Sentencing Guidelines Increase Federal Prison Sentences for Organized Insider Trading

By: Houston Criminal Lawyer John Floyd and Paralegal Billy Sinclair


The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into slightly more than two years ago by President Barak Obama. The official purpose of the law is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices and for other purposes.” Dodd-Frank has been called the most sweeping piece of financial regulatory reform since the Great Depression. It was created in response to the 2008 recession that nearly sent America into yet another Great Depression. Much has been written about the impact of Dodd-Frank on multiple industries and other legislation governing those industries. To say the Act changed the way Wall Street will be regulated, whose propensity for corrupt financial practices is legendary, would be putting it mildly.


But, Dodd-Frank’s impact on various U.S. Sentencing Guidelines applicable to fraud offenses has gone virtually unnoticed, despite the fact that the Act itself directed the U.S. Sentencing Commission to “review and, if appropriate, amend” those guidelines. The changes it will have on federal criminal cases and sentencing is more than significant because, as Judge Patti B. Saris, the Chair of the Commission, “fraud offenses represent almost 10% of the federal criminal docket annually.”

The new Dodd-Frank-produced amendments to the Sentencing Guidelines will take effect November 1, 2012, and will likely increase sentences for those convicted of fraud offenses. While Congress maintains the authority to modify these new amendments, it is not likely to do so given the current gridlock affecting every aspect of political life in Washington.


Attorneys David Debold and Matthew Benjamin recently published a Findlaw piece about various aspects of the new guidelines produced by Dodd-Frank. These two white collar attorneys note that the Commission amended “insider trading guidelines” (USSG § 2B1.4) in two significant ways. First, it creates a new offense level of 14 that increases the recommended prison range to 15-21 months for a defendant with no criminal record for any “organized scheme to engage in insider trading.” This amendment also grants judges the authority to determine whether the insider trading scheme is “organized,” meaning whether the scheme involved “considered, calculated, systemic, or repeated efforts to obtain and trade on inside information, as distinguished from fortuitous or opportunistic instances of insider trading.” Debold/Benjamin explained the impact this enhanced judicial scrutiny will have on insider trading sentencing:


“ … For cases where there is little or no gain from insider trading, this will mean an automatic increase of 6 offense levels (from a pre-amendment recommended prison range of 0-6 months for defendants with no criminal record) for all participants in the offense. As the profitability of a scheme increased, however, the effect of this new provision diminishes, disappearing entirely when the overall gain from the scheme reaches $30,000. Because this new provision is based on how the scheme operated, rather than the role of a particular defendant in that scheme, the amendment may have the unintended consequence of increasing punishment for the least culpable offenders, particularly in schemes that enjoyed little or no success.”


And another Dodd-Frank amendment targets the “abuse of trust” provisions of USSG § 3B1.3 governing insider trading cases. Debold/Benjamin explained that defendants under the pre-amended guidelines could receive increased punishment if they abused a position of public or private trust which significantly facilitated the crime. This provision was triggered only if the defendant’s position involved “substantial discretionary judgment that is ordinarily given considerable deference.” Under the Dodd-Frank amendment, however, the abuse of trust provision attaches “if the defendant’s employment in a position that involved regular participation or professional assistance in creating, issuing, buying, selling, or trading securities or commodities was used to facilitate significantly the commission or concealment of the offense.” Debold/Benjamin noted that the amendment’s broader standard was intended to apply to a hedge fund professional who “regularly participates in securities transactions.” This will allow prosecutors to push for sentence increases in cases where a defendant “lacked discretionary trading or investment authority.” And, from our perspective, that is another official license for prosecutors to abuse the plea negotiation process and sentencing with undue threats of harsher sentences.


