Asset Freeze and Forfeiture Procedures in Criminal and Civil Cases

ABA Section of Litigation and Criminal Justice Section Annual CLE Conference, April 13 15, 2011: What to Do When the Government Freezes Your Client s Assets Asset Freeze and Forfeiture Procedures in Criminal and Civil Cases Vincent P. (Trace ) Schmeltz III Dewey & LeBoeuf LLP Chicago, Illinois Sharon Cohen Levin United States Attorney s Office New York, NY Danielle Sallah Securities and Exchange Commission New York, New York Ghillaine A. Reid Gibbons P.C. New York, New York The views set forth in this paper do not necessarily reflect the views of the US Department of Justice or the United States Attorney s Office for the Southern District of New York. The views in this paper reflect solely personal views, and do not necessarily reflect the views of the Securities and Exchange Commission, the individual members of the Commission, or its Staff.

INTRODUCTION This paper examines the Government s authority to freeze assets held by private citizens and provides some strategies and tactics for defense attorneys who find their clients left without funds for living expenses or to pay attorneys fees. ASSET FREEZES IN SEC CIVIL ENFORCEMENT CASES Initial Imposition of Ex Parte Asset Freeze Order in Civil Cases A District Court has the authority in a civil securities fraud case to impose a temporary asset freeze; one of the primary reasons for this requirement is to ensure that the defendant has not secreted assets while insuring that there will be assets available to compensate defrauded investors. SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1105 (2 nd Cir. 1972). 1 When ancillary relief in the form of an asset freeze is requested, the motivating purpose is to facilitate enforcement of any disgorgement remedy that might be ordered in the event a violation is established at trial. SEC v. Unifund SAL, 910 F.2d 1028, 1041 (2 nd Cir. 1990). When a court is making a determination as to whether an asset freeze is appropriate, it will consider whether the freeze is in fact in the allegedly defrauded investors interests. SEC v. Coates, No. 94 Civ. 5361, 1994 WL 455558, at *1 (S.D.N.Y. Aug. 23, 2004). A court may impose a pre-trial freeze upon a defendant s assets in a SEC enforcement case. This freeze is appropriate even in light of a defendant s claim that the asset freeze precludes him from obtaining counsel in a related criminal case. Id. at *3. Courts have consistently held that a defendant is not entitled to foot his legal bill with funds that are tainted by fraud. Id. (citing SEC v. Quinn, 991 F.2d 287, 289 (7 th Cir. 1993)). This liberal approach is furthered by the fact that pre-trial asset freezes are not limited to funds that can be directly traced to the defendant s alleged illegal activity. SEC v. Sekhri, No. 98 Civ. 2320, 2000 WL 1036295, at *1 (S.D.N.Y. July 26, 2000); SEC v. Grossman, 887 F. Supp. 649, 661 (S.D.N.Y. 1995). Instead, it is irrelevant whether the funds affected by the Assets Freeze are traceable to the illegal activity, where defendants are jointly and severally liable for the profits of their tippees. Id.; SEC v. Glauberman, No. 90 Civ. 5205 (MBM), 1992 WL 175270, at *2 (S.D.N.Y. July 16, 1992). Continuation of SEC Asset Freeze Order Throughout Pre-Trial Period When there is no parallel criminal proceeding, a defendant may attempt to obtain a carve-out from the asset freeze for the defense of the civil case. In order to obtain this carve-out, the defendant must show: 1) that the funds were not tainted by the fraud, and 2) whether there are sufficient funds to satisfy any disgorgement remedy that might be ordered at trial. SEC v. Stein, No. 07 Civ. 3125, 2009 WL 1181061, at *1 (S.D.N.Y. Apr. 30, 2009) ( defendant must establish that the funds he seeks to release are untainted and that there are sufficient funds to satisfy any disgorgement remedy that might be ordered in the event a violation is established at trial. ); SEC v. Roor, No. 99 Civ. 3372, 1999 WL 553823, at *3 (S.D.N.Y. July 29, 1999) ( A defendant in a case brought by the SEC may not use income derived from alleged violations of the securities laws to pay for legal counsel. ). When a defendant is also subject to a parallel criminal proceeding, the inquiry becomes more exacting. When a defendant seeks to obtain a carve-out for the purposes of defense, an adversary hearing is 1 This would apply to civil enforcement cases brought by the CFTC as well. See Commodity Futures Trading Commission v. Walsh, 618 F.3d 218, 225 (2nd Cir. 2010); Armstrong v. Guccione, 470 F.3d 89, 93 (2nd Cir. 2006); SEC v. Brennan, 230 F.3d 65, 80 (2nd Cir. 2000). 2

