iShowdown: 18th Century Law Meets Smartphone Lockscreen
Significant Decision on Fraud Loss Computation out of the Third Circuit
Passcode Privilege
Payor’s Perspective
Random Thoughts On Proffers
Recent Third Circuit Search and Seizure Decisions May Mark Continued Erosion of the Exclusionary Rule
DOJ Waves the White Flag on Waivers
SEC Win in Third Circuit on Disgorgement Supreme Court Bound? (or how much is too much?)
The Future of Email may be Disappearing
iLockdown: Immune from Warrants and Wiretaps?

iShowdown: 18th Century Law Meets Smartphone Lockscreen

A federal magistrate judge ordered Apple to build a backdoor to the iOS 9 operating system on an iPhone. On February 16, AUSAs from the Central District of California filed an Ex Parte Application seeking a court order compelling Apple to assist the FBI in a search of an iPhone used by one of the deceased San Bernardino shooters. The Government filed its application pursuant to the All Writs Act of 1789, 28 U.S.C. § 1651, which provides that federal courts “may issue all writs necessary or appropriate in aid of their respective jurisdictions and agreeable to the usages and principles of law.” 28 U.S.C. § 1651(a).

In its Application, the Government argues that “[d]espite both a warrant authorizing the search and the [current] phone owner’s consent, the government has been unable to complete the search because it cannot access the iPhone’s encrypted content.” The Government asserts that the iPhone is “locked” with a user-determined, numeric passcode, and if the “auto-erase function” is enabled, then the information on the device would be permanently inaccessible after 10 failed attempts at inputting the passcode.  Although agents were able to obtain “several iCloud backups,” the Government believes that the most recent data may exist solely on the device. As a result, it is seeking an order compelling Apple to build a new version of its software to ensure that the auto-erase function is disabled and thereby allow the government “multiple investigative attempts to determine the passcode.”  This comes after a warning by Apple in 2014 that it would not be technically possible for it to respond to government search warrants for data from devices running its latest operating system. See iLockdown blog post, below.

Apple objects to the court’s order, and explained its reasons in a letter posted to its website this morning. Apple contends that if it creates such a backdoor tool, even if it will be used on only one iPhone, it will be a “threat to data security” because it will weaken encryption efforts and become the “equivalent of a master key” capable of opening millions of locks. Apple’s challenge has constitutional implications and will force courts to revisit the reach of an 18th century law.


Significant Decision on Fraud Loss Computation out of the Third Circuit

In United States v. Nagle, 2015 U.S. App. LEXIS 17187, *33–36 (3d Cir. Pa. Sept. 30, 2015) the Third Circuit rendered a significant decision with respect to the computation of dollar loss calculation in a DBE contract fraud case. The matter involved the fraudulent use of a purported DBE contractor in connection with large PennDot, SEPTA and other construction contracts. The use of the DBE was to satisfy the requirement that a set percentage of the contract had to be performed by a certified DBE. The Third Circuit reversed the District Court decision which had found that the fraud loss was the entire amount of the contracts obtained. Instead, the Third Circuit ruled that under §2B1.1 of the U.S. Sentencing Guidelines and the Notes thereto, the loss was the net profit since the contracting entities received value in the performance of those contracts. The case was remanded for re-sentencing.

In this matter, the two defendants, Nagle and Fink, had ownership interests and executive managerial positions with two related companies, Schuylkill Products, Inc. (“SPI”) and its wholly owned subsidiaries CDS Engineers, Inc. (“CDS”). SPI manufactured concrete beams that were used in highway construction. CDS was a construction company that stored and installed the concrete beams manufactured by SPI. The DBE firm in question, Marakina, was wholly owned by Romeo Cruz, an American citizen of Filipino descent. Marakina was a certified DBE company in Pennsylvania and Connecticut, among other states.

In practice, SPI would identify and locate projects and CDS would build them. SPI and CDS, by Nagle and Fink, agreed Marakina would bid as a certified DBE contractor to serve on various projects, including PennDot and SEPTA projects. If Marakina was awarded any contract, SPI and CDS would perform all work on the contract for Marakina and, in turn, pay Marakina (Cruz) a fixed fee for utilizing Marakina as a pass through company to get the DBE work. SPI and CDS would use Marakina stationery, prepare all bids under the Marakina name and perform all construction tasks under the name of Marakina. As to the latter, CDS would use its employees who performed work under the arrangement who would represent themselves to be Marakina employees and the construction trucks would have Marakina signs magnetically placed on the doors. Over the course of years relevant to the case, the DBE contracts awarded to Marakina totaled well over $100 million.

Nagle was found guilty after a jury trial and Fink pled guilty. At their respective sentencings, the same sentencing guideline contest arose in connection with the appropriate computation of the fraud loss. The government pressed for a loss representing the total dollar figure of all DBE contracts acquired and performed through the use of the fraudulent arrangement between SPI, CDE and the DBE company. The defendants argued that the fraud loss should be calculated on the basis of the net profit attributable to the use of the shell DBE, that is, the amount of the DBE contract with a credit for the fair market value of the raw materials, the cost to transport and assemble the materials and the cost of storage. This calculation, they agreed represented a more accurate gauge of the loss since the contracting agencies, in this case PennDot and SEPTA, received a value under the performance of the contract work, irrespective of the use of the fraudulent DBE company.

