Yesterday, the 10th Circuit panel reversed Nottingham’s “gain” and forfeiture determinations and remanded the case back to the district court to follow the 10th Circuit’s instructions on the proper calculations. These instructions could have the effect of reducing the “gain” for federal sentencing purposes to reduce Nacchio’s six year sentence to 3 to 4 years and of reducing his forfeiture of approximately $52,000,000 to $44,600,000 representing the gross proceeds of $52,000,000 less the brokerage expenses and perhaps the cost of exercising the options. Unless the 10th Circuit en banc reverses this same panel of judges (2 to 1 prior decision to grant Nacchio a new trial), today’s unanimous panel decision will create a conflict with the Mooney en banc decision in the 8th Circuit triggering automatic review by the U.S. Supreme Court. Currently, the Supreme Court is considering whether to hear Nacchio’s appeal for a new trial from the first 10th Circuit en banc decision upholding his original conviction. The decision yesterday is at the 10th Circuit’s website. I will analyze the “gain” for purposes of the federal sentencing guidelines first.
Determination of the “Gain” for Purposes of the Federal Sentencing Guidelines
A factor in sentencing Nacchio was the gain or total increase in value realized through insider trading. Before siding with Nacchio’s argument, the 10th Circuit’s decision explained how Nottingham adopted the majority decision in Mooney, (United States v. Mooney, 425 F.3d 10903 (8th Cir. 2005) (en banc, 9 judges for the majority, 3 dissented--cert. denied 2006). Nottingham determined this “gain” was approximately $28,000,000. This was based upon the government’s calculation of approximately $44,000,000 ($52,000,000 sales from insider trading less the cost of the options for the stock and brokerage fees). However, Judge Nottingham reduced the gain further by the $16,000,000 in income taxes that was withheld which I blogged at the time was inconsistent with Mooney. For background on how I viewed the error by Nottingham as a harmless one since his error still resulted in a sentence within the range of the government’s and my perspective, see my July 30th, 2007 post entitled: Judge Nottingham's Sentencing Error a Harmless One.
Nottingham’s determination of the gain from the insider trades resulted in a sentencing range under the Federal Sentencing Guidelines of 63 to 78 months and Nottingham sentenced Nacchio to 72 months (6 years or in the middle of range). As did majority in Mooney, Nottingham specifically pointed to the commentary to Section 2F1.2 of the sentencing guidelines that “because the victims and their losses are difficult if not impossible to identify” in insider trading cases, “the gain, i.e., the total increase in value realized through trading in securities by the defendant ... is employed instead of the victims’ losses.” The 10th Circuit counters that this comment must be interpreted to mean the gain related to the insider trading deception to be consistent with the intent of the underlying federal sentencing guideline.
Nacchio appealed on the basis that the amount of gain is too high since it incorporates the permissible increase in value of Qwest stock before the illegal insider trades. Nacchio pointed to his expert’s calculation that the maximum amount of gain attributable to inside information was approximately $1.8 million which results in a sentencing range of 41 to 51 months (over three years to a little over 4 years).
The 10th Circuit adopted the rationale of the dissent in Mooney on how “gain” was to be computed under the Federal Sentencing Guidelines and then stated the following under “Our Approach” heading:
We further determine that it was incumbent upon the district court to adopt a realistic, economic approach (1) that would take into account that Mr. Nacchio’s offense did not inhere in his sale of the shares itself, but in the deception intertwined with the sales due to his possession of insider knowledge, and (2) that consequently would endeavor to compute his gain for sentencing purposes based upon the gain resulting from that deception. (page 19 of the opinion).