Furthermore, Dodd-Frank not only changed the offense level and range of punishment in securities fraud cases but also the way “loss” from those offenses are calculated. Debold/Benjamin discussed these calculations at length:


“The Commission also amended the fraud guideline (USSG § 2B1.1) to add a special rule for determining loss in cases involving fraudulent inflation or deflation of the value of publicly traded securities or commodities. The amendment directs use of what is known as the ‘modified rescissory method’ for determining actual loss: First, calculate the difference between (i) the average share price during the fraud period; and (ii) the average share price during the 90-day period after the fraud was disclosed to the market. Second, multiply the difference by the number of shares outstanding.  In seeking comment on this issue in January 2012, the Commission identified four methods used by different federal courts around the country. Some courts employ the market-adjusted method that the U.S. Supreme Court requires in civil cases, in which the plaintiff must exclude from the calculation those changes in share price caused by forces external to the fraud, such as general declines in the market. The reasoning of these courts is that where a defendant’s liberty is at stake, the calculation should be no less reliable than it is in cases where the outcome is merely a judgment to pay damages. Adoption of the ‘modified recissory method’ threatens to undermine that progress, because it imposes no duty to disaggregated the causes unrelated to a defendant’s criminal conduct.


“Despite the Commission’s adoption of a less precise method, this amendment continues the Commission’s recent trend of using rebuttable presumptions rather than the one-size-fits-all rules. The new provision directs the court to presume that the modified recissory method has accurately calculated the actual loss, but a party may rebut that presumption and persuade the court that is not a ‘reasonable estimate of the actual loss.’ The court may consider, among other factors, the extent to which the amount so determined includes less significant damages 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 facts, conditions, or events).


“In last year’s amendments, the Commission took a similar approach to calculating losses from health care fraud, directing that the aggregate dollar amount of fraudulent bills submitted to a government health care program ‘shall constitute prima facie evidence of the amount of the intended loss,’ but adding that this means it is sufficient evidence to establish that amount only ‘if not rebutted.’ Each provision leaves room for a defendant to make the case that using the ‘presumptive’ approach would overstate the seriousness of the harm resulting from his offense.”


But another disturbing aspect about the Dodd-Frank amendments is that the Commission expanded the fraud guidelines under USSG § 2B1.1 allowing judges to depart upward from the recommended guideline range.  Debold/Benjamin explained that the Commission felt a judge should have the authority to depart upward “if the offense created a risk of substantial loss beyond the loss determined under the guideline,” such as a “’risk of a significant disruption of a national market.’”

Encouragingly, however, the Commission also offered “new guidance” to judges for downward departures in such cases where the securities fraud involve “fraudulent misrepresentations” that inflate stock prices such that “an aggregate loss amount that is substantial but diffuse, with relatively small loss amounts suffered by a relatively large number of victims.” The Commission was concerned that in these kinds of cases the existing “guidelines tables” dealing with the amount loss/number of victims could “overstate the seriousness of the offense, and, thus, would warrant consideration of a downward departure by the judge.


And where does that leave us in sentencing of securities fraud-related offenses after the Dodd/Frank amendments take effect?


Debold/Benjamin offered this assessment: “Given that judges, academics, and the defense bar have long called for a wholesale revision of the fraud guideline—indeed, even the Department of Justice has supported a comprehensive review—the Commission’s actions should be seen as modest. In particular, the new downward departure language should not be read as the Commission’s final word on addressing undue severity in the punishment for certain fraud offenses. Chairman Saris explained that these amendments are ‘the first step in a multi-year review of the fraud guideline’ and specifically noted the criticisms about disproportionate or disparate sentences, ‘particularly in high-loss fraud cases.’”


David Debold and Matthew Benjamin know about which they speak. But we’re not at all certain we can embrace their optimism that the Commission is prepared to change the entire fraud guidelines systems to produce a more equitable sentencing scheme in these cases. The fact that Chairman Saris used language that it will take a “multi-year review” to produce equitable sentencing in fraud cases gives us pause for concern. The current fraud sentencing guidelines are unfair and disproportional, and the Dodd-Frank amendments are not designed, the downward guidance to judges notwithstanding, to change this.


By: Houston Criminal Lawyer John Floyd and Paralegal Billy Sinclair

John Floyd is Board Certified in Criminal Law by the Texas Board of Legal Specialization