White Collar Crime News

You get a call from a client who is under investigation for securities fraud.  To make your job even easier, you are able to figure out (because you are told or you are good enough to piece  it together) the specific trades at issue.  So, you focus your attention on the circumstances and documents surrounding the trade itself.  You think that the Government has nothing and they will figure that out eventually (probably with your help).  Case closed right?  Not quite.

Consider the case of Kevin O. Kelley.   From 1999 until 2004, he operated Acorn Research & Management, Inc. (“Acorn”), where he worked as a stock broker. Kelley was also employed as a registered representative of Royal Alliance, a broker-dealer, and served as the managing executive of
its Stamford, Connecticut office.  He defrauded his stock brokerage clients through schemes involving four separate securities: Coyote Network Systems (“Coyote”), First Venture Leasing (“FVL”), E-Tel Corporation
(“E-Tel”), and AusAm Biotechnologies (“AusAm”).

While the schemes involved different companies, they all had a similar  pattern.  Kelley had an ownership (and/or other) interest in these companies but he failed to disclose this to his clients.  He advised his clients to buy the companies and that they were good and/or safe investments.  These companies failed and investors lost money.  In addition, Kelley misappropriated some funds for his own use that should been used for investments. 

To hide the fact that his investors had lost money or that their money was never used for investments to begin with, he started to issue bogus account statements.  Prior to the start of the jury trial, Kelley moved to strike the portions of the superseding indictment that referred to bogus account statements, arguing that the use of bogus account statements is insufficient to establish a securities violation because the false statements were not
made in connection with the sale or purchase of securities.  The motion was denied by the District Court.  On appeal, Kelley argued that because the bogus account statements were created and disseminated two to four years after the purchases of the related securities, they were not made in connection with the sale or purchase of a security.  Thus, they should not have been admitted into evidence.

However, the 2nd Circuit held that references to the bogus statements were admitted as evidence because they tended to demonstrate Kelley’s intent to defraud his clients and the scope of the schemes he employed. See Perez, 387 F.3d at 209 (“While falsehoods told by a defendant in hope of evading prosecution are not themselves sufficient evidence on which to base a conviction, such falsehoods may strengthen an inference of guilt supplied by other evidence.”). They were never offered as proof of independent violations but instead, they were relevant evidence with respect to the charged securities law violations. See SEC v. Holschuh, 694 F.2d 130, 143 (7th Cir. 1982) (“[A] scheme to defraud may well include later efforts to avoid detection of the fraud.” (internal quotations omitted)). The statements provided the jury with evidence both that Kelley had intended to defraud his clients and that he continued efforts to avoid detection by deceiving his clients about the value of the investments, often up to two years after a particular investment ceased to have any value. The account statements also indicate that Kelley’s actions in defrauding his clients were not simple mistakes but were instead part of a larger, intentional scheme to defraud. See id. at 144 (“The court was entitled to consider the lulling activities because they were evidence of a scheme which, viewed as a whole, was sufficiently closely connected to the sale and was relevant to the question of intent.” (footnote omitted)).

It is often  this “other crimes evidence” that is the most difficult to deal with.  It seems like Kelley was not prepared to meet this evidence at trial and that he had hoped that it would have been kept out.  Any lawyer handling this type of case must examine all evidence that can be connected with the investment at issue no matter how remote it may seem (in this case, years later).

In US v Hickey, the 9th Circuit reiterated the fact that the intent to cause a loss to investors is not an element for securities fraud.  For Hickey, his misrepresentations to investors is what did him in. 

 John A. Hickey (“Hickey”) and his business partner, Mamie Tang (“Tang”), induced over 700 individuals to invest approximately $20 million in two real estate development funds. Their plan was to purchase land in Northern
California, prepare the land for residential development, and then resell the properties to developers at a profit. As it turned out, however, the investors were duped by false representations regarding land title, guarantees, and securitization of the funds.  This was problem number one. 

Forensic accounting also showed that Hickey and Tang appropriated money from the funds for personal use.  This was problem number two.

As the investment scam progressed, it devolved into a Ponzi scheme;  and this was before Madoff made “ponzi scheme” a household word. Hickey used the money from later investors to pay earlier investors the “interest” they were owed. When the money ran out and the fraud was exposed, the investors had lost approximately $18.5 million.

When the investment scheme fell apart in mid-1994, the Securities and Exchange Commission (“SEC”) filed a civil enforcement action against Hickey, resulting in a consent decree that included a $1.1 million disgorgement payment. The investors also obtained an as-yet-unpaid $10 million civil judgment. Like many of these cases, the civil case eventually lead to a criminal case as Hickey was indicted in July of 1997. 

With all of these problems in his case, you would be surprised that his attorney took this case to trial huh?  Well the case did go to trial and it seems like Hickey had a flawed trial strategy as it seemingly ignored the problems in the case.

Hickey hired an expert witness, Stephen Roulac, who testified at length
about real estate finance—about the topic generally, market conditions, the reasonableness of Hickey’s plan for the funds, whether the amount of money Hickey raised was reasonable given his stated plan, and whether the plan was likely to succeed.  Of course, none of this took into account that Hickey lined his pockets while he was lying to his clients about the investment.  His trial theme seems to have been that lying is ok if he had good intent (or a lack of criminal intent).

The district court barred him from testifying that he believed that if the SEC had not intervened, Hickey’s investments would have been profitable and the investors would not have lost money. Hickey argued that this testimony would have established that he did not have an intent to
defraud investors.  However, both the district court and the 9th Circuit found that loss to investors is not an element of either mail fraud or securities fraud, nor is an intent to cause loss. See United States v. Utz, 886 F.2d 1148, 1151 (9th Cir. 1989) (for mail fraud, “[i]t is enough . . . that the government charge and the jury find either that the victim was actually deprived of money or property or that the defendant intended to defraud the victim of same.”) (emphasis in original); United States v. Benny, 786 F.2d 1410, 1417 (9th Cir. 1986) (actual loss is not an element of securities fraud).

At trial, Hickey was free to advance the claim that he did not intend to defraud the victims.  While an honest, good-faith belief in the truth of the misrepresentations may negate intent to defraud, a good-faith belief that the victim will be repaid and will sustain no loss is not a defense.” Benny, 786 F.2d at 1417. In other words, even if Hickey genuinely believed his
investment scheme would be profitable and would result in gains for his investors, he would still be guilty of securities fraud and mail fraud if he knowingly lied to investors about the risks associated with his plan. As a result, his expert’s testimony was properly excluded.

Not only was his expert’s testimony properly excluded by the trial court, it should have been excluded by the defense attorney.   Several years went by between the civil suit and the criminal case.  There was no reason why this case should not have been prepared for trial unless the client bought his own line of BS which is a common problem in these cases.  Convincing someone that they need to spend a large sum of money to prep for a trial when they haven’t even been arrested yet is not easy.  If the trial prep was done, witnesses could have been interviewed and all of these problems could have been dealt with.

This case shows us that while intent is important, the focus needs to first be on the misrepresentations.  Its one thing to make a mistake or leave out some  important information, its another thing to do that while your investors lose money and you make a ton.