Court Opinion

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Opinions of the United
2006 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit

12-12-2006

USA v. Fallon
Precedential or Non-Precedential: Precedential

Docket No. 03-4184

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                                                  PRECEDENTIAL

             UNITED STATES COURT OF APPEALS
                  FOR THE THIRD CIRCUIT

                            No. 03-4184

                 UNITED STATES OF AMERICA

                                 v.

                       JAMES C. FALLON,
                                    Appellant

           On Appeal from the United States District Court
              for the Eastern District of Pennsylvania
                   (D.C. Crim. No. 02-cr-00324)
                District Judge: Hon. James T. Giles

                       Argued July 12, 2005*

 Before: SLOVITER, McKEE and ROSENN,** Circuit Judges

                     (Filed: December 12, 2006)

       *
        The court en banc heard argument on November 1, 2005 on
the issue raised by Fallon with respect to the applicability of the
Sixth Amendment to the restitution order. The en banc opinion
rejecting Fallon’s argument was filed February 15, 2006. Fallon
and the defendants in the other cases raising the same issue filed a
petition for a writ of certiorari before the Supreme Court of the
United States, which denied the petition on November 27, 2006.

       **
        Judge Rosenn heard oral argument on this case both before
the panel and before the en banc court on November 1, 2005, but
passed away on February 7, 2006.
Robert Epstein      (Argued)
      Assistant Federal Defender
David L. McColgin
      Supervising Appellate Attorney
Maureen Kearney Rowley
      Chief Federal Defender
Federal Court Division
Defender Association of Philadelphia
Philadelphia, PA 19106-2414

      Attorneys for Appellant

Patrick L. Meehan
       United States Attorney
Laurie Magid
       Deputy United States Attorney
       for Policy and Appeals
Robert A. Zauzmer
       Assistant United States Attorney
       Senior Appellate Counsel
David Farnham        (Argued)
       Trial Attorney
United States Department of Justice
Philadelphia, PA 19106

      Attorneys for Appellee

                  OPINION OF THE COURT

SLOVITER, Circuit Judge.

       Appellant James C. Fallon was convicted by a jury of one
count of wire fraud and three counts of mail fraud in the United
States District Court for the Eastern District of Pennsylvania.
This is an appeal of the District Court’s judgment of conviction

                                2
and sentence entered on October 16, 2003.1

                                  I.

       Fallon was the president of Derma Genesis, a company
which manufactured and distributed microdermabradors under
the name “Derma Peel.”2 Dermabradors are classified by the
Food, Drug, and Cosmetic Act (“FDCA”) as class I medical
devices (a device which carries the lowest amount of medical
risk). See generally 21 U.S.C. § 360c(a). Prior to February 18,
1998, manufacturers who wished to market a Class I device were
required to first obtain a 510(k) letter from the Food and Drug
Administration, indicating that the device was substantially
equivalent to an existing device previously approved for
distribution. See generally 21 U.S.C. § 360(k).3

        In November 1997, the FDA received notice that Fallon
was marketing Derma Peel without obtaining the requisite
clearance from the FDA. By letter dated November 4, 1997, a
representative of the FDA informed Fallon that this practice was
prohibited; Fallon acknowledged receipt of the letter and filed a
formal clearance application on November 19, 1997. On that
date, the FDA assigned a unique computer-generated number to
his application, and sent Fallon a letter instructing him to use the
number on all future correspondence.

      In January 1998, prior to obtaining 510(k) approval from
the FDA, Fallon met with a group of medical-device salesman in

       1
       The District Court had jurisdiction under 18 U.S.C. § 3231;
we have jurisdiction under 28 U.S.C. § 1291 and 18 U.S.C. §
3742(a).
       2
         Dermabradors are motor-driven devices that force abrasive
crystals over the surface of the skin and vacuum away exfoliated
skin.
       3
         The reference to a 510(k) letter is to § 510(k) of the Food,
Drug, and Cosmetic Act which is codified as 21 U.S.C. § 360(k).
Because it is generally referred to in the industry as a 510(k) letter,
it will be referred to in that manner in this opinion.

                                  3
an effort to promote the Derma Peel. In attendance was Michael
Coffelt, director of medical sales for a company in the process of
merging with American Business Leasing (“ABL”). Coffelt was
impressed with Fallon’s presentation and recommended to ABL
that it enter into a vendor agreement with Derma Genesis,
whereby ABL would buy Derma Peel devices and lease them to
interested doctors.

