Opinion ID: 3065256
Heading Depth: 2
Heading Rank: 1

Heading: Loss Causation Principles Applied to Criminal

Text: Securities Fraud Berger first argues that the district court erred by including losses in its $2.1 million shareholder loss figure that did not actually occur, or that were not caused by his fraudulent conduct.
[1] The Supreme Court has ruled that to sustain a damages claim for civil securities fraud under 15 U.S.C. §§ 78j(b) and 78u-4, a plaintiff must show that the fraud was publicly revealed and that the disclosure caused the shareholders to suffer loss. Dura Pharms., 544 U.S. at 346-47 (finding that plaintiff must show that “share price fell significantly after the truth [of the fraud] became known”). In so holding, the Dura Pharmaceuticals Court rejected the notion that stock over15626 UNITED STATES v. BERGER valuation resulting from so-called “fraud-on-the-market” may form the basis for a plaintiff’s damages award in a private securities action. Id. at 341-43. In other words, a shareholder’s allegation that he was led to buy stock at a price that was artificially inflated due to fraud does not state a claim for loss. Id. (noting that while “one might say that the inflated purchase price suggests that the misrepresentation . . . ‘touches upon’ a later economic loss” that is insufficient because “[t]o ‘touch upon’ a loss is not to cause a loss” (internal citations omitted) (citing 15 U.S.C. § 78u-4(b)(4))). As a result, it is now clear in civil securities fraud actions that “the complaint must allege that the practices that the plaintiff contends are fraudulent were revealed to the market and caused the resulting losses.” Metzler Inv. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049, 1063 (9th Cir. 2008). B. Application of Civil Rule to Criminal Securities Fraud [2] The Supreme Court has not applied its Dura Pharmaceuticals loss causation principle to sentencing enhancements in criminal securities fraud cases, but two federal circuit courts have suggested that they are applicable in this context. In United States v. Olis, the Fifth Circuit intimated that the civil loss causation principle described in Dura Pharmaceuticals should inform criminal securities fraud sentencing. See 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.”) (citing Dura Pharms., 544 U.S. 336, 341-43). Olis cited several out-of-circuit cases, including various so-called “cook the books” scenarios, and noted with approval that “each case takes seriously the requirement to correlate the defendant’s sentence with the actual loss caused in the marketplace, exclusive of other sources of stock price decline.” Id. at 547. UNITED STATES v. BERGER 15627 And in United States v. Rutkoske, the Second Circuit endorsed the application of Dura Pharmaceuticals’s principle to criminal sentencing even more strongly, stating that: [t]he Government contends that the principles set forth in Dura Pharmaceuticals, a civil case, should not apply to loss calculation in a criminal case. The dicta in [our decision in United States v. Ebbers, 458 F.3d 110, 128 (2d Cir. 2006)] strongly undermines that position. Moreover, we see no reason why con- siderations 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. 506 F.3d 170, 179 (2d Cir. 2007). [3] This court has not applied Dura Pharmaceuticals’s strict loss causation standard to criminal fraud cases, but we have endorsed a more general loss causation principle, permitting a district court to impose sentencing enhancements only for losses that “resulted from” the defendant’s fraud. United States v. Hicks, 217 F.3d 1038, 1048 (9th Cir. 2000). In Hicks, we stated that “[t]he Guidelines’ ‘relevant conduct’ provision requires a defendant’s sentence to be based on ‘all harm that resulted from the acts or omissions’ of the defendant.” Id. (quoting U.S.S.G. § 1B1.3(a)(3) (1995)); id. at 1048-49 (holding that government must show both “but-for” and “proximate” causation in establishing loss).6 Berger now urges us to take the next step and follow the Second Circuit in expressly applying Dura Pharmaceuticals’s civil principle to criminal securities fraud sentencing. 6 The government in this case concedes that, “in order to be a basis for an increase in base offense level under the guidelines, the losses from defendant’s securities fraud offenses must have resulted from those offenses.” 15628 UNITED STATES v. BERGER [4] We decline to do so for two reasons. First, we believe that the primary policy rationale of Dura Pharmaceuticals for proscribing overvaluation as a valid measure of loss does not apply in a criminal sanctions context. Second, application of Dura Pharmaceuticals’s civil rule to criminal sentencing would clash with the parallel principles in the Sentencing Guidelines, which have persuasive value in federal courts. See United States v. Staten, 466 F.3d 708, 710 (9th Cir. 2006) (holding that failure to consider Guidelines note in applying sentencing enhancement was reversible error). As noted, Dura Pharmaceuticals rejected the notion that an allegation by a private plaintiff that he purchased securities that were overvalued because of fraud is sufficient to state a damages claim for civil securities fraud. 