C. Cir. 2006) (“Our problem with the various formulations of this instruction is that the jury might convict a defendant for acting recklessly ' . Negligence and recklessness are not the same as intentional knowing conduct.”).

This year, the Supreme Court, which had never formally endorsed the conscious avoidance doctrine, provided some guidance on the subject. In the course of holding that the “willful blindness” doctrine could be used to show knowing inducement of patent infringement, the Court identified “two basic requirements” of the doctrine: “(1) the defendant must subjectively believe that there is a high probability that a fact exists and (2) the defendant must take deliberate actions to avoid learning of that fact.” Global-Tech Appliances Inc. v. SEB S.A., 131 S. Ct. 2060, 2070(2011). The Court distinguished the case of “a reckless defendant [who] is one who merely knows of a substantial and unjustified risk of such wrongdoing.” 131 S. Ct. at 2071.

Although the Supreme Court said this articulation summed up the holdings of the various courts of appeals to address the issue, in fact the second Global-Tech element goes beyond at least some lower court formulations. Indeed, all too many courts seem to ignore any requirement that the defendant take some deliberate action to avoid actual knowledge of a crime, though it is proof of such action that might have the capacity of establishing scienter. The statement of the doctrine in United States v. Whitehill, 532 F.3d 746, 751 (8th Cir. 2008), is not atypical: “Ignorance is deliberate if the defendants were presented with facts putting them on notice criminal activity was particularly likely and yet intentionally failed to investigate.” For these courts, knowing that a transaction is very probably criminal is, without more, functionally equivalent to knowing that it is criminal. This standard does not require any objective basis that would justify a finding of actual knowledge.

The Red Flag Theory

The term “red flag” has not traditionally been found in the context of criminal law. Principally it has been used in relation to inquiry notice in civil law. Thus, disregarding red flags may estop a party from asserting a claim or defense. For example, a party claiming fraudulent concealment to avoid a statute of limitations defense must show that there were no red flags putting the party on inquiry notice. See, e.g., Seatrax Inc. v. Sonbeck Int'l Inc., 200 F.3d 358, 367 (5th Cir. 2000). Similarly, there is a “'red flag' doctrine [that] guides the GAAP [Generally Accepted Accounting Principles] and GAAS [Generally Accepted Auditing Standards] inquiries: the more facts alleged that should cause a reasonable auditor to investigate further before making a representation, the more cogent and compelling a scienter inference becomes.” New Mexico State Inv. Council v. Ernst & Young LLP, 641 F.3d 1089, 1098 (9th Cir. 2011).

The red flag theory has been used to show reckless conduct under the federal securities laws. For example, in Voss v. SEC, 222 F.3d 994, 1006 (D.C. Cir. 2000), the court affirmed sanctions against a broker for aiding and abetting a fraudulent scheme involving wash trades by her customer. “Given the abundance of red flags here,” the court said, “it would be very hard to characterize Graham's conduct as anything but extremely reckless.”

There is even a statute imposing civil liability for failing to heed red flags. The Fair and Accurate Credit Transactions Act of 2003 (FACTA) amended the Fair Credit Reporting Act, 15 U.S.C. ' 1681m(e), to add a section relating to identity theft titled “Red Flag Guidelines and Regulations Required.” Under 16 C.F.R. ' 681.1(d)(2)(i) and parallel provisions, financial institutions must “[i]dentify relevant Red Flags for the covered accounts” maintained by its customers, and investigate potential violations of the law if those red flags are discovered. Here, the defendant has notice of which facts trigger an obligation to investigate, and can reasonably be held liable for a failure to do so.

In all of these situations, the presence of red flags is supposed to inspire further inquiry. A party who encounters red flags should look further. Those who do not will suffer the consequences. But these are the consequences of a lack of due diligence, not of constructive or actual knowledge. There is a serious question whether this “red flag” theory is sufficient to establish mens rea, especially under the federal securities law. In the Madoff era, the risk of having recklessness transmuted into intentionality is manifest.

