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Published: 2012-08-28

U.S. Sentencing Commission Approves Increased Penalties for Certain Fraud Offenses



In the Dodd-Frank Wall Street Reform and Consumer Protection Act,1 Congress issued directives to the U.S Sentencing Commission to "review and, if appropriate, amend" various sentencing guidelines and policy statements applicable to fraud offenses. On April 13, the Commission responded, promulgating amendments to the federal sentencing guidelines for securities fraud, mortgage fraud and financial institution fraud.

In announcing these amendments, Judge Patti B. Saris, Chair of the Commission, explained their importance, noting that "fraud offenses represent almost 10% of the federal criminal docket annually." The newly adopted amendments, which will take effect November 1, 2012 unless Congress modifies them through legislation, are likely to stiffen sentences for many defendants convicted of fraud offenses, particularly insider trading. At the same time, the Commission has continued its recent trend toward the use of rebuttable presumptions, rather than inflexible rules, in determining certain aspects of offense seriousness. That emerging approach gives criminal defense counsel greater latitude to advocate for sentence calculation methodologies more carefully tailored to each particular case.

Insider Trading--"Organized Schemes" & Abuse of Trust

The Commission amended the insider trading guideline2 in two ways. First, it adopted a new minimum offense level of 14 (which equates to a recommended prison range of 15-21 months for defendants with no criminal record) for any "organized scheme to engage in insider trading." The Commission also amended its commentary to list factors that courts may consider in determining whether an insider trading scheme is "organized," in other words, whether it involved "considered, calculated, systemic, or repeated efforts to obtain and trade on inside information, as distinguished from fortuitous or opportunistic instances of insider trading." For cases where there is little or no gain from insider trading, this will mean an automatic increase of 6 offense levels (from a pre-amendment recommended prison range of 0-6 months for defendants with no criminal record) for all participants in the offense. As the profitability of a scheme increases, however, the effect of this new provision diminishes, disappearing entirely when the overall gain from the scheme reaches $30,000. Because this new provision is based on how the scheme operated, rather than the role of a particular defendant in that scheme, the amendment may have the unintended consequence of increasing punishment for the least culpable offenders, particularly in schemes that enjoyed little or no success.

The second change to the insider trading guideline broadens the applicability of the "abuse of trust" enhancement3 in insider trading cases. Defendants currently receive increased punishment under the guidelines if their abuse of a position of public or private trust significantly facilitated the crime. The pre-amendment version of this provision is not triggered unless the defendant's position was characterized by professional or managerial discretion, in other words, "substantial discretionary judgment that is ordinarily given considerable deference." The amendment will loosen that requirement in the insider trading context, specifying that the enhancement applies "if the defendant's employment in a position that involved regular participation or professional assistance in creating, issuing, buying, selling, or trading securities or commodities was used to facilitate significantly the commission or concealment of the offense." That broader standard expressly includes a hedge fund professional who "regularly participates in securities transactions." Prosecutors can therefore be expected to argue for this sentence increase even when the defendant lacked discretionary trading or investment authority.

Calculation of Loss in Securities Fraud Cases--Criminal Penalties to Require Less Precision than Civil Damage Awards

The Commission also amended the fraud guideline4 to add a special rule for determining loss in cases involving fraudulent inflation or deflation in the value of publicly traded securities or commodities. The amendment directs use of what has become known as the "modified rescissory method" for determining actual loss: First, calculate the difference between (i) the average share price during the fraud period; and (ii) the average share price during the 90-day period after the fraud was disclosed to the market. Second, multiply the difference by the number of shares outstanding. In seeking comment on this issue in January 2012, the Commission identified four methods used by different federal courts around the country. Some courts employ the market-adjusted method that the U.S. Supreme Court requires in civil cases, in which the plaintiff must exclude from the calculation those changes in share price caused by forces external to the fraud, such as general declines in the market. The reasoning of these courts is that where a defendant's liberty is at stake, the calculation should be no less reliable than it is in cases where the outcome is merely a judgment to pay damages. Adoption of the "modified rescissory method" threatens to undermine that progress, because it imposes no duty to disaggregate the causes unrelated to a defendant's criminal conduct.

Despite the Commission's adoption of a less precise method, this amendment continues the Commission's recent trend of using rebuttable presumptions rather than one-size-fits-all rules. The new provision directs the court to presume that the modified rescissory method has accurately calculated the actual loss, but a party may rebut that presumption and persuade the court that it is not a "reasonable estimate of the actual loss." The court may consider, among other factors, the extent to which the amount so determined includes significant changes in value not resulting from the offense (e.g., changes caused by external market forces, such as changed economic circumstances, changed investor expectations, and new industry-specific of firm-specific facts, conditions, or events).

