Did the Southern District of Texas Just Legalize Securities Fraud?

Posted On Friday, March 22, 2024
By: Alexander M. Owens

In December 2022, the Department of Justice indicted eight individuals for securities fraud for allegedly operating a $114 million social media pump and dump scheme. United States v. Constantinescu, No. 4:22-CR-00612 (S.D. Tex. Mar. 20, 2024). According to the government, the defendants promoted stocks on Twitter and Discord to increase the price of the shares they owned and sold their shares as their social media followers piled into the stocks and drove the share prices higher. The indictment painted the picture of a classic securities fraud scheme. For decades, stock promoters used boiler rooms and newsletters to pump the prices of stocks that the promoters then sold as the assets appreciated. The only twist here was that the government alleged a pump-and-dump campaign through the more modern channels of social media. 

Yesterday, Judge Andrew Hanen of the Southern District of Texas dismissed the superseding indictment in full. The Court’s opinion reflects a stunning expansion of the Supreme Court’s Ciminelli v. U.S., 598 U.S. 306 (2023) ruling and a potentially devasting blow to federal securities law enforcement. 

In Ciminelli, the Supreme Court rejected the right-to-control theory in wire fraud cases. Ciminelli held that the government cannot premise wire fraud on schemes to merely “deprive a victim of potentially valuable economic information necessary to make discretionary economic decisions.” Rather, money or property must be the object of a wire fraud scheme. 

Judge Hanen was tasked with determining whether Ciminelli applies to securities fraud charges under 18 U.S.C. §§ 1348 and 1349, and, if so, how. Judge Hanen reasoned that Ciminelli’s teachings apply to all federal fraud statutes and so Ciminelli must govern securities fraud charges. He then held that because the alleged victims did not purchase their shares directly from the defendants, the defendants could not have engaged in a scheme to deprive them of property or money:

Unlike a traditional fraud cause, in which the victim directly surrenders their property to the defendant (or an entity in the defendant’s control), the investors here surrendered their property to the stock market at market prices, and in return, received the benefit of the bargain in the form of securities.

Put another way, Judge Hanen found that the government had only alleged a scheme to deprive victims of information which, under Ciminelli, is insufficient.

The implications here are far-reaching. This same intermediated sale structure is present in virtually all securities transactions that take place on stock exchanges and similar markets. In stock trading, for example, there will be a market maker between the seller-fraudster and the purchaser-victim. And the holding begs the question as to how its logic may apply outside the securities markets (e.g., to non-securities fraud prosecutions where a buyer and a seller are one or more steps removed from one other). An inordinate array of goods and services are sold through intermediaries every day. Manufacturers sell goods to Amazon and brick-and-mortar stores which then sell them to consumers. Auto sales play out in much the same way. 

If other courts embrace Judge Hanen’s decision, Constantinescu may spark a sea of change in federal fraud prosecutions. But it seems unlikely that the Supreme Court in Ciminelli sought to effect such a breathtaking change in the law. Those involved in the securities markets should not take Constantinescu’s holding as gospel. Plus, the case addressed securities fraud charges under 18 U.S.C. §§ 1348 and 1349 only. It did not, for example, address Ciminelli’s application to 15 U.S.C. §§ 78j and 78ff, which are worded far more capaciously. Time will tell whether Constantinescu is a turning point or a blip on the radar for federal fraud prosecutions.      

DOJ’s Emphasis of Individual Accountability – Where it Stands, and Where it Could be Headed

Posted On Wednesday, January 24, 2024
By: Scott A. Coffina

A recent article in Law360 sparked a vigorous conversation among members of Pietragallo’s white collar practice group about the current state of the U.S. Department of Justice’s (DOJ) evolving emphasis on individual prosecution. Our consensus is that the Justice Department is currently stressing individual accountability as it seeks to assure the business community that timely self-disclosure and meaningful cooperation will be rewarded with some type of leniency, if not non-prosecution altogether. 