The District Court favored the government position on fraud loss and found the loss to be the gross amount of each and every DBE contract obtained and performed under this contract. As to Fink, the face value of the DBE contracts with PennDot and SEPTA Marakina received while Fink was an executive was $135.8 Million. With a category I criminal history, the guideline calculation corresponded to a Guideline range of 168 to 210 months, which was reduced to a sentence of 5 years, based on the maximum exposure available pursuant to 18 U.S.C. § 371, the count to which he pled.

After Nagle’s trial, the total amount of the DBE contracts for which he was responsible while an executive was calculated to be $53.9 Million. With that and other enhancements, the applicable guideline range was to 292 months to 365 months. At sentencing Nagle requested a departure of 10 levels, which the Court granted. The Court concluded the relevant guideline range was 87 months to 108 months. The District Court sentenced Nagle to 87 months.

On appeal, the Third Circuit reversed. The Third Circuit, with Judge Fisher writing for the majority, reasoned that utilizing the District Court approach disregarded the value/benefit received by the transportation entities pursuant to the contract. As such, the Third Circuit determined that the Defendants should be entitled to a credit for the value of performance under the contract, that is, the fair market value of the raw materials provided by SPI and the labor CDS provided to transport and assemble those materials.

The Third Circuit relied on the traditional case law applicable to calculating fraud loss in a normal fraud case that “where value passes in both directions [between defrauded and defraudee] that victim’s loss will normally be the difference between the value he or she gave and the value he or she received.” United States v. Dickler, 64 F.3d 818, 825 (3d Cir. 1995). For example:

We have repeatedly emphasized that the amount of loss in a fraud case, unlike that in a theft case, often depends on the actual value received by the defrauded victim. Thus, when a defendant obtains a secured loan by means of fraudulent representations, the amount of loss is the difference between what the victim paid and the value of the security, because only that amount was actually lost.

United States v. Nathan, 188 F.3d 190, 210 (3d Cir. 1999) (Becker, C.J. (citation omitted)).

The Court, then, concluded that the transportation agencies gave up the price of the contracts and received performance on those contracts. The Court found, if the standard definition of “loss” in Note 3(A) applies, the amount of loss the Defendants were responsible for is the value of the contracts received less the value of the performance on the contracts. The Court also concluded that the result would be the same if one assumed the DBE program was a “government benefit” and, therefore, the special rule of Note 3(F) (ii) of §2B1.1 applied. It cited to Note 3 (E) (i) to §2B1.1 as compelling a credit to the contract amount because it states, “the fair market value of the property returned and the services rendered, by the defendant or other persons acting jointly with the defendant to the victim before the offense was detected” shall be credited against the loss.

Finally, the Court differentiated certain prior cases which found the total amount of the contract was loss. The Court noted the prior case law was distinguishable since it was decided under the old §2F1.1, which did not have the Note under §2B1.1 relied upon for the credit theory. The Third Circuit found Note 3(E) (1) to §2B1.1 made a difference and compelled a finding that such services should be credited against the value of the contract for the computation of fraud loss.

Passcode Privilege

By Lorie Dakessian and Sarah Damiani

A Pennsylvania federal district court has joined the recent trend of permitting defendants facing threat of prosecution to invoke the Fifth Amendment to preclude the production of their smartphone passcodes. The Court denied the Securities and Exchange Commission’s (“SEC”) motion to compel two defendants “to disclose their secret personal passcodes for smartphones owned by the defendants’ former employer, who, as a matter of policy, required their employees to keep their personal passcodes secret from everyone.” SEC v. Huang, et al., Civ. A. No. 15-269 (E.D. Pa. Sept. 23, 2015) (Kearney, J.). The Court concluded that “Defendants’ confidential passcodes are personal in nature and Defendants may properly invoke the Fifth Amendment privilege to avoid production of the passcodes.” Id.

In the underlying complaint, the SEC has alleged that Defendants, who worked at Capital One as senior data analysts and were responsible for investigating fraud against the bank, used their access to Capital One’s database to misappropriate material nonpublic information that they used to conduct stock trades. As part of their employment, Capital One provided defendants with smartphones, “but allowed them to create and set their own passcodes,” and asked them to keep the passcodes secret for security reasons. Capital One’s policies confirmed that “it owned the smartphone and any corporate documents on the smartphones.” Although Capital One turned the phones over to the SEC, the SEC could not access them without the passcodes.

During discovery, the SEC sought Defendants’ passcodes, arguing that Defendants were corporate custodians in possession of bank records. The Court, however, found that the SEC’s reliance on the content of the documents was misplaced. According to the Court, application of the Fifth Amendment privilege does not turn on the content of the underlying documents, but rather on the act of production itself, and specifically, whether the act of production is testimonial in nature. Where an act requires “the use of the contents of [a person’s] mind” or her “personal thought process,” it cannot be “fairly characterized as a physical act” and is testimonial in nature. The Court likened the act of providing a passcode to the act of opening a safe or decrypting a computer—acts deemed testimonial by the Supreme Court and the Eleventh Circuit, respectively. The Court therefore held “as the SEC is not seeking business records but Defendants’ personal thought processes, Defendants may properly invoke their Fifth Amendment right.”