Red flags in this sense are relevant criminally, therefore, only with respect to statutes that include a duty to investigate, and, in our view, where there is a proven specific intention to ignore that duty. Statutes that incorporate this duty do exist. For example, the Foreign Corrupt Practices Act states that “[w]hen knowledge of the existence of a particular circumstance is required for an offense, such knowledge is established if a person is aware of a high probability of the existence of such circumstance, unless the person actually believes that such circumstance does not exist.” 15 U.S.C. ” 78dd-1(f)(2)(B, 78ddd-2(h)(3)(B), 78dd-3(f)(3)(B). The point of this language is to require companies, in particular, to inquire into possible bribery or related misconduct by their employees. Similarly, the Federal Food, Drug, and Cosmetic Act, which prohibits knowingly selling or distributing certain drugs without a prescription, defines “knowingly” to include “deliberate ignorance or reckless disregard of the truth or falsity of the information.” 21 U.S.C. ' 321(bb)(2). Again, Congress has specifically determined in connection with this statute that people will be prohibited from acting with impunity in highly suspicious circumstances. A failure to investigate when confronted with red flags is a direct violation of the law but, again, there is necessarily much room for differences of opinion, which are always a danger in making charging decisions.

The Combination of Conscious Avoidance with Red Flags

The Second Circuit's merger of the doctrine of conscious avoidance and the concept of red flags set forth in the Ferguson opinion represents a concerning and growing development. When a criminal statute penalizes “knowing” conduct, ordinarily the government must show “knowledge of the facts that constitute the offense.” Bryan v. United States, 524 U.S. 184, 193 (1998). The doctrine of conscious avoidance allows the government to go one step further, and convict based on a defendant's refusal to perceive the facts that constitute the offense.

Under the two-part test set out in Global-Tech Appliances, only a defendant who has actually taken deliberate action to avoid acquiring knowledge can be convicted. It must be shown by solid evidence that the deliberate act must have been taken with specific intent to avoid acquiring guilty knowledge. However, in Ferguson, the Second Circuit held that red flags about the legitimacy of a transaction (such as a secret side agreement and a fake offer letter) alone justified a conscious avoidance charge. But none of the evidence cited in Ferguson “amounted to an attempt to remain ignorant of some fact bearing on the criminality of [the defendant's] endeavors.” United States v. Alston Graves, 435 F.3d at 342.

Thus, the “red flags” theory articulated by Ferguson in essence creates a duty of investigation without a statutory basis. See Ira P. Robbins, Criminal Law: The Ostrich Instruction: Deliberate Ignorance As a Criminal Mens Rea, 81 J. Crim. L. & Criminology 191, 231 (1990) (“The high-probability/unless standard describes recklessness rather than knowledge, and its adoption by the judiciary instead of the legislature infringes on the legislature's province of defining criminal conduct.” ). Plainly, one should not draw an inference of subjective actual knowledge ' criminal scienter ' simply from the existence of red flags. The Ferguson articulation of the doctrine thus allows the prosecution to convict based on the failure of the defendant to undertake an inquiry that would have led him to actual knowledge of the offense. Inquiry notice is thus dangerously and improperly accepted as a substitute for actual knowledge.

Conclusion

By requiring that the defendant take some deliberate action to avoid obtaining knowledge, the Supreme Court has limited the willful blindness doctrine to those situations where there exists objective evidence from which actual knowledge may be inferred. This reduces the danger that a person could be convicted for mere negligence or recklessness. It is not enough under this approach that a defendant knew he or she was engaged in conduct with a risk of criminality and failed to investigate. To be categorized as conscious avoiders ' and hence as persons acting with the requisite intentionality ' the defendants must have taken specific active steps to ensure their ignorance. Otherwise, the prosecutor has shown only “a reckless defendant” who “merely knows of a substantial and unjustified risk” of wrongdoing. 131 S. Ct. at 2071.

In our view, the Second Circuit's expansion of the conscious avoidance doctrine is unwarranted and is inconsistent with the Supreme Court's articulation of the doctrine in Global-Tech Appliances. The requirement that a defendant take deliberate and affirmative action to avoid learning of a fact is the minimum necessary to ensure that a criminal charge or conviction is based on solid evidence of intentionality; an inference based on what a prosecutor or jury believes the defendant reasonably should have known is insufficient.

