Fraud - Module 1 of 5

Module 1: Fraud

Overview of White-Collar Crime

            White-collar crime is a branch of criminal law that deals with non-violent offenses that are typically characterized by fraud, deceit, concealment or violation of trust. The common denominator among white collar crimes is that their commission does not depend on physical force or violence.[1] Examples of white-collar crimes include fraud, money laundering, corruption, perjury, racketeering and many types of securities and corporate crime.

            Because other LawShelf video-courses on business law and securities detail corporate crimes such as insider trading, securities fraud, antitrust violations and the like, we will look at other types of white-collar crimes in this course. In this module, we’ll look at fraud, especially wire and mail fraud.

            Under our federalist system of government, criminal law is generally supposed to be run by state law.[2] Most traditional crimes, such as murder, assault, rape, arson, robbery, etc., are, in fact, prosecuted under state law. However, over the past century, there had been increasing federalization of criminal law, prompting the American Bar Association to release a 1998 report lamenting the “adverse costs of inappropriate federalization” of criminal law.[3] White-collar crime in particular has come under increased federalization as major federal statutes such as the Racketeer Influenced and the Corrupt Organizations Act (known as “RICO”) have brought more and more criminal law into the federal sphere.

While states have enacted their own criminal codes, federal crimes and their punishments are primarily set forth in Title 18 of the United States Code. Federal crimes run the gamut from drug offenses to money laundering to murder of federal officials. White-collar crimes dominate the federal criminal code due to the interstate nature of many common white-collar crimes.

Though criminal statutes set forth maximum penalties, the truer indication of penalties imposed for federal white-collar crimes comes from the Federal Sentencing Guidelines.[4] The Guidelines, which comprise a comprehensive document explaining how to calculate sentence ranges for any and every possible federal crime, were designed to promote uniformity and fairness in sentencing. Though since a Supreme Court ruling in the 2005 case, United States v. Booker,[5] the guidelines are considered “advisory” and not mandatory, they are followed closely by most judges. Therefore, in discussing punishments for white-collar crimes, we will focus on those set forth by the Guidelines.

Corporate and Personal Liability

            It may seem counterintuitive that a corporation or organization should be criminally prosecuted or found guilty of a crime. Indeed, British Chancellor Lord Edward Thurlow is purported to have observed, “Did you ever expect a corporation to have a conscience when it has no soul to be damned and no body to be kicked?”[6]

            Still, the law provides for corporations to be tried and convicted for crimes committed by its administrators. As far back as 1909, the Supreme Court observed that “Congress can impute to a corporation the commission of certain criminal offenses and subject it to criminal prosecution therefor.”[7] In fact, a corporation is responsible for acts and statements of its agents, done or made within the scope of their employment, even though their conduct may be contrary to their actual instructions or contrary to the corporation's stated policies.”[8]

            Corporations found guilty of crimes can be subject to fines and punitive damages. They can also be forced to pay restitution to people harmed by the criminal activity.[9] For example, in September of 2017, Wells Fargo was ordered to pay $185 million for a pattern of opening accounts for customers without their consent, a form of consumer fraud.[10] The ultimate penalty corporations face would be revocation of their charters, requiring them to stop operating. This “corporate death penalty” is rarely applied.[11]

            While corporate officers, directors or employees cannot be personally imprisoned or otherwise punished merely by virtue of their corporations’ crimes, they can, of course, also be prosecuted personally for criminal activity committed on their corporations’ behalf. Kenneth Lay, Scott Sullivan and Dennis Koslowski, for example were three prominent corporate executives who were convicted and sent to prison for their crimes committed on behalf of Enron, WorldCom and Tyco, respectively.

Theft Crimes: Fraud

            The first white-collar crime we’ll focus on is, by far, the most expansive and common white-collar crime – theft. Theft comes in myriads of forms, though in white-collar crime, theft is usually committed as some variant of fraud. Embezzlement, which means failing to return assets entrusted to the defendant, and receiving stolen property, are other examples of theft crimes. There are also, of course, “blue-collar” theft crimes that include larceny, robbery and burglary.