The District Court’s decision is consistent with other federal cases that have considered the issue and determined that revealing a password is a testimonial act, see, e.g., In re Grand Jury Duces Tecum Dates March 25, 2011, 670 F.3d 1335, 1346 (11th Cir. 2012) (holding that a defendant accused of possessing child pornography could assert his Fifth Amendment privilege to avoid decrypting a hard drive); United States v. Kirschner, 823 F. Supp. 2d 665 (E.D. Mich. 2010) (denying the Government’s request to compel defendant to reveal all passwords associated with his computer), and provides clear analysis of why such an act is testimonial. However, it is unclear how far this holding extends. For example, the Court, in a footnote, refers to United States v. Smalcer, 464 F. App’x 469, 473 (6th Cir. 2012), in which the defendant was ordered to divulge his Facebook password in connection with his probation hearing. The Court notes that “Defendants [in the instant matter] apprehend an imminent threat of prosecution and have not already been convicted.”

Most intriguing about the Court’s opinion is what it could be read to suggest about fingerprint access to electronic devices, an issue which, save for a Virginia Circuit Court that ordered such access in Commonwealth v. Baust, 89 Va. Cir. 267 (Va. Cir. Ct. 2014), courts have yet to definitively address. A fingerprint identification feature is available on certain devices (e.g., TouchID for Apple devices and Fingerprint Scanner for Samsung devices), and allows a user to unlock her device by simply placing her finger on the fingerprint reader. Such an act is purely physical in nature, and does not obviously require “the use of the contents of [a person’s] mind” or her “personal thought process.” While literally applied in the content of fingerprint access, this language might suggest that a defendant could be compelled to place her finger on her device in order to unlock it, decades of jurisprudence regarding the Fifth Amendment privilege may support the opposite result.

Payor’s Perspective

The United States Court of Appeals for the Third Circuit recently “synthesized” its case law addressing the standard for mental states required to uphold a conviction for Hobbs Act extortion under color of official right.  In United States v. Fountain, _ F.3d _ (3d Cir. July 10, 2015) (Krause, J.), the Court upheld an IRS employee’s extortion conviction, rejecting her arguments that she did not actually have the power to grant the fraudulent tax refunds she filed and the person whom she extorted could not have reasonably believed that she had that power. Instead, the Court determined that there was sufficient evidence that the payor reasonably believed that the defendant IRS employee could use her position to help the payor receive a tax refund, and that the IRS employee knew that payor had paid her for that reason.

The Hobbs Act, codified at 18 U.S.C. § 1951, penalizes “[w]hoever in any way or degree obstructs, delays, or affects commerce or the movement of any article or commodity in commerce” by extortion, which is defined in part as “the obtaining of property from another, with his consent… under color of official right.” The “importance of a defendant’s public office or official act to a Hobbs Act charge is its coercive effect on the payor.” Fountain.

In Fountain, the Third Circuit analyzed prior Hobbs Act cases and clarified that, when read together, these cases articulate “a unified standard for official right extortion cases.” The Court stated that it will uphold a conviction for Hobbs Act extortion “where the evidence indicates (1) that the payor made a payment to the defendant because the payor held a reasonable belief that the defendant would perform official acts in return, and (2) that the defendant knew the payor made the payment because of that belief.”

Fountain clarifies that the focus is on the payor’s state of mind, and not whether the public official actually used her position or performed an official act to further a scheme.

Random Thoughts On Proffers

Too often over the past several years, I have encountered situations in which so-called “white collar practitioners” have permitted their clients to undergo a “proffer” session with the government without any apparent benefit or valid basis. Proffers are not a “one size fits all” solution, and practitioners should never view a proffer as a “free shot” at an interview with no downside risk simply because some may (rather naively) refer to them as “immunity for a day.” From my and others’ experiences, proffers are given far too frequently and can result in severe, adverse consequences for the client.

Practitioners should be far more selective when deciding whether a proffer is in their client’s best interest. The particular facts of the case should be evaluated carefully, and, if proffering appears to be a suitable solution, the prudent practitioner will need to put in a substantial amount of work and preparation beforehand. Only then—after carefully considering the risks and benefits that a proffer presents to the client’s unique circumstances—can any serious thought be given to advise a client to proceed with a proffer.

While there certainly are valid uses of a proffer session for a client, the valid uses are far fewer than some practitioners initially think. One potential use for the proffer exists when the client has, for all intents and purposes, a “lost cause” case; that is, when the client hopelessly lacks any defenses and has been caught, as the adage goes, with their “hand caught in the cookie jar.” In that instance, a proffer session may be useful to: (1) narrow the focus of charges and relevant conduct; (2) facilitate the negotiations of a plea; or (3) explore cooperation as part of a negotiated plea. These situations still require a great deal of preparation with the client before any proffer is considered or a decision is made to proffer. For instance, a proffer may not be advisable, even in anticipation of a plea, if far more damaging information on other matters could be brought to the attention of the government through the proffer.

