Per Ramfjord Stoel Rives, LLP CHALLENGING AMOUNT OF LOSS IN SECURITIES FRAUD CASES

Transcription

1 Per Ramfjord Stoel Rives, LLP CHALLENGING AMOUNT OF LOSS IN SECURITIES FRAUD CASES

2 The Problem Securities fraud and insider trading defendants facing massive prison sentences: 25 years for Bernard Ebbers, WorldCom 24 years for Jeff Skilling, Enron 24 years for Jamie Olis, Dynegy (pre-reversal) 20 years for Timothy Rigas, Adelphia 15 years for Sturart Wolff, Homestore, Inc. 15 years for Mehdi Gabayzadeh, American Tissue

3 Sentencing Drivers Loss (and gain) provisions of the US Sentencing Guidelines Add up to 30 levels to already stiff sentencing levels for securities fraud and insider trading Base offense level for securities fraud 7 (2B1.1(a)) Base offense level for Insider trading 8 (2B1.4(a)) Come on top of other likely enhancements: 6 levels for 250 or more victims (2B1.1(b)(2)(C)) 2 levels for sophisticated means (2B1.1(b)(9)) 4 levels for public company officer (2B1.1(b)(15)(A)) 2 to 4 levels for organizer, leader, manager (3B1.1(c))

4 The Loss Table Loss Level Increase $5,000 0 > $5,000 2 > $10,000 4 > $30,000 6 > $70,000 8 > $120, > $200, > $400, > $1,000, > $2,500, > $7,000, > $20,000, > $50,000, > $100,000, > $200,000, > $400,000,000 30

5 Challenges for the Defense Although loss and/or gain is the largest single driver of sentences in securities fraud and insider trading cases, the Guidelines provide only minimal assistance in determining how loss and gain should be calculated Given this leeway, the government can and has sought to apply calculations that maximize loss and or gain and the defendant s sentence Such loss and gain calculations often include loss and or gain that is unrelated to the defendant s conduct

6 Responding to the Challenge Two recent cases have opened new paths to challenge government loss or gain calculations: United States v. Olis, 429 F3d 540 (5 th Cir 2005) and its progeny for loss in securities fraud cases; and United States v. Nacchio, 573 F3d 1062 (10 th Cir 2009) for gain in insider trading cases These cases lay the foundation for strong arguments against excessive loss and gain calculations

7 United States v. Olis Jamie Olis tax lawyer and accountant at Dynegy Conviction involving a transaction known as Project Alpha Designed to generate positive cash flow to Dynegy in 2001 and negative cash flow in Involved an SPE created by Deutsche Bank and Credit Suisse ABG Gas Supply ABG bought gas on the market and sold it at a discount to Dynegy in 2001 (generating $300 million in profit), then at a premium in (generating $300 million in negative cash flow, plus interest) Olis concealed parent level hedge and tear up agreements from auditors

8 Olis Original Sentencing Olis was convicted of conspiracy, securities fraud, mail fraud and wire fraud District Court sentenced Olis to Guidelines sentence of 292 months (24 years 3 mo) District Court calculated $105 million loss based on the difference between the purchase and sale price for one major shareholder This loss calculation, however, failed to consider other factors that affected the stock price while the shareholder held the stock In fact, 2/3 of the loss occurred before the problems with Project Alpha were revealed or more than a week after the restatement of earnings caused by Project Alpha

9 Olis 5 th Circuit s Decision 5 th Circuit reversed District Court sentence The loss calculation did not take into account the impact of extrinsic factors on Dynegy s stock price decline At the same time the 5 th Circuit Acknowledged skeletal nature of loss Guideline noting that it applies dozens of federal property crimes But held that courts should look to civil damages remedies to fill in the gap for securities fraud cases

10 Olis Key Holdings District courts must take a realistic, economic approach to determine what losses the defendant truly caused or intended to cause. The civil damage measure should be the backdrop for criminal responsibility both because it furnishes the standard for compensable injury for securities fraud victims and because it is attuned to stock market complexities. Courts should rely on the principle of loss causation developed in Dura Pharmaceuticals, Inc. v. Brudo, 544 US 336 (2005), under which there is no loss attributable to a misrepresentation unless and until the truth is subsequently revealed and the price of the stock accordingly declines.