In last year's amendments, the Commission took a similar approach to calculating losses from health care fraud, directing that the aggregate dollar amount of fraudulent bills submitted to a government health care program "shall constitute prima facie evidence of the amount of the intended loss," but adding that this means it is sufficient evidence to establish that amount only "if not rebutted." Each provision leaves room for a defendant to make the case that using the "presumptive" approach would overstate the seriousness of the harm resulting from his offense.

Mortgage Fraud & Financial Institution Fraud--A New Rule for Valuing Undisposed Loan Collateral

Another amendment tackles the thorny issue of how to determine the amount of "credit" a defendant should receive for undisposed loan collateral in a mortgage fraud case. First, the guidelines will no longer direct determination of what the collateral is worth at the time of sentencing. Instead, the court is to determine value as of the time of the defendant's plea or guilty verdict. This change prevents the problem of a moving target, where the probation department must revisit the question of value if the sentencing is adjourned. Second, the amended guideline creates another rebuttable presumption; in this instance, it is presumed that the most recent tax assessment value of the collateral is a reasonable estimate of the fair market value. In deciding the appropriateness of the presumption, the court may consider how recent the assessment was and "the extent to which the jurisdiction's tax assessment practices reflect factors not relevant to fair market value." Because the Commission heard testimony at its hearing on March 14 that many jurisdictions base tax assessment value on factors unconnected to fair market value, this presumption may carry little weight in many cases.

The Commission's other change in this area is to broaden the applicability of a four-level enhancement5 for offenses involving specific types of financial harms, including jeopardizing a financial institution or organization. The Commission amended the instructions to direct courts to consider whether one of the listed harms was likely to result from the offense, but did not result because of federal government intervention "such as a bailout." As Chairman Saris noted, this amendment "ensures that no defendant will receive a reduced penalty because of a… bailout." Given how the new provision is worded, there is likely to be litigation over whether "federal government intervention" should be limited to something comparable to a "bailout," as opposed to a broader reading that might encompass successful law enforcement efforts to stop a scheme before it fully plays out.

Potential Departures--A Small Step Toward Curbing Undue Severity in the Guidelines

Finally, the Commission expanded the provisions in the fraud guideline6 that govern when a judge may depart above or below the recommended guideline range. First, the Commission noted that an upward departure may be warranted if the offense created a risk of substantial loss beyond the loss determined under the guideline, "such as a risk of a significant disruption of a national financial market." Second, the Commission provided new guidance on downward departures, adding the example of a securities fraud where fraudulent misrepresentations inflate the price of a stock in a manner that produces "an aggregate loss amount that is substantial but diffuse, with relatively small loss amounts suffered by a relatively large number of victims." The new language states that in such cases, the guidelines tables for amount of loss and number of victims may combine to produce an offense level that substantially overstates the seriousness of the offense, thus warranting consideration of a downward departure.

Conclusion--What the Future Holds

Given that judges, academics, and the defense bar have long called for a wholesale revision of the fraud guideline--indeed, even the Department of Justice has supported a comprehensive review--the Commission's actions should be seen as modest. In particular, the new downward departure language should not be read as the Commission's final word on addressing undue severity in the punishment for certain fraud offenses. Chairman Saris explained that these amendments are "the first step in a multi-year review of the fraud guideline" and specifically noted the criticisms about disproportionate or disparate sentences, "particularly in high-loss fraud cases."

The Chair's statement gives hope for further modification of the guidelines, particularly to address their overemphasis on loss and other characteristics of an offense, while failing to account for various mitigating factors such as lack of personal gain, less culpable motives and lesser degrees of intent. The fact that the Chair acknowledged the need for further work in this area only reinforces the point that courts can and should continue to assess, on a case-by-case basis, whether a sentence below the recommended range is warranted.


Notes
1. The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203.
2. U.S. Federal Sentencing Guidelines Section 2B1.4.
3. Guidelines Section 3B1.3.
4. Guidelines Section 2B1.1.
5. Guidelines Section 2B1.1(b)(15)(B).
6. Guidelines Section 2B1.1.


David Debold is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher LLP. Mr. Debold practices in the Litigation Department, and is a member of the firm’s Appellate and Constitutional Law, Securities Litigation and White Collar Defense and Investigations Practice Groups. Matthew Benjamin is an associate in Gibson Dunn’s New York office, and a member of the firm's Litigation Practice. Contact: ddebold@gibsondunn.com or mbenjamin@gibsondunn.com.