Fraud in the Corporate Context - Department of Justice

Fraud in theCorporate Context

The FBI Criminal Undercover Operations Review Committee . . . . . . . . . 1

By Joshu a R. Hochberg

Investigating Accounting Frauds . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

By Dav id L. A nderso n and J oseph W . St . Denis

Prime Bank/High Yield Investment Schemes . . . . . . . . . . . . . . . . . . . 1 0

By Joel E. Leising and Mic hael Mc Garry

Prosecuting Corporations: The Federal Principles and Corporate Compliance

Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 9

By Phi lip Urofsky

Ex Parte Contacts with Corporate Employees . . . . . . . . . . . . . . . . . . 2 6

By Edw ard I. Hag en

Navigating the Evolving Landscape of M edical Record Privacy . . . . . . . 3 0

By Ian C. Sm ith DeW aal

Primer for Using Sentencing Guidelines Enhancement for Identity Theft-

Related Conduct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 9

By Paula J. Desio and Donald A . Purdy, J r.

M arch 20 02

V olu me 5 0

Num ber 2

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In This Issue

MARCH 2002 UNITED STATES ATTORNEYS' BULLET IN 1

The FBI Criminal UndercoverOperations Review CommitteeJoshua R. HochbergChief, Fraud Section, Criminal Division

The FBI Criminal Undercover OperationsReview Committee (CUORC) is a formalcommittee whose approval is required for all FBIundercover operations involving “sensitivecircumstances”, so-called “Group I” UndercoverOperations. The Committee, which is chaired bythe FBI, meets every other w eek. Its membersinclude Section Chiefs from FBI headquarters,FBI representatives from the office of GeneralCounsel and senior Department of JusticeCriminal Division members.

Representatives from the Fraud, AssetForfe iture an d M oney Laun derin g, Pub licIntegrity, Narcotic and Dangerous Drug, andOrganized Crime and Racketeering Sectionsusually attend CUORCs. In addition, the Office ofInternational Affairs, the Computer Crime andIntellectual Property Section and the Terrorismand Violent Crime Section send representatives asneeded.

The Attorney General’s Guidelines on FBIUnd ercov er Op eration s, whic h we re rev ised in1992 and are available on the Department ofJustice Intranet, govern the CUORC . Theseguidelines currently are being rework ed to clarifyprocedures relating to potential terrorisminvestigations. SAC’s can authorize undercoveroperations that do not involve “sensitive”circumstances or that need authorization on anemergency basis. This article gives a briefoverview of the operations of the CUORC andhighlights a few of the issues that may arise. Itdoes not discuss many of the specific rules andconsiderations applicable to undercoveroperations. Other federal law enforcementagencies have analogous review procedures andcommittees for their own undercover operations.AUS As sh ould c onsu lt with the ir case agen ts toensure that appr opriate ru les are be ing follow ed.

The CUORC reviews written submissionsfrom the sponsoring FBI field office and the FBIheadquarters Section, which describe the nature ofthe undercover operation, analyze any “sensitive”circumstances, and provide a legal opinion on theprop riety of the inv estiga tive tec hniqu e. In allundercover operations, reviewing officials mustconsider the suitability of government activity andevaluate and weigh the risks of injury, liability,interference with privileged activity, andinvolvement in criminal activity. All proposedGroup 1 undercover operations require thepersonal, written approval of the United StatesAttorney for the District sponsoring theinves tigation . The F BI als o requ ires va rious le velsof approval including the approval of the SAC,the headquarters section, and an AssistantDirecto r, or high er level of ficial.

The Guidelines provide specific definitions ofthe sensitive circumstances that require CUORCreview. In general terms, AU SAs should be aw arethat the follow ing typ es of a ctivities a re likely tobe considered sensitive circumstances:

• Most investigations of criminal conduct bygove rnme nt offic ials, inclu ding s ystem iccorruption in government, or activities whichwill intrude on the governmental function.

• Undercover operations which require thecreation or use of a proprietary business.

• Participation in most felonious activities.

• Relationships which impinge on privilegedareas.

• Operations which create a significant risk ofviolence.

• Operations which may subject the governmentto significant damage claims.

• Operations in which the government providesgoods or services that are essential to thecommission of a crime and are otherwise notreasonably available.

2 UNITED STATES ATTORNEYS' BULLET IN MARCH 2002

The a ppro vals re quire d for p articipa tion infelonious and other serious crimes, are detailedand specific. The Guidelines require CUORCapproval, except for a limited number of felonies,including, the receipt of stolen property, and thecontrolled delivery of drugs that will not entercom merc e. SA Cs m ust au thorize partic ipation inall undercover operations involving illegalactivities, and higher level FBI approvals areneeded for specific types of activities, includingthose w hich cre ate a risk o f violenc e.

In addition to sensitive circumstances, theCUORC evaluates complex issues, includingthose related to investigations which impact othercoun tries an d the G over nme nt’s pr oper role incom puter -relate d inve stigatio ns. Th e CU ORC willalways consider whether the targets of theproposed undercover operation have beenappropriately predicated. In determining theadeq uacy of pre dicatio n, the C omm ittee willgenerally engage in an analysis of potentialentrapment issues. Next, even if the subjects areclearly predisposed to engage in the targetedcrimin al activ ity, Co mm ittee me mbe rs willcons ider w hethe r these targets are su fficien tlysignificant targets, whether other investigativetechniques have been tried, and whether theinvestigation merits the use of undercovertechniques that involve a major investment oftime an d reso urces , as we ll as pote ntial liab ilityissues.

In practice, the CUORC approves undercoveroper ations only a fter rea ching a con sensu s of itsmembers. Typically, through the use ofstipulations pursuant to the UndercoverGuidelines, the Committee attempts to “minimizethe incidence of sensitive circumstances andreduce the risks of harm an d intrusion that arecreated by such circumstances.” Stipulations setforth written restrictions and policies for theoperation. In addition to the CUORC review, theFBI will often perform an onsite review of theongo ing op eration to iden tify pro blem s and toensure that stipulations are being followed.

As a practical matter, AUSAs and SpecialAgents are encouraged to raise and discuss anyissues posed by the undercover operation. Thesupervising AUSA should evaluate types of issuesconsidered in the CUORC before support is givenfor a proposal. Furthermore, the CUORCapproves undercover operations for specified timeperiods, generally six months. The undercoveroperations have to be re-presented to the CUORCfor renewal beyond six months, for additionalfund ing, or if there has been a chan ge in th eirfocus. At all times during the undercoveroper ation, a nd sp ecifica lly at the time o f rene wal,AUS As sh ould b e con sulting with the case agen tsand monitoring and reevaluating the progress ofthe undercover operation. AUSAs are encouragedto discuss any issues informally with members ofthe CUORC before they actually present anunde rcov er pro posa l. AUS As sh ould p ose th eirquestions to the Criminal Division Section Chiefwith re spon sibility fo r the typ e of ac tivityinvolved in the undercover proposal or to the FBISection that is reviewing the application. Onocca sion, A USA s attend CUO RC m eeting s toanswer questions and explain the significance ofthe investigations. The CUORC committeemembers have seen numerous proposals over theyears and can often suggest ways to minimizerisks and to ensure that, once the undercoveroper ations are co mple ted, the re will b e well-founded, prosecutable cases.�

ABOUT THE AUTHOR

�Joshua R. Hochberg has been the Chief of theCrimin al Division ’s Frau d Section since 19 98. Mr. Hochberg was the Deputy Chief forLitigation in the Public Integrity Section from1995 to 1998, and a Trial Attorney and SeniorLitigation Counsel in the Fraud Section from 1986to 1995. He has been a regular member of theCUORC for several years.a


Investigating Accounting FraudsDavid L. Anderson Assistant United States AttorneyNorthern District of California

Joseph W. St. DenisAssistant Chief AccountantDivision of EnforcementUnited States Securities and ExchangeCommission

“How can this be a criminal matter?”

This question seems to com e up in everyaccounting-fraud investigation. The person askingthe qu estion is typica lly a targ et and likelyspeaking through his attorney.

The targ et’s que stion has no bas is in law. Acrimin al pros ecutio n is auth orized by statu tewhenever a willful violation of the SecuritiesExchange Act of 1934 or any rule or regulationadopte d unde r that Act o ccurs. See 15 U.S.C.§ 78ff(a). Rule 10b-5 prohibits fraud, includingaccounting fraud, in connection with the purchaseor sale of any sec urity. See 17 CFR 240.10b-5.Wh en a p ublicly traded com pany willfullyengages in accounting fraud, it commits a federalcrime.

The target’s question may be rooted in thefalse hope that accounting frauds are too technicalor arcane for a prosecutor to explain to a lay jury.This h ope h as no basis in fact.

In the Northern District of California, theUnited States Attorney has established aSecurities Fraud Unit with a team of pro secutorsdedic ated to secur ities-fra ud m atters, p rincipallyaccounting frauds and insider trading. Theexperience in our District is that prosecutors canmake accounting frauds understandable to laypeople.

The N orthe rn Dis trict of C aliforn ia is hom e toSan F rancis co an d Silico n Va lley. Th e Distr ict isalso h ome to com panie s such as Ca l Micr o, M ediaVision, Critical Path, Indus, and ScorpionTech nolog ies, all of whic h hav e seen theirofficers, directors, or employees prosecuted forsecurities fraud. These cases have been brought on

investigations conducted by the Federal Bureau ofInvestigation, usually in cooperation with theUnited States Securities and ExchangeComm ission (“SEC”).

This article draws on recent experiences in theNorthern District of California and on the evenbroa der, n ationw ide ex perien ce of th e SEC inaccounting-fraud cases. This article discusses howto recognize common accounting frauds, usedocumentary evidence to obtain witnessstatements in an accounting-fraud case, andcooperate effectively with the SEC.

I. Common accounting frauds

In his bo ok, Financial Shenanigans (1993),How ard M . Schilit id entifies the sev en ba sicpatterns of accounting fraud. They are:

• Recording bogus revenues;

• Recording revenues too soon (for example, bybackdating or chann el stuffing);

• Boosting income with one-time gains;

• Shifting current expenses to future periods(manipulating accruals or reserves);

• Failing to record or disclose all liabilities(understating expenses or hiding d ebt);

• Shifting current income to a later period; and

• Shifting future expenses to the current period.