544 U.S. at 342 (reversing Broudo v. Dura Pharms., Inc., 339 F.3d 933 (9th Cir. 2003)). A key component of the Court’s holding was that “as 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.” Id. Because “[s]hares are normally purchased with an eye toward a later sale[,] . . . if, say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.” Id. Moreover, the Court reasoned, “the common law has long insisted that a plaintiff in such a case show not only that had he known the truth he would not have acted but also that he suffered actual economic loss.” Id. at 343-44 (citing e.g., Pasley v. Freeman, 100 Eng. Rep. 450, 457 (1789)). Thus, the Court was concerned principally with the plaintiff’s ability to show that he suffered actual loss caused directly— and exclusively—by the defendant’s fraudulent misrepresentation. The Dura Pharmaceuticals Court’s concern is not implicated in the criminal sentencing arena. As demonstrated, in a private civil fraud action, a court gauges loss from the perspective of the plaintiff-victim, i.e., whether the plaintiff can UNITED STATES v. BERGER 15629 show the amount and cause of loss he sustained. Id. Because a civil plaintiff bears the burden to show loss, it is logical to require that the plaintiff show that any loss he sustained was attributable directly to devaluation caused by revelation of the defendant’s fraud. It likewise follows that a plaintiff’s mere allegation that he purchased overvalued stock is insufficient to state a claim, because the allegation does not by itself establish that the plaintiff personally incurred loss commensurate with the overvaluation. In criminal sentencing, however, a court gauges the amount of loss caused, i.e., the harm that society as a whole suffered from the defendant’s fraud. See, e.g., Zolp, 479 F.3d at 720. Whether and to what extent a particular individual suffered actual loss is not usually an important consideration in criminal fraud sentencing. Therefore, where the value of securities have been inflated by a defendant’s fraud, the defendant may have caused aggregate loss to society in the amount of the fraud-induced overvaluation, even if various individual victims’ respective losses cannot be precisely determined or linked to the fraud. As a result, the principle underlying the Dura Pharmaceuticals Court’s reluctance to allow mere overvaluation as a basis for establishing loss is generally not present in the criminal sentencing context, and we are not persuaded that it would be appropriate to expand the Dura Pharmaceuticals rule to the criminal sentencing context.7 The Sentencing Guidelines provide further support for limiting the scope of Dura Pharmaceuticals’s loss causation rule in a criminal sentencing context. In arguing for this interpreta- 7 We note that, based on this reasoning, Dura Pharmaceuticals may be more relevant in the context of criminal restitution under, for instance, the Mandatory Victims Restitution Act of 1996 (MVRA), 18 U.S.C. § 3663A, which, unlike the sentencing enhancement scheme, focuses on harm to the victims as opposed to loss caused by the defendant. See, e.g., Berger, 473 F.3d at 1104 (“The MVRA requires a defendant to pay restitution to a victim who is ‘directly and proximately harmed as a result of’ the fraud.” (quoting 18 U.S.C. § 3663A(a)(2)). 15630 UNITED STATES v. BERGER tion, the government cites the commentary to the 1995 Guidelines (the version applied at Berger’s sentencing), specifically its endorsement of a flexible approach to loss calculation in criminal sentencing.8 E.g., Zolp, 479 F.3d at 718-19. The government notes that § 2F1.1 commentary note 8 of the 1995 Guidelines9 states that: The court need only make a reasonable estimate of the loss, given the available information. This estimate, for example, may be based on the approximate number of victims and an estimate of the average loss to each victim, or on more general factors, such as the nature and duration of the fraud and the revenues generated by similar operation. The offender’s gain from committing the fraud is an alternative estimate that ordinarily will underestimate the loss.10 In addition, the government contends that § 2F1.1 condones measuring loss by overvaluation. See U.S.S.G. § 2F1.1, cmt. n.7(a) (1995). That note states: [a] fraud may involve the misrepresentation of the value of an item that does have some value (in con- trast to an item that is worthless). Where, for exam- 8 The Guidelines, including those for enhancements purposes, “are ordinarily applied in light of available commentary, including application notes.” Staten, 466 F.3d at 715 (citing United States v. Allen, 434 F.3d 1166, 1173 (9th Cir. 2006) (“The application notes to the Guidelines are exactly that—notes about when a particular Guideline applies and when it does not.”)). 9 Section 2F1.1 was repealed in 2001. 10 Similarly, the government points out that § 2B1.1 commentary note 3 provides that: The court need only make a reasonable estimate of the loss, given the available information. This estimate, for example, may be based upon the approximate number of victims and the average loss to each victim, or on more general factors such as the scope and duration of the offense. UNITED STATES v. BERGER 15631 ple, a defendant fraudulently represents that stock is worth $40,000 and the stock is worth only $10,000, the loss is the amount by which the stock was over- valued (i.e., $30,000). Thus, were Dura Pharmaceuticals’s loss causation rule applied to criminal sentencing enhancements, that principle’s plain rejection of the overvaluation loss measurement method, see 544 U.S. at 343, would collide with Congress’s clear endorsement of that method, see U.S.S.G. § 2F1.1, cmt. n.7(a). [5] For these reasons, we decline to require, in finding facts relevant to sentencing, a showing that “share price fell significantly after the truth became