A second legitimate use of a proffer may be to solidify and confirm the client’s role as a mere witness, not to “hope” one can unilaterally convince the government not to change the status of the client. To engage in the latter practice is the equivalent of placing your client’s head in the mouth of a lion and hoping it does not bite. Again, a great deal of preparation needs to be done with the client, and a substantial effort needs to be devoted to understand all available facts and issues prior to considering a proffer. If an attorney believes, after due consideration of all factors, the client has not really committed a crime, several discussions with the prosecutor are necessary to further evaluate the advisability of engaging in a proffer. Those meetings and discussions with the prosecutor are vital to see if there are facts and/or evidence of which the practitioner is not aware and/or to gauge the government’s evaluation of the client’s status as a witness, subject, or target based on an overview of what the client’s theory of the case may be. A proffer should only be considered if the attorney is reasonably confident he or she has all the facts and evidence and the government is in reasonable agreement that if client says “X,” he or she will be a witness. If not, see the “Mouth of Lion” analogy above and do not proffer.

Far too often, this writer has been asked for a consultation after a practitioner has allowed a client to proffer in the hopes of “persuading” the government not to prosecute the client since the proffer is, in their mind, risk-free. Incredibly, some attorneys have proffered clients after being advised the clients are “targets,” and, when asked why they advised their clients to proffer, said they thought they could convince government not to prosecute the case. This decision making is rarely advisable.

Even when it is appropriate to proffer, significant preparation is necessary with the client before a proffer session is held. In every sense, the preparation for a proffer must be the equivalent of preparation for trial testimony. This preparation is necessary because if the proffer does not result in a witness status and there is a trial at which the client testifies, then there can be no material deviations from the proffer. Any such material inconsistencies arising from lack of preparation might permit the client/witness to be cross-examined or impeached by materially inconsistent statements from the proffer.

Finally, a caveat about the proffer letters now being utilized is necessary. Beware of the various “expansions” to the “standard” proffer letter and act accordingly. The “standard” proffer letter, depending on the federal office, can vary dramatically. Recently, a proffer letter provided by a DOJ attorney out of Main Justice contained so many provisions to essentially make it is virtually impossible to sign. Just as proffers are not “one size fits all” solutions, the “standard” proffer letter now seems to be far from uniform and requires a more careful review based on the extensive variety of such letters in use.

Recent Third Circuit Search and Seizure Decisions May Mark Continued Erosion of the Exclusionary Rule

In the last four months, two Third Circuit decisions seem to signal a continuing trend that the exclusionary rule is eroding in favor of the government and against evidence being suppressed in search and seizure matters.  As will be discussed, even a healthy dissent from an en banc Third Circuit includes a conclusion that the continued viability of the exclusionary rule is in doubt.

In United States v. Katzin and United States v. Franz, the general “good faith” analysis standard was invoked to salvage otherwise facially defective searches violative of the Fourth Amendment.  United States v. Katzin, 769 F.3d 163 (3d Cir. 2014); United States v. Franz, 772 F.3d 134 (3d Cir. 2014).  The caveat to all practitioners is that even when a search violates Fourth Amendment constitutional safeguards, more focus must be directed to the lack of good faith in the government conduct to justify the application of the exclusionary rule to obtain suppression of evidence.

Each of the two decisions has a rather intriguing set of facts and procedural history so a thorough reading of the full opinions is recommended.

On November 4, 2014, the Third Circuit decided the matter of Franz, affirming the conviction of Franz on charges relating to child pornography.  Franz, 772 F.3d at 138–58.   The investigation began in 2009 when the Bureau of Land Management (“BLM”) obtained information that Franz, a Plymouth Meeting, PA resident, may have stolen a wooly mammoth tusk and other paleontological items from BLM managed lands in Alaska and may have smuggled them back to his residence.  Based on information obtained in the BLM investigation in Alaska concerning the activities of a wilderness expedition company in Alaska, the BLM agents believed they developed sufficient basis to obtain a search warrant for the Franz residence in Plymouth Meeting, PA to seek to seize a 36” mammoth tusk and a 6-8” tusk.¹

The search warrant was prepared in conjunction with the U.S. Attorney’s Office in EDPA, and the Affidavit was sealed by the Magistrate upon motion of the government.  The face sheet of the warrant, in the space assigned to describe the items to be seized, contained a reference to “See Attachment B”.  When the search was executed, the agent only provided the front sheet and not the attachment even though Franz, who was at the residence at the time of the search, requested the attachment.  During the course of the search, the agents observed and seized photos of young naked girls and pamphlets containing images of nude minors engaged in sexual activity; they also accessed a computer and saw images of a young partially nude girl and seized the computer.  BLM then turned all the seized material related to potential pornography violations to the FBI, which later secured a separate search warrant for the complete contents of the computer.