The 10th Circuit then concluded that the civil disgorgement remedy provides an appropriate guidepost for computing how much of the gain is attributable to the “deception” of insider trading. Lastly, the court noted that its decision was consistent with the key objectives of federal sentencing policy—namely:
Federal sentencing is individualized sentencing: the sentencing court seeks to craft a sentence that fully reflects a particular defendant’s criminally culpable conduct, including the harm caused by it, and the defendant’s personal circumstances....However, if the impact of unrelated twists and turns of the market is ignored in the sentencing calculus then an insider trading defendant is likely to suffer a sentence that is detached from his or her individual criminal conduct and circumstances. And this detachment can have a profound, detrimental impact on another objective of federal sentencing—the elimination of unwarranted disparities between similarly situated defendants. (citing Booker) See pages 38-40 of the decision.
Certainly, the 10th Circuit's fundamental fairness sentiments are laudable. However, while the 10th Circuit’s professed concern for the market vagaries facing insider trading defendants and the consequential “unwarranted disparities between similarly situation defendants,” the government pointed out that Nacchio, by withholding the material nonpublic information, artificially kept the Qwest stock price higher and longer than it should have. Moreover, I could add that Nacchio, as is the case with any insider, was able to lock in his profits at the time of the insider sales when legally he was required to abstain. Granted the gain has some element of non-deception gain, but Nacchio’s insider trades effectively insulated him from the vagaries of the market place. Who knows how much the stock could have declined (due to industry and national economic trends, for example) while he abstained until the nonpublic information was announced by Qwest? Under this analysis, all the economic gain relates to the insider trading deception and is another rationale for the commentary to Section 2F1.2 under Federal Sentencing Guidelines that the total amount of the gain from the insider trades should be used.
Moreover, the 10th Circuit makes the point that Nacchio should not have his prison term lengthened by the gain prior to the insider trades in 2001 (1997 to 2001). However, it is ironic that the SEC’s civil suit alleges that Nacchio committed Rule 10b-5 financial statement misrepresentation during those pre-insider trading years, but that lawsuit has been postponed during the criminal proceedings.
Finally, it is interesting to note that my prior blog post two years ago made the following observation:
[Nacchio’s position] is not completely without legal merit. In Mooney, there was well reasoned vigorous dissent based on the lack of uniformity that could result in applying the total gain, some of which might not be attributable to the material nonpublic information. Moreover, in the law journal article entitled “Reexamining 'loss' and 'gain' in the wake of Dura Pharmaceuticals v. Broudo -- New Ammunition for Securities Fraud Defendants” (30 Champion 10), the authors provide the following recommendation to legal counsel in Nacchio’s position:
The goal of uniformity in sentencing is clearly undermined by applying the Guidelines in a way that leads to such disparate sentences for defendants who engaged in identical conduct. "Such an application would create a through-the-looking-glass inversion of the Guidelines -- advising unequal sentences for identical crimes -- defeating the chief purpose of the Guidelines." While the "realistic economic approach" adopted in Olis advances the guidelines' goals of uniformity and fairness, the "brightline" rule applied in Mooney sacrifices those goals in favor of expediency.
For all of these reasons, it is difficult to reconcile Mooney with the Fifth Circuit's subsequent holding in Olis, or with the pragmatic approach adopted by the Supreme Court in Dura. Consequently, Mooney should not deter counsel from encouraging sentencing courts, when calculating the gain attributable to insider trading, to apply "thorough analyses grounded in economic reality," aimed at determining the economic impact that the "'defendant truly caused or intended to cause,'" "exclusive of other sources" of impact on the price of the security. (Emphasis added). To see the entire post, see my July 11, 2007 post entitled: The Extreme Importance of the Gain on Nacchio’s InsiderTrades.
Truly, the 10th Circuit has squarely placed this issue front and center for consideration by the U.S. Supreme Court unless reversed by the entire 10th Circuit. This post is my initial analysis of the 50 pages the 10th Circuit devoted to this issue. I plan to post a series on each of the critical arguments on both sides of this important legal issue.
Determination of the Amount of Forfeiture
On balance, the 10th Circuit’s decision regarding a reduction of the amount of the forfeiture will probably be upheld, but winning this issue will likely save Nacchio only $60,081.09 out of the $52,007,545.47 forfeiture determined by Nottingham.
