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Second Circuit Vacates Restitution Order in Complex Fraud Case

On December 3, 2019, the Second Circuit (Kearse, Pooler, Livingston) issued a decision in United States v. Calderon, et al., reversing an $18 million restitution order and otherwise affirming the defendants convictions and sentences.  In reversing the restitution order, the Court determined that the defendants’ fraud had not proximately caused the financial losses suffered by the U.S. Department of Agriculture (“USDA”) and certain banks.

Background

The defendants’ convictions arose from their involvement in a scheme to defraud two banks, Deutsche Bank and CoBank, in connection with an export guarantee program administered by USDA.  Some background on the nature of international transactions is necessary to understand the case.

International Transactions Involving Physical Goods

As described by the Court, international business transactions involving the sale of physical goods are carried out through the use of unique documents and contracts that serve to mitigate risk among geographically disparate parties.  To mitigate the risk of nonpayment by a foreign importer, American exporters will bargain for and include in the sales contract a term that will require payment by a “confirmed and irrevocable letter of credit.”  Once the contract is signed, the foreign importer will then apply to an “issuing bank”—which is usually a foreign bank—to receive that letter of credit.  The issuing bank will then issue the letter of credit in favor of the American exporter.  The letter of credit constitutes an “irrevocable promise” to pay the exporter when it presents certain documents that conform to the terms of the credit.  At the same time that the letter of credit is secured, the American exporter typically works with a “confirming bank”—which is usually a domestic bank—and assigns its right to payment on the letter of credit to the domestic bank in exchange for immediate payment of the contract price.  This triggers the issuing bank’s obligation to reimburse the confirming bank, which is done over time and with interest.

In order to receive immediate payment from the confirming bank, an exporter must compile a complete set of documents and present them to the confirming bank.  Among these documents is a “bill of lading,” which is a contract between either the exporter or importer and an international carrier obligating the carrier to transport the goods to the importer’s location.  The government’s prosecution arose from the defendants’ presentation of altered bills of lading to confirming banks in order to induce those banks to honor their obligations under various letters of credit.

In connection with these sorts of international transactions, a confirming bank has two duties when it examines documents for the purpose of obtaining payment on a letter of credit.  First, it must determine whether the documents conform exactly to the terms of the letter of credit.  Second, it must respond if it finds any discrepancies.  Under the law in many jurisdictions, if the documents provided by an exporter to the confirming bank do not strictly comply with the letter of credit, the issuing bank is entitled to refuse to honor the letter of credit.  Even if nonconforming documents were honored, an issuing bank could still sue a confirming bank after the fact for “wrongful honor.”

USDA’s GSM-102 Program and the Defendants’ Scheme

USDA has implemented a program called GSM-102 which provides an incentive for U.S. banks to participate in letters of credit export transactions with developing nations.  In the sorts of transactions described above, the confirming domestic bank bears the risk that a foreign issuing bank will default on its payment obligations under the letter of credit, resulting in a situation in which the domestic bank may be unable to obtain redress.  Accordingly, USDA encourages domestic banks to participate in such transactions by typically guaranteeing 98% of the foreign bank’s obligation under the letter of credit.

The defendants participated in the GSM-102 program as financial intermediaries who structured third-party transactions.  The defendants would pay a fee to “rent” or “purchase” GSM-102 eligible trade flows from exporters and importers.  After acquiring the trade flow, the defendants would arrange for letters of credit between foreign and domestic banks backed by the USDA guarantee.  As part of this process, the defendants were responsible for presenting complying documents to the confirming domestic banks.  The defendants made money through this process by receiving a fee from the foreign banks involved. 

At trial, the government presented evidence showing that the defendants falsified bills of lading before presenting them to Deutsche Bank and CoBank (two confirming banks) in order to make the bills of lading facially compliant with the terms of the relevant letters of credit and the requirements of the GSM-102 program.  The defendants did not deny making the modifications of the documents, but stated that the changes were insignificant, and that the changes “made it easier for everybody” in the transaction. 

Following the global financial crisis in 2007-08, several issuing banks defaulted on their obligations under various letters of credit arranged by the defendants.  USDA therefore reimbursed the confirming bank the full amount available under the GSM-102 guarantee.

Jury Deliberations, Verdict, and Restitution Order

The jury deliberated for approximately a week after an 18-day trial, at which point it informed the trial court that it was deadlocked on some counts.  The trial court gave a modified Allen charge that encouraged the jury to continue deliberating.  The jury subsequently returned a verdict (1) convicting Defendant Lillemoe on one count of conspiracy to commit bank and wire fraud and five substantive counts of wire fraud, and (2) convicting Defendant Calderon on the conspiracy count and one substantive count of wire fraud.  The defendants—including a third defendant, Zirbes—were acquitted on all other charges, including various counts of wire fraud, bank fraud, money laundering, and false statements. 

The trial court subsequently entered a restitution order as to both defendants, finding that USDA was entitled to approximately $18 million in restitution after reimbursing the banks in the GSM-102 program for various transactions involving the defendants.

The defendants appealed their convictions and the restitution order, raising four issues addressed by the Court in its decision.