In the prosecution of the child pornography violations, Franz moved to suppress both search warrants, the first premised, inter alia, on the failure to provide the list of items to be seized and the second based on the unlawful taint of the improper first search.²

After the District Court denied the suppression motions, a conviction by a jury followed and Franz appealed.  The Third Circuit found that the first warrant was facially invalid when executed and violated the Fourth Amendment; however, the Court went on to salvage the search by finding that the agent had acted in “good faith” and, therefore, the exclusionary rule was not appropriate to exclude the fruits of the search.  The factors cited by the Court included that this was the agent’s first search warrant, the agent had been confused about the sealing order, and the agent purportedly had orally advised Franz what they were seeking.  The Court rejected the contention that a facially defective warrant automatically led to suppression but, rather, applied a totality of the circumstances analysis to determine if the conduct of the agent rose to the level of gross negligence, recklessness, or intentional conduct to support a determination that the deterrent effect outweighed the cost of suppression.  Although the Third Circuit found that the agent had acted in “good faith” for the reasons stated above, this writer is far less impressed than the Court with the notion of giving leeway to the federal agent for the fact that this was his first search or that he was confused over the sealing order.  As a former federal prosecutor, it seems there should be no “free bite of the apple” for federal agents in exercising search warrants nor should there be credit given based on “confusion” when the AUSA could be called for clarification on a moment’s notice.

In Katzin, a case decided by the Third Circuit on October 1, 2014, the Third Circuit rendered a decision from an en banc argument held in May 2014, and the Court’s conclusion more clearly reflected what this writer believes is a classic example of the erosion of the exclusionary rule.  Katiz, 769 F.3d at 167–87.   The case stemmed from the warrantless installation of a GPS device, and subsequent surveillance of the vehicle that ensued, which developed key evidence linking 3 brothers, the Katzins, to a string of pharmacy burglaries.  The installation of the GPS device occurred prior to the decision by the U.S. Supreme Court in U.S. v. Jones, which held that such an installation of a GPS tracking device was a search and required a warrant.  132 S. Ct. 945, 949 (2012).  The Katzins moved to suppress all evidence obtained as a result of the warrantless installation of the GPS device.  The District Court granted the motion and suppressed the evidence, finding the search to be illegal under Jones.  The court refused to apply or find good faith on the part of law enforcement and extended standing to all 3 brothers who were passengers in the vehicle.  On appeal, a panel of the Third Circuit affirmed the ruling of the District Court.  The panel unanimously agreed that the conduct of the agents required a warrant, but the panel divided 2-1 in favor of affirmance on the issue of whether a good faith analysis needed to be applied.  The government filed a Motion for Rehearing en banc which was granted.  After en banc argument, and by an 8-5 vote, the Third Circuit reversed the decision of the District Court and the panel and found that it need not find whether agents conducted an unreasonable search because, even if so, the good faith exception applied.  The majority concluded the suppression of evidence was unnecessary.  The Third Circuit found that there was either a good faith reliance on then current case law, or, in the alternative, good faith conduct by the government under the general good faith exception.  Therefore, even had the search been a violation of the 4th Amendment, the Court ruled evidence would not be suppressed.

Circuit Judge Greenaway, writing a dissent joined by Chief Judge McKee and three other Circuit Judges, observed at the outset of the dissenting opinion that, “Once touted as a way to ensure the rights of citizens are protected from overzealous law enforcement the exclusionary rule’s very existence, long eroding, is in serious doubt.”  Katzin, 769 F.3d at 187.  Unfortunately, his observations may well be very accurate.

In addition to the Third Circuit cases, a more recent U.S. Supreme Court decision addressed the issues of constitutionality of search and seizure from a different perspective.  The U.S. Supreme Court, in an opinion filed December 15, 2014, did not even need to go to the exclusionary rule for relief.  See generally, Heien v. North Carolina, 135 S. Ct. 530 (2014).  Instead, it applied a good faith reasonable man standard to a mistake of law to find that a stop of a vehicle by a police officer was not violative of the Fourth Amendment, even if the stop was not warranted under state law.  In Heien, a North Carolina officer stopped a vehicle for a missing taillight; however, under North Carolina traffic law, driving a car with a missing taillight does not constitute a traffic violation.  As a result of the stop, the officer developed additional suspicions, asked for and received consent to search, and recovered cocaine from the search of the vehicle.  The Supreme Court ruled that it did not need to go to the exclusionary rule because it deemed that the search was reasonable based on the mistake of law by the officer, which it found to be objectively reasonable.³

The seeming ever expanding use by the Courts of the “good faith” rationale, on a case by case basis, to salvage evidence from suppression, requires practitioners to focus on this issue during an evidentiary hearing even after a constitutional violation has been shown to exist.  In other words, even if a search is facially defective or otherwise constitutionally infirm, substantial additional work and effort is necessary to prevent a “good faith” rationale from salvaging the suppression of evidence seized in the search.

¹Franz had admitted to an undercover BLM agent, who took a wilderness excursion with Franz, that he had those at his home.
²Franz was indicted on the charge related to the wooly mammoth tusks in 2010.  Franz pleaded guilty to those charges and did not challenge the searches; he was later separately indicted in 2012 for the violations related to child pornography.
³The majority stressed that the application of this principle would likely be very limited since the traffic laws regarding rear lights was ambiguous.  The action was only clarified as not being a violation of NC law by the intermediate appellate Court in this case.