            On the federal level, theft crimes are usually prosecuted under the mail fraud and wire fraud statutes. Owing to the nature of the authority of the federal government, Congress typically may only criminalize actions that impact interstate commerce.[12] As such, the federal criminal fraud statutes each include a nexus requirement to interstate commerce. The federal mail fraud statute, Section 1341 of the federal criminal code, criminalizes executing a fraud by placing anything “to be sent or delivered by the Postal Service” that furthers the fraud.[13] Section 1343 criminalizes transmitting “by means of wire, radio or television communication” anything that furthers the scheme.[14] Both are connected to interstate commerce, the former because the mail is an instrumentality of interstate commerce, while the latter specifies that it applies only to communications in “interstate or foreign commerce.”

            Other federal statutes criminalize other types of fraud, such as bank fraud, healthcare fraud and securities fraud. Common to all types of fraud are that they require:

1.    A scheme to defraud; and

2.    Use of some instrumentality of interstate commerce (such as the mail or Internet) to further the fraud.

The communication in interstate commerce may take place after the scheme has been completed or otherwise separate from the scheme itself. For example, in Schmuck v. United States, the defendant rolled back odometers on cars and then sold those cars to car dealers. He was convicted of mail fraud because he mailed title applications to the Department of Transportation as part of each transaction. The conviction was upheld even though the frauds (the odometer rollbacks and sales) had already taken place before the applications were mailed. The Court held that the mailing was part of the execution of the continuing scheme and so conviction for mail fraud was appropriate.[15]

Moreover, the defendant himself need not personally mail or send the communication to be guilty. It’s sufficient that the defendant acted with “knowledge that use of the mails will follow in the ordinary course of business” or even that such usage was “foreseeable” as part of the scheme.[16] The Supreme Court upheld the mail fraud conviction of the defendant when the defendant deposited a check drawn on one bank to another bank as part of the scheme. That the defendant knew (or should have known) that the bank would mail the check back to the bank on which it was drawn constituted sending the check in the mail, even though it wasn’t actually mailed until after the defendant relinquished control of the check.

Common to all frauds are false statements or misrepresentations that are part of a “scheme or artifice to defraud.” This is a fairly broad term and includes virtually any use of deceit, trick or dishonesty in obtaining or securing money or property. It does, however, require both intent and materiality.

Intent is required because, like almost all theft crimes, mail and wire fraud are specific intent crimes. That is, the defendant must intend to deprive the owner of property wrongfully. If the defendant mistakenly believed he had the right to the money, even if the mistake was based on negligence, there can be no conviction for fraud. Moreover, to prove intent to defraud, there must be some contemplated “harm or injury” to the victim, and some contemplated gain to the defendant.[17]

Materiality means that the deception must be important in furthering the scheme. If the false statements cannot reasonably be said to have influenced the transaction, there is no fraud. Note, though, that the statements need not be outright lies. In Lustiger v. United States, the Ninth Circuit upheld the conviction of a real estate developer/salesperson when “considered as a whole,” his statements were “fraudulently deceptive and misleading, exhibiting an intent and purpose to defraud,” even though no one statement in the literature could be shown to be an outright falsehood.[18]

Other Types of Fraud

While most fraudulent schemes are covered by classical mail and wire fraud, it’s worth looking at some other types of schemes that have generated case and/or statutory law. In McNally v. United States,[19] Kentucky elected officials funneled state business to insurance agencies nominally owned and operated by a third party, but which were really controlled by state officials. The government charged the officials under the mail fraud statute, but the Supreme Court ruled it inapplicable. The court held that the mail fraud statute protected “property rights.” “As there were no constructive offenses and the statute was limited to property rights, defendants' actions were beyond the scope of the statute.”

Thereafter, Congress passed a new law that stated that the term “scheme or artifice to defraud includes a scheme or artifice to deprive another of the intangible right of honest services,” to overrule McNally and subject these sorts of government official schemes to the fraud statutes.[20]

This statute, known as the “honest services” fraud was limited in 2010 by a pair of cases, including the prosecution of former Enron CEO Jeffrey Skilling. Skilling had been convicted of “honest services fraud” based on his “engaging in a scheme to deceive the investing public about the corporation's finances.”[21] The Court overturned his conviction on that count because he was “not alleged to have solicited or accepted side payments from a third party in exchange for making the alleged misrepresentations.” In a sister case decided on the same day, the court observed that Section “1346, properly confined, criminalizes only schemes to defraud that involve bribes or kickbacks.”[22]