Id.

The impropriety of some of these accountingfrauds is readily a pparen t. For exa mple, acom pany that find s itself ju st shor t of qua rterlyrevenue goals m ight “keep its books open” for afew days into the succeeding quarter, therebyimproperly accelerating the recognition ofrevenues from a later quarter to an earlier one. Toavoid detection, someone at the company maybackdate sales contracts and shipping documents.If a sale s con tract w as bac kdate d to m eet qu arterlynumbers, arguing that the backdating was theresult of “accounting judgment” or “immaterialinadv ertenc e” is go ing to b e diffic ult.

The significance of other accounting fraudsmay not be so tran spare nt. A c omp any th at shifts


curre nt inco me to a later p eriod or that s hiftsfuture expe nses to the cu rrent p eriod isunderstating its current financial performance.The motive for this type of accounting fraud maybe to “smooth” or “manage” earnings. If thecom pany has alr eady exce eded its quar terlyfinancial goals, it might create a safety net forfuture quarters by delaying the recognition ofrevenue or accelerating the recognition ofexpenses.

Having at least some awareness of all seven ofSchilit’s financial shenanigans is advantageousbecause they seldom appear in isolation. Anaccounting misstatement, wh ich appearsdefen sible in isolation , may beco me c omp letelyunjustifiable when viewed in the context of other,contem poran eous m isstateme nts. For e xamp le, acompany may improperly record revenue from abogus sales contract but still find itself short ofquar terly fin ancia l goals , and s o drain off itsreser ves to mak e up th e diffe rence . View ed inisolatio n, the c omp any’ s decis ion to a djust itsreser ves m ight loo k like a perfe ctly pe rmiss ibleaccounting judgment that takes into considerationsome recent chan ges in circumstances. How ever,if you find a bogus sales contract, you may bewell on your way to unraveling the more obsc ureaspects of the overall fraud.

Here is a sad ly com mon fact pa ttern: Acompany engages in a low-risk, low-transparencyaccounting fraud. To meet its second-quartergoals, the company draws down its accountingreserves in a way that is somewhat defensible. Thecompany reports pleasing quarterly results andmakes third-quarter predictions that appearaggr essive , but no t overly so, in lig ht of itsreported second-quarter performance. Theproblem is that even its second-quarter nu mberswere a stretch. To compound the problem, thecompany has eliminated whatever cushion it hadby drawing down its reserves. At the end of thethird quarter, it is far short of its quarterly goals.Now there is pressure to engage in some biggeraccounting fraud — executing a bogus salescontract, or characterizing a one-time gain asincome from operations. If that accounting fraudsucceeds, it sets the stage for even higherexpectations for the fourth quarter. Sooner orlater, the company engages in some truly brazenaccounting misstatement. Investigating the mostegregious violation, you uncove r a larger pattern

of fraud.

An egregious accounting fraud may providethe initial impetus for your investigation.However, its significance does not end there. Theworst frauds are typically the most difficult fortargets or defendants to defend, either before orduring trial. During a proffer session, a target whois perfectly comfortable defending his com pany’sfraud ulent re serve practic es, ma y find himse lfwith no choice but to tell the truth about a sideagreement or backdating scheme. A defendant attrial may lose credibility with the jury as heattempts to explain his most outlandish accountingfrauds.

Here are four brazen accounting fraudsaround which you can build a good criminal case:

A. Side agreem ents

It is the end of the quarter. Top managementdesperately wants to meet its publicly statedrevenue goals for the quarter. A valued customeris ready to execute a transaction that will push thecompany beyond its goals. However, the customerwants one last concession to close the deal – anextended payment term, or an evaluation period,or something else that will disrupt revenuerecogn ition during the quar ter.

To close the deal and m eet the company’sgoals, a sales manager prepares the dealpape rwor k in the usua l form , omittin g the la st-minute concession. Separately, he assures thecustomer that the special concession will bedelivered as promised. The phrase “sideagreement” refers to the common practice ofplacin g that la st-min ute co nces sion in to a sep aratedocument. Whatever form the side agreement maytake, th e prob lem a rises w hen its substa nce ishidden from the company’s accountingdepartment and external auditors. What looks likea standard deal has additional baggage that would,if fully disclosed, prevent revenue recognition, atleast until some later period.

In the Northern District of California, we haveseen side agreeme nts that promise customersunlimited rights of return, extended or unusualpayment terms, or even the right to void salescontracts at will. A company that gives thesetypes of special concessions typically cannotrecognize revenue until after the concessionsexpire because, in the face of such concessions,


collectibility is n ot reaso nably a ssured . SeeAICP A Statem ent of Po sition 97-2 , SoftwareRevenue Recognition (“SOP 97-2”), ¶ 8 (1997)(describing four primary criteria, includingreasonable assurances of collectibility, for therecognition of software-licensing revenue); SECStaff A ccoun ting Bulletin No. 10 1, RevenueReco gnition in Fina ncial S tatem ents (“SAB 101”)(1999) (applying the criteria set forth in SOP 97-2to all types of business transactions).

If you discover the existence of a sideagreement, look for high-level managementinvolvement. Customers often will demand thattheir special concessions be approved by topmanagement. Even if the side agreement is notsigned by a top manager, the customer may havereceived comfort from managem ent, in the formof a telephone call, or verbal approval through thesalesperson. What customer wants a sideagreement that is later repudiated by topman agem ent?

Sales peop le ma y also have an inc entive toinvolve top management in the approval of sideagreements. Rarely do individual salespeople haveactual legal authority to change standard contractterms. Except in cases involving the “roguesalesperson,” expect to find top-level mana gersinvolved in some way with the issuance of theside ag reem ent.

B. Nonmonetary transactions

Wh en a c ustom er pay s cash for a p rodu ct inan arm s-leng th trans action , the tran saction isgenerally valued in the amount of money paid.For example, if a house buyer and house selleragree on a c ash p rice fo r a hou se, tha t cash p rice isgenerally considered good evidence of the truevalue of the house at the moment the transactionis closed.

The situation is different if two parties agreeto exc hang e hou ses. In this situa tion, the iragreement m ay establish that the houses areapproximately equal in value, but the agreementdoes little to show how much each house is worth.The p arties m ight ag ree tha t each hous e is wo rth$1 or $1 million, but because cash is not changinghands, the parties’ agreement is not persuasiveevidence of value.

Transactions, in which something other thanmoney changes hands, are sometimes described as

“swap transactio ns” or “ barter de als.”Accountants call them “no nmonetarytransactions.” In a nonmonetary transaction, theaccounting issue is typically not whether revenueshould be recognized, but how much revenueshould be reco gnized . See Accounting PrinciplesBoard Opinion No. 29 , Accounting forNonmonetary Transactions (“APB Opinion No.29”), ¶ 2 (1973).

The valuation rules for nonm onetarytransac tions are c omple x in som e way s. See, e.g.,APB Opinion No. 29; FASB Emerging IssuesTask F orce, Iss ue No . 99-17 , Accounting forAdvertising Barter Transactions (“BarterTransactions”) (November 17, 1999); AICPATechn ical Prac tice Aid 5 100.46 , NonmonetaryExchanges o f Software (Part I) (December 29,2000).

You need not become bogged down in thesevaluation rules to recognize a problem transaction.Nonmonetary transactions must generally beseparately disclosed to investors. APB OpinionNo. 29 at ¶ 28. A company engaging in afraudulent nonmonetary transaction will almostinvariably fail to disclose it. Even if thecompany’s valuation of the transaction conformswith generally accepted accounting principles(GA AP), the failu re to dis close will still like lyconstitute fraud.

To avoid the special scrutiny to whichnonmonetary transactions are subjected underGAAP, a company may structure the transactionto mak e it look like tw o separ ate cash sales. Acom pany may go so far as to prepa re two separ atesales contracts and to exchange checks in equal(or, better yet, not quite equal) amounts. Butswapping checks does not evidence fair value.Barter Transactions at ¶ 4 (“An exchangebetween the parties to a barter transaction ofoffsetting monetary consideration, such as a swapof checks for equal amounts, does not evidencethe fair value of the transaction.”).

If you find evidence of a fraudulentnonmonetary transaction, look for theinvolvement of the company’s internal accountingand fin ance perso nnel. T heir ex pertise will likelyhave been called upon in structuring thetransaction and perhaps in disguising it. Also lookfor the involv eme nt of top com pany man agem ent.


C. Backdating

The a ccou nting r ules d o not a llow “w iggleroom” for transactions that close one week, oneday, or even one hour after the end of theaccounting period. If the company has a calendarfiscal year, and its fourth quarter ends onDecember 31, it cannot count fourth-quarterrevenue for a transaction closed on January 1, or5, or 15.

What happens if a company discovers onJanuary 2 that it is a mere few million dollarsshort o f pub lic exp ectatio ns for its quar terlyrevenues? Or if a customer delays signing anagreement that the company had been counting onto meet its numbers? Company management maybe tempted to backdate the agreement to create thefalse appearance that the transaction was closedduring the previous quarter.

Reve nue g enera lly can not be recog nized untilthere is evidence of a sales arrangement anddelivery of the product. SOP 97-2 at ¶ 8; SAB101. If a company customarily executes writtencontracts with its customers, a written contractwill normally be required before revenue may berecognized. SOP 97-2 at ¶¶ 15-17.

If you find backdating, look for otherevidence of wrongdoing because a criminal casefocu sed o n bac kdatin g alon e ma y be d ifficult toprosecute. An individual salesperson maybackdate an agreement without the overt orobvious involvement of sales management. Also,if the customer eventually pays under theagree men t, your prose cution will be s usce ptible tothe argument that the backdating w as a meretechnical violation.

Backdating may provide important evidencein the context of a larger pattern of fraud.Back dating is both inexc usab le and readilycomprehensible. Periodic reporting systemsobligate a company to report its revenues in theappropriate accounting period. Accelerating thoserevenues by backdating sales contracts or shippingdocu men ts cann ot be ju stified w ith refe rence togenerally accepted accounting principles.