Stanley S. Arkin ([email protected]), a member of this newsletter's Board of Editors, is senior partner at New York's Arkin Kaplan Rice LLP. He is chairman of the Arkin Group, a private intelligence company, the lead author of “Business Crime,” and a fellow of the American College of Trial Lawyers. Howard J. Kaplan ([email protected]) is a Partner at the firm.

We live in times where there is an extreme amount of anger and distrust regarding our country's financial institutions. Such circumstances traditionally impel prosecutors to exercise their discretion to indict in an aggressive way expressive of the political environment. This is all the more reason why there is a need to encourage prosecutors to seek indictments based only on reliable and solid evidence, and not on evidence that may shift with mere perspective. The “red flag” theory, which we discuss here, carries the danger of fostering undeserved prosecutions, for so much of it involves the feelings or the opinions of the prosecutor ' and conceivably of a jury.

Proof of “willful blindness” or “conscious avoidance” now appears to be a generally accepted (if not overused) substitute for proof of actual knowledge in criminal cases, i.e., criminal scienter, the sine qua non of a criminal proceeding. The doctrine has been criticized, and courts have cautioned that certain formulations of the elements of “willful blindness” could lead a jury to convict based on negligent or reckless conduct. This danger is squarely presented by the U.S. Court of Appeals for the Second Circuit's recent decision in United States v. Ferguson, — F.3d — (2d Cir. Aug. 1, 2011), which held that “[r]ed flags about the legitimacy of a transaction can be used to show both actual knowledge and conscious avoidance.” While not entirely unprecedented, the growing invocation of the red flag theory is new and dangerous, investing far too much discretion in the prosecution to charge without a solid basis of proof of intentionality. This extension of the willful blindness doctrine is problematic, and inconsistent with the Supreme Court's recent discussion of this doctrine in Global-Tech Appliances, Inc. v. SEB S.A. , 131 S. Ct. 2060, 179 L. Ed. 2d 1167 (2011).

The Doctrine of Conscious Avoidance

The doctrine of conscious avoidance holds that a perpetrator cannot avoid criminal liability by taking deliberate actions to avoid knowledge of a crime. It thus serves as an alternative method for showing “knowing” conduct. United States v. Stadtmauer , 620 F.3d 238, 255 (3d Cir. 2010) (“[W]illful blindness is a subjective state of mind that is deemed to satisfy a scienter requirement of knowledge.”). For example, in United States v. Kehm , 799 F.2d 354, 362 (7th Cir. 1986), the evidence showed that the defendant set up a company that was used to smuggle drugs, that he arranged for the company to rent a plane that was used for the smuggling operation, but that he left the room when the use of the plane was discussed because “he didn't want to hear about it.” The court held the jury could have properly found that the defendant deliberately avoided direct knowledge of the crime, and thus acted knowingly for purposes of the criminal law.

The basic principal is seemingly straightforward. People who take steps to deliberately remain ignorant of facts establishing the criminality of the enterprise in which they are engaged are just as guilty as the “knowing” participants. The legal theory behind this doctrine, on the other hand, is controversial and not easily articulated or submitted to objective gauges of fairness. The problem is that holding defendants criminally liable for something they did not actually know creates a potential to convict them for negligence or recklessness. Courts have understandably expressed some discomfort with the doctrine. See, e.g., United States v. Nektalov , 461 F.3d 309, 311 (2d Cir. 2006) (“The doctrine of conscious avoidance is indeed susceptible of several well-founded attacks.”); United States v. Alston-Graves , 435 F.3d 331, 340 (D.C. Cir. 2006) (“Our problem with the various formulations of this instruction is that the jury might convict a defendant for acting recklessly ' . Negligence and recklessness are not the same as intentional knowing conduct.”).