       ABL’s credit personnel were reluctant to do business with
Derma Genesis because Fallon had previously filed for
bankruptcy protection, Derma Genesis was a start-up company
with an unproven track record and unproven equipment, and
because Fallon failed to provide certain requested tax and social
security information. Coffelt, however, lobbied ABL to re-
consider its decision.

        On February 9, 1998, Fallon faxed to ABL, among other
things, a purported 510(k) clearance letter on FDA letterhead.
The government’s evidence at trial demonstrated definitively
that the letter was a fabrication. The November 4, 1997 date
stamp of the letter was lifted from an earlier FDA
correspondence to Fallon, which cautioned him not to market
Derma Peel until he had obtained prior FDA clearance. Further,
although the letter was purportedly signed by Consumer Safety
Officer “Margaret Shuppers,” FDA’s records reveal that there
has never been an FDA employee by that name. Finally, the
letter bore Fallon’s unique 510(k) application number, even
though that number was not assigned to him until November 19,
1997, two weeks after the November 4 date stamp.4

       In February of 1998, Alan Frankel, president of ABL,

       4
         By letter dated December 10, 1998, the FDA advised
Fallon that as of February 19, 1998 (ten days after Fallon faxed the
fabricated 510(k) clearance letter to ABL), his product had been
exempted from the pre-clearance requirement by virtue of Food
and Drug Administration Modernization Act of 1997.

                                 4
authorized the company to enter into a relationship with Fallon.5
Over the next several months, ABL purchased 70
microdermabradors from Derma Genesis which it planned to
lease to physicians. ABL’s relationship with Derma Genesis
ended in October 1998, after ABL determined that the value of
the devices had dropped significantly over the course of the year
and that an abnormally high percentage of doctors were behind
on their lease payments.

       On June 4, 2002, Fallon was indicted by a grand jury and
charged with one count of wire fraud, in violation of 18 U.S.C. §
1341, and four counts of mail fraud, in violation of 18 U.S.C. §
1343. A superseding indictment was returned on October 1,
2002, adding one count of witness tampering in violation of 18
U.S.C. § 1512. The basis for the fraud charges was the
fabricated FDA clearance letter.

       At trial, Frankel testified that ABL had a policy of
requiring FDA clearance from medical device manufacturers
which he claimed he had brought with him from his prior
employer, Capelco Leasing. He further testified that he
explicitly required Fallon to produce a 510(k) clearance letter as
a condition to doing business with Derma Genesis. He stated
that documentary proof of this statement was lost at the time of
trial.

        Fallon attempted to rebut Frankel’s testimony through the
testimony of Michael Coffelt and Joseph Nachbin. Coffelt
testified that in his fifteen years experience in the medical
leasing business, he had never requested nor seen an FDA
clearance letter prior to this case.

       Nachbin, a former Vice President and Chief Operating

       5
         The record reveals some support for Fallon’s contention
that ABL was doing business with Derma Genesis even before
ABL received the fabricated 510(k) letter. On February 5, 1998
(four days before receiving the fabricated 510(k)), ABL approved
a lease of Fallon’s product to Dr. William Green.

                                5
Officer at Capelco, was proffered as a fact witness6 to testify to
the customs and practices of the medical leasing industry,7 and to
rebut Frankel’s assertion that Capelco had a policy of requiring
FDA clearance before entering into leasing relationships with
medical device suppliers. Before allowing Nachbin to testify at
trial, the District Court made an in limine inquiry into his
testimony outside the jury’s presence.

       Although the Court allowed Nachbin to testify to his
personal experience at Capelco, it prohibited him from offering
testimony on the custom and practice of the medical leasing
industry, stating that:

       I will not permit him to testify as to [the] industry,
       because he does not speak for an[d] cannot speak
       for the entire industry. And, beyond that, he
       cannot say that a particular company could not
       have, for a particular product or particular
       circumstances presented by the manufacturer,
       required a 510(k) clearance letter. And, he can’t
       say what was, in fact, done by this particular
       leasing company.

App. at 867.

      At the conclusion of trial the District Court dismissed
Count Six (witness tampering) for insufficient evidence. The

       6
         Nachbin was originally offered as an expert witness to
testify as to custom and practice. For reasons not entirely clear
from the record, on May 12, 2003, Fallon apparently withdrew
Nachbin as an expert witness and proffered him instead as a fact
witness.
       7
          Nachbin has thirty-two years’ experience in the medical
leasing industry. At the time of trial, Nachbin was a principal of
the Alta Group, a consulting group to the equipment leasing and
financing industry, had been on the board of directors of the
Equipment Leasing Association, and was the author of several
articles in Leasing Monitor Magazine.

