Calculated Draconianism: 2012 Guidelines Amendments Make the Sentencing Loss Calculation in Securities Fraud Cases Even Tougher


Over the past decade, there has been a tremendous amount of controversy over the harsh sentences imposed on defendants convicted of fraud offenses in federal court.  The sentencing range for fraud convictions is determined primarily by United States Sentencing Guidelines § 2B1.1, better known as the fraud guideline.  In April 2012, the United States Sentencing Commission promulgated a number of amendments in response to the directives of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which had instructed the Commission to review the fraud guideline with respect to securities fraud, fraud on financial institutions, and mortgage fraud.  The amendments went into effect November 1, 2012, after consideration of the often competing concerns of the defense bar, the courts, and the Department of Justice. Although the Commission noted the widespread questions over the fairness of the fraud guideline, particularly its potential to create disproportionate or disparate sentences, the actual amendments to the guideline do almost nothing to alleviate what Judge Jed Rakoff described recently as “an ever more draconian approach to white collar crime, unsupported by any empirical data.”   In fact, under the guise of promoting uniformity in sentencing, the amendments are likely to continue the trend of excessively punitive sentences for white collar defendants.

One amendment in particular that provides a new method of calculating loss in securities fraud cases appears facially benign, with the stated objective of promoting consistency and uniformity. However, the amendment actually promotes unfairness in sentencing by increasing the likelihood that the actual harm caused by the fraud will be misstated due to failure to account for the effect of market forces unrelated to the fraud and by shifting the burden of proof to the defendant.

securities fraud

New Application Note 3(F)(ix) seeks to standardize the calculation of “actual loss” (defined as the reasonably foreseeable pecuniary harm that resulted from the offense)  in cases involving the fraudulent inflation or deflation of a publically traded security or commodity.   Application Note 3(F)(ix) reads as follows:

In a case involving the fraudulent inflation or deflation in the value of a publicly traded security or commodity, there shall be a rebuttable presumption that the actual loss attributable to the change in value of the security or commodity is the amount determined by—


“(I)         calculating the difference between the average price of the security or commodity during the period that the fraud occurred and the average price of the security or commodity during the 90-day period after the fraud was disclosed to the market, and


(II)          multiplying the difference in average price by the number of shares  outstanding.


In determining whether the amount so determined is a reasonable estimate of the actual loss attributable to the change in value of the security or commodity, the court may consider, among other factors, the extent to which the amount so determined includes significant changes in value not resulting from the offense (e.g., changes caused by external market forces, such as changed economic circumstances, changed investor expectations, and new industry-specific or firm specific facts, conditions, or events).”


The amendment resolves a Circuit split on how to measure loss, specifically whether (1) loss should be measured by the difference in the price of the security before and after the fraud was disclosed (either at a set point in time or the average price over a set time period), or (2) the loss measurement must exclude changes in value that were caused by external market forces unrelated to the fraud.

Contrary to the recommendations of the NACDL, the Federal Public and Community Defenders, and other defense bar associations, the Commission adopted a formulation of the first approach, known as the “modified rescissory method.” The defense bar associations had urged the Commission to implement the second approach, known as the “market-adjusted method,” which the Second and Fifth Circuits had approved.

The chief argument against the modified rescissory method is that it misstates actual loss caused by the defendant in that it fails to exclude from the calculation changes in price caused by factors unrelated to the fraud. Stock prices change frequently for a variety of reasons other than fraudulent activity, such as evolving economic conditions, changing investor expectations, new facts or conditions specific to an industry or company, and a number of other events.  Accordingly, the difference between the average price over the duration of the fraud and the average price over 90 days following revelation of the fraud reflects not only the actual loss due to the fraud, but also all changes in the stock price caused by other factors during those periods.  The longer the time periods, the more likely it becomes that factors unrelated to the fraud will contribute to the calculated loss.

Another concern is that the modified rescissory method is biased toward higher loss estimates because it assumes that all shares outstanding incurred harm.  It does not account for investors who purchased their shares before the fraud occurred or for shares owned by the defendant(s).  Because it excludes consideration of those shareholders, the calculation ignores that the number of shares that incurred losses is likely to be lower than the number of shares outstanding.

By choosing the modified rescissory method, the Commission rejected the market-adjusted method, which was the standard in the Second and Fifth Circuits.  Proponents of the market-adjusted method argue that it excludes gains or drops in price due to market factors unrelated to the defendant’s conduct and therefore properly limits loss to that proximately caused by the fraud.  The market-adjusted method is also consistent with the analysis used in civil securities fraud cases.

In practice, the market-adjusted method required sentencing courts to look to expert opinion and considerations of the general market and particular relevant segments. Since the burden was on the government to prove the existence and amount of loss attributable to the fraud, the onus was on the government to demonstrate that economic loss was proximately caused by the fraud and not attributable to other factors. The government’s burden is now much lighter.

The Commission attempted to address concerns about the unfair influence of external market factors by making the modified rescissory method a rebuttable presumption.  The sentencing court may consider evidence of other factors, including external market forces, to determine whether the loss amount calculated by the modified rescissory method includes “significant changes in value not resulting from the offense….”  Accordingly, courts ostensibly retain discretion to achieve a properly tailored loss calculation.

However, it cannot be ignored that the modified rescissory method easily could lead to a decrease of consideration of external market factors.  The language of the amendment states that the sentencing court “may consider” alternative explanations for the change in price; however, this means that a court also can choose not to consider such explanations.  It is likely that some sentencing judges, now provided with a clear and simple guidelines-endorsed rule, will be disinclined to credit expert testimony and extensive offers of proof, and will instead rely heavily on the arithmetic formula.

Defense counsel must now be prepared to rebut the presumption that the loss calculation under the modified rescissory method is a reasonable representation of the actual loss amount, and demonstrate instead that it is inaccurate and unfair.  The defendant will now bear the burden of introducing evidence of specific external factors and arguing their impact. Defense counsel should be equipped with thorough research and expert advice to identify increases or decreases in securities prices that are unrelated to the fraudulent activity.

Thorough preparation of this information early in the case is important for several reasons.  First, it often is preferable to negotiate the loss amount with the government, rather than litigate the issue. Because the new guideline provision permits consideration of non-fraud related factors, defense counsel can first try to persuade the government that it simply is not fair to apply the new calculation in a lockstep fashion.  If the government can be persuaded to exclude loss amounts as unrelated to the fraud, litigation may be unnecessary.

If negotiation with the government fails or is not possible, full-bore litigation on the loss issue may be required. Although sentencing hearings on certain issues sometimes can jeopardize a defendant’s acceptance of responsibility points or devalue an expression of remorse, the issue of the loss amount in securities fraud cases can be presented as a technical and legal argument supported by market data and expert opinion, rather than an attempt to excuse the defendant’s conduct.

The sentencing memorandum should include a detailed loss analysis supported by market data and expert opinion in order to prime and educate the judge about the various issues at stake.  A general legal argument that the provision unfairly shifts the burden of proof and consistently leads to overrepresentation of the actual harm also may be appropriate.  In addition, prior to sentencing, defense counsel should consider lobbying the Probation Department to exclude from the pre-sentence report loss amounts due to market factors unrelated to the fraud.  It is always an advantage to have Probation on your side at sentence.

From the moment defense counsel is retained in a securities fraud case, in-depth research, planning, and preparation must be undertaken to determine the best approach to the loss calculation. Even if the case is certain to proceed to trial, it is critical to calculate the likely downside risk. The earlier counsel is in control of the loss amount in a securities fraud case, the greater the chance of avoiding or reducing the severe sentences occasioned by the fraud guideline.

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