DOJ Waves the White Flag on Waivers

For many years, U.S. Attorney’s Offices nationwide have required that written guilty plea agreements contain appellate waiver provisions under which the defendant (but not the Government!) waives his or her appeal rights. These waiver provisions tended to be broad, prohibiting the defendant from taking a direct appeal from sentencing or filing a post-sentencing, collateral attack (commonly known as a habeas petition). Indeed, some U.S. Attorney’s Offices even took the position that these appellate waivers precluded a defendant’s claim that defense counsel was ineffective for recommending the guilty plea agreement in the first place.

In response, some defense counsel simply advised their clients not to enter into written plea agreements containing broad appellate waivers, but instead to plead “open,” that is, plead guilty without entering into any written plea agreement with the Government. Other defense counsel determined that certain concessions received from the Government, and/or the certainty of a written plea agreement, outweighed counsel’s distaste for a broad waiver of a defendant’s right to directly appeal or collaterally attack the sentence.

Over time, some federal courts held that when a defendant files an ineffective-assistance-of-counsel motion, and the Government moves to dismiss the motion based on a waiver contained in the plea agreement, the court will apply various factors to determine whether a “miscarriage of justice” would occur if the waiver were enforced.  (See United States v. Mabry, 536 F.3d 231 (3d Cir. 2008)) Further, state bar ethics committees began to opine that it is a conflict of interest for a lawyer to advise a client to accept a plea agreement that includes a waiver of ineffective assistance of counsel claims concerning his or her representation. (See Conflict of Interest and Other Misconduct Related to Waiver of Claims for Ineffective Assistance of Counsel, Pennsylvania Bar Association Legal Ethics and Professional Responsibility Committee, Formal Opinion 2014-100.)

Recently, the U.S. Department of Justice issued a Memorandum entitled “Department Policy on Waivers of Claims of Ineffective Assistance of Counsel,” in which DOJ instructed federal prosecutors to no longer ask defendants to waive claims of ineffective assistance of counsel.  Deputy Attorney General James Cole wrote:

“While the Department is confident that a waiver of a claim of ineffective assistance of counsel is both legal and ethical, in order to bring consistency to this practice, and in support of the underlying Sixth Amendment right, we now set forth uniform Department of Justice policies relating to waivers of claims of ineffective assistance of counsel. Federal prosecutors should no longer seek in plea agreements to have a defendant waive claims of ineffective assistance of counsel whether those claims are made on collateral attack or, when permitted by circuit law, made on direct appeal …. As long as prosecutors exempt ineffective-assistance claims from their waiver provisions, they are free to request waivers of appeal and of post-conviction remedies to the full extent permitted by law as a component of plea discussions and agreements.”

Thus, while federal prosecutors will continue to present defense counsel with guilty plea agreements that contain appellate waiver provisions, defendants will not be asked to waive post-sentencing claims for ineffective assistance of counsel. Perhaps DOJ recognized that such broad appellate waivers were increasingly disfavored by the judiciary, or that such waivers raise significant ethical concerns, but in any event DOJ has now made it official that AUSAs no longer will ask defendants to waive claims of ineffective assistance.

SEC Win in Third Circuit on Disgorgement Supreme Court Bound? (or how much is too much?)

In SEC v. Teo, 746 F.3d 90 (3d Cir. 2014), the Third Circuit affirmed a jury verdict in favor of the SEC which, at trial, successfully obtained disgorgement from an investor who, in connection with stock market investments, profited by using false statements on certain SEC filings as to the extent of his investments.  More significantly, the Third Circuit in affirming the SEC victory at trial, approved a broad construction of disgorgement when applied to prevent unjust enrichment.  The Third Circuit affirmed the award of disgorgement of approximately $17 million in profit from the sale of stock and over $14 million in pre-judgment interest.

The case stems from the actions of an individual, Teo, who invested as an individual and through a trust where he was the beneficial owner.  Over the course of time, through his trust, Teo directly and indirectly purchased stock in a corporation, Musicland.  Musicland had a “shareholder rights plan,” commonly known as a “poison pill,” which could be activated when any individual or group reached an ownership in excess of 17.5% of the company stock to prevent a hostile takeover.  Once the critical percentage was reached, shareholders were able to dilute the individual’s shares by purchasing stock at a lower percentage.

Beginning in 1998, Teo filed or caused to be filed false SEC Schedule 13D forms; he underreported his stock ownership as below 17.5% when, in fact, it exceeded 17.5% and continued to increase until it reached 35.97% by the end of 2000.  Also, Teo falsely noted in a report that he ceased to have control over the Trust and later a Schedule 13D falsely claimed his sister-in-law had sole power to buy and sell stock for the Trust.

In December 2000, Best Buy Co. (“Best Buy”) announced an all-cash tender offer of all Musicland stock, which occurred in January 2001.  Teo sold all of his stock— some in the market and the rest to Best Buy as part of the tender.  Teo’s original cost of acquisition of the stock was approximately $89 million and the gross proceeds from the sale yielded almost $155 million.  When the District Court calculated the profit from the date of the first false report, the net profit was approximately $21 million, which based on other offsets, was ultimately entered as a judgment of approximately $17 million.