This year, the Supreme Court, which had never formally endorsed the conscious avoidance doctrine, provided some guidance on the subject. In the course of holding that the “willful blindness” doctrine could be used to show knowing inducement of patent infringement, the Court identified “two basic requirements” of the doctrine: “(1) the defendant must subjectively believe that there is a high probability that a fact exists and (2) the defendant must take deliberate actions to avoid learning of that fact.” Global-Tech Appliances Inc. v. SEB S.A. , 131 S. Ct. 2060, 2070(2011). The Court distinguished the case of “a reckless defendant [who] is one who merely knows of a substantial and unjustified risk of such wrongdoing.” 131 S. Ct. at 2071.

Although the Supreme Court said this articulation summed up the holdings of the various courts of appeals to address the issue, in fact the second Global-Tech element goes beyond at least some lower court formulations. Indeed, all too many courts seem to ignore any requirement that the defendant take some deliberate action to avoid actual knowledge of a crime, though it is proof of such action that might have the capacity of establishing scienter. The statement of the doctrine in United States v. Whitehill, 532 F.3d 746, 751 (8th Cir. 2008), is not atypical: “Ignorance is deliberate if the defendants were presented with facts putting them on notice criminal activity was particularly likely and yet intentionally failed to investigate.” For these courts, knowing that a transaction is very probably criminal is, without more, functionally equivalent to knowing that it is criminal. This standard does not require any objective basis that would justify a finding of actual knowledge.

The Red Flag Theory

The term “red flag” has not traditionally been found in the context of criminal law. Principally it has been used in relation to inquiry notice in civil law. Thus, disregarding red flags may estop a party from asserting a claim or defense. For example, a party claiming fraudulent concealment to avoid a statute of limitations defense must show that there were no red flags putting the party on inquiry notice. See, e.g., Seatrax Inc. v. Sonbeck Int ' l Inc. , 200 F.3d 358, 367 (5th Cir. 2000). Similarly, there is a “'red flag' doctrine [that] guides the GAAP [Generally Accepted Accounting Principles] and GAAS [Generally Accepted Auditing Standards] inquiries: the more facts alleged that should cause a reasonable auditor to investigate further before making a representation, the more cogent and compelling a scienter inference becomes.” New Mexico State Inv. Council v. Ernst & Young LLP , 641 F.3d 1089, 1098 (9th Cir. 2011).

The red flag theory has been used to show reckless conduct under the federal securities laws. For example, in Voss v. SEC , 222 F.3d 994, 1006 (D.C. Cir. 2000), the court affirmed sanctions against a broker for aiding and abetting a fraudulent scheme involving wash trades by her customer. “Given the abundance of red flags here,” the court said, “it would be very hard to characterize Graham's conduct as anything but extremely reckless.”

There is even a statute imposing civil liability for failing to heed red flags. The Fair and Accurate Credit Transactions Act of 2003 (FACTA) amended the Fair Credit Reporting Act, 15 U.S.C. ' 1681m(e), to add a section relating to identity theft titled “Red Flag Guidelines and Regulations Required.” Under 16 C.F.R. ' 681.1(d)(2)(i) and parallel provisions, financial institutions must “[i]dentify relevant Red Flags for the covered accounts” maintained by its customers, and investigate potential violations of the law if those red flags are discovered. Here, the defendant has notice of which facts trigger an obligation to investigate, and can reasonably be held liable for a failure to do so.

In all of these situations, the presence of red flags is supposed to inspire further inquiry. A party who encounters red flags should look further. Those who do not will suffer the consequences. But these are the consequences of a lack of due diligence, not of constructive or actual knowledge. There is a serious question whether this “red flag” theory is sufficient to establish mens rea, especially under the federal securities law. In the Madoff era, the risk of having recklessness transmuted into intentionality is manifest.