Another fraud crime, bank fraud, is also spelled out by the US Code. It prohibits using a “scheme or artifice to defraud a financial institution or to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution.”[23]

Fraud in relation to loan applications also comprises a major component of the fraud spectrum. This usually manifests itself in loan applicants making false statements to induce lenders to extend loans. Even if the false statements are not made directly to the lending institution, but are made to agents, brokers, subsidiaries, affiliates or other parties related to the transaction, mail, bank and wire fraud statutes can apply.[24] False statements made to help others obtain loans or those that falsely guarantee such services have also been held to be fraud.[25]

Check fraud can also constitute bank fraud, though the Fourth Circuit Court of Appeals held that the federal bank fraud statute was not intended to apply to writing isolated bad checks, for which there was adequate remedy under state law.[26] Still, a scheme whereby the defendant wrote a series of 46 bad checks to keep up the appearance of high account balances (while the bad checks were pending) and thus to allow interest-free use of the banks' money and gain other perks was sufficient for a bank fraud conviction.[27]

            Computer fraud is punishable under the Code even if no money or property is stolen. Computer fraud applies where the defendant, using a computer:

-       Accesses secured government information without authorization;

-       Accesses financial institution records, credit card records or federal agency records without authorization;

-       Accesses any government computer without authorization;

-       Transmits a virus or similarly harmful code to a government “protected” computer;

-       Sends access passwords of other people without authorization; or

-       Uses a threat to damage a protected computer to extort anything of value.[28]

Securities fraud is another major branch of fraud law. Though covered in other LawShelf courses on securities and business law, they are worth outlining here. Under the Code of Federal Regulations Rule 10-5-b, it is “unlawful for any person… to employ any device, scheme, or artifice to defraud, to make any untrue statement of a material fact or to omit to state a material fact… or to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”[29] This rule has been, for example, used to prosecute accountants for falsifying financial statements to help keep the client’s stock price high.[30] It also has been interpreted to prohibit insider trading, which means trading stock based on information received from (or by) an employee, director, officer or other fiduciary of the company.[31]

Sentencing in Fraud Cases

            The Federal Sentencing Guidelines make little distinction between various types of fraud and theft. Rather, most theft crimes, fraud, property damage, forgery, counterfeiting and more, are lumped in the same category.[32] The penalties mostly depend on the amount of money stolen or the value of the injury caused. The base offense level for a fraud or theft crime is just level 6, punishable by 0-6 months in prison (which often means probation and little or no prison time) for a defendant with no criminal history.[33]

            The penalties can increase dramatically based on the amount stolen. For example, 4 levels are added when the amount stolen is $15,000 or more, 12 levels when the amount reaches $250,000, and 16 levels when we’re dealing with $1,500,000. Theft crimes involving more than $550,000,000 are punished as a level 36, which means 188-235 months in prison for a defendant with no criminal history.

            Martha Stewart, for example, was famously sentenced for insider trading for selling her ImClone shares after having received insider information adverse to the company. With her trade, she avoided a (roughly) $45,000 loss. In sentencing, the judge gave her a base level of 6 and added 6 levels because the offense involved more than $40,000. Because her total offense level was 12, she was sentenced to the guidelines’ minimum of 10 months for that range, half of which was served under house arrest, which is allowed by the sentencing guidelines for offenses in Zone “C” of the Guidelines’ sentencing table.[34]

It’s important to note also that the amount used for this calculation is not necessarily the amount that the defendant benefitted from the fraudulent transaction, but the amount of damage caused. So, a stock scheme that nets the defendant $50,000 while costing multiple investors hundreds of thousands, can result in the latter number being used in the guidelines’ application.

The Sentencing Guidelines also provide for various enhancements where the fraud is considered worse than garden-variety fraud. For example, the Guidelines call for the following enhancements particularly relevant to white-collar crime:

-       for federal healthcare fraud that costs the government more than certain thresholds;

-       if the defendant claimed falsely to be acting on behalf of a charity or comparable organization;

-       if the offense involved misappropriation of trade secrets;

-       if the offense targeted financial institutions, and especially if it jeopardized their financial security; and

-       for securities fraud, when the defendant was an officer or director of a publicly traded company or a broker.

In our second module, we’ll turn to crimes involving currency, such as counterfeiting, currency reporting violations and money laundering. We’ll also look at the related crime of tax evasion and at Ponzi schemes.