In April 2004, SEC filed the civil enforcement seeking disgorgement of profit based on a host of violations of 10(b), 13(d), and numerous SEC rules and regulations.  In August 2004, Teo was indicted and later pled guilty to insider trading from June 2006.

A jury trial was held on certain of the civil counts and Teo and the Trust were found to have violated various SEC sections and rules.  The District Court found Teo and the Trust jointly and severally liable and entered judgment in the amount of over $17 million and awarded pre-judgment interest of $14 million.  Teo and the Trust appealed.

The Third Circuit affirmed and, in so doing, addressed several issues raised on appeal from the trial.¹  The key issue to highlight in this discussion is the analysis concerning the standards applied when SEC seeks disgorgement and the breadth of disgorgement here.  By way of background, the Court first distinguished the difference between the purposes of an SEC action versus a private investor claim inasmuch as the SEC pursues its claims “independent of the individual investors” and noted that the SEC reinforces this principle by consistently stressing “it is not a collection agency for defrauded investors.”  The Court further noted, however, that where the SEC seeks disgorgement, the difference between the burden on private plaintiff and SEC does not entirely eliminate need in SEC action for proof of a causal connection between the securities violation and the disgorged funds.  The Third Circuit adopted the analysis and approach that the SEC burden is more like a “but for” test and relied on the DC Court of Appeals holding in SEC v. First City FinCorp., quoting as follows:

Since disgorgement primarily serves to prevent unjust enrichment, the court may exercise its equitable power only over property that is causally related to the wrongdoing. The remedy may well be a key to the SEC’s efforts to deter others from violating securities laws, but the disgorgement may not be used punitively.

746 F.3d at *103.

After applying the threshold standard to the record in this case, the Court affirmed that the SEC had easily met their burden.

Teo argued the intervening act of Best Buy in tendering an offer for Musicland stock was independent from his violations, thus the Best Buy tender offer was responsible for the sale and profits and not his securities violation.  The Third Circuit again adopted the First City approach applied to intervening acts: “In First City, the Court endorsed a burden shifting approach to causation in which the SEC is required to produce evidence supporting a reasonable approximation of actual profits on the tainted transactions, which is essentially satisfying a but-for standard.”  Id. at 105.  From First City, it drew two immediate points —“First, intervening causation is not an element of the SEC’s evidentiary burden in setting out an amount to be disgorged that reasonably approximates illegal profits. Second, if the issue of an intervening cause is to be raised, it will normally be the defendant’s burden to do so.”  Id. at 105-06.

In applying the announced standard, the Third Circuit not only found that the SEC had carried its burden to show the profits were related to the wrongdoing , but also concluded that Teo failed to carry the burden of showing that an intervening act of the Best Buy offer diminished the amount of profit attributable to the wrongdoing.²  The Court ruled it insufficient that Teo merely asserted Best Buy’s tender offer was an intervening factor, which either was responsible for all or some of the profit separate and apart from his wrongdoing.  The dissent by Circuit Court Judge Jordan, however, sharply disagreed with the majority on the weight and effect to be given the Best Buy tender offer.  While Judge Jordan agreed with the majority’s approach as to the standards that apply in an SEC action both for disgorgement and when an intervening act is alleged, he concluded the Best Buy action was clearly an independent and intervening act and the premium offer by Best Buy and was not in any fashion related to Teo’s conduct; additionally, it was readily known and therefore should not have been included in the disgorgement.  Id. at 113-114(citing SEC v. MacDonald, 699 F.2d 47, 55 (1st Cir. 1983)).  Teo has filed a writ of certiorari to the US Supreme Court raising, inter alia, the breadth of disgorgement.³

Suffice it to say, anyone involved in an SEC enforcement action seeking disgorgement, should be mindful of the analysis in Teo and follow to see if the US Supreme Court grants certiorari.  In most cases, the criminal matter is deemed to be the more severe punishment and there is certainly something to be said for the consequences of a criminal conviction and its non-monetary consequences.  Here, however, it appears that far greater financial consequences resulted from the civil enforcement disgorgement (over $31 million) largely as a consequence of the breadth of disgorgement approved by the Third Circuit; whereas, the criminal case resulted in a $3 million penalty from the consequences of the amount attributable to insider trading.  Finally, this case demonstrates the fragile relationship, and dangers associated, between a criminal case (insider trading) and civil disgorgement action.

¹ For instance, the Court addressed the appropriateness of the use of Teo’s guilty plea colloquy from his criminal plea under the standards of Rule 404(b) when his under oath statements were used to cross examine Teo when he testified at trial (See 746 F.3d at *94-*97); the Third Circuit found it was appropriate and approved the cautionary instruction by the trial court.

² The dissent argued:

The Majority states, without any supporting authority, that the Appellants’ “burden is not simply one of carrying the ball back across the fifty-yard line” but one of “adduc[ing] — at a minimum — specific evidence explaining the interplay (or lack thereof) among the violation(s) at issue.” I fundamentally disagree with that assertion. It is axiomatic that “the SEC bears the ultimate burden of persuasion.” First City, 890 F.2d at 1232. Therefore, once a defendant has pushed back with evidence of what is more likely than not an intervening cause, it is the SEC’s responsibility to carry the ball.