The article that caught our attention was a thoughtful analysis of United States vs. Valle Boza, the prosecution of HealthSun Health Plans Inc.’s former director of Medicare risk adjustment analytics for entering false, more serious diagnosis codes for Medical Advantage participants, resulting in higher monthly payments to HealthSun for the anticipated costs of their care.  HealthSun, according to the DOJ, undertook “timely and appropriate remediation, including terminating employees who were involved in the misconduct, reporting and correcting the false and fraudulent information submitted to [the U.S. Department of Health and Human Services’ Centers for Medicare and Medicaid Services], and substantially improving their compliance program and internal controls” and thus will not be prosecuted for the $53 million fraud scheme.

Recent DOJ Policy Shifts

Over the past twenty-five years, the DOJ occasionally has restated its Principles of Corporate Prosecution, formally expressed through memoranda issued by the Deputy Attorney General. These memos set forth the factors the DOJ will consider in giving companies consideration in prosecution decisions (or non-prosecution decisions) for cooperating with an investigation into corporate wrongdoing. 

Likely as a reaction to criticism the Department received over a paucity of individual prosecutions following the financial crisis of 2008, the DOJ under the Obama administration demanded that corporations seeking credit for cooperation turn over all relevant facts about all individuals involved in wrongdoing. 

The DOJ under the Trump administration t dialed that back a bit. In the “Rosenstein Memo,” the DOJ continued to emphasize individual accountability, but it no longer required corporations under investigation to disclose “all” information about “all” employees involved in order to receive any credit for cooperation.

The Current Enforcement Protocol

Under Attorney General Merrick Garland and Deputy Attorney General Lisa Monaco, the Department has returned to the more rigid demands of a complete turnover of information on all wrongdoing by all participants for corporations to receive any credit for cooperation, reflecting its emphasis on prosecuting individuals. For example, in September 2022, DAG Monaco wrote, “The Department’s first priority in corporate criminal matters is to hold accountable the individuals who commit and profit from corporate crime.”

In Valle Boza, the defendant and her co-conspirators allegedly obtained physicians’ login credentials and used them to enter false chronic conditions into the medical records of beneficiaries, as if entered by the physicians themselves. Their scheme allegedly caused HealthSun to submit to CMS tens of thousands of false and fraudulent diagnosis codes, which resulted in HealthSun being overpaid millions of dollars by the government.

The Valle Boza HealthSun case can be viewed as an example of the DOJ’s emphasis on the prosecution of individuals; a corporate employee is being prosecuted, while the entity fully cooperated to the government’s satisfaction, and will not be prosecuted. But one should not overread this as part of the renewed DOJ paradigm – the defendant and her co-conspirators’ alleged conduct was particularly egregious, and it is difficult to envision any company acting differently than HealthSun upon being made aware of such wrongdoing. If true, Valle Boza’s conduct would warrant individual prosecution under any regime.   

Still, the Justice Department’s current emphasis on individual prosecution is undeniable. Last June, for example, the DOJ bundled three unrelated schemes into one mega-announcement that it had charged 78 individual defendants with health care fraud. In one of the cases charged in this “coordinated . . . nationwide law enforcement action,” three executives of purported software and services companies allegedly conspired to generate and sell templated doctors’ orders for orthotic braces and pain creams in exchange for kickbacks and bribes. Their software allegedly facilitated a telemedicine scheme that yielded $2 billion in false claims. While these executives were charged, the companies with which they are associated were not. 

In another case announced at the same time, Steven Diamantstein, an owner and corporate officer of Scripts Wholesale, Inc., was charged after the company (which was not charged) allegedly purchased illegally diverted prescription HIV medication, and then marketed and resold the medication by falsely representing that the company acquired it through legitimate channels.

This omnibus announcement by the DOJ of “78 Individuals Charged for $2.5B in Health Care Fraud” in several unrelated cases clearly seemed calculated to underscore the Department’s prioritization of individual accountability. Attorney General Merrick Garland commented that “These enforcement actions . . . represent our intensified efforts to combat fraud and prosecute the individuals who profit from it,” and Assistant Attorney General Kenneth A. Polite, Jr., then-head of the DOJ’s Criminal Division, noted that “Today’s announcement . . . demonstrates the Department’s commitment to seeking justice for those at all levels of the healthcare industry who put profits above patient care, from professionals in doctors’ offices to executives in corporate boardrooms.”   

