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Commodities Fraud Opinion Sweeps More Broadly than “Spoofing” Cases
United States v. Coscia, No. 16-3017 (Aug. 7, 2017)
Much has been written already about the Court’s first-in-nation ruling upholding the Dodd-Frank prohibition on the trading practice known as “spoofing.” Spoofing occurs when a trader places a large number of orders with the intent to cancel them before execution. The purpose is to move the market in one direction and then execute a smaller number trades on the opposite side at a now-advantageous price. For example, the trader may place a buy order for 1000 contracts of a commodity and a sell order for 50 contracts. The apparent demand for that commodity due to the large buy order causes the price to increase for a very short time (a fraction of a second). During that short time, the trader executes his sell order at a profit and the large buy order is cancelled. The practice depends on high-frequency trading algorithms. In affirming Coscia’s conviction under Dodd-Frank, the Court rejected his argument that the provision was unconstitutionally vague – primarily because the law explicitly required proof of defendant’s intent that the large order not be executed.
The case is perhaps more important for a different and more generally-applicable reason: Coscia was also convicted of general commodities fraud separate from the Dodd-Frank “spoofing” violation. Like the mail and wire fraud statutes, Title 18 also generally prohibits “schemes to defraud” involving the purchase or sale of commodities or securities. 18 U.S.C. §1348. That statute, of course, does not specifically address “spoofing” or high-frequency trading strategies. Yet, the Court affirmed Cosica’s convictions under those generic provisions. During oral argument, Judge Rovner challenged the government to explain why Coscia wasn’t being punished simply for “building a better mousetrap.” In other words, he came up with a trading algorithm that took advantage of the deficiencies in the trading algorithms created by other high-frequency traders. Ultimately, the Court held that the evidence supported the existence of fraudulent intent. The trading program was intended to act “like a decoy” and create the “illusion” of market movement, so the Court affirmed the convictions under Title 18 as well.
But the Court’s decision should give pause to high-frequency traders of all types, not just those who wish to “spoof.” Aggressive prosecutors may seek to charge other sorts of trading strategies that are used to mask the trader’s plan. By their nature, many strategies could be characterized as “deceitful,” in that the trader is attempting to conceal certain facts from counterparties. Other strategies may attempt to take advantage of market movements for which the trader himself is responsible. The point isn’t that those strategies are necessarily unlawful; it is that – in contrast to the specific anti-spoofing law – the broad sweep of the generic fraud statutes creates uncertainty and risk for those traders who rely on innovative technology and strategies.
Qui Tam Opinion Extends Public Disclosure Bar
Bellevue v. Universal Health Services of Hartgrove, Inc., No. 15-3473 (Aug. 8, 2017)
One of the most powerful tools in combating fraud and abuse in government procurement is the qui tam provision of the False Claims Act. Whistleblowers (a.k.a. “relators”) are deputized to bring claims in the government’s name. A relator who is an “original source” of the allegations may be entitled to a large percentage of any recovery as a bounty. To avoid “parasitic lawsuits” by those who are not true whistleblowers, the FCA bars qui tam cases if the allegations are substantially the same as those already in the public domain. In other words, if the facts showing each element of the fraud were already publicly disclosed, the plaintiff will be barred. Bellevue appears to extend that bar to situations where the facts supporting the element of scienter were not explicitly disclosed.
Hartgrove is a psychiatric hospital that received Medicare reimbursements. Conditions for payment included that admitted patients be assigned a room and that Hartgrove not be over census, meaning that it not admit more patients than allowed by its state license. Audits by state and federal agencies revealed that Hartgrove was over census on certain occasions, yet billed for patients who were given roll-away beds in a dayroom instead of actual beds in overnight hospital rooms. Neither audit concluded that the reimbursements were obtained by fraud, as opposed to mistake. Bellevue, a nurse at Hargrove, filed a qui tam complaint against Hartgrove. Based on his understanding of Hartgrove’s admission practices, he alleged that Hartgrove acted knowingly by submitting claims for reimbursement when it was over census.