D. Concealing debt or expenses

The fraudulent schemes just discussed —issuing side agreements, execu ting nonmonetary

transa ctions , or bac kdatin g sales agree men ts — allinvolve the improper recognition of revenues.Overstating revenues is the most common type ofaccou nting frau d. See Lynn E. Turn er, RevenueRecognition (“Revenue Recognition”) (May 31,2001) ,<http://www.sec.gov/news/speech/spch495.

htm>. Revenue fraud also has the greatest impactin terms o f dama ges to sh arehold ers. Id. (statingthat “[b]ased on research performed by my office,restate men ts for re venu e reco gnition also re sult inlarger drops in market capitalization than anyother type of restatements.”).

Frauds involving debt or expenses should notbe ov erloo ked, h owe ver. T hese , too, m ay res ult insubstantial losses to shareholders. For example,from 1992 to 1996, Arthur Andersen LLP issuedaudit re ports f or fina ncial sta teme nts of W asteManagement, Inc. that improperly deferredcurre nt exp ense s to futu re per iods a nd faile d todisclose one-time gains, which were used to offsetcurren t expen ses. See In re Arthur Andersen LLP,SEC Accounting and Auditing EnforcementRelease No. 1405 (June 19, 2001). Thecum ulative effec t of thes e and other m isstatem entswas to overstate Waste Management’s earnings by$1.43 b illion. Id. Losses to shareholders were ashigh as $6.5 billion.

One common way for companies to concealexpe nses is to defe r the re cogn ition of expe nses tosome future period. Waste Managementimpro perly reduc ed de precia tion ex pens es on itsvehicles, equipment, and containers, so as to deferthose depreciation expenses to later accountingperiods . Id.

Ano ther w ay to c once al deb t or exp ense s is toattribute them to unconsolidated subsidiaries orspecial-purpose entities. In such instances, theattribution may be permitted by GAAP, but thecompany’s failure to disclose the true nature ofthe en tity or tra nsac tion res ults in an unfairpresentation of the company’s financialperformance or position.

Yet another way for companies to concealexpe nses is to accelerate their re cogn ition. Th isfraudulent scheme is sometimes referred to as the“big bath.” In conjunction with a bad-newsannouncement or nonrecurring event, thecompany records expenses in an amount greater


than actually incurred. The excess of recordedover actual expenses is “stored” in a reserveaccount, sometimes referre d to as a “cookie-jar”reserve. In a later period, the company uses thecookie-jar reserve to reduce then-currentexpenses.

Here is a well-known example of a companytaking a big bath: In 1996, after “Chainsaw” AlDunlap took control of Sunbeam Corporation, theCompany inflated its reported annual loss bycreating cookie -jar reser ves. See In re SunbeamCorporation, SEC Accounting and AuditingEnforceme nt Release No. 1393 (May 15, 200 1).Then, in 1997, the company released thesereserves to reduce expenses and inflate income,thus c reating the fals e imp ressio n of a r apidturnaro und. Id. When the fraud was revealed,shareholders lost $3.5 billion.

II. Turning paper into witnesses

The government doesn’t often win criminaltrials with documents alone. Strong witnessesmake strong cases. Accounting-fraud cases maybe paper intensive, but they are witness intensivetoo. In an accounting-fraud case, just as in othertypes of cases, you need powerful testimony, notjust incriminating documents.

One common mistake in the prosecution ofacco unting -frau d case s is to fo cus o n the p aper tothe exclusion of key witnesses. Another commonmistake is to spend so much time obtaining oranalyzing the relevant documents that, in themeantime, key witnesses forget or misrememberrelevant facts. Don’t let your witnesses go stale!Obtain and organize your paper quickly, and thenuse it while interviewing witnesses.

A. “Flip” lower-level participants likenarc otics p rose cuto rs wo uld

Narcotics prosecutors are familiar with theconcept of “flipping” a witness. A lower-levelparticipant in the narcotics-distribution schemeagree s to testif y aga inst a hig her-le vel pa rticipan t.Typically, the lower-level participant does notagree to bec ome a gov ernm ent w itness s olelybecause of strong feelings of patriotism or goodcitizenship. He has an eye on his own criminalliability.

Company salespeople, lower-level managers,

and ra nk-a nd-file acco unting perso nnel a re allpotential government witnesses. Many of themwill have a keen appreciation of their ownpotential criminal exposure. In the NorthernDistrict of California, lower-level employees whofully cooperate with an accounting-fraudinves tigation may not be prose cuted for the irinvolvement in the accounting fraud . To securenonprosecution, they must, among other things,provide statements and testimony that are truthfuland complete.

Some lower-level employees demonstrate anunfortunate tendency to minimize the misconductof themselves, their supervisors, or the company.If a lower-level employee has difficulty providingtruthful cooperation, he will not be an effectivegovernment witness. In the Northern District ofCalifornia, a lower-level employee who hasdifficulty telling the truth may quickly findhimself a defendant, not merely a witness, in anaccounting-fraud case.

B. Use ema ils to obtain witness stateme nts

As narcotics prosecutors know, the mostsucc essfu l narco tics distr ibutor s do n ot often talkabout drugs on the telephone. Instead, they usetheir telephones to arrange personal meetings ormake calls over payphones. Some narcoticsdistributors speak in coded language. They realize what they say may be recorded and used againstthem.

Incredibly, white-collar criminals often usetheir email accounts with much less sophisticationthan street-level criminals handle their telephones.Wh ite-colla r crim inals m ay co mm unica te ope nlyin email about their criminal plans.

A company that cooperates fully with anaccounting-fraud investigation may not beprosecuted for the criminal acts of its officers oremployees. To secure nonprosecution, thecom pany mus t, amo ng oth er thing s, prom ptlyproduce all relevant emails in its possession orcontrol. Typically, this includes all emails thatwere sent or received on company computers.

Con temp oran eous ema ils betw een p articipa ntsin an accounting-fraud conspiracy may provide anabundance of evidentiary and investigativeinform ation. C ontem pora neou s ema ils may help


estab lish pla ns, inte ntions , dates , or par ticipan tsrelevant to the criminal scheme. They may beuseful at trial or, just as importantly, they mayhelp obtain early, truthful statements fromcompany witnesses.

C. Focus on the defendant’s acts ofdeception

In som e instan ces, G AAP is high lydiscretionary or even quite malleable. In theory,this discretion allows the accounting professionalto choose the most appropriate accountingtreatment for any given transaction. Regrettably,in practice, this discretion may allow a companyto ma nage its reve nues or ear nings in a wa y that isadva ntage ous to man agem ent bu t does not res ultin a fair presentation.

At trial, an accounting-fraud defendant mayproffer expert testimony that his accountingjudgments were within GAAP, or that anydepa rture f rom G AAP was im mate rial. Th isexpert testimony may present unique challenges.Although the government may present its ownexpe rt testim ony, th is may leave a lay ju ry withthe w rong impre ssion that the case is abou t adebate within the accounting profession, notcriminal wrongdoing.

Look for the contemporaneous acts andstatem ents o f the de fend ant tha t revea l thedefen dant h imself b elieve d he w as en gage d inwrongdoing. A de fend ant’s e xper t testimo ny w illring hollow at trial if the defendant has acted orspok en in a way that sho ws aw arene ss of h iswrongdoing.

For example, a defendant in a side-agreementcase m ay arg ue at tria l that the ame ndm entscontained in the side agreemen t are immaterial. Ifthey are immaterial, then why did the defendanthide them in a side agreement? By pointing to thedefen dant’ s own action s, you may avoidbecoming embroiled in a debate over materiality.Your closing argument is that the defendant knewthe amendments were material, which is why hehid the m in a side ag reem ent.

Here is another example: A defendant in abarter -trans action case a rgue s at trial th at hisvaluation of the transaction was fair andappr opria te und er the c ircum stanc es. If th at is

true, then why didn’t the defendant disclose thebarter nature of the transaction? Again, bypointing to the defendant’s own actions, you mayneutralize a technical defense based on accountingprinciples that may be challenging to even themost intelligent lay juror. Your closing argumentis that the defendant knew the company could notproperly recognize revenue for the bartertransaction without further evidence of value andthat’s why he hid the true nature of thetransaction.

Acts of deception may prove useful during aninves tigation as we ll as at tria l. A witn ess w ho isperfectly comfortable defending his accountingjudgments may have greater difficulty explainingwhy he failed to disclose significant aspects of asuspect transaction.

III. Conducting parallel investigations

United States Attorney’s Offices handle awide ra nge of f ederal c riminal an d civil ma tters. Agood, experienced prosecutor may have a deepunderstanding of the rules of evidence and a nosefor wrongdoing, but nothing in the job description says he or she has to be an accounting expert also.

The United States Securities and ExchangeCommission has more than sixty years ofinvestigatory and regulatory experience with theUnited States securities markets. Among otherconsiderable resources, the Commission has astaff o f acco unting profe ssionals dep loyed in fieldoffices around the country and in Washington,D.C.

Public policy and good practice dictate thatfederal prosecutors work cooperatively with theSEC whenever possible. As a matter of policy,“prosecutors should consult with the governmentattorneys on the civil side and appropriate agencyofficia ls rega rding the inv estiga tive stra tegies tobe used in their cases.” Office of the AttorneyGene ral, Coo rdina tion of P aralle l Crim inal, C ivil,and Administrative Proceedings (“Coordinationof Proceedings”), 2 (July 28, 1997). As a matterof pra ctice, y ou w ill almo st inva riably bene fitfrom effective cooperation with the SEC. SECattorneys an d acc ounta nts ma y assis t you infinding, organizing, and understanding relevantdocuments. They may also educate you on thespec ific acc ountin g prin ciples mos t releva nt to


your investigation.

To cooperate effectively with the SEC, youmust be sensitive to the requirement of gran d jurysecrecy. You generally may not disclose to theSEC m atters occ urring b efore the grand ju ry. SeeFed. R . Crim . P. 6(e )(2); cf. Fed. R. Crim. P.6(e)(3)(A)(ii) (permitting disclosure only asnecessary to enforce the fed eral criminal law). Ifyou subpoena a witness before the grand jury, yougenerally may not disclose even the identity of thewitness or the existence of the subpoena.Although documents subpoenaed before the grandjury m ay, in s ome circum stanc es, be disclo sed tothe SE C, this o utcom e is gen erally a chiev ed on lyby mo tion befo re the D istrict Cour t. SeeUnited States v. Dynovac, 6 F.3d 1407, 1411-12(9th C ir. 199 3) (fin ding th at “if a d ocum ent issought for its own sake rather than to learn whattook p lace b efore the gra nd jur y, and if itsdisclosure will not compromise the integrity of thegran d jury proce ss, Ru le 6(e) does not pro hibit itsrelease”).