Nottingham determined that Nacchio’s insider trading sales should be classified under 18 U.S.C. § 981(a)(2)(A) as an unlawful activity involving “illegal goods, illegal services, unlawful activities, and telemarketing and health care fraud schemes” requiring forfeiture of the gross receipts from the unlawful activity or in Nacchio’s case: $52,007,5745.47. In contrast, the 10th Circuit decided that 18 U.S.C. § 981(a)(2)(B) is the appropriate classification for the illegal insider trading sales since this provision provides:
In cases involving lawful goods or lawful services that are sold or provided in an illegal manner, the term “proceeds” means the amount of money acquired through the illegal transactions resulting in the forfeiture, less the direct costs incurred in providing the goods or services. . . The direct costs shall not include any part of the overhead expenses of the entity providing the goods or services, or any part of the income taxes paid by the entity. (Emphasis added.)
The 10th Circuit reasoned that since selling stock is a lawful activity, but sold in an illegal manner (insider trading), subparagraph (B) applies by its terms and is not covered under subparagraph (A) that “was meant to cover inherently unlawful activities such as robbery that are not captured by the words ‘illegal goods’ and ‘illegal services.’” Otherwise, the court reasoned that under Nottingham’s decision, the proceeds of every section 981(a)(1) offense would fall under the broad definition of subparagraph (A), and subparagraph (B) “becomes a null set.” Citing a more recent case from another judge from the same court that criticized All Funds (the case Nottingham relied upon), the 10th Circuit found the latter case more persuasive. (United States v. Kalish, No. 06 Cr. 656(RPP), 2009 WL 130215, at * (S.D.N.Y. Jan. 18, 2009).
In footnote 27 of the opinion below, the 10th Circuit declined to determine whether the $5 per share option price could also be used to lower the amount of Nacchio’s forfeiture, leaving that decision to the district court:
The government argues that even under § 981(a)(2)(B), it would be erroneous to deduct the exercise costs of the options Mr. Nacchio received as this amount was not “incurred” in the subsequent illegal sales. We express no opinion on whether the costs to exercise the options should be deducted alongside brokerage fees as the district court can revisit that issue in recalculating the forfeiture amount under the proper provision.
It will indeed be interesting to see whether the District Court includes in “direct costs” the $5.50 per share option price paid by Nacchio, but that outcome is far from certain. The calculation below shows the likely net amount Nacchio will save by winning this issue:
Nottingham’s Determination $52,007,545.47
Less Brokerage Fees (60,081.09)
Net Forfeiture $51,947,464.38
Less Option Costs (7,315,000.00) Unlikely
Less Income Taxes (16,078,147.81) Not allowed under 18 U.S.C. § 981(a)(2)(B)
The issues “Option Costs” and “Income Taxes” will be analyzed in depth in a subsequent post since Nacchio will most assuredly press for both reductions in his forfeiture calculation in district court. For example, at the trial, he asserted that the income taxes of approximately $16,078,147.81 should be allowed since he never received the total proceeds, only the net after the income taxes were withheld.
However, if you are anxious to get up to speed on these issues immediately, you can access my blog posts on these issues after the conviction, but before Nottingham’s sentence. For an extensive analysis of the calculation of Nacchio’s sentence that was later mirrored by the government’s calculation of the sentence for Nottingham to consider, see my April 23, 2007 post entitled: What Prison Term Range will Nottingham Consider? For an extensive analysis of the calculation of the sentence under the federal sentencing guidelines before Nacchio was sentenced, see my July 9th, 2007 post entitled: Government's and Nacchio's Different Perspectives on His Sentence. For extensive background on the issues before Nottingham made his determinations, see my July 11, 2007 post entitled: The Extreme Importance of the Gain on Nacchio’s Insider Trades. For background on how I viewed the error by Nottingham as harmless one since his error still resulted in a sentence within the range of the government’s and my perspective: see my July 30th, 2007 post entitled: Judge Nottingham's Sentencing Error a Harmless One.