Id. at 113

³ The Petition for Certiorari argued:

“The Third Circuit’s decision endorses a limitless conception of disgorgement that conflicts with the decisions of four other circuits, disregards the settled equitable limitations on disgorgement, and exposes defendants in SEC civil enforcement actions to staggering liability untethered to the scope of their violations”….the Third Circuit’s ruling is at odds with decisions by the First, Second, Tenth and D.C. circuits holding that a district court can’t use disgorgement to recover profits attributable to intervening events with no connection to a defendant’s securities-law violations.

Jeff Sistrunk, Musicland Investor Asks High Court to Ax $32M Disgorgement, LAW360, http://www.law360.com/articles/556797/musicland-investor-asks-high-court-to-ax-32m-disgorgement(quoting Petition for Cert., SEC v. Teo, 746 F.3d 90 (3d Cir. 2007), petition for cert. filed, (No. 14-19).


The Future of Email may be Disappearing

One of the biggest costs associated with major litigation against a business (be it a criminal investigation, a civil suit, or even an internal investigation) is the data. While there are several ways to minimize these costs, perhaps the easiest is to limit the universe of available information in the first place. How is that best done? Easy: with a rigorous and well-adhered-to document retention and destruction policy. But in the same way everyone understands the need to eat more fruits and vegetables and exercise maybe a little more, the advice about a good document retention policy is sometimes easy to hear but hard to implement.

Yet good news may be on the horizon in the form of disappearing email. Unquestionably the largest chunk of data (at least by quantity of documents) in any typical litigation is the email. But now it appears it may soon be easier than ever to make those messages automatically destroy per the organization’s document retention policy.

Indeed, recently NPR’s Planet Money Podcast (Episode 568: “Snoops, Hackers And Tin Foil Hats”) reported on an influx of capital into the company that produces the Wickr app. Among other things, Wickr allows users to send and receive encrypted messages, and, as is most important here, allows the sender to pre-select how long the message will last before it automatically disappears. As reported, apparently this technology has found great interest in the financial sector, one which has both great scrutiny, and is thus a likely target for litigation, and one that has certain legal requirements for document retention. Imagine if users in that sector and others could at the time of sending an email easily adhere to both the law and prudent document management by instantly pegging a message to a terminal date; that would certainly be a tremendous cost and time saver. (As a pre-emptive word of caution, the pre-selection of terminal dates would need to be uniformly applied, otherwise the selection of some emails but not others could lead to an inference of guilt or perhaps spoliation.) And because of that potential savings, disappearing email is a development worth monitoring closely.

iLockdown: Immune from Warrants and Wiretaps?

Apple recently announced that it will not be technically possible for it to respond to government search warrants for data from devices (like iPhones and iPads) that run its just-launched iOS 8 operating system. On its website, Apple states, “[o]n devices running iOS 8, your personal data such as photos, messages (including attachments), email, contacts, call history, iTunes content, notes, and reminders is placed under the protection of your passcode. Unlike our competitors, Apple cannot bypass your passcode and therefore cannot access this data. So it’s not technically feasible for us to respond to government warrants for the extraction of this data from devices in their possession running iOS 8.” Apple already encrypts iMessages and FaceTime calls, rendering them accessible only with device users’ passcodes, so the company cannot comply with government wiretap orders for messages in transit between the devices.

Although the new iOS 8 encryption feature appears to increase the ability of users to lockdown their data from the government’s reach, data residing in the cloud or on older devices may be retrievable in response to a warrant. Apple may produce active iCloud content in response to a search warrant, so data from a device running iOS 8 could be attainable if those devices sync to iCloud. And according to Apple’s Legal Process Guidelines, if the company receives a valid search warrant that identifies the serial or International Mobile Equipment Identity (IMEI) number of a device running an earlier version of Apple’s operating system, then the company “can extract certain categories of active data from passcode locked iOS devices,” such as text messages, call history, contacts, photos, and videos (but not email, calendar entries, or third-party app data).

Earlier this year, the United States Supreme Court confirmed that a warrant is generally required before a search of digital information on a cell phone, even for a phone seized incident to arrest, but it stated that its holding “is not that the information on a cell phone is immune from search…” Riley v. California, 134 S. Ct. 2473, 2493 (2014). The Court recognized that the encryption of data “is a security feature that some modern cell phones use in addition to password protection. When such phones lock, data becomes protected by sophisticated encryption that renders a phone all but ‘unbreakable’ unless police know the password.” Id., at 2486. Although it acknowledged the Government’s concerns about destruction or concealment of evidence on a phone as a result of remote wiping or data encryption, the Court determined that it had been “given little reason to believe that either problem is prevalent,” noting that the encryption argument “has never been considered by the Courts of Appeals.” Id. at 2486-2487. Given lower courts’ differing views on the extent to which the Fifth Amendment applies to compelled password disclosure, and the possibility that Apple devices running iOS 8 are “immune” from search, the Government’s “encryption argument” may be before the Court again soon.

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