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Being reasonable is easier said than defined when calculating the prison sentences of executives found guilty of securities fraud, if their prison terms rest on hotly contested calculations of stock losses. Around the country, federal judges are struggling with ways to calculate reasonable sentences under the Federal Sentencing Guidelines for corporate criminals caught when news of potential skullduggery sends the stock market into gyrations that cost investors millions. Such huge losses can send potential white-collar sentences into the stratosphere. On July 28, in the closely watched case of ex-WorldCom Inc. chief Bernard J. Ebbers, the 2d U.S. Circuit Court of Appeals upheld his 25-year prison term as reasonable based on an $11 billion fraud that sent WorldCom to bankruptcy. Dynegy Corp. tax lawyer Jamie Olis’ 24-year sentence for securities and wire fraud was just too long for the 5th Circuit, which sent the case back to U.S. District Judge Sim Lake in Houston. But a one-week sentence for fraud by former HealthSouth Corp. Chief Financial Officer Michael Martin was just too short for the 11th Circuit. In New York last month, U.S. District Judge Jed S. Rakoff used traditional stock-price loss calculation to project a potential 85-year term for securities fraud for Impath Inc. Chief Operating Officer Richard Adelson. But Rakoff called the virtual life term for Adelson “patently unreasonable,” of the sort reserved for Mafia dons and drug kingpins. The sentencing guideline calculations are so unreasonable in Adelson’s case that Rakoff said he had to look to other factors to bring it in line with federal law. U.S. v. Adelson, No. S2 05-325JSR. Many white-collar sentences are measured by the artificial inflation of the stock price due to the fraud, compared with the price drop after the fraud is exposed. But judges have applied a variety of methods to estimate loss, including actual loss, intended loss to the victim or gain for the defendant. The choice is significant. As the amount of loss increases, the potential sentence rises under the guidelines. The difference between zero loss and $400 million-the top of the guideline range-can mean the difference between probation and 19 years in prison. But many defense lawyers argue that stock-price drop alone does not take into account other intervening events-apart from criminal conduct-that drive stock prices up and down. After Enron Corp.’s collapse in 2001, “you saw sentences for white-collar crime get ratcheted up and up and up,” said David Angeli, a defense litigator in Stoel Rives’ Portland, Ore., office. “Judges were uncomfortable imposing them and hamstrung to get around them” prior to the Supreme Court’s Booker decision declaring the guidelines advisory rather than mandatory, he said. U.S. v. Booker, 543 U.S. 220 (2005). “Today, judges are still struggling with unduly harsh sentences but feeling constrained to be inside the guidelines,” said Angeli, who defended Joseph Hirko, head of Enron’s broadband unit. After a three-month trial, jurors acquitted Hirko on 14 insider trading counts and convicted on 13 counts related to conspiracy and fraud. The conviction is on appeal. For large, publicly traded companies like Enron, a drop in the share price of a few cents on millions of outstanding shares can shoot criminal sentences over the top of the guideline range, he said. With years of prison time riding on a slight change in stock price, the loss calculation has become a critical component in sentencing for both the government and defense. “The trickiest issue is loss causation,” said John Hemann, a white-collar defense lawyer in Morgan, Lewis & Bockius’ San Francisco office. The Supreme Court’s decision in Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005), “opened the door to a battle of experts” on these sentencing questions, he said. Dura held in part that allegations of fraud in private securities cases can’t rest on the drop in a stock price alone. Plaintiffs must prove that the share price fell after the truth came out and that plaintiffs suffered for it. Its holding that an inflated stock price is insufficient to support a civil fraud claim is significant in criminal cases because sentencing is driven by the amount of loss caused by the criminal fraud. Three factors drive the sentencing calculations: the reasonableness of the sentence, the losses attributable to the fraud and the extent to which one looks at the culpability of the individual-was the chief executive officer more or less responsible than the person who carried out the acts, said Ellen Podgor, a criminal law professor who teaches about white-collar crime at Stetson University College of Law in Gulfport, Fla. The Olis sentence Before the 5th Circuit overturned the 24-year Olis sentence, the case was on every defense attorney’s mind, according to Patrick Robbins, a Shearman & Sterling white-collar defense lawyer and former federal prosecutor in San Francisco. “It was a huge sentence for a middle manager because he was held entirely responsible for the company’s stock drop, even though his conduct was a small part of the company’s problems.” Lake sentenced Olis on a market-capitalization approach. He appeared to look at the market capitalization, the price of the company’s stock before and after the fraud, and then figured the difference, according to Robbins. In 2005, the 5th Circuit sent the Olis case back, saying that judges must take a “realistic economic approach” to loss calculation and settle on what the defendant actually caused, or intended to cause, exclusive of other impacts on the stock price. By contrast, the 8th Circuit, in 2004, did not use the 5th Circuit’s “realistic economic approach” to calculate gain but chose what Angeli called an “intellectually lazy” bright-line rule of using the net profit realized in an insider trading case. U.S. v. Mooney, No. 02-3388. “There is so much dependent on loss calculation and there is such a wide variance in sentences, do you really want to turn these into a battle of experts like civil cases?” asked Adelson’s attorney, Mark Arisohn of Labaton, Sucharow & Rudoff in New York. The sentencing guidelines provide little help to judges on how to figure out loss, stating only that “the court need only make a reasonable estimate of the loss.” This has led to a variety of approaches around the country, only now starting to come under appellate scrutiny. And for many courts, loss calculation remains a battle of experts on economics and the stock market. “I don’t think there is a consensus yet among the judges,” said Douglas Young of Farella, Braun + Martel in San Francisco. “Many defense lawyers take the position the loss-causation element was built into the sentencing guidelines. If that is the case, you want to force the government to prove what it is that the defendant caused to happen,” said Young, who defended William Grabske, former chief executive officer of Indus International Inc., who was convicted of securities fraud in 2002. The rescissory method Young declined to discuss the Grabske case, but the sentencing approach by U.S. District Judge Charles Breyer has caught the attention of the defense bar. After listening to experts from both sides, Breyer rejected both and opted for what’s known as a rescissory method, or a measure of damages that would return the injured party to the position he or she held before the crime. Breyer took an average of share price during the fraud, minus the average share price for a period after the fraud was disclosed, and found a total loss of $230,000, rather than the government’s $1.9 million loss claim. Grabske got two rather than five years in prison. U.S. v. Grabske, 260 F. Supp. 2d 866 (N.D. Calif. 2002). U.S. District Judge David O. Carter took a similar approach in the case of Osamah Bakhit, who pleaded guilty to securities fraud in an aviation company in a 2002 Los Angeles case, U.S. v. Bakhit, 218 F. Supp. 2d 1232 (C.D. Calif. 2002). Carter calculated the average loss per victim, again with an average selling price during the fraud and average selling price after the fraud. He found a $2.8 million loss compared with a government assertion of a nearly $7 million loss. The court “need not find a perfect theoretical model to calculate loss, only a realistic, economic approach,” Carter concluded. It may be years before the competing loss-calculation formulas work their way to the Supreme Court, according to Angeli. A lot of cases today are pleaded so there are no appeals. “Issues are being litigated but I am not seeing a lot of opinions yet,” he said. Podgor said the judges may continue to work through systems for loss calculation case by case for a while. “Frankly, I think they should. The guidelines are very mechanical and don’t account for the specifics of individual cases.”

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