required. SEC v. Coates, 1994 WL 455558, at *3. In order to maintain the asset freeze, the SEC must demonstrate that: 1) a prima facie case of securities law violations has been made, and 2) that a showing has been made that the frozen assets are traceable to fraud. Id.; U.S. v. Monsanto, 924 F.2d 1186, 1203 (2 nd Cir. 1991), cert. denied, 112 S.Ct. 382 (1991); SEC v. Quinn, 997 F.2d at 289 (noting with approval the district court s procedure of requiring the SEC to make a showing that the assets can be traced to fraud, followed by opportunity for defendant to demonstrate that he possessed assets untainted by fraud). In addition to requiring a showing made by the SEC, courts also require a defendant to demonstrate that the frozen funds are necessary, and without them the defendant s Sixth Amendment right to counsel will be infringed upon. SEC v. FTC Capital Markets, Inc., No. 09 Civ. 4755, 2010 WL 2652405, at *9 (S.D.N.Y. June 30, 2010); SEC v. Cobalt Multifamily Investors, LLC, No. 06 Civ. 2360 (KMW) (MHD), 2007 U.S. Dist. Lexis 25872, at *10-12 (S.D.N.Y. April 2, 2007); Sekhri, 2000 WL 1036295, at *2. However, courts will refuse to release frozen funds where the amounts already paid to defense counsel, or amounts available from other sources, are sufficient to pay reasonable defense costs. Id. CRIMINAL AND CIVIL FORFEITURE Criminal prosecutors can seize the property of a criminal defendant either through criminal or civil forfeiture; the following section discusses both. Criminal forfeiture is an action in personam against property of a criminal defendant. The property is said to be tainted because, for example, it constitutes the proceeds of criminal conduct, property traceable to criminal proceeds, or property used to facilitate (or which is otherwise involved in) a criminal offense. The criminal prosecution determines only the interest of the convicted criminal defendant in the property. Whether the interests of other owners in the forfeited property are exempt from forfeiture is determined in a post-forfeiture ancillary hearing. Restraint/Seizure of Assets A criminal forfeiture action is commenced by including an allegation of forfeiture in the criminal indictment of a criminal defendant. See Fed. R. Crim. P. 32.2(a). The government may also obtain a ten-day, ex parte, pre-indictment temporary restraining order (TRO) of assets subject to forfeiture. 2 To obtain such an order the government must establish probable cause to believe that: 1) the property to be restrained will, in the event of conviction, be subject to criminal forfeiture; and 2) the provision of notice will jeopardize the availability of the property for forfeiture. This TRO expires ten days after entry unless it is extended by the court for: 1) good cause shown or 2) upon consent of the party against whom it is entered to an extension for a longer period. Preliminary Pre-Indictment Restraining Order Regardless of whether the government has obtained a pre-indictment, ex parte, TRO, it may either obtain a preliminary restraining order or convert the TRO to a preliminary restraining order, upon affording an opportunity for a hearing to all persons appearing to have an interest in the property notice. 3 At the 2 See 21 U.S.C. 853(e)(2) (incorporated by reference in nearly all federal criminal forfeiture statutes [e.g., 18 U.S.C. 798(d)(3); 982(b)(1); 1028(g) 1467(b); 2253(b); 31 U.S.C. 5317(c)(1)(B); 50 U.S.C. 783(e)(3)] and 18 U.S.C. 1963(d)(2). 3 See, e.g., 21 U.S.C. 853(e)(1)(B) (incorporated by reference in nearly all federal criminal forfeiture statutes [e.g., 18 U.S.C. 798(d)(3); 982(b)(1); 1028(g) 1467(b); 2253(b); 31 U.S.C. 5317(c)(1)(B); 50 U.S.C. 783(e)(3)] and 18 U.S.C. 1963(d)(1)(B). 3