known.” Dura Pharms., 544 U.S. at 347. We instead reiterate our broader rule that “[t]he Guidelines’ ‘relevant conduct’ provision requires a defendant’s sentence to be based on ‘all harm that resulted from the acts or omissions’ of the defendant.” Hicks, 217 F.3d at 1048 (quoting U.S.S.G. § 1B1.3(a)(3) (1995)). C. The District Court’s Loss Valuation Approach While the district court was not required to follow Dura Pharmaceuticals’s loss causation approach, the losscalculation method it did employ troubles us; it leaves us with little confidence that the government demonstrated, by the applicable standard of proof,11 that shareholder loss occurred, let alone that approximately $2.1 million of loss occurred. [6] Though the Guidelines state that courts may employ various methodologies to determine loss and that loss need not be established with precision, the fact that “[t]he court need only make a reasonable estimate of the loss,” U.S.S.G. § 2B1.1, cmt. n.3, § 2F1.1, cmt. n.8, does not obviate the 11 As we discuss below, the standard in this case should be preponderance of the evidence. 15632 UNITED STATES v. BERGER requirement to show that actual, defendant-caused loss occurred. Rather, the plain language of the Guidelines commentary merely indicates that, in arriving at the loss figure, some degree of uncertainty is tolerable. First, the Guidelines’ statement that the “estimate [of loss] . . . may be based on the approximate number of victims and an estimate of the average loss to each victim,” U.S.S.G. § 2F1.1, cmt. n.8, presupposes that the court has already determined that some defendant-caused loss occurred. Indeed, without any loss to victims, there would be nothing on which to base an estimate. In the same way, the fact that the loss estimate “may be based on . . . general factors, such as the nature and duration of the fraud and the revenues generated by similar operation,” id., or on the “offender’s gain from committing the fraud,” id., does not suggest that a court is relieved of the duty to determine that some loss actually occurred. Even the overvaluation method example in § 2F1.1 commentary note 7(a) does not suggest that a showing of actual loss is unnecessary. That illustration provides a model for calculating the amount of loss where fraud caused the value of stock to decrease, but where the stock retained residual value. The example assumes that the stockholders were left holding stock that depreciated because of the fraud. In sum, each of these possible methodologies assumes that some loss was proximately caused by the defendant, while recognizing that the amount of loss may not be easily measurable. [7] In determining that the shareholder loss was $2.1 million in this case, the district court employed a counterfactual approach. The method examined the effect on the stock value of other, unrelated companies after accounting irregularities were disclosed to the market. Using that method, the court determined that the average depreciation in value was 26.5%. That figure was applied to the value of Craig’s initial public offering. The court’s method appears to have assumed that defendant-caused shareholder loss existed, and only then purported to measure that loss. Moreover, that measure of loss UNITED STATES v. BERGER 15633 was not based on Craig’s finances or on the actual effect of Berger’s fraud, but rather on data from other companies in previous years and different economic conditions. More importantly, it was based on cases in which there had been disclosure of accounting irregularities to the market, despite the fact that Craig’s accounting irregularities were never disclosed while its stock was still publicly traded. As a result, because the method did not properly establish that Berger’s sentence was based only on “ ‘all harm that resulted from the acts or omissions’ of the defendant,” Hicks, 217 F.3d at 1048 (quoting U.S.S.G. § 1B1.3(a)(3) (1995)), it was an abuse of discretion.12 [8] We therefore remand to the district court to redetermine, based on the principles described herein, how much of the shareholders’ loss was actually caused by Berger’s fraud. While we do not dictate the exact method the district court must use, we note that whatever method is chosen should attempt to gauge the difference between Craig’s share price— as inflated through fraudulent representation—and what that price would have been absent the misrepresentation. 12 In concluding that the district court’s method was erroneous, we do not suggest that Berger’s fraud caused no loss to investors. The district court found that Craig’s spring 1997 stock value decline was “unrelated to Berger’s criminal conduct” because it resulted not from disclosure of fraud, but from disclosure of the company’s poor financial status. But that conclusion is valid only in the narrowest sense. While revelation of Berger’s fraud to the public did not depreciate Craig’s stock value (as Craig was no longer publicly traded by that point), it appears that the stock value was overvalued, at least in part, because of the fraud. As a result, many investors were likely induced to buy Craig stock at its IPO price under the false pretenses created by Berger and his cohorts. Had Craig’s financial troubles not been masked by fraud during the IPO, then surely (assuming the IPO had happened at all) Craig’s stock price would already have been significantly lower in spring 1997, Craig’s earnings would not have required restatement, and the stock value would not have plummeted. 15634 UNITED STATES v. BERGER