In many cases, not launching an extensiveearly grand jury investigation is best. Witnessstatem ents m ay ofte n be o btaine d info rmallythrough FBI interviews, rather than through grandjury su bpoe nas. T he SE C ma y be in vited toparticipate in these witness interviews or may beprovided with the FBI 302s memorializing thewitnesses’ statements. If you take witnesstestimony before the grand jury, or withhold theresults of your witness interviews from the SEC,the SEC will likely issue administrative subpoenasfor the same witness testimony. Taking testimonyfrom the same witnesses in separate proceedingsmay be desirable if the witnesses are evasive ormotivated to lie, but for witnesses who arecoop erative and tru thful, ra rely m uch is to gainfrom having them testify before both the grandjury and the SEC.

Oftentimes, documentary evidence may alsobe ob tained in a ma nner that rea dily fac ilitates itsuse by your office and the SEC. “With propersafeguards, evidence can be obtained without thegrand jury by administrative subpoenas, searchwarrants and other means. Evidence can then beshared among various personnel responsible forthe matter.” Coordination of Proceedings at 2.

IV. Conclusion

Here is a final case example: In the third andfourth quarters of 2000, a high-tech companyknow n as C ritical Pa th, Inc . enga ged in the sor tsof accounting frauds discussed in this article —backdating sales contracts, issuing undisclosedside agreements, execu ting improper nonm onetarytransac tions, and conce aling exp enses. SeeSecurities And Exchange Commission v. David A.Thatcher and Timothy J. Ganley, SEC Accountingand Auditing Release No. 1504 (February 5,2002 ). On A pril 5, 2 000, th e Com pany restate d itsfinancial results for those quarters and for thefiscal year 2000. Net losses for the third andfourth quarters of 2000 were restated upward bymore than 50% . Revenues for those qu arters wererestated d ownw ard by m ore than 20%. Id.

Both the FBI and SEC opened investigationsinto Critical Path’s accounting practices, with theU.S. Attorney’s Office for the Northern District ofCalifornia vigorously participating in the FBI’sinvestigation. On February 12, 2002, less than ayear f rom th e date of the C omp any’ s resta teme nt,Critica l Path’ s form er pre siden t pled g uilty toconspiring to commit securities fraud.

In today’s legal and market environment, theinvesting public needs and demands the criminalenforcement of the federal securities laws. As theSEC’s former Chief Accountant recently stated,“at some point in time, investors are going to losemore than th eir mo ney, th ey are going to lose th eirtrust in th e num bers a nd the system and p eoplewho prod uce a nd au dit them . We cann ot, and shallnot let that ha ppen.” See Lynn E. Turn er, RevenueRecognition (“Revenue Recognition”) (May 31,2001) ,<http://www.sec.gov/news/speech/spch495.

htm>. Wh at are y ou do ing in y our D istrict toprotect investors and prosecute accountingfraud?�

ABOUT THE AUTHORS

�David L. Anderson is an AssistantUnited States Attorney in the Northern District ofCalifo rnia. M r. And erson has a d egree inaccounting from Sa n Jose State University. Mr.And erson gradu ated fr om S tanfo rd La w Sc hool in1990 and clerked for Associate Justice AnthonyM. Kennedy. In 1998, Mr. Anderson testified


before Congress on securities litigation reform.a

Jose ph W . St. De nis is an Assistant ChiefAccountant in the United States Securities andExchange Commission’s Division of Enforcementin W ashin gton, D .C. M r. St. De nis ha s a deg ree inaccounting and an M.B.A. from the University ofColorado at Boulder. Mr. St. Denis is a licensedCPA in Colorad o. Before joining the SEC’sDivision of Enforcement, Mr. St. Denis was anauditor with Coopers & Lybrand and a CFO,controller and vice president-finance in the high-tech industry.a

The Securities and Exchange Commission, as amatter of policy, disclaims any responsibility forany private publication or speech by its membersor staff. The views expressed herein are those ofthe authors and do not necessarily reflect theviews of the Commission or the authors’colleagues on the staff of the Commission.

Prime Bank/High Yield InvestmentSchemesJoel E. LeisingSenior Trial AttorneyFraud Section, Criminal Division

Michael McGarryTrial Attorney Fraud Section, Criminal Division

I. Introduction

Ever since Breton Woods and the formationof the I ntern ationa l Mo netary Fund and W orldBank in the late 1940's, the major banks in theworld have engaged in trading programs amongthem selve s, yield ing retu rns ra nging from 10% to100% per month, at little or no risk. Only thesebanks, and a few select traders authorized by theFede ral Re serve , are allo wed to partic ipate inthese trading prog rams , whic h are p rincipallydesigned to generate funds for humanitarian andother worthwhile projects. On occasion, particulartrader s allow individ ual inv estors to partic ipate inthese secret trading programs by pooling theindividual’s funds with funds from other investorsuntil a certain amount, usually a minimum of$100 million, is accumulated for a trade.However, these individuals must enter non-

disclo sure a greem ents w ith the tra ders a nd ag ree tocontribute half of their profits to a designatedcharitable cause.

Intere sted? You r inves tmen t advis or nev er toldyou about this? Maybe that's because all of whatyou have just read is false. Nevertheless,thousands of people during the past decade havefallen prey to scams based on similar claims andlost billions of dollars believing they wereinvesting in such mythical trading programs.Despite repeated warnings over the years fromvarious regulatory agencies and internationalorganizations that such trading programs do notexist, these prime bank or high-yield investmentschemes have continued to proliferate and are nownearing epidem ic levels.

Various agencies or organizations, such as theFederal Reserve Board, Office of Comptroller ofCurrency, Department of Treasury, Securities andExchange Commission (SEC), InternationalChamber of Commerce, North AmericanSecurities Administrators Association,International Monetary Fund, and World Bankhave all issue d exp licit war nings to the p ublicabou t prime bank fraud . Occa siona lly, you willfind copies of these among the items seized duringexecution of a search w arrant at a fraudster’s


office. A number of g ood reference m aterials arepublicly-available relating to these schemes,including PRIME BANK AND RELATED FINANCIAL

INSTRUMENTS FRAUD issued by the SEC in 1998.Two others are PRIME BANK INSTRUMENT FRAUDS

II (THE FRAUD OF THE CENTURY), prep ared in1996 by the ICC Commercial Crime Bureau, andTHE MYTH OF PRIME BANK INVESTMENT SCAMS,by Professor James Byrne of the Institute ofInternational Banking Law & Practice, GeorgeMas on Un iversity L aw Sc hool.

Prim e ban k frau d first a ppea red in th e early1990 's, wan ed so mew hat in th e mid 1990 's inresponse to aggressive enforcement actions andmedia coverage, then reemerged as a significantproblem in the late 1990's. At present, over onehundred pending federal criminal investigationsinvolve prime bank fraud. In addition, theSecurities and Exchange Commission and variousstate law enforcement agencies have a number ofactive investigations. Moreover, as the problemhas become worldwide, more foreign lawenforcement agencies, particularly in English-speaking countries, have actively investigated andprosecuted this type of fraud.

The purpose of this article is primarily two-fold: fir st, to aler t reade rs to the existen ce of th isparticular type of fraudulent scheme, and second,to offer some suggestions for investigating aprime bank scheme.

II. Common characteristics of the scheme

"Prime bank" schemes — "prime bankinstrument" schemes, "high yield tradingprog rams " or "ro ll prog rams "— a re ess entiallyPonzi schemes, in which the perpetrators claim exists a secret trading market among the world’stop ba nks o r "prim e ban ks." Pe rpetra tors cla im tohave unique access to this secret market. The"top" or "prime" banks purportedly trade someform of bank security such as bank guarantees,notes, or debentures. These instruments cansupp osed ly be b ough t at a disc ount a nd so ld at apremium, yielding greater than market returnswith no risk. In reality, no such market exists.Furthermore, high-yield "prime bank notes," asdescrib ed by th ese per petrators , do not ex ist.

They often claim that there are only a few"traders" or "master comm itment holders" who are

authorized to trade in these securities and that thesecu rities m ust be traded in large block s, typic allymillion s of do llars or more . Prom oters te llpoten tial inve stors th at they have specia l acces s toa tradin g pro gram , and th at by p ooling theirmoney with that of other investors, they canparticip ate in th e prog ram. P romo ters als o tellinvestors that the programs participate in somehumanitarian cause and that they are giving theinvestors a special opportunity to participate in theprogram, but only if they agree to give a share ofthe profits to the cause. They also typically requireinvestors to execute a "non-disclosure" and "non-circumvention agreem ent" because , as they aretold, banks and regulatory agencies will deny theexistenc e of these trading p rogram s.

III. Case law involving prime bank schemes

Over the past few years, a number of reporteddecisions affirmed convictions of prime bankschemers. For example, this past summer theFour th Circ uit affirm ed de fend ants’ c onvic tions inUnited S tates v. Bo llin, 264 F.3d 391 (4th C ir.2001), for conspiracy, wire fraud and moneylaundering. As described by the Court of Appeals:

This case arose out of a wide-ranginginvestment fraud scheme, carried out by anetwork of conspirators, who bilked millionsof dollars from investors across the country.The investments were programs that promisedenormous profits, supposedly derived fromsecret trading in debentures issued byEurop ean "pr ime" ba nks.

The programs involved supposed trading ofEuropean "prime bank" debentures andprom ised v ery hig h rates of retu rn with littleor no risk to investo rs. Acc ording to the ...literature that they distributed, the programswere available on a limited basis to groups ofinvestors whose money would be pooled anddelivered to a "prime" bank. The investmentprincipal was supposedly secured by a bankguarantee and, therefore, was never at risk.Millions of dollars in profits were to begenerated within a few months from thetrading of debentures. For example, oneprog ram ... offer ed a p rofit of $73,0 00,00 0 inten months, based on an investment of$400,000.


Id. at 399-400.