hearing, the government bears the burden of establishing a substantial probability that: 1) the property will be subject to forfeiture upon conviction; 2) failure to restrain the property will result in its destruction, removal, or unavailability for forfeiture; and 3) the need to preserve the availability of the property outweighs the hardship of its restraint on the owner(s). This pre-indictment preliminary restraining order is good for 90 days unless it is either extended by the court for good cause shown or an indictment or information is returned charging a violation in which criminal forfeiture is alleged and for which a criminal forfeiture may ultimately be entered. (In the latter instance, the post-indictment restraining order will be governed by the rules set forth below.) Post-Indictment Restraining Order Once an indictment or information is filed charging a violation supporting criminal forfeiture and alleging that the property as to which the restraint is sought would, in the event of conviction, be subject to criminal forfeiture, the government may obtain a restraining order. 4 Under certain criminal forfeiture statutes, the government may obtain a seizure warrant for property subject to criminal forfeiture upon demonstrating that: 1) the property to be seized is subject to forfeiture under the applicable criminal forfeiture statute; and 2) the issuance of a restraining order would be insufficient to insure the availability of the property for forfeiture. 5 Monsanto Hearings The Second, Fourth, Fifth, Seventh and Tenth Circuits have required post-restraint hearings only in cases where the defendant needs the restrained assets in order to retain counsel-of-choice in a criminal prosecution and the defendant first demonstrates that he has no other assets available with which to retain counsel. 6 The Government s burden of proof at a Monsanto hearing is probable cause. See U.S. v. Monsanto, 491. U.S. 600, 615 (1989). 7 4 See, e.g., 21 U.S.C. 853(e)(1)(A) (incorporated by reference in nearly all federal criminal forfeiture statutes [e.g., 18 U.S.C. 798(d)(3); 982(b)(1); 1028(g) 1467(b); 2253(b); 31 U.S.C. 5317(c)(1)(B); 50 U.S.C. 783(e)(3)] and 18 U.S.C. 1963(d)(1)(A). 5 See 21 U.S.C. 853(f) (incorporated by reference in nearly all federal criminal forfeiture statutes e.g., 18 U.S.C. 798(d)(3); 982(b)(1); 1028(g) 1467(b); 2253(b); 31 U.S.C. 5317(c)(1)(B); 50 U.S.C. 783(e)(3). 6 See U.S. v. Kirshenbaum, 156 F.3d 784 (7th Cir. 1998); U.S. v. Jones, 160 F.3d 641(10th Cir. 1998); U.S. v. Monsanto, 924 F.2d 1186 (2d Cir.) (en banc; on remand from Supreme Court), cert. denied, 502 U.S. 943 (1991); U.S. v. Moya-Gomez, 860 F.2d 706 (7th Cir. 1988), cert. denied ("Monsanto to IV"), Estevez v. U.S., 492 U.S. 908 (1989); United States v. Harvey, 814 F.2d 905, 928 (4th Cir. 1987), superseded as to other issues sub nom. In re Forfeiture Hearing as to Caplin & Drysdale, Chartered, 837 F.2d 637, 644 (4th Cir. 1988) (en banc) (addressing only Sixth Amendment challenge to forfeiture of defense attorney fees and noting that "[n]o... procedural due process claim is before us"), aff d, 491 U.S. 617 (1989); U.S. v. Thier, 801 F.2d 1463 (5th Cir. 1986). See also United States v. Holy Land Foundation for Relief and Development, 493 F.3d 469 (5th Cir. 2007); U.S. v. Roth, 912 F.2d 1131 (9th Cir. 1990) (applying the general rule of Crozier II in the "attorney fee-restraint" context). Cf. U.S. v. Farmer, 274 F.3d 800 (4th Cir. 2001) (defendant entitled to post-seizure, pre-trial hearing if property is seized for civil forfeiture and the defendant demonstrates there are no unrestrained assets available to pay counsel). Accord U.S. v. Michelle s Lounge, 39 F.3d 684, 693 (7th Cir. 1994). The Supreme Court, in U.S. v. Caplin & Drysdale, Chartered, 491 U.S. 617 (1989), held that a defendant has no right to use forfeitable property in the exercise of his/her qualified right to counsel of choice under the Sixth Amendment. In a companion case, the Court expressly did not decide whether the Due Process Clause of the Fifth Amendment requires a post-restraint hearing where a defendant needs potentially-forfeitable assets that are under restraint in order to retain counsel-of-choice in a criminal case. See U.S. v. Monsanto, 491 U.S. 600, 615 n.10 (1989). The foregoing circuits have resolved this issue in favor or the post-restraint hearing. 4