The Court’s Analysis

The defendants first challenged the sufficiency of the evidence underlying their convictions, arguing that the government (1) failed to offer sufficient evidence regarding the “materiality” of their alterations to the bills of lading, and (2) failed to present sufficient evidence that they intended to deprive the victim banks of money or property.  The Court rejected both of these contentions.  On the first point, the defendants argued that their alterations were not material because the bills of lading appeared to be compliant with the letters of credit and GSM-102 program.  As a result, the defendants contended that the issuing banks would not have been able to sue the confirming bank—the issuing banks were presented with evidence that the shipment was program compliant.  The Court quickly dispatched with this argument, noting that “under the Defendants’ theory, the better the fraudster, the less likely he is to have committed fraud.”  The Court likewise held that the modifications were not needless but were changed so as to prevent the rejection of the bills of lading.  On the second point, the Court noted that a deprivation of property could include intangible interests such as the right to control one’s assets.  It further observed that it had previously upheld fraud convictions where misrepresentations exposed a lender to unexpected economic risk.  The Court found that standard easily met here, where the evidence showed that the modifications to the bills of lading (1) exposed the confirming banks to risk of default or non-reimbursement from the foreign issuing banks, and (2) increased the risk that USDA would decline to reimburse the banks in the event of the foreign bank’s default.  The bottom line of the Court’s analysis seemed to be that the submission of forged bills of lading is not the sort of thing that can be brushed off with a “no harm, no foul” approach under the wire fraud statute.

The defendants’ second challenge concerned two jury instructions, only one of which they objected to at trial.  First, the defendants challenged the trial court’s decision to give a “no ultimate harm” charge to the jury.  The Court rejected this argument because the defendants’ trial strategy—in which they focused on the fact that the banks were ultimately reimbursed by USDA for their losses—created the factual predicate for the charge (which the district court originally declined to give, until it ruled that the door was opened).  The Court also found that the instruction that was given correctly required the jury to find intent to defraud and did not cause any confusion.  Second, the defendants challenged the district court’s instruction regarding the elements of bank fraud, which the Court reviewed only for plain error.  The defendants contended that the district court should have instructed the jury that a bank fraud conviction requires a finding that the defendant “contemplated harm or injury to the victim.”  But the Court found that the absence of this language did not affect the defendants’ substantial rights because the jury acquitted them on the substantive bank fraud charge, while the conspiracy charge concerned both wire fraud and bank fraud meaning that the conspiracy conviction could have rested on the wire fraud alone. [1]

The defendants’ third challenge concerned the trial court’s modified Allen charge, which the defendants claimed was improper after the jury reached an apparent deadlock. The Court rejected this argument, finding that the modified Allen charge contained “all of the safeguards, and none of the pitfalls,” that have been recognized as relevant to an assessment of such charges.  In particular, the Court observed that the trial court repeatedly warned the jurors not to surrender their conscientiously held beliefs and did not inform jurors that they were required to reach an agreement.

The defendants’ fourth—and only successful—challenge concerned the trial court’s restitution order.  The Court noted that the Mandatory Victims Restitution Act (“MVRA”) requires a court to order restitution in the full amount of each victim’s losses in the case of an “offense resulting in…loss or destruction of property.”  The defendants argued that the banks were not “victims” under the MVRA because their financial losses were not directly and proximately caused by the alleged fraud.  The Court agreed, noting that the MVRA’s proximate cause requirement was akin to the “loss causation” requirement associated with securities fraud cases.  The Court observed that the defendants’ fraud concealed two risks from the domestic banks at issue: (1) that the issuing bank would refuse to honor the letter of credit on the theory that the confirming bank had failed to demand a valid, conforming presentation; and (2) that USDA would decline to reimburse the banks for their losses because the transactions were not GSM-102 compliant.  According to the Court, neither of these risks materialized.  Instead, the foreign banks defaulted on their obligations due to their inability to fulfill them following the “global financial crisis.”  The Court found that the specific losses therefore turned on the creditworthiness of the foreign banks, which implicated a risk that was borne solely by the banks and USDA because they had pre-approved the defaulting banks for participation in these transactions.   The Court cast the actions of the domestic banks in a dim light, writing that they “made a bet that the foreign banks would be able to repay the relevant loans with interest and their assessments as to advisability of that bet were completely unrelated to the risks concealed by Defendants’ fraud.”

Discussion

The Court’s decision in Calderon illustrates the close scrutiny that large restitution orders may draw, particularly where there are concerns that such an order may result in an unjustified windfall to the victims.  We saw not long ago the Supreme Court adopt a narrow view of the restitution provisions in Lagos v. United States, 138 S. Ct. 1684 (2018).  The Court was clear on this point, stating: “The MVRA provides redress to victims of fraud, but it does not supply a windfall for those who independently enter into risky financial enterprises through no fault of the fraudsters.  This is somewhat different from the approach taken by the Court in a 2017 summary order in United States v. Frenkel, 682 F. App’x 20 (2d Cir. 2017) (see this blog’s prior coverage here) where the Court rejected a defendant’s argument that the loss amount for purposes of Section 2B1.1 of the Sentencing Guidelines should be reduced because the collapse in the real estate market was a significant contributing factor to the loss amount.  There, the Court held that the defendant should have reasonably anticipated declining market conditions.  While the question of proximate cause may not be hotly disputed in run-of-the-mill fraud cases, there may be other cases like Calderon that present interesting questions of loss causation with respect to a global financial crisis (the last one or perhaps the next one) that should be carefully considered by defense counsel. 

-By Jared Buszin and Harry Sandick


[1] On this legal point, the Court avoided deciding an interesting question.  In United States v. Nkansah, 699 F. 3d 743, 748 (2d Cir. 2012), the Court reversed (over an objection by Judge Lynch) a conviction for bank fraud in the absence of evidence of intent to defraud a bank.  But two years later in Loughrin v. United States, 134 S. Ct. 2384 (2014), Justice Kagan held that the government did not need to “prove that a defendant charged with [bank fraud] intended to defraud a bank.”  Whether Loughrin overruled Nkansah is left for another day.