In United States v. Polichemi, 201 F.3d 858,aff’d on rehearing, 219 F.3d 698 (7th Cir. 2000 ),defendants defrauded nearly thirty investors out ofmore than $15 million by marketing "prime bankinstrum ents," w hich th ey de scribe d as m ulti-million-dollar letters of credit issued by the topfifty or one-hundred banks in the world. As theSeventh Circuit explained, defendants

told their victims that they could purchasethese instruments at a discount and thenresell them to other institutions at facevalue; the difference in price representedthe pro fits that w ould g o to the defen dantsand their “investors.” This was nothingmore than a song and dance: the tradeswere fictional; there was no market for thetrading of letters of credit; and nothingcapable of generating profits everoccurred. Somehow, notwithstanding theimplausibility of “prime bankinstruments” to one familiar with normalbusiness practice for letters of credit, theymanaged to persuade their victims to givethem money to finance the purchase ofphan tom d iscou nted in strum ents. W hilethis did not earn a cent for any of theinvestors, it definitely changed thedefendants’own lifestyles.

Id. at 859 -860 . Amo ng tho se con victed inPolichemi were attorneys, salespeople, anindividual who acted as a reference, andPolechemi, who claimed to be one of the fewpeople in the world with a license to trade primebank s ecurities.

In a relate d case, United States v. Lauer, 148F.3d 766 (7th Cir. 1998), Lauer, the administratorof an e mplo yee p ensio n fun d, plea d guilty todiverting millions of dollars to the prime bankscheme prosecuted in the Polichemi case. Inrejecting Lauer’s appeal on the loss calculation forsente ncing purp oses, th e Sev enth C ircuit up heldthe trial court’s use of an intended loss figure,rather tha n a lowe r actual los s amo unt.

In anoth er recen t case, S.E.C. v. Lauer, 52F.3d 667, 670 (7th Cir. 1995), Chief Judge Posnerdeclared

Prime Bank Instruments do not exist. Soeven if [a co -sche mer] had succe eded inraising mon ey fro m ad ditiona l inves tors, itwould not have pooled their money to buyPrime Bank Instruments. It would eitherhave pocketed all of the money, or, if whatits masterminds had in mind was a Ponzischeme, have pocketed most of the moneyand paid the rest to the investors to foolthem into thinking they were makingmoney and should therefore invest more(or tell their friends to invest).

In United States v. Richards, 204 F.3d 177(5th C ir. 200 0), the Fifth C ircuit up helddefendants’ convictions for conspiracy, wire fraud,mail fraud and interstate transportation of stolenproperty. At trial, the government presented thefollow ing ev idenc e desc ribing how defen dantsinduced participants to invest in a “roll program”:

Poten tial inve stors w ere told that the irmoney would be pooled with that of otherinves tors an d use d to bu y letters of cre dit.The letters of credit would be “rolled”--sold, re purc hase d, and resold -- toEuropean banks frequently and repeatedly.Each “roll” w ould g enera te a larg e prof itto be d istribute d am ong th e inve stors, inproportion to their investment. Theinves tors w ere told that the ir fund s wou ldbe safe at all times, held either in anaccount at a nationally-known brokeragefirm or invested with a “prime” or “top50" international bank. Investors were alsotold that they would receive at least thereturn of their initial inv estme nt, withinterest, and would likely make substantialprofit. In fact, the defendants took theinvested funds for their own use, boughtno lette rs of c redit, an d, exc ept for a sma llpayment to one participant, returned nomoney to the investors.

Id. at 185.

In United States v. Rude, 88 F.3d 1538, 1548(9th C ir. 199 6), de fend ants w ere ch arged withengaging in a prime bank scheme. In affirmingtheir convictions, the Court of Appeals found,among other things, that the government hadproved beyon d a reasonable doub t "that the very


notion of a ‘prime bank note’ was fictitious," andcited other evidence that the term "prime bank"was not used in the financial industry "and wascommo nly associated with fraud schem es." Id. at1545.

In Stokes v. United States, No. 97-1627, 2001WL 29 997, at *1 (S.D.N.Y. Jan. 9, 200 1),defendant was co nvicted of conspiracy, wirefraud , mon ey lau nder ing an d inters tatetransportation of fraudulently obtained money.Defendant claimed that "through various personalconn ection s in the b ankin g indu stry, he couldpurchase and sell 'prime bank guarantees' orletters of credit and make a substantial profit in ashort pe riod of tim e, with no risk to the in vestor."As is typical in these kinds of cases, the defendantattempted, unsuccessfully, to portray himself as avictim, as someone unwittingly conned by co-conspirators to carry out the fraud.

A number of other criminal cases involvingprime b ank sch emes have a lso been reported . Seee.g., United States v. Wonderly, 70 F.3 d 102 0 (8thCir. 19 95); United States v. Hand, No. 95-8007,1995 W L 743841 (10 th Cir. Dec. 15, 1995);United States v. Aggarwal, 17 F.3d 737 (5th Cir.1994 ); Unite d State s v. Gr avatt , No. 90-6572,1991 W L 278979 (6th C ir. Dec. 27, 1991);United States v. Lewis, 786 F.2d 1278 (5th Cir.1986 ). The re are also a n umb er of re porte d civilcases b rough t by the S.E .C. See, e.g. S.E.C. v.Milan C apital Gr oup, Inc., No. 00 Civ. 108(DLC), 2000 WL 1682761 (S.D.N.Y. Nov. 9,2000 ); S.E.C. v . Kenton Capital, L td., 69 F.Supp .2d 1 ( D.D .C. 19 98); S .E.C. v . InfinityGrou p., 993 F . Supp. 3 24 (E.D . Pa. 199 8), aff'd,212 F .3d 18 0 (3d Cir. 20 00); S.E.C. v. Deyon, 977F. Sup p. 510 (D. M e 199 7); S.E.C. v. Bremont,954 F. Supp. 726 (S.D.N.Y. 1997).

Assis tant U. S. Atto rney Mich ael Sc hwa rtz inHouston prepared an excellent memorandumtitled "United States’ Memorandum of LawConcerning Fraudulent High-Yield orInternational ‘Prime Bank’ Financial InstrumentSchemes," a copy of which can be obtained fromeither h im or th e Frau d Sec tion. A ppro priatelymodified versions of this memorandum can notonly be used to educate your trial judge on thelegality of such schemes, but also excerpted foruse in search warrant affidavits.

IV. First steps

While the particular facts presented in eachcase w ill obvio usly d ictate w hich s teps y ou sh ouldfirst take in investigating a prime bank or highyield investment program (HYIP) scheme, wehave found the following to be generally veryusefu l:

• Check subject’s background: Chec k tosee if the subject has a criminal record, orif his name appears anywhere in FBIindices. Check with other agencies aswell, since these types of investigationsare handled not only by the FBI, but alsoby Customs, Secret Service, IRS-CID, orthe Postal Inspection Service. Many primebank scammers are career cons who havebeen previously convicted of fraud. Primebank scam mers also se em to opera tewithin an extensive network, using eachother to brok er or s olicit inv estme nts inparticular HYIP schemes, to backstopsome fraudulent claim, or to help create a"plausible deniability" defense. Therefore,your subje ct ma y hav e bee n interv iewed inthe past by an agent in another matter andmad e statem ents th at cou ld pro ve us eful inyour case. I f you are fo rtuna te, you willfind that an agent expressly put yoursubject on notice in the past as to thefraudulent nature of prime bank tradingprog rams . Such notice wou ld sub stantiallyaid yo ur eff orts in e stablish ing pr obab lecaus e for a searc h wa rrant a nd ge nerally inprov ing the subje ct’s fra udule nt inten t.

• Contact the Securities and ExchangeCommission: The S EC a ctivelyinvestigates and prosecutes prime bankfraud as securities fraud. Your subject maybe, or has been, involved in a SECinves tigation . If so, th is wou ld also helpbuild probable cause for an eventualsearch warrant, and pro ve intent at trial. Ifthe SE C has not inv estiga ted yo ur sub ject,you should consider asking them to do so.Contact either your regional SEC office orBrian Ochs, Assistant Director, Divisionof En force men t, SEC at (202 ) 942 -474 0 inWas hington , D.C. (See Tips below).


• Con tact J im K ram er-W ilt and BillKerr: Jim K rame r-W ilt is an atto rney inthe Treasury Department’s Bureau ofPublic Debt and has taken a very activerole in attempting to expose and combatprime bank fraud. He has compiled anextensive database on known andsusp ected prime bank scam mers and w illreadily share with you the database, aswell as other u seful m aterials . In alllikelihood he will have, or can get, somebackground information about yoursubject. He may be reached at (304) 480-8690. Bill Kerr, with the Enforcement andCompliance Division, Office of theComptroller of Currency, may alsoprovide some valuable information aboutyour subject, particularly if a bank hasfiled a Suspicious Activity Report (SAR)with the OCC, or has otherwise made aninformal inquiry to the OCC or FederalReserve about a particular financialtransa ction o r inves tmen t. His nu mbe r is(202) 874-4450.

• Locate subject’s bank accounts and/orassets: These cases typically involvemillions of dollars of victims’ funds, andare of ten dire cted a t wealth y indiv idualsor institutions, with minimum investmentlevels (e.g., $25,000) and representationsthat "trades" can not be entered until $100million has been pooled. Althoughoffsh ore ac coun ts are fr eque ntly us ed inthese schemes, surprisingly enough, youwill often find that the subject still haslarge sums on deposit in accounts atUnite d State s ban ks un der his contro l.This may be because he has not yettransferred the funds offshore, or perhapsbecause, as part of his scheme, the fundsare being maintained in an alleged trustaccount so he can as sume the persona of awell fin ance d inve stmen t man ager w iththe ba nk em ploye es. At a ny rate , to loca tethe ac coun ts is imp ortan t, in ord er todetermine the scope and nature of thefraud , as we ll as pre pare f or ultim ateseizure of the funds. A subject’s accountcan usually be identified by asking avictim for the wiring instructions that he

received from the subject. Accounts canalso be located through other means,including mail drops, trash runs, theclearing process of a victim’s check, andgrand jury subpoenas. Of course, thelikelihood that the subject has used morethan one account is high. In determiningwhe ther to s eize th e account, in form allyconta ct the fin ancia l institutio n’s se curityoffice r to get a roug h idea of how mu ch isin the a ccou nt.