Substitute Assets The criminal forfeiture statutes provide for the forfeiture of "substitute assets" in place of tainted property where certain conditions are met. 8 Courts are split on whether restraining orders may be entered against such "substitute assets" in advance of conviction. The majority rule holds, as a matter of statutory construction, that "substitute assets" are not subject to pre-conviction restraint under the criminal forfeiture statutes. 9 Only the Fourth Circuit permits pre-conviction restraint of substitute assets. 10 The same rule would apply to seizure warrants where available under certain criminal forfeiture statutes. The courts that do not permit the pre-conviction restraint of "substitute assets" rest their holdings solely on statutory construction. However, courts allow the use of lis pendens public notices that the property in question is subject to litigation to be filed on real property (and, in some states, other property) sought to be forfeited as substitute assets, or to satisfy a money judgment, to the extent state law permits. 11 Civil Forfeiture and Seizure of Assets Civil Forfeiture is an in rem action against the property that was derived from or used to commit a crime. The seizure of property for civil forfeiture is premised on the existence of probable cause to believe that the property is subject to forfeiture to the United States under the applicable statute(s). This is the same "probable cause" standard as applies to search warrants and arrest warrants under the Fourth Amendment. There must be reasonable grounds to believe, amounting to more than a mere suspicion, that each of the statutory elements of the violation giving rise to the forfeiture is satisfied and that a sufficient nexus exists between the property and the commission of the violation. Several of the more commonly used civil forfeiture statutes permit property to be seized for civil forfeiture pursuant to a seizure warrant obtained in the same manner and under the same probable cause standard as a search warrant under Fed. R. Crim. P. 41. 12 Such seizure warrants may be executed on 7 Accord U.S. v. Bollin, 264 F.3d 391, 421 (4th Cir. 2001); U.S. v. Jones, 160 F.3d 641 (10th Cir. 1998). 8 See 21 U.S.C. 853(p) (incorporated by reference in most criminal forfeiture statutes, for example, 18 U.S.C. 798(d)(3); 1028(g); 1467(b), 2253(b); 31 U.S.C. 5317(c)(1)(B); 50 U.S.C. 783(e)(3) and, with limitations, in 18 U.S.C. 982(b)(1) and (2)); 18 U.S.C. 1963(m). 9 See U.S. v. Gotti, 155 F.3d 144 (2d Cir. 1998); In re Martin, 1 F.3d 1351 (3d Cir. 1993). Accord U.S. v. Field, 62 F.3d 246 (8th Cir. 1995); U.S. v. Ripinsky, 20 F.3d 359 (9th Cir. 1994); U.S. v. Floyd, 992 F.2d 498 (5th Cir. 1993). 10 See In re Billman, 915 F.2d 916 (4th Cir. 1990), cert. denied, McKinney v.u.s., 500 U.S. 952 (1991). 11 U.S. v. Parrett, 530 F.3d 422 (6th Cir. 2008); U.S. v. Woods, 436 F. Supp. 2d 753 (E.D.N.C. 2006); U.S. v. Lebed, 2005 WL 2495843 (E.D. Pa. 2005); U.S. v. Hyde, 287 F. Supp. 2d 1095 (N.D. Cal. 2003) (assuming without deciding that notice of lis pendens may be filed on substitute asset). But see U.S. v. Jarvis, 499 F.3d 1196 (10th Cir. 2007) (under New Mexico law, a notice of lis pendens may only be filed on property involved in pending litigation; substitute assets are not involved in pending criminal case except where forfeiture is sought in satisfaction of a money judgment). Contra U.S. v. Jewell, 556 F. Supp. 2d 962 (E.D. Ark. 2008) (notices of lis pendens under Arkansas state law may be filed only in actions affecting title to real property, not to actions in which real property is sought to be forfeited in satisfaction of a money judgment). See also U.S. v. Kramer, 2006 WL 3545026 (E.D.N.Y. Dec. 8, 2006) (state law prohibits use of notices of lis pendens against substitute assets). 12 See, e.g., 18 U.S.C. 981(b)(2); 21 U.S.C. 881(b). 5

