on Dec 31st, 2009Sentencing in Fraud Cases Involving Shareholder Loss
Eventually, the Supreme Court probably will need to decide whether sentences in criminal fraud cases involving publicly traded stock may be based on relatively crude estimates of shareholder loss. In civil cases, the Court already has spoken. In Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005), the Court held in a case brought under the federal securities laws that a plaintiff must adequately allege and prove that fraudulent conduct caused the value of his stock to drop after the truth was revealed to the market. In other words, a plaintiff in such a case will not survive a motion to dismiss merely by alleging that he purchased stock at an artificially inflated price. As the Court put it: “[A]s a matter of pure logic, at the moment the transaction takes place, the plaintiff has suffered no loss; the inflated purchase payment is offset by ownership of a share that at that instant possesses equivalent value. . . . [T]he most logic alone permits us to say is that the higher purchase price will sometimes play a role in bringing about a future loss.” Id. at 341-43 (emphasis in original).
The logic behind Dura has enormous importance in federal criminal cases involving publicly traded securities. Under the advisory United States Sentencing Guidelines, the calculation of a sentence in a fraud case is largely driven by the amount of “loss” caused by the fraud. U.S.S.G. Section 2B1.1. “Actual loss” is defined as the “reasonably foreseeable pecuniary harm that resulted from the offense.” Id., Commentary, 3(A)(i). Under the guidelines, a district court is required only to make a “reasonable estimate of loss.” Id., Commentary, 3(C). If a corporate executive – Enron’s Jeff Skilling and WorldCom’s Bernie Ebbers are two prominent examples – is convicted of fraud involving hundreds of millions of dollars in decreased market capitalization, he or she may be subject to decades in prison under the guidelines (or what amounts to a life sentence).
Given the liberty interests involved in a criminal case, one might think that the standards would be at least as strict as those that apply in a civil case. Not so. Recently, the Ninth Circuit rejected the proposition that Dura should apply to sentencing in a federal criminal case. See United States v. Berger, No. 08-50171 (9th Cir., Nov. 30, 2009). According to the Ninth Circuit, the criminal sentencing context is different because “a court gauges the amount of loss caused, i.e., the harm that society as a whole suffered from the defendant’s fraud.” Slip op. at 15629 (emphasis in original). But that reasoning is utterly circular. Whether “society as a whole” suffered any loss depends on the facts involved. If a fraud is committed but is never disclosed to the market, it is possible that the fraud did not actually affect share price at all. And even if a fraud is disclosed, the actual harm to any particular purchaser can’t simply be determined by subtracting the share price on the date of purchase from the price on the date the fraud was revealed. The effect of the fraud needs to be isolated from the many other variables that affect share price over time.
Other courts of appeals, as the Ninth Circuit recognized in Berger, have embraced the logic of Dura in the criminal context. See United States v. Rutkoske, 506 F.3d 170, 179 (2d Cir. 2007) (“we see no reason why considerations relevant to loss causation in a civil fraud case should not apply, at least as strongly, to a sentencing regime in which the amount of loss caused by a fraud is a critical determinant of the length of a defendant’s sentence.”); United States v. Olis, 429 F.3d 540, 546 (5th Cir. 2005) (“The civil damage measure should be the backdrop for criminal responsibility both because it furnishes the standard of compensable injury for securities fraud victims and because it is attuned to stock market complexities.”). Still, the practical reach of those cases may be limited in light of the requirement in the guidelines that a court need only make a “reasonable estimate of loss.” Defendants will argue that the government must prove actual loss with sophisticated analysis; the government will argue that no such exactitude is required. See United States v. Ferguson, 584 F. Supp.2d 447, 451-52 (D. Conn. 2008).
Time will tell whether the Ninth Circuit’s view of Dura in the criminal context will stand. Even in the Ninth Circuit, however, Berger cannot be allowed to end the story. In every federal criminal case involving alleged shareholder loss, defense counsel must be prepared to advocate Dura’s plain logic. To the extent that a sentencing court views Dura as inconsistent with the sentencing guidelines, defense counsel must be prepared to convince the court that the guidelines don’t deserve to be followed. They are merely advisory. A district court is free to disagree with a policy of the Sentencing Commission that has not been mandated by Congress. See Kimbrough v. United States, 128 S. Ct. 558, 564 (2008).
Congress has not mandated that criminal defendants faced with potentially long prison sentences be subject to standards less exacting than those applicable to defendants in civil cases. To the contrary, Congress has mandated that a sentencing court must consider the “nature and circumstances of the offense and the history and characteristics of the defendant” and that a court “court shall impose a sentence sufficient, but not greater than necessary,” to “reflect the seriousness of the offense, to promote respect for the law, and to provide just punishment for the offense,” and to “afford adequate deterrence to criminal conduct” and “protect the public from further crimes of the defendant.” See 18 U.S.C. Section 3553(a). Those principles, and proof of actual harm, must be guiding lights in all cases involving alleged shareholder loss. Anything less exacting serves to elevate administrative convenience and excessive retribution over fundamental fairness.