                                 6
jury then returned a verdict of guilty on Count One (wire fraud)
and on Counts Two through Four (mail fraud). Fallon was found
not guilty on Count Five (mail fraud). On October 14, 2003,
Fallon was sentenced to a term of imprisonment of twelve
months and one day to be followed by a thirty-six month term of
supervised release, a fine of $1,000, and restitution in the
amount of $55,235.86.

       Fallon filed a timely notice of appeal.

                                 II.

        Fallon argues that 1) The District Court committed
reversible error by precluding him from eliciting Nachbin’s
testimony regarding the custom and practice of the medical
leasing industry; and 2) the Court erred with respect to its order
of restitution by adopting an unlimited theory of “but for”
causation.8

A. Exclusion of Nachbin’s Custom and Practice Testimony

       We review a district court’s decision to admit or exclude
testimony for abuse of discretion. See United States v. Pelullo,
964 F.2d 193, 199 (3d Cir. 1992). To the extent that these
rulings are based on an interpretation of the Federal Rules of
Evidence, however, our review is plenary. Id.

       The critical issue at Fallon’s trial was the materiality of
the fabricated 510(k) letter. The jury was instructed, as part of
the mail fraud counts, that:

       [t]he Government has to prove . . . that the scheme
       to defraud employed false material
       misrepresentations. False embraces the concept
       that there was a fake FDA letter. Material means

       8
         Falon’s third argument, that the District Court violated his
Sixth Amendment rights by ordering restitution on the basis of
facts that were not found by the jury beyond a reasonable doubt
was rejected by the en banc court. See supra note *.

                                 7
       that the statement would have a natural tendency to
       influence or is capable of influencing the decision
       of a person or entity to which it is addressed. That
       it would have the tendency and is capable of
       influencing or causing another person to rely upon
       it, to act because of it.

App. at 1013a; see also Neder v. United States, 527 U.S. 1, 16
(1999).

        Fallon sought to introduce Nachbin’s testimony regarding
the custom and practice of the industry to rebut Frankel’s
assertions that ABL had a policy of requiring FDA clearance
from device manufacturers (which he had brought from
Capelco), and that he himself relied upon the fabricated 510(k)
letter in entering into the business relationship with Derma
Genesis.

        This court has consistently allowed “testimony
concerning business customs and practices.” United States v.
Leo, 941 F.2d 181, 196 (3d Cir. 1991) (citation omitted)
(providing that such evidence is relevant “both to explain the
practice of the industry in which this prosecution arose and to
establish what someone with Leo's extended background in the
industry probably would know”); First Nat’l State Bank v.
Reliance Elec. Co., 668 F.2d 725, 731 (3d Cir. 1981) (per
curiam) (permitting admission of evidence of customs and
practices in the banking industry); see also Marx & Co., Inc. v.
Diners’ Club, Inc., 550 F.2d 505, 509 (2d Cir. 1977)
(“Testimony concerning the ordinary practices of those engaged
in the securities business is admissible under the same theory as
testimony concerning the ordinary practices of physicians or
concerning other trade customs[.]”). Contrary to the District
Court’s understanding, a witness need not represent an entire
industry in order to have sufficient knowledge of that industry’s
customs and practices so as to render substantial assistance to the
jury. See, e.g., Leo, 941 F.2d at 196-97. Thus, we find the
District Court’s exclusion of Nachbin’s custom and practice
testimony was erroneous as a matter of law.

       We will not, however, grant Fallon a new trial because we

                                8
find this error harmless.9 As stated in Chapman v. California,
386 U.S. 18, 24 (1967), an error is harmless if the record
demonstrates “beyond a reasonable doubt that the error
complained of did not contribute to the verdict obtained.” See
also Fed. R. Crim. P. 52(a).10 As the Supreme Court has stated,
an “otherwise valid conviction should not be set aside if the
reviewing court may confidently say, on the whole record, that
the . . . error was harmless beyond a reasonable doubt.”
Delaware v. Van Arsdall, 475 U.S. 673, 681 (1986).