property located outside the district of issuance notwithstanding language to the contrary in Rule 41(b)(1). 13 Other commonly used civil forfeiture statutes accomplish the same result by incorporating by reference "the provisions of chapter 46 of Title 18, relating to civil forfeitures," which include 18 U.S.C. 981(b)(2), and/or the procedural provisions of the customs laws, 19 U.S.C. 1602 et seq., which include 19 U.S.C. 1603(a). 14 Many of the commonly used civil forfeiture statutes specifically provide for the warrantless seizure of property in specified circumstances. See 18 U.S.C. 981(b)(2)(B) (seizure pursuant to lawful arrest or search or other exception to the Fourth Amendment warrant requirement); 21 U.S.C. 881(b) (incorporating by reference 981(b)). Property may, of course, be seized and held as evidence pursuant to one of the exceptions to the warrant requirement of the Fourth Amendment. CIVIL ENFORCEMENT AND CRIMINAL PARALLEL PROCEEDINGS A PRACTITIONER S APPROACH When representing a client who faces criminal and civil parallel proceedings, a practitioner is faced with a number of approaches. Two of these approaches have proven to be effective means of obtaining a carveout from an asset freeze for reasonable personal expenses and attorney s fees. These approaches are best described by two recent cases, CFTC v. Walsh and SEC v. Petters. Commodity Futures Trading Commission v. Walsh In CFTC v. Walsh, both criminal and civil proceedings had been brought against defendants Greenwood and Walsh. In an effort to obtain a carve-out for household and personal living expenses and for attorney s fees, defendants Greenwood and Walsh filed motions in the criminal cases requesting that the court allow a release of funds. No. 09-CV-1749 (GBD), 09-CV-1750 (GBD), 09-CR-722 (MGC), 2010 WL 882875, at *1 (S.D.N.Y. Mar. 9, 2010). These motions were argued before a two-judge panel, which granted defendants motions and permitted payment of attorney s fees with untainted funds. Id. In granting the defendants motions, the two-judge panel required the government to meet the burden of showing to what extent, if any, the funds which the defendants intended to use for payment of the attorney s fees were tainted. Id. at *3. In light of the parallel civil and criminal proceedings, the court held that: although a court may impose an asset freeze in a civil case, notwithstanding a companion criminal case, these circumstances dictate that the court pay particular attention to the defendant s Fifth and Sixth Amendment rights. Id. Because the government has the burden of demonstrating probable cause to believe that funds are tainted by the alleged fraud in a criminal case, the panel rejected the government s argument that a defendant is not entitled to use untainted funds, frozen in a civil action, in order to pay legal fees for his counsel of choice in a parallel criminal action. Id. SEC v. Petters In SEC v. Petters, the SEC had commenced a case against defendants to maintain the status quo pending a related criminal case. No. 09-1750 (ADM/JSM), 2010 U.S. Dist. Lexis 125667, at *2 (D. Minn. Nov. 29, 2010). As a result of this action, defendants assets had been frozen pending disgorgement proceedings by the SEC. On behalf of one of the defendants, Mr. Bell, Counsel sought a carve-out from the asset freeze in order to pay legal fees and living expenses for the defendant s family. Unable to 13 Id. 14 See, e.g., 8 U.S.C. 1324(b)(2); 18 U.S.C. 1467(c); 1594(c)(2); 2254; 2320(b)(2); 2344(c); 22 U.S.C. 401(b); 47 U.S.C. 510(c). 6

negotiate a carve-out with SEC enforcement staff, Counsel sought relief from the court. Although the amount of disgorgement sought by the SEC far exceeded the amount of the frozen funds, the court granted a reduced award of fees and living expenses. In contrast to the holding of the panel in CFTC v. Walsh, the court in SEC v. Petters relied upon its discretion to reach its decision. Instead of examining whether the funds were tainted by fraud, the court relied upon equitable considerations and the defendants need to retain legal counsel during the criminal proceedings. Obtaining a Carve-Out: When a practitioner approaches an asset-freeze with the intention of obtaining a carve-out for the purposes of paying for reasonable household expenses and for attorney s fees, there are a number of elements that should be taken into consideration. For instance, if the defendant is facing civil