You’ve Uncovered Wrongdoing – What Now?

The Justice Department’s emphasis on prosecuting individuals can complicate companies’ investigations of alleged wrongdoing. Obviously, a company’s enhanced incentive to cooperate – which can be viewed as borderline coercive – by “turning in” its employees, creates potential formal and informal conflicts that can impede internal investigations. And in circumstances where the government’s theory of prosecution is more novel or nuanced than was the case with HealthSun, a company may not believe that its employees did anything wrong, which creates a dilemma in terms of government cooperation. After all, a company may be fully cooperative with the government’s investigation, but must it fire an employee it believes to be innocent of wrongdoing in order to receive leniency from the government in a prospective resolution of a disputed claim? 

When confronted with an instance of fraudulent conduct, defense counsel and corporate executives must carefully consider the seriousness of the misconduct they uncover and what a potential prosecution might look like in deciding whether and how much to disclose to the government, as well as the collateral consequences to their organization in subsequent civil litigation and business relationships. They also must evaluate the likelihood that the company ultimately will receive meaningful credit for its cooperation, an assessment which should include how the local U.S. Attorney’s Office typically handles cooperation credit, as each of the 93 United States Attorneys operate with a large degree of autonomy and discretion within their jurisdictions.

What the Future Might Look Like

One last note on our internal discussion here at Pietragallo about corporate and individual prosecutions, and where they might be headed, particularly in an election year where a change of the party in power is a distinct possibility. Over the past 15 years, the two Democratic administrations have taken a more formulaic approach while demanding more of corporations for cooperation credit, while the Trump Administration took a more holistic approach. 

One should be cautious to predict a less rigid insistence on individual accountability in these matters if the Republicans regain control of the federal government in 2025. First, the DOJ’s recent re-emphasis on individual accountability isn’t necessarily a reflection of partisan philosophy as much as a desire to demonstrate vigorous law enforcement in the midst of a notable decline in corporate prosecutions in recent years. The Department may believe that prosecuting individuals signals greater accountability than the corporate pleas or non-prosecution agreements the defense bar typically advocates strongly for in white collar cases. Moreover, individual accountability never goes out of fashion, and the Justice Department, no matter who leads it, will always proclaim an intention to hold individual wrongdoers accountable. 

That said, each new Administration should evaluate the effectiveness of the Department’s Principles of Corporate Prosecution and adjust them to ensure they are effective and meet their priorities. As a former Assistant United States Attorney and Associate White House Counsel who has experienced the modification of prosecution policies and priorities, I would expect that the next administration (whether in 2025 or in 2029) will consider whether the current stringent requirements for corporate cooperation credit – specifically for this discussion, the demand that “all”information about “all” individuals involved in wrongdoing be disclosed for the company to receive any credit – are yielding more or fewer voluntary disclosures. 

If such a review finds that corporations are not readily coming forward because of a belief that doing so ultimately may not get them the cooperation credit they seek or creates too many ancillary risks, we probably will see a new “DAG Memo,” with more flexibility for corporations, but with a sustained emphasis on individual accountability.

While the landscape for corporate prosecution may be layered with uncertainty, here are two time-tested approaches that no change in DOJ policy should affect. First, like so many business and legal decisions, the strategy to address a problem will depend on the particular facts of that situation, the applicable law, and the exercise of sound, clear-headed judgment as to the best interests of the organization. Second, regardless of whether a company chooses to cooperate or put the government to its proofs, it is incumbent upon its leadership to promptly put an end to any fraud or other wrongdoing of which it becomes aware, conduct a thorough internal investigation to determine the scope, mechanism, and cause of the misconduct, strengthen its compliance policies as needed, and refund any ill-gotten gains.