11 Olis What It Means

12 Olis Strategy Implications Retain an expert Develop an event study Analyze other factors affecting stock price Review press releases, analyst reports, and industry trends Advocate for a proper calculation both in plea negotiations (Rule 11(c)(1)(C)) and sentencing Government is continuing to argue for high loss amounts using simplified approaches Government is also using its own experts and seeking to exclude or undermine defense experts

13 Olis Strategy Implications Prepare for a battle of experts and consider alternative bases for a loss adjustment or ways to take advantage of uncertainty The resentencing in Olis illustrates how widely experts can vary in their analysis Government expert loss between $161 and 714 million, depending on periods examined and choices about how much weight to ascribe to events unrelated to the fraud Defense expert no loss District court ignored both sides and resentenced based on $79 million tax savings intended by the transaction Range of months, but court sentenced to 72 months on grounds that no more was necessary for general deterrence

14 Olis -- Progeny United States v. Rutkoske, 505 F3d 170 (2d Cir. 2007) Reversed sentence based on loss calculation that improperly attributed the total amount of the decline in stock price to the defendant s conduct United States v. Leonard, 529 F3d 83 (2d Cir 2008) Reversed sentence based on loss calculation equal to the total value of the securities sold where the securities were not actually worthless

15 United States v. Nacchio Principles of Olis extended to determining the proper amount of gain for insider trading sentences

16 United States v. Nacchio Nacchio, former CEO of Qwest, convicted of insider trading for exercising options and selling shares in April and May 2001 Nacchio possessed nonpublic information that: Qwest was only meeting its Q1 and Q2 earnings targets because of one-time sales of IRUs Qwest did not have sufficient recurring revenue to meet its year-end goals Information became public in a series of disclosures starting in July 2001 and culminating in a September 10, 2001 revision of 2001 and 2002 earnings targets

17 Nacchio Original Sentence District Court sentenced Nacchio to 72 months Based on a calculated gain of $28 million using net profits from stock sales Failed to account for the fact that much of the gain was due to factors unrelated to the failure to disclose nonpublic information

18 The Guidelines on Gain 2B1.4 provides that: [i]f the gain resulting from the offense exceeded $5,000, the offense level should be increased by the number of levels from the [loss]table in 2B1.1 But the Guideline itself does not specify how the gain is to be calculated The Background Commentary to 2B1.4 notes that [b]ecause the victims and their losses are difficult if not impossible to identify in insider trading cases, the gain, i.e., the total increase in value realized through trading in securities by the defendant is employed instead of the victims losses.

19 Gain Calculation in Nacchio Amount realized on Nacchio s stock sales was not disputed: Gross proceeds $52,007,545 Cost of options $7,315,000 Brokerage commissions $60,081 Taxes $16,078,147 But the government and Nacchio took strikingly different positions on how much of the proceeds should be considered gain under the guidelines

20 Different Views of Gain The government contended that Nacchio s gain should be his net profit, calculated as his gross proceeds, less his cost of options, or $44.6 million Nacchio, in contrast, argued that his gain should only reflect that portion of his stock sales proceeds attributable to the fact that he traded on inside information i.e., that portion of his proceeds that resulted from the stock price being higher than it would have been had the nonpublic information been disclosed Based on an event study, this amount was $1.8 million

21 District Court s Calculation Rejected Nacchio s argument that sentence should only reflect gain attributable to offense, citing Guidelines commentary US v. Mooney, 425 F3d 1093 (8 th Cir 2005) Adopted government s methodology but excluded taxes and brokerage expenses, for a total gain of approximately $28 million.

22 Nacchio s Appeal Nacchio argued that he was effectively being punished for gains resulting from the normal appreciation of Qwest s stock price that had nothing to do with the offense charged The 10 th Circuit agreed, holding that Mr. Nacchio s increased prison sentence should be linked to the gain actually resulting from the offense, not to gain attributable to legitimate price appreciation and the underlying value of the Qwest shares.

23 10 th Circuit s Rationale Found that Nacchio s position was consistent with the Guidelines and commentary Guidelines prescribe an increase corresponding to the gain resulting from the offense The essence of the offense of insider trading is not simply trading, but trading on inside information Because mere trading is not an offense, any gain associated with lawful portion of the trading should not be considered for sentencing Properly read, the commentary supports this result ( total increase in value realized through trading must be read as referring to the offense)

24 10 th Circuit Reliance on Olis The Court found further support in Olis Olis specifically recognized that stock price movements based upon factors unrelated to the defendant s offense should be excluded from a Guidelines loss determination. Olis also specifically recognized the propriety of relying on civil remedy provisions, which the Nacchio court extended to the insider trading context

25 Nacchio Key Holdings Courts should look to civil remedy provisions, specifically rules governing disgorgement of ill-gotten profits used by the SEC, in calculating gain Sentencing judges should have considerable discretion in applying th[is] approach but should focus on ensuring that the gain figure resulting from the offense excludes to the extent possible... factors unrelated to the defendant s criminally culpable conduct

26 Nacchio Strategy Same lessons as Olis Retain an expert Develop an event study Analyze other factors affecting stock price Review press releases, analyst reports, and industry trends Advocate for a proper calculation both in plea negotiations (Rule 11(c)(1)(C)) and sentencing Keep your presentations simple, but recognize the need to educate prosecutors, probation officers and, to some extent, judges

27 Questions? Thank you! Per Ramfjord Stoel Rives LLP (503)