Red flags in this sense are relevant criminally, therefore, only with respect to statutes that include a duty to investigate, and, in our view, where there is a proven specific intention to ignore that duty. Statutes that incorporate this duty do exist. For example, the Foreign Corrupt Practices Act states that “[w]hen knowledge of the existence of a particular circumstance is required for an offense, such knowledge is established if a person is aware of a high probability of the existence of such circumstance, unless the person actually believes that such circumstance does not exist.” 15 U.S.C. ” 78dd-1(f)(2)(B, 78ddd-2(h)(3)(B), 78dd-3(f)(3)(B). The point of this language is to require companies, in particular, to inquire into possible bribery or related misconduct by their employees. Similarly, the Federal Food, Drug, and Cosmetic Act, which prohibits knowingly selling or distributing certain drugs without a prescription, defines “knowingly” to include “deliberate ignorance or reckless disregard of the truth or falsity of the information.” 21 U.S.C. ' 321(bb)(2). Again, Congress has specifically determined in connection with this statute that people will be prohibited from acting with impunity in highly suspicious circumstances. A failure to investigate when confronted with red flags is a direct violation of the law but, again, there is necessarily much room for differences of opinion, which are always a danger in making charging decisions.

The Combination of Conscious Avoidance with Red Flags

The Second Circuit's merger of the doctrine of conscious avoidance and the concept of red flags set forth in the Ferguson opinion represents a concerning and growing development. When a criminal statute penalizes “knowing” conduct, ordinarily the government must show “knowledge of the facts that constitute the offense.” Bryan v. United States , 524 U.S. 184, 193 (1998). The doctrine of conscious avoidance allows the government to go one step further, and convict based on a defendant's refusal to perceive the facts that constitute the offense.

Under the two-part test set out in Global-Tech Appliances, only a defendant who has actually taken deliberate action to avoid acquiring knowledge can be convicted. It must be shown by solid evidence that the deliberate act must have been taken with specific intent to avoid acquiring guilty knowledge. However, in Ferguson, the Second Circuit held that red flags about the legitimacy of a transaction (such as a secret side agreement and a fake offer letter) alone justified a conscious avoidance charge. But none of the evidence cited in Ferguson “amounted to an attempt to remain ignorant of some fact bearing on the criminality of [the defendant's] endeavors.” United States v. Alston Graves , 435 F.3d at 342.

Thus, the “red flags” theory articulated by Ferguson in essence creates a duty of investigation without a statutory basis. See Ira P. Robbins, Criminal Law: The Ostrich Instruction: Deliberate Ignorance As a Criminal Mens Rea, 81 J. Crim. L. & Criminology 191, 231 (1990) (“The high-probability/unless standard describes recklessness rather than knowledge, and its adoption by the judiciary instead of the legislature infringes on the legislature's province of defining criminal conduct.” ). Plainly, one should not draw an inference of subjective actual knowledge ' criminal scienter ' simply from the existence of red flags. The Ferguson articulation of the doctrine thus allows the prosecution to convict based on the failure of the defendant to undertake an inquiry that would have led him to actual knowledge of the offense. Inquiry notice is thus dangerously and improperly accepted as a substitute for actual knowledge.

Conclusion

By requiring that the defendant take some deliberate action to avoid obtaining knowledge, the Supreme Court has limited the willful blindness doctrine to those situations where there exists objective evidence from which actual knowledge may be inferred. This reduces the danger that a person could be convicted for mere negligence or recklessness. It is not enough under this approach that a defendant knew he or she was engaged in conduct with a risk of criminality and failed to investigate. To be categorized as conscious avoiders ' and hence as persons acting with the requisite intentionality ' the defendants must have taken specific active steps to ensure their ignorance. Otherwise, the prosecutor has shown only “a reckless defendant” who “merely knows of a substantial and unjustified risk” of wrongdoing. 131 S. Ct. at 2071.

In our view, the Second Circuit's expansion of the conscious avoidance doctrine is unwarranted and is inconsistent with the Supreme Court's articulation of the doctrine in Global-Tech Appliances. The requirement that a defendant take deliberate and affirmative action to avoid learning of a fact is the minimum necessary to ensure that a criminal charge or conviction is based on solid evidence of intentionality; an inference based on what a prosecutor or jury believes the defendant reasonably should have known is insufficient.

Stanley S. Arkin ([email protected]), a member of this newsletter's Board of Editors, is senior partner at New York's Arkin Kaplan Rice LLP. He is chairman of the Arkin Group, a private intelligence company, the lead author of “Business Crime,” and a fellow of the American College of Trial Lawyers. Howard J. Kaplan ([email protected]) is a Partner at the firm.