       Notwithstanding the District Court’s decision prohibiting
Nachbin from testifying to the custom and practice of the
industry, the Court did permit Nachbin to testify to the more
pertinent issue of whether Capelco had a practice of requiring
FDA clearance from device manufacturers during the time
period when Frankel was employed at the company. Thus, to the
extent that Fallon sought to impeach Frankel’s testimony,
Nachbin’s more specific and relevant testimony was heard by
the jury. Furthermore, the jury did hear general testimony
regarding custom and practice of the leasing industry from
Coffelt, who testified that in his fifteen years’ experience of
bringing new products to market, he had never requested a
manufacturer to produce a clearance letter nor had he even seen
such a letter prior to this case.11

       We therefore conclude that although the District Court’s
decision prohibiting Nachbin from testifying as to industry

       9
           Fallon properly preserved this error at trial.
       10
         Rule 52(a) of the Federal Rules of Criminal Procedure,
which governs direct appeals from judgments of conviction in the
federal system, provides that “[a]ny error, defect, irregularity, or
variance that does not affect substantial rights must be
disregarded.”
       11
          Coffelt further testified FDA clearance letters were not
customary because leasing companies, such as ABL, make no
representations regarding the equipment they lease. Instead, the
lessee assumes the equipment at his or her own risk.

                                    9
custom and practice was error, this error was harmless, and a
new trial is not warranted.

B. The District Court’s Calculation of Restitution

         As part of his sentence, Fallon was ordered to pay
restitution in the amount of $55,235.86. The District Court
calculated this figure by crediting ABL’s statement that it had
approximately $125,000 in unpaid lease payments on Derma
Peel accounts. The court subtracted approximately $30,000 for
lease payments that had in fact been paid, and subtracted another
$40,000 was for the residual value of the Derma Peel devices
now owned by ABL. In making its calculations, the Court
stated:

       I credited the testimony of ABL that it would not
       have dealt with Mr. Fallon, but for the
       representations made to it . . . that it was [a]
       cleared device. . . . And therefore having launched
       itself based upon Mr. Fallon’s misrepresentation,
       whatever was not collected under those contracts
       becomes part of the loss to the victim.

App. at 1087a-88a.

        Fallon contends that the District Court erred by adopting
a theory of unlimited “but for” causation by which he was
ordered to pay restitution for any lease payments that ABL did
not receive, regardless of the doctors’ reasons for not making
them. For instance, one doctor had passed away while his lease
was still active; ABL could not enforce the lease against his
heirs, and the company charged Fallon with a loss of $11,562.06.
Another doctor filed for bankruptcy during the course of his
lease. Nonetheless, ABL charged Fallon with causing a loss of $
22,219.89. In addition, Fallon notes that the District Court failed
to credit any profit that ABL may have made by leasing Fallon’s
product. Thus, Fallon argues, ABL may not have experienced
any loss whatsoever with respect to the lease transaction; rather,
it may merely have earned a lesser profit than it had originally
anticipated.

                                10
       We “review a restitution order under a bifurcated
standard: plenary review as to whether restitution is permitted by
law, and abuse of discretion as to the appropriateness of the
particular award.” United States v. Quillen, 335 F.3d 219, 221
(3d Cir. 2003) (internal quotation and citations omitted).
Because Fallon challenges the legality of the restitution order,
our review is plenary.

      The Mandatory Victims Restitution Act (“MVRA”)
provides that:

       (a)(1) Notwithstanding any other provision of law,
       when sentencing a defendant convicted of an
       offense described in subsection (c), the court shall
       order, in addition to . . . any other penalty
       authorized by law, that the defendant make
       restitution to the victim of the offense . . . .

       (2) For the purposes of this section, the term
       “victim” means a person directly and proximately
       harmed as a result of the commission of an offense
       for which restitution may be ordered including, in
       the case of an offense that involves as an element a
       scheme, conspiracy, or pattern of criminal activity,
       any person directly harmed by the defendant’s
       criminal conduct in the course of the scheme,
       conspiracy, or pattern . . . .

18 U.S.C. § 3663A. By the statute’s explicit terms, loss can only
be paid to victims who are “directly and proximately harmed.”
Id.

       Thus, this court, as well as others, has repeatedly
recognized that under the MVRA “restitution must be . . . ‘based
upon losses directly resulting from [the defendant’s criminal]
conduct.’” Quillen, 335 F.3d at 222 (quoting Gov’t of V.I. v.
Davis, 43 F.3d 41, 45 (3d Cir. 1994)).12 The First Circuit has

       12
          For scheme-based crimes such as wire fraud and mail
fraud, see, e.g., United States v. Dobson, 419 F.3d 231 (3d Cir.

                                11
adopted the following two-prong test:

       First: Restitution should not be ordered in respect
       to a loss which would have occurred regardless of

2005), the term “victim” is broadly defined by the MVRA. See 18
U.S.C. § 3663A (stating that the “in the case of an offense that
involves as an element a scheme, conspiracy, or pattern of criminal
activity, [the term victim means] any person directly harmed by the
defendant’s criminal conduct in the course of the scheme,
conspiracy, or pattern. . . .”).