One of the elements of an FCA violation is that the defendant obtained payment by “knowingly” making false representations. Mere falsity is not enough; scienter is required. Because the public disclosure bar only applies where the facts supporting each element of an FCA claim are in the public domain, one would think that disclosure of mere falsity of a claim for payment would not bar the relator who otherwise is an “original source.” In barring Bellevue’s case, the Court called that assumption into doubt. Although neither audit concluded that Hartgrove acted knowingly, the Court held that scienter could be “inferred.” It distinguished cases where incorrect Medicare billings turned on “qualitative judgments,” such as the patient’s standard of care. In those cases, there is an equally plausible inference that billing errors were simple mistakes as opposed to knowing violations. But where incorrect bills result from objective facts, such as the number of beds in census, the Court appears to lay down a new rule: Public disclosure of those errors allows one to infer fraud, and the bar thus applies to the relator’s claims.
The ruling provides defendants in qui tam cases with a strong argument to bar a whistleblower’s claims where the objective facts were otherwise in the public domain, even if nobody but the relator previously concluded that those facts amounted to fraud.
Court Buttresses Confrontation Clause – Rejects Use of “Course of Investigation” Hearsay Exception
Richardson v. Griffin, No. 16-1700 (Aug. 8, 2017)
The Supreme Court held in Crawford v. Washington, 541 U.S. 36 (2005) that the Sixth Amendment’s Confrontation Clause applies to all witness statements taken by law enforcement agents during their investigation. Such out-of-court statements may not be admitted in a criminal case under any of the traditional hearsay exceptions. Prior to (and even since) Crawford, a standard exception to hearsay was the so-called “course of investigation” exception. That is, in giving otherwise non-hearsay testimony, an investigator could be allowed to fill in the gaps by providing a witness’s out-of-court statement to the investigator if needed to explain what the investigator did next. In Richardson, the Court held that, in light of Crawford, the exception has been taken too far.
Defendant was on trial for shooting Mobley. The assigned detective came upon defendant as a suspect by talking to an eyewitness named Holden, who told him that “Chris” (the defendant’s first name) was the shooter. The detective then went to the hospital where Mobley was recovering and asked him if he knew a “Chris.” Mobley said he did, and he identified defendant from a photo spread. At trial, both Mobley and the detective testified. (Holden did not testify, for some unexplained reason.) To bolster Mobley’s testimony, the detective testified about his investigation, including the statement he took from Holden identifying “Chris” as the shooter and relating his discussion with Mobley in the hospital. Defendant objected to the detective’s recitation of Holden’s statement as being hearsay. The trial court allowed it, however, based on the prosecutor’s argument that it was necessary to explain the “course of the investigation,” particularly how the detective first came across the name “Chris.”
The Court reversed the district court’s decision denying defendant’s habeas petition. Citing to Crawford, the Court found that admission of Holden’s out-of-court statements through the police officer violated the Confrontation Clause because those statements served no legitimate non-hearsay purpose. In doing so, the Court provided ammunition for future cases where the “course of investigation” exception is blindly invoked.
Opinion Testimony from Government “Summary” Witness OK, as is Comparison to Bernie Madoff
United States v. Lopez, No. 16-2269 (Aug. 29, 2017))
One challenge the government confronts in prosecuting complex financial crimes is making the evidence understandable for lay people with little or no background in finance or accounting. The government often calls a summary witness (usually an FBI or IRS agent) under Fed.R.Evid. 1006 to distill that evidence for the jury. Through charts sponsored by that witness, the government spoon-feeds the jury with its version of the numerous complicated transactions that form the basis for the alleged scheme to defraud. That testimony typically is limited to an unadorned summary of otherwise-voluminous evidence. Those witnesses are not usually deemed experts or even lay witnesses who may offer explanatory opinions. In Lopez, however, the Court rejected defendant’s challenge that the government’s summary witness improperly offered his opinion regarding the nature of the charged transactions. The Court also affirmed the conviction notwithstanding repeated references to Bernie Madoff during the government’s closing argument.