• Consider initiating a proactiveapproach: The m ost diff icult ele men t toprove in a prime bank case, as with mostinves tmen t fraud s, is frau dulen t intent.The most com mon defense is, "I didn’tknow those trading prog rams didn’ t exist.I believed Mr. X when he told me theydid." Therefore, it is important at the startof an in vestig ation to plan h ow toovercome this defense. The FBI hasdeveloped a number of different proactiveappr oach es that h ave p rove n suc cessf ul inestab lishing the req uisite inte nt that w illsubstantially assist you in prosecutingyour case. Indeed, in most instances, thedefendant will enter a plea after beingconfronted with such evidence. For onesuccessful prosecution resulting from asting operation, see United States v.Klisser, 190 F.3 d 34 (2 d Cir. 19 99).

• Execute search and seizure warran ts:As so on as you h ave b een a ble todetermine the nature and scope of thefraud, you should consider applying forsearch and seiz ure wa rrants.

• Victim questionnaires: Many of thesecases involve hundreds, if not thousands,of potential victims. Questionnaires sentout to victims have proven to be anexcellent way to quickly collect evidence,including witness statements anddocuments, which you can then review forpossible in-depth interviews later.Obviously, this should be done only oncethe existence of the investigation becomespublic. Questionnaires are also a goodway to gauge the degree of cooperationyou can expect to receive from victims,


who oftentimes in these Ponzi typeschemes do not feel "victimized". (SeeSection VII below).

V. Pssst... here are a few good "tips"

Identifying the existence of a prime bankinvestment scheme is clearly easier thandeterm ining th e scop e of the schem e, or try ing toexplain to a jury precisely what is meant by (orsupposedly meant by) such terms as "prime bankdiscounted negotiable debenture" or "World Bankhigh-yield humanitarian trading program." Thefollowing tips will hopefully help you build andprove a case.

• Kee p it sim ple : Once you determine thetarget or targets, focus your investigativeefforts on building the strongest caseagainst them without trying to uncoverevery transaction or proving every illegalact they may have committed. First, as apractical matter, you simply can notinclude every transaction. These schemesare often quite broad in scope and canoften meld into other investment schemes.Stay focused on the heart of the case youare de velop ing. A ttemp ting to b e all-inclusive can be a waste of time andresources. By focusing on the keytransactions, you can present a case thatthe average juror will understand. Second,you need not include eac h and everyvictim. More than likely, the majority ofthe scheme can be proven through ahandful of victims. Use your bestwitnesses. Often these are people whoretained investment contracts theyexecuted with the targets or whoremember specific misrepresentations.The details regarding the other victimscan be saved for the sentencing phase.Third, you need not endeavor to disprovethe m yriad of mis repre senta tions m ade tothe victims. Prime bank schemes are oftenbased on a series of misrepresentationsthat seem, at least to the investors at thetime, to have some basis in reality. Youare better off focusing on the materialmisrepresentations that establish thenature of the scheme than disproving eachof the various ancillary

misrepresentations. Proving that thesubject did not invest investor funds, butinstead spe nt for h is pers onal b enefit, iseasier than disproving a tale about theWorld Bank, the IMF, or the yield onprime bank notes from an emergingnation. In short, do not argue on thedefendant’s terms. Just show that thedefendant did not invest the money aspromised.

• Get a financial analyst assigned to thematter: Reac hing o ut and utilizing the fullrange of tools available to a prosecutorcan go a long way towards turning aninvestigation into a prosecutable case.Having an FBI Financial Analyst (FA)assigned early in the investigation canhelp in a number of ways. First, an FA canreview the pages and pages of bankrecords and determine how the subjecttransf erred , conc ealed and e ventu allyspent the victim’s invested funds. Second,in many of these cases, che cks and wiretransfers go back and forth between theaccounts of targets, investor-victims, andbrokers who bring victims into thescheme. A thorough review by an FA canhelp determine who’s who. Further, anearly r eview will mo st likely u nearthadditional victims, either because theysent funds into a target’s account orbeca use th ey rec eived lulling p aym entsfrom the target's accounts. Interviews ofthese witnesses may yield additionalcounts of fraud and money launderingpursuant to 18 U.S.C. §§ 1956 (lullingpayments) and 1957 (spending ofproceeds from a “specified unlawfulactivity”). Third, the FA will generally beable to identify additio nal ba nk ac coun tsinto which the subject is secretingproceeds. Such information will provideadditional accounts to subpoena, includingforeign accounts of which you may nothave known. Identifying the foreignaccounts as early as possible is importantbecause of the time involved in attemptingto obtain that information.

• Get M LAT s out e arly : If you anticip ate


needing evidence from abroad, youshould contact the Office of InternationalAffairs (OIA) in Washington, D.C. at(202) 514-0000 to initiate the stepsnecessary to obtain such information. TheUnited States has Mutual LegalAssistance Treaties (MLAT) with manynations, establishing a framework forobtaining evidence from another country.For those countries with which we haveno MLAT in force, OIA can advise youon the appro priate m eans by w hich toobtain the requested information. OIAwill provide you with a format-request foryour particu lar cou ntry, w hich y ou w illneed to complete and return to OIA.ML ATs can b e used to obta inauthenticated foreign documents andtestimony abroad, execute searchwarra nts, and s eize fun ds.

• Get started soon:

Once OIA has forwarded your request onto the foreign country, the requestedevidence can take months to arrive. Asdiscussed above, ban k security officerscan often tell you if an account is activeand if th ere ar e fund s in the a ccou nt.Obtaining this information throughinform al cha nnels can h elp de termin e ifyou need to wait for a response to anMLAT request. In the meantime, you mayreceive the collateral benefit ofenco urag ing the foreig n auth orities toopen their own investigation, which maylater provide you with an invaluable levelof cooperation.

• Don’t go it alone: Coor dinatin g withother agen cies ca n sav e time a nd eff ort.While you must be mindful of the non-disclosure obligations of Rule 6(e),working with the SEC, IRS, NASD, andother federal and state regulatory agenciescan save a great deal of time. Theseagencies and regulators may haveinvestigations underway and may havecollected useful information about yourtargets as well as potential victims. Oftenvictim s com plain to the SE C or th eirparticu lar state regula tor, an d, as a r esult,

civil enforcement actions may already beunderway. W orking with the regulatorsand o ther ar ms o f law e nforc eme nt isalways preferable to working at crosspurposes. Additionally, civil cases mayalready be in the works. Not knowing thefull sco pe of th e scam , victim s often retainlawyers to pursue civil claims for breachof contact. These civil attorneys can alsobe a useful source of information. Finally,requesting information from FinCEN andthe IR S ma y also prov e to be usefu l.

• Helpful websites: A number of websitescan be consulted in investigating a primebank schem e. Two of the mo st useful arethe Treasury Dep artment’swww.treasurys cams.gov and the SEC’swww.sec.gov/divisio ns/en force /prime bank .shtm l, bothof which list numerous other very helpfullinks.

• Don’t reinvent anything: More thanlikely, the target is operating in a similar,if not identical, manner to that of anumber of other prime bank scammers.Consulting with other prosecutors whohave handled these types of cases maysave you time and effort. Furthermore,these prose cutor s can p rovid e you withmaterials such as sample indictments andsearch warrant affidavits. The FraudSection, Criminal Division, in WashingtonD.C., (202) 514-7045, also has someguidan ce ma terials.

VI. Countering defenses - "It wasn’t me"

Echo ing the lyrics o f a rec ent reg gae-p op hit,when caught red-handed, even on camera,defend ants will of ten claim simply "I t wasn’ t me."The participants and funds of a particular primebank schemes are often intertwined with otherschemes. For the target or targets to send fundsback and forth to other brokers or "traders" whoare running similar scheme s either in this countryor offshore is not uncommon. Those brokers ortraders often return the favor. The precise reasonfor the se inter ming led tran sactions is no t entirelyclear, b ut it doe s mak e tracin g fun ds m ore dif ficultand sometimes gives defendants a built-in defense.


Defendants m ay claim that they sent an investor’smoney to Mr. X on the Isle of Man, and thus, likeeveryo ne else, w ere foo led by M r. X, i.e., "itwasn ’t me."

On March 15, 2001, in a case prosecuted byAUSA Linda M. Betzer of the Northern Districtof Ohio and Fraud Section Trial Attorney Glen G.McGorty of the U.S. Department of Justice,defendants Geoffrey P. Benson, Susan L. Bensonand Geoffrey J. O’Connor were found guilty oftwenty-one counts including conspiracy, mail andwire fraud, and tax evasion. Th e defendants werethe former operators of The Infinity GroupCom pany (“ TIGC ”), whic h collecte d over $ 26.6million from over 4,400 victim investors acrossthe country over a one and one-half year period.Through their Financial Resources newsletter, thedefendants prom ised investors up to 181% returnon their money, depending on the principalinvested. The defendants claimed successfulinvestment experience and business associationswith individuals providing access to prime bankprograms “ordinarily unavailable to the individualinvestor.” The defendants promised the victims that their money would be pooled to purchase“prime bank instruments” in the European marketwith high guaranteed rates of return.

In reality, the defendants sold no product andoffered no service. They had no investmentexpe rience , nor d id they have any succe ss with“prime bank investm ent” programs in Eu rope. Intypica l Ponz i/pyramid sc hem e fash ion, the y paidsome investors in TIGC’s “Asset EnhancementProgram” with money collected from newinvestors, but the great majority of victims neverreceived any money back from TIGC. In 1997 theState of Ohio, Department of Commerce, Divisionof Securities, and the federal Securities andExchange Commission halted the TIGCoperations, resulting in a court-ordered injunctionof TIGC’s sales activities. Of the $26 millioncollected by the defendants, a court-appointedtrustee and forensic accountant collected almost$12 m illion in a ssets, w hich w as sub sequ entlyreturn ed to th e victim s. The allege d inve stmen tsyielded no profits for the investors for over a yearand a half, though TIGC allegedly sentapproximately $11 million out of the $26 million

to “investment programs” run by GeoffreyBenson’s associates located around the world.