        Several courts have interpreted this language to hold that
restitution: 1) may be ordered to a victim not named in the
indictment, provided that the victim was “directly harmed by the
defendant’s criminal conduct in the course of a scheme or
conspiracy.” United States v. Henoud, 81 F.3d 484, 489 (4th Cir.
1996); see also United States v. Kones, 77 F.3d 66, 70 (3d Cir.
1996); 2) may be ordered for losses which result from acts or
conduct related to the scheme, but for which the defendant was not
convicted; cf. United States v. Lawrence, 189 F.3d 838, 846 (9th
Cir. 1999); United States v. Hensley, 91 F.3d 274, 277 (1st Cir.
1996); or 3) may be ordered for losses of a common scheme, even
though the loss was caused by conduct occurring outside the statute
of limitations. See United States v. Dickerson, 370 F.3d 1330,
1342 (11th Cir. 2004).

        Nonetheless, despite Congress’ clear intent to broaden the
district court’s authority to grant restitution for crimes involving
a scheme or conspiracy, we are unaware of any cases holding that
the definition of “victim” for scheme-based crimes diminishes the
requirement that losses be “directly” caused by the defendant’s
actions. See, e.g., Dickerson, 370 F.3d at 1342-43 (“The district
court must find that the victims’ losses resulted ‘directly’ from the
defendant’s conduct in the course of the scheme.”); Kones, 77 F.3d
at 70 (holding the “harm to the victim [must be] closely related to
the scheme, rather than tangentially linked”). Thus, even for
scheme or conspiracy based crimes, the government bears the
burden of showing that the loss suffered was “directly” caused by
defendants’ actions.

                                 12
      the defendant’s conduct. . . .

      Second: Even if but for causation is acceptable in
      theory, limitless but for causation is not.
      Restitution should not lie if the conduct underlying
      the offense of conviction is too far removed, either
      factually or temporally, from the loss.

United States v. Vaknin, 112 F.3d 579, 589 (1st Cir. 1997).

        In the present case, the Court found by a preponderance
of the evidence that ABL would not have entered into the leasing
arrangement with Fallon but for the fabricated 510(k) FDA
clearance letter. We believe that where, as here, the government
demonstrates that a business transaction was consummated due
to fraud by the defendant, a commonsense, but rebuttable
inference arises that subsequent losses suffered by the victim of
the fraud are sufficiently linked to the underlying fraud to
support an award of restitution. Cf. Vaknin, 112 F.3d at 590.
We conclude, however, that Fallon presented the District Court
with sufficient evidence to rebut certain portions of the Court’s
restitution award. As noted, approximately $34,000 of the
District Court’s $55,235.86 restitution judgment can be
attributed to lease payments missed by two doctors, one dead
and one who filed for bankruptcy. The government failed to
present evidence that either of these nonpayments was directly
related to the fraud.

       The government argues, however, that the District
Court’s restitution order was appropriate because ABL was
unable to enforce any of its lease agreements related to the
Derma Peel. It explains that because the various leases were
entered into after each doctor was assured that the device had
received FDA clearance, the doctors could assert defenses of
fraudulent inducement. In support of its argument, the
government relies on the testimony of ABL’s in-house counsel
that one doctor raised such a defense in a telephone
conversation.

      The government is correct that the District Court should
consider the enforceability of the outstanding lease contracts

                                13
when calculating the appropriate amount of restitution.
However, whether the doctors may have colorable fraudulent
inducement claims is far from certain. See In re Allegheny Int’l,
Inc., 954 F.2d 167, 178 (3d Cir. 1992) (setting forth the common
law elements of fraudulent inducement). On February 19, 1998,
prior to the start date of any of the leases, Derma Peel was
exempted from all pre-clearance requirements by the Food and
Drug Administration Modernization Act of 1997.

        Finally, the record shows only one incident where a
doctor raised (informally) the defense of fraudulent inducement.
Even assuming that a fraudulent inducement defense is colorable
under these facts, several doctors defaulted for reasons
completely unrelated to the representations made regarding
Fallon’s product (i.e., death or bankruptcy). Thus, the
government’s blanket argument supporting the present
restitution order cannot be sustained.

      Accordingly, we will vacate the restitution order and
remand to the District Court for a new restitution hearing.13

                               III.

       For the reasons given above, we will affirm Fallon’s
judgment of conviction and sentence and vacate the District
Court’s restitution order and remand for further proceedings
consistent with our opinion.

       13
         Fallon has served his sentence of incarceration and is on
supervised release. He has been permitted to work so that he can
accumulate funds necessary to pay restitution. It is therefore
requested that the District Court schedule a restitution hearing as
promptly as possible.

                                14