The defendant was charged with engaging in a Ponzi scheme – promising investors high rates of return on a sham investment and paying prior investors with funds provided by newer ones to maintain the illusion that the venture actually existed. The government called an IRS agent under Rule 1006 to summarize the flow of funds into and out of defendant’s bank accounts. In walking the jury through his summary charts, the IRS Agent was repeatedly allowed over objection to characterize the repayments to the prior investors as “lulling payments.” He explained that by “lulling payments” he meant that instead of investing the new funds as promised, the defendant used those funds to pay off prior investors. In closing, the government repeatedly used the term “lulling payments” in describing the repayments as a key aspect of defendant’s fraud.
Defendant argued on appeal that it was improper to allow a Rule 1006 summary witness to offer his characterization of those payments as “lulling” because they were based on the witness’s unwarranted opinions. In a split-panel decision, the Court rejected that argument and held that even a summary witness may offer “conclusory” testimony as a lay witness that is reasonably based on the evidence presented at trial. The majority appeared to be swayed by the fact that the IRS agent did not explicitly offer his view as to defendant’s intention in making those payments (i.e., to “lull” the investors), although the Court did not explain how the term “lulling” could be taken to imply anything other than the defendant’s fraudulent intent.
The majority also affirmed the conviction despite the government’s comparison of aspects of defendant’s scheme to Bernie Madoff’s unprecedented fraud. The government specifically argued to the jury that defendant’s repayment of certain investors was no defense any more than it was for Madoff. Because the Court did not believe that those comments could have “inflamed the jury,” it held that they were not out of bounds. Judge Posner dissented both as to the summary witness’s opinion testimony and the Madoff comments, concluding that those rulings constituted “serious” errors. Because the majority’s decision may expand the traditional scope of summary testimony, and because the Madoff comments could inspire both prosecutors and defense counsel to make similar references to matters outside the record in other cases, an en banc rehearing could be in the cards.
United States v. Coscia, No. 16-3017 (Aug. 7, 2017)
Much has been written already about the Court’s first-in-nation ruling upholding the Dodd-Frank prohibition on the trading practice known as “spoofing.” Spoofing occurs when a trader places a large number of orders with the intent to cancel them before execution. The purpose is to move the market in one direction and then execute a smaller number trades on the opposite side at a now-advantageous price. For example, the trader may place a buy order for 1000 contracts of a commodity and a sell order for 50 contracts. The apparent demand for that commodity due to the large buy order causes the price to increase for a very short time (a fraction of a second). During that short time, the trader executes his sell order at a profit and the large buy order is cancelled. The practice depends on high-frequency trading algorithms. In affirming Coscia’s conviction under Dodd-Frank, the Court rejected his argument that the provision was unconstitutionally vague – primarily because the law explicitly required proof of defendant’s intent that the large order not be executed.
The case is perhaps more important for a different and more generally-applicable reason: Coscia was also convicted of general commodities fraud separate from the Dodd-Frank “spoofing” violation. Like the mail and wire fraud statutes, Title 18 also generally prohibits “schemes to defraud” involving the purchase or sale of commodities or securities. 18 U.S.C. §1348. That statute, of course, does not specifically address “spoofing” or high-frequency trading strategies. Yet, the Court affirmed Cosica’s convictions under those generic provisions. During oral argument, Judge Rovner challenged the government to explain why Coscia wasn’t being punished simply for “building a better mousetrap.” In other words, he came up with a trading algorithm that took advantage of the deficiencies in the trading algorithms created by other high-frequency traders. Ultimately, the Court held that the evidence supported the existence of fraudulent intent. The trading program was intended to act “like a decoy” and create the “illusion” of market movement, so the Court affirmed the convictions under Title 18 as well.
But the Court’s decision should give pause to high-frequency traders of all types, not just those who wish to “spoof.” Aggressive prosecutors may seek to charge other sorts of trading strategies that are used to mask the trader’s plan. By their nature, many strategies could be characterized as “deceitful,” in that the trader is attempting to conceal certain facts from counterparties. Other strategies may attempt to take advantage of market movements for which the trader himself is responsible. The point isn’t that those strategies are necessarily unlawful; it is that – in contrast to the specific anti-spoofing law – the broad sweep of the generic fraud statutes creates uncertainty and risk for those traders who rely on innovative technology and strategies.
Qui Tam Opinion Extends Public Disclosure Bar
Bellevue v. Universal Health Services of Hartgrove, Inc., No. 15-3473 (Aug. 8, 2017)
One of the most powerful tools in combating fraud and abuse in government procurement is the qui tam provision of the False Claims Act. Whistleblowers (a.k.a. “relators”) are deputized to bring claims in the government’s name. A relator who is an “original source” of the allegations may be entitled to a large percentage of any recovery as a bounty. To avoid “parasitic lawsuits” by those who are not true whistleblowers, the FCA bars qui tam cases if the allegations are substantially the same as those already in the public domain. In other words, if the facts showing each element of the fraud were already publicly disclosed, the plaintiff will be barred. Bellevue appears to extend that bar to situations where the facts supporting the element of scienter were not explicitly disclosed.
Hartgrove is a psychiatric hospital that received Medicare reimbursements. Conditions for payment included that admitted patients be assigned a room and that Hartgrove not be over census, meaning that it not admit more patients than allowed by its state license. Audits by state and federal agencies revealed that Hartgrove was over census on certain occasions, yet billed for patients who were given roll-away beds in a dayroom instead of actual beds in overnight hospital rooms. Neither audit concluded that the reimbursements were obtained by fraud, as opposed to mistake. Bellevue, a nurse at Hargrove, filed a qui tam complaint against Hartgrove. Based on his understanding of Hartgrove’s admission practices, he alleged that Hartgrove acted knowingly by submitting claims for reimbursement when it was over census.
One of the elements of an FCA violation is that the defendant obtained payment by “knowingly” making false representations. Mere falsity is not enough; scienter is required. Because the public disclosure bar only applies where the facts supporting each element of an FCA claim are in the public domain, one would think that disclosure of mere falsity of a claim for payment would not bar the relator who otherwise is an “original source.” In barring Bellevue’s case, the Court called that assumption into doubt. Although neither audit concluded that Hartgrove acted knowingly, the Court held that scienter could be “inferred.” It distinguished cases where incorrect Medicare billings turned on “qualitative judgments,” such as the patient’s standard of care. In those cases, there is an equally plausible inference that billing errors were simple mistakes as opposed to knowing violations. But where incorrect bills result from objective facts, such as the number of beds in census, the Court appears to lay down a new rule: Public disclosure of those errors allows one to infer fraud, and the bar thus applies to the relator’s claims.
The ruling provides defendants in qui tam cases with a strong argument to bar a whistleblower’s claims where the objective facts were otherwise in the public domain, even if nobody but the relator previously concluded that those facts amounted to fraud.
Court Buttresses Confrontation Clause – Rejects Use of “Course of Investigation” Hearsay Exception
Richardson v. Griffin, No. 16-1700 (Aug. 8, 2017)
The Supreme Court held in Crawford v. Washington, 541 U.S. 36 (2005) that the Sixth Amendment’s Confrontation Clause applies to all witness statements taken by law enforcement agents during their investigation. Such out-of-court statements may not be admitted in a criminal case under any of the traditional hearsay exceptions. Prior to (and even since) Crawford, a standard exception to hearsay was the so-called “course of investigation” exception. That is, in giving otherwise non-hearsay testimony, an investigator could be allowed to fill in the gaps by providing a witness’s out-of-court statement to the investigator if needed to explain what the investigator did next. In Richardson, the Court held that, in light of Crawford, the exception has been taken too far.