Thou gh the defen dants did no t testify a t trial,their attorneys argued through governmentwitne sses a nd ex hibits th at the $ 11 m illion sen t tothese prog rams was e viden ce tha t the de fend antsbelieved the money they solicited from theinvestors was being invested in the prime bankprog rams they p romo ted in th e new sletters . Thisdefense attempted to convince the jury that thedefendants were themselves victimized byBens on’s a ssocia tes and that the y we re actin g ingood faith in operating TIGC’s AssetEnha ncem ent Pr ogram. To refute this arg ume nt,the go vern men t dem onstra ted tha t the on ly asse tsthe defendants enhanc ed were their own. A s partof its case, the government called several exp ertwitnesses, including an expert on internationalbanking, who testified that the prime bankinstruments and programs promoted by thedefendants do not exist. The governmenthighlighted the fact that only part of the receivedfunds were invested, while the balance was placedin offshore bank acco unts o r used by de fend antsto purchase an eighty-six acre plot of lakefrontproperty, build a multi-million dollar home, andpay for many personal expenses. Thegovernment’s fraud case focused on themisrepresentations contained in the FinancialResources newsletters. In these monthly mailings,the de fend ants n ot only lured in vesto rs withguarantees of high returns, but also lulled them byclaiming successful investments and even startinga grant program us ing the “profits” of the trust’sinvestments abroad. Over the period of the AssetEnhancement Program, TIGC’s alleged $11million investments yielded no profits — a clearinconsistency with what TIGC told its investors.The governm ent succeeded in conv incing the juryto focus on these lies and to understand that TIGCnever intended any monies sent to its businessassociates to return a profit, but rather only to behidden from a ny futur e investig ating auth ority.

The jury found that the defendants were notvictim s as the y claim ed, bu t were guilty o n allcharg ed co unts. G eoffr ey Be nson was u ltimate lysente nced to 360 mon ths' inc arcer ation, w hileSusan Benso n and Geoffrey O'Connor eac h were


sentenced to 121 m onths' incarceration. All wereordered, jointly and severally, to pay $12,975,341in restitution. All of the sentences reflectedguideline enhancements for a fraud loss of over$20 million, more than minimal planning, massmarketing, violation of a judicial order, use ofsophisticated means, and obstruction. GeoffreyBenson's sentence also reflected enhancements forhis leadership role, an offense affecting a financialinstitutio n, and abus e of a p osition of trus t.

Defeating this defense and proving intent canbe accomplished in a number of ways. First, oneof the proactive approaches discussed above canbe used. After a target is put on notice by thegovernment that prime bank trading programs donot exist and that claims to the contrary would befalse, s ubse quen t involv eme nt by th e targe t wou ldnot surv ive the "I too was du ped de fense."Seco nd, cir cum stantial e viden ce can be u sed toestablish intent. In most cases, an analysis by theFA will be able to show that a majority ofinvestors’ money did not go directly to the so-called "bigge r fish," b ut inste ad w ent to a ccou ntscontrolled by the target(s). Moreover, the amountof money sent to these other traders/brokers, theso-called "bigger fish," rarely coincides with theamo unts in veste d. The lulling p aym ents se nt toother investors as interest also demonstrate intentsince the fraudster misrepresents the true source offunds, i.e., fellow investors. Intent can also becircumstantially proven through evidence of thedefendant’s conscious avoidance of variousindicia of fraud or red flags associated with primebank schemes. Third, experts can help show thatthe representations made to investor/victims werefalse o n their f ace and tha t the ling o use d toinduce investors was made from whole cloth.United States v. Robinson, No. 98 CR 167 OLC,2000 W L 65239 (S.D .N.Y. Jan. 26, 2000),contains a discussion of the use of an expert in aprime b ank ca se.

Among government officials who havetestified as experts in such cases are JamesKramer-Wilt (Department of Treasury, Bureau ofPublic Debt (304) 480-8690); Bill Kerr (Office ofthe Comptroller of Curren cy (202) 874-44 50);Herb Biern and Richard Small (Federal ReserveBoard (202) 452-5235). There are also a number

of priv ate pe rsons who prov ide ex pert tes timon y inthese ca ses, e.g., John Shockey (retired OCCofficial (703) 532-0943); Professor James Byrne(George Mason University Law School (301) 977-4035); and Arthur Lloyd (retired Citibank seniorcounsel (802) 253-4788). In addition, JenniferLester of the International Monetary Fund (202)623-7130 and Andrew Kircher of the World Bank(202) 473-6313 may be able to provide assistance.

VII. Dealing with uncooperative victims

Unlike victims of some other crimes, victimsof prime bank schemes often do not know or wantto believe that they have been scammed. Oftenfraudsters have told them up front not to believethe government. Some prime bankvictim /inves tors m ay, at le ast initially , refus e tocoope rate with a gents or prosec utors.

Man y victim/in vestors are "true b elievers,"who have receiv ed "inte rest pa yme nts" in a timelyfashion and are often talked into "rolling over" or"reinvesting" their principal. While much of theprincipal has been secreted aw ay by the fraudster,true be lievers rema in con vince d (or w ant toremained convinced) that the "high yield primebank market" does exist and that their proverbialship has come in. This belief, coupled with thenon- disclo sure, s ecret n ature o f the inv estme nt,prevents them from cooperating with theinvestigation, their reasoning being: "why riskbreaching the non-disclosure provision of thecontract by talking to the governmen t when I’mgetting paid?"

Most investors have been told that thegovernment will deny the existence of the"programs," and that speaking to an FBI agent orother government agent will jeopardize the successof the secret programs, as well as bar them fromany future opportunity to invest in these tradingprogra ms.

However, some investors may recognize thePonzi scheme but want it to continue for just a fewmore payment periods so they can get their moneyback. These investors have little interest in seeinga speedy investigation and wo uld rather be leftalone so that they can get their money o ut beforethe roof caves in.

Dealing with each of these types o f investors


can be difficult. However, being forewarned thatyou may encounter some of them will allow youto plan ahead. In our experience, a few low keymeetings or phone calls from the agent will allowat least the first two categories of witnesses timeto com e to grip s with r eality. If they re mainunco oper ative, s imply mov e on a nd co ncen trateon counts centered around more helpful witnesses.

VIII. Conclusion

Over the past decade, prime bank schemeshave proven to be an incredibly durable form ofPonzi scheme by being able to adapt to changingconditions and obstacles. We can expect thescheme to continue to m orph into whatever formnecessary in an attempt to lure victims and evadedetection. A vigorous and coordinated effort onthe part of federal and state law enforcement andregulato ry agen cies is clea rly need ed. �

ABOUT THE AUTHORS

�Joel E. Leising is a Senior Trial Attorney in theFraud Section of the Criminal Division. He hasinvestigated and prosecuted a number of primebank cases in the past. He is a member of theSteering Committee of the Combating Prime Bankand Hi-Yield Investment Fraud Seminar of GeorgeMason University Law School, and has been aspeaker at the Seminar’s annual meetings.a

�Michael McGarry has b een a trial attor ney inthe Fraud Section of the Criminal Division since2000. His casework includes matters involving"Prim e Ban k" or "H igh Y ield Ins trume nt"investment schemes. Prior to joining theDep artme nt, M r. Mc Garr y wo rked in priva tepractice in the New York office of Fried FrankHarris Shriver & Jacobson for five years where heworked on large white collar criminal andregulator matters. Mr. McGarry has writtenarticles published in newspapers and journals onmoney laundering regulation and procurementfraud.a

Prosecuting Corporations: TheFederal Principles and CorporateCompliance ProgramsPhilip UrofskySenior Trial AttorneyFraud Section

Increasingly prosecutors m ust decide whether,in specific cases, a corporation should beprose cuted for crim es com mitted by on e of itsofficers, employees, or agents. Since 1999, theDepartment’s Principles of Federal Prosecutionof Corporations have provided a framework formaking this decision and hav e identified factorsrelevant to the determination. In the end, howeve r,as in every criminal case, the essential question

remains: should this corporation be prosecuted forthis cond uct?

I. Corporate cr iminal liability

Every law student learns early on of theconcept known as the “legal person,” i.e.,corp orations. In la w sch ool, w e are ta ught th at tohave a legal personality means that a corporationcan be served w ith process and sued for tortdamages and in contract disputes, and that thecorporate form protects individual shareholders,including other legal persons, from liability exceptin those limited circumstances in which the“corporate veil” can be pierced. H owever, therewas little discussion as to what the consequences


of having a legal personality might mean in thecrimin al law c ontex t.

The b lack le tter law in this ar ea is fa irlysimple. A corporation, having been granted legalpersonality, may be prosecuted to the same extentas a natural person. For the most part, federalcriminal statutes make no special provision forcorporations and simply assume that the sameprohibitions applicable to natural persons areapplic able to corpo rations. To th e exte nt that th isapproach is vague, the first section of theUnited States Code, the “Dictionary Act,” whichprovides “the words ‘p erson’ and ‘who ever’include corporations, companies, associations,firms, partnerships, societies, and joint stockcompanies, as well as individuals,” resolves anyambiguity. 1 U.S.C. § 1. Particular statutes thatfind it necessary to be more explicit define thelegal person extremely broadly orcom preh ensiv ely. Fo r instan ce, for all offe nses inTitle 18, a statutory definition provides: “As usedin this title, the term ‘organization’ means aperso n othe r than a n indiv idual.” Altern atively , inthe Fo reign Corr upt Pr actice s Act, a perso n isdefined as a natural person or “any corporation,partnership, association, joint-stock company,business trust, unincorporated organization, orsole proprietorship.” See 15 U.S.C. §§ 78dd-1(g)(2). On the other hand, Congress has provideda narr owe r defin ition w hen n ecess ary toimplement the specific goals of a particularstatute. See, e.g., 15 U.S.C. 78c(8) (defining“issuer” for purposes of the Securities ExchangeAct of 1934 as only those “persons” who hadissued or proposed to issue secu rities).