proceedings without a parallel criminal action, the burden is more onerous on the defendant. Can the defendant demonstrate 1) that the funds were not tainted by the fraud, and 2) that there are sufficient funds to satisfy any disgorgement remedy that might be ordered at trial? In a criminal proceeding without a parallel civil action, the burden and Constitutional implications weigh more heavily on the government. In the Second, Fourth, Fifth, Seventh and Tenth Circuits, the defendant is entitled to a post-restraint hearing if the defendant can demonstrate 1) that he/she needs the restrained assets in order to retain counsel-of-choice, and 2) that he/she has no other assets available with which to retain counsel. In parallel proceedings, as shown above, the practitioner may choose to require a post-restraint hearing and force the government to meet its burden, or the practitioner may elect to bring a motion in the civil case and rely on the equitable discretion of the judge. A practitioner has a number of strong arguments at his/her disposal when appealing to the court s discretionary authority. A close examination of the purpose of the asset freeze aids in these approaches: because an asset freeze is intended to protect the interests of investors and preserve assets for future disgorgement, a freeze that prevent[s] defendants from making expenditures necessary to preserve some of those assets circumvents that purpose. See Memorandum of Law of Defendants Paul Greenwood and Stephen Walsh in Response to Orders to Show Cause, No. 109-CV-01749, 2009 WL 1633171, at 7 (S.D.N.Y. Mar. 2, 2009). Attorneys should rely on this underlying purpose in obtaining carve-outs for reasonable expenses such as taxes, mortgages, and reasonable maintenance fees necessary to stave off foreclosure and to preserve the value of an asset. Additionally, attorneys should emphasize the importance of protecting their client s constitutional rights. In parallel criminal and civil proceedings, even when the SEC has met the relatively low standard to obtain a pre-trial asset freeze, a defendant s Sixth Amendment right to counsel is implicated and must be protected. In fact, considerations of fundamental fairness supports releasing funds for attorneys fees when wrongdoing is not proven and the restrained property is a defendant s only means of securing counsel. See United States v. Petters, No. 08-5348, 2009 WL 803482, at *4 (D. Minn. Mar. 25, 2009). It would be untenable for a court to assume wrongdoing before judgment, and thus remove a defendants ability to defend themselves. See Fed. Sav. & Loan Ins. Corp. v. Dixon, 835 F.2d 554, 565 (5 th Cir. 1987). When the SEC requires a defendant to provide an accounting of assets, liability, and property, a defendant is placed in the unsustainable position of being required to gain access to their records and documentation without the funds or means to do so. A defendant would be unable to obtain full and accurate records in the absence of funds; therefore, courts must use their discretionary authority to release frozen assets to assist defendants in complying with the demands of the SEC. 7

Lastly, even when a court determines that an asset freeze is warranted, the defendant may show that certain assets are completely untainted by fraud in order to obtain a release. A practitioner should demonstrate that an injunction or freeze order is overly broad because it covers funds that are not tainted or that belong to a person who is not accused of wrongdoing. 15 Under this approach, one may be welladvised to attempt to convince the Government that one can mount an effective challenge to the scope of any asset freeze before a prior restratint such as a preliminary injunction becomes permanent. However, if the government is able to prove that commingling of funds has occurred, thus tainting the funds, the assets may remain frozen. 16 15 See Commodity Futures Trading Commission v. Walsh, 2010 WL 882875 at *3 ( Defendants are entitled to pay for lawyers of their choice with untainted funds ). 16 See SEC v. Byers, 637 F.Supp.2d 166 (S.D.N.Y. 2009) (where the court found that comingling of funds had occurred and thus frozen assets would not be released). 8