Defendant was on trial for shooting Mobley. The assigned detective came upon defendant as a suspect by talking to an eyewitness named Holden, who told him that “Chris” (the defendant’s first name) was the shooter. The detective then went to the hospital where Mobley was recovering and asked him if he knew a “Chris.” Mobley said he did, and he identified defendant from a photo spread. At trial, both Mobley and the detective testified. (Holden did not testify, for some unexplained reason.) To bolster Mobley’s testimony, the detective testified about his investigation, including the statement he took from Holden identifying “Chris” as the shooter and relating his discussion with Mobley in the hospital. Defendant objected to the detective’s recitation of Holden’s statement as being hearsay. The trial court allowed it, however, based on the prosecutor’s argument that it was necessary to explain the “course of the investigation,” particularly how the detective first came across the name “Chris.”
The Court reversed the district court’s decision denying defendant’s habeas petition. Citing to Crawford, the Court found that admission of Holden’s out-of-court statements through the police officer violated the Confrontation Clause because those statements served no legitimate non-hearsay purpose. In doing so, the Court provided ammunition for future cases where the “course of investigation” exception is blindly invoked.
Opinion Testimony from Government “Summary” Witness OK, as is Comparison to Bernie Madoff
United States v. Lopez, No. 16-2269 (Aug. 29, 2017))
One challenge the government confronts in prosecuting complex financial crimes is making the evidence understandable for lay people with little or no background in finance or accounting. The government often calls a summary witness (usually an FBI or IRS agent) under Fed.R.Evid. 1006 to distill that evidence for the jury. Through charts sponsored by that witness, the government spoon-feeds the jury with its version of the numerous complicated transactions that form the basis for the alleged scheme to defraud. That testimony typically is limited to an unadorned summary of otherwise-voluminous evidence. Those witnesses are not usually deemed experts or even lay witnesses who may offer explanatory opinions. In Lopez, however, the Court rejected defendant’s challenge that the government’s summary witness improperly offered his opinion regarding the nature of the charged transactions. The Court also affirmed the conviction notwithstanding repeated references to Bernie Madoff during the government’s closing argument.
The defendant was charged with engaging in a Ponzi scheme – promising investors high rates of return on a sham investment and paying prior investors with funds provided by newer ones to maintain the illusion that the venture actually existed. The government called an IRS agent under Rule 1006 to summarize the flow of funds into and out of defendant’s bank accounts. In walking the jury through his summary charts, the IRS Agent was repeatedly allowed over objection to characterize the repayments to the prior investors as “lulling payments.” He explained that by “lulling payments” he meant that instead of investing the new funds as promised, the defendant used those funds to pay off prior investors. In closing, the government repeatedly used the term “lulling payments” in describing the repayments as a key aspect of defendant’s fraud.
Defendant argued on appeal that it was improper to allow a Rule 1006 summary witness to offer his characterization of those payments as “lulling” because they were based on the witness’s unwarranted opinions. In a split-panel decision, the Court rejected that argument and held that even a summary witness may offer “conclusory” testimony as a lay witness that is reasonably based on the evidence presented at trial. The majority appeared to be swayed by the fact that the IRS agent did not explicitly offer his view as to defendant’s intention in making those payments (i.e., to “lull” the investors), although the Court did not explain how the term “lulling” could be taken to imply anything other than the defendant’s fraudulent intent.
The majority also affirmed the conviction despite the government’s comparison of aspects of defendant’s scheme to Bernie Madoff’s unprecedented fraud. The government specifically argued to the jury that defendant’s repayment of certain investors was no defense any more than it was for Madoff. Because the Court did not believe that those comments could have “inflamed the jury,” it held that they were not out of bounds. Judge Posner dissented both as to the summary witness’s opinion testimony and the Madoff comments, concluding that those rulings constituted “serious” errors. Because the majority’s decision may expand the traditional scope of summary testimony, and because the Madoff comments could inspire both prosecutors and defense counsel to make similar references to matters outside the record in other cases, an en banc rehearing could be in the cards.
This article was first published in the August 2017 issue of the Seventh Circuit White Collar Litigation Update on the 7th Circuit Bar Association’s website.
Loeb & Loeb partner Corey Rubenstein authors this monthly newsletter containing helpful summaries and practice pointers for key Seventh Circuit Court opinions involving civil and criminal white collar matters.