Obviously, a corporation, despite its legalpersonality, acts only through natural persons —its offic ers, dir ectors , emp loyee s, age nts, an d, incertain circumstances, its shareholders — orthrough its subsidiaries, as well as the naturalpersons affiliated with them. In the former case,the law imposes what is essentially strict liability:a corporation is liable for the acts of a naturalperson acting within the scope of his or her dutiesand, at least in part, for the benefit of thecorpo ration. See United States v. AutomatedMedical Laboratories, 770 F.2d 399 (4th Cir.1985 ); Unite d State s v. Cin cotta , 689 F.2d 238(1st Cir. 1982). In the latter case, the parent

corporation can only be held liable for the acts ofits subsidiary or affiliate if it directed, ordered, orcontrolled the subsidiary’s violation of the law.See United States v. Bestfoods, 524 U.S. 51, 52(1998) (stating that “the corporate veil may bepierced and the shareholder liable for thecorpo ration’s c onduc t when , inter a lia, thecorp orate f orm w ould o therw ise be m isused toaccomplish certain wrongful purposes, mostnotably fraud, on the shareholder’s b ehalf.”);Chica go, M . & St. P .R. Co . v. Min neap olis Civ icand Commerce Assn., 247 U.S. 490, 501 (1918)(finding that the corporate veil may be piercedwhen subsidiary com pany is used as a “a m ereagency or instrumentality of the owningcom pany ”). Th ese ru les app ly wh ether o r not aparticular statute refers to parent corporationliability. See United States v. Sutton, 795 F.2d1040, 1059 (Te mp. Emer. Ct. Ap p. 1986).

In most cases, the liability of the corporationfor the acts of a corporate agent is not a matter oflaw but of prosecutorial discretion. As discussedbelow, charging a corporation is often justifiedand a ppro priate. O n the o ther ha nd, the fact tha t acorporation is technically subject to strictrespondeat superior for the acts of its employees,even if contrary to the corporation’s policies andinterests, requires a prosecutor to examinecarefully the equities of charging a corporationunder the specific circumstances presented by aparticular case.

II. The principles of federal prosecution ofcorporations

The “Holder memo” of June 16, 1999 setforth th e Dep artme nt of Ju stice’s policy in thisarea through the Principles of FederalProsecution of Corporations. See BringingCriminal Charges Against Corporations (lastmodified Ma rch 9, 2000) <http://w ww. usdo j.gov/c rimina l/fraud/policy/Chargingcorps.html>. ThesePrinciples, which were modeled on the familiarPrinciples of Federal Prosecution in theUnited States Attorney’s Manual, § 9-27.000, arenon-binding and are intended to guide aprosecutor in the exercise of his or her discretion,not to mandate a specific outcome in a particularcase. They do, ho wev er, list fac tors tha t will helpa prosecutor evaluate the appropriateness of


criminal charges and weigh the merits of theinevitable arguments by corporate defense counselthat his client was merely the victim of the acts ofa “rogue employee” or, having already reformeditself, has no need of the corrective whip of acriminal prosecution.

The single over-arching principle governingcharging corporations, as set forth in thePrinciples, is wor th quo ting in fu ll:

Corporations should not be treatedleniently because of their artificial nature,nor should they be subject to harshertreatment. Vigorous enforcement of thecrimin al laws again st corp oratewron gdoe rs, wh ere ap prop riate, re sults ingreat benefits for law enforcement and thepublic , particu larly in th e area of wh itecollar crime. Indicting corporations forwron gdoin g ena bles th e gov ernm ent toaddress and be a force for positive changeof cor pora te cultu re, alter corpo ratebehavior, and prevent, discover, andpunish white collar crime.

Corporate Prosecutions Principles at § I.A.However, “charging a corporation . . . does notmean that individual directors, officers,employees, or shareholders should not also becharg ed. Pr osec ution o f a cor pora tion is n ot asubs titute for prose cution of crim inally c ulpab leindividuals within or without a corporation.” Id. at§ 1.B.

Initially, prosecutors, in determining whetherto charge a corporation, should ap ply the factorsset out in the Principles of Federal Prosecution,such as sufficiency of the evidence, likelihood ofsucces s, and pr obable deterren t effect. Id. at § II.A(citing USAM § 9-27.220-27.260). When acorporation is the putative defendant, additionalfactors become relevant because of the artificialnature of the “legal person.” As set forth in theCorporate Prosecution Principles, these factorsare:

• The nature and seriousness of the offense,including the risk of harm to the public,and a pplica ble po licies an d prio rities, ifany, governing the prosecution ofcorporations for particular categories ofcrime;

• The p ervas ivene ss of w rong doing withinthe co rpora tion, inc luding the co mplic ityin, or condonation of, the wrongdoing bycorp orate m anag eme nt;

• The corporation’s history of similarcond uct, inc luding prior c rimina l, civil,and regulatory enforcement actionsagain st it;

• The corporation’s timely and v oluntarydisclo sure o f wro ngdo ing an d itswillingness to cooperate in theinves tigation of its ag ents, in cludin g, ifnece ssary , the w aiver o f the co rpora teattorney-client and work productprivileges;

• The existence and adequacy of thecorporation’s compliance program;

• The corporation’s remedial actions,including any efforts to implement aneffective corporate compliance programor to improve an existing one, to replaceresponsible management, to discipline orterminate wrongdoers, to pay restitution,and to cooperate with the relevantgovernment agencies;

• Collateral consequences, includingdisproportionate harm to shareholders andemp loyee s not p rove n pers onallyculpable; and

• The adequacy of non-criminal remedies,such as civil or regulatory enforcementactions.

Id. at II.A (citations omitted).

Although some of these factors appear self-explanatory, the Principles provide additionalguidance and discussion in subsequent sections,and the reader is encou raged to review these.

III. Attorney-client privilege waivers

A co rpora tion’s w illingne ss to w aive itsattorney-client and work product privileges maybe taken into account in evaluating a corpo ration’scoope ration. See id. at II.A(4) and VI(A & B).Perhaps no aspect of the Corporate ProsecutionPrinciples has caused more consternation in thedefen se bar than th is simp le statem ent. Th is


section has resulted in denunciations of thePrinciples as dem onstra ting the Dep artme nt’s fu ll-bore attack upon the atto rney -client p rivilege , itsdenigration of the important role played bycorporate counsel, its attempt to override theSentencing Guidelines, and its disregard for ournation’s firmly em bedde d rights an d liberties. See,e.g., Conference Rep. on 15th Ann. Natl. Inst. onWhite Collar Crime: DOJ Guidelines onCorporate Waivers of Attorney Client PrivilegeDraws Criticism, 68 Crim. L. Rep. 563 (Mar. 28,2001) ; Loom is, Privilege Waivers: ProsecutorsStep Up Use of Bargaining Chips, N.Y .L.J (S ept.9, 2000 ) at 5; Am erican C orpora te Coun sel Assn .,Letter to Hon. Eric Holder, Deputy AttorneyGen eral (dated May 12, 2000)<ww w.ac ca.co m/gc advo cate/a dvoc acy/h older .html>; Brec kinridge Willcox , Attorney ClientPrivilege Waivers: Wrongheaded Practice?, 6 No.12 BUS. CRIMES BULL., Jan. 2000 at 1. Thesegroups predict a parade of horribles arising fromthe suggestion that a waiver may sometimes beappropriate, including that corporations will nolonger seek advice of counsel and will excludecounsel from corporate deliberations, and thatcoun sel will n ot me moria lize the ir advic e or w illdestro y note s of m eeting s and intervie ws to a voidhavin g to pro duce them at som e later d ate tocom ply w ith a co rpora te coo peratio n agre eme nt.

The reaction to Corporate ProsecutionPrinciples’ statement on waiver of the privilegehas been overblown. The Principles do no morethan acknowledge an existing practice that haslong been used by the defense bar and pro secutorsacros s the co untry . A pro secu tor ma y requ est awaiver when necessary to enable him or her: (1)to determine the completeness o f the corporation’sdisclosure; (2) to evaluate the accuracy of thatdisclosure; (3) to identify potential targets andwitne sses; a nd (4 ) to obta in evid ence to use in itsinvestigation and any resulting prosecution. ThePrinciple s do no t require, o r even e ncour age, aprosecutor to seek a waiver in all circumstances,and they make it absolutely clear that suchwaivers are not absolute requirements forcoope ration. Corporate Prosecution Principles atVI.B.

How ever, such waiv ers ar e som etime s critica l,and the Principles acknowledge the importance of

such waivers in evaluating a corp oration’scooperation. The reason s why such w aivers aresometimes necessary are not hard to discern, and,indeed, some are even tacitly acknowledged bymembers of the defense bar. For instance, as notedby, Breckinridge Willcox, former United StatesAttorney for the District of Maryland,“Cor pora tions o n occ asion have mad e care fullyconsidered strategic decisions to produce some ofthis material to the prosecutors, often preceded bya plan to minimize or to shape the work productthat may later be dis closed.” Supra (emp hasisadded). This is precisely the evil that thePrinciples seek to avoid. A corporation that seeksleniency must be fully forthright. It cannot pickand choose which crimes it will admit or againstwhich employees it will provide evidence. Eitherit cooperates or it does not; no middle-groundexists.

The corporate bar’s reliance on the absence ofa waiver requirement from the SentencingGuideline’s definition of a corporation’scoope ration, see U.S.S.G. § 8C2.5, demonstrates afundamental misunderstanding of the purpose ofthe Corporate Prosecution Principles. Althoughthe Sentencing Guidelines clearly enco urage self-reporting and cooperation, they apply only when acorporation has already been charged andconv icted. T hus, th ey ha ve no releva nce todetermining whether that corporation should becharged in the first place. Section 8C2.5 permits acourt to mitigate a convicted corporation’spunishment in recognition of its cooperation. TheGuidelines, however, do not attempt to limit thescope of a cooperation a corporation may orshou ld pro vide to the go vern men t.

The Principles, on the other hand, areexplicitly intended to guide a prosecutor’sdiscretion in determining whether or not to bringcharges against a corporation. The criticaldistinction at work here is between leniency at thecharging stage and mitigation at the punishmentstage. A corporation, in approaching thegovernment and offering to cooperate, is askingthat the government refrain from charging it forthe crimes it admits to committing. This is notsom ething whic h a co rpora tion ca n auto matic allyearn simply by coming to the government in thefirst pla ce. To echo John Hou sema n in tha t old


Smith Barney ad, a corporation that hascom mitted a crim e is not entitled to lenie ncy; itmus t earn it.

One way that a corporation may earn leniencyis by fully cooperating with the government bynot ho lding b ack a ny rele vant in form ation in itspossession. Contrary to the corporate defensebar’s assertions, the Principles do not authorize orencourage a prosecutor to trespass in the defensecamp. Indeed, the Principles clearly state tha t,whe n a pro secu tor req uests a waiv er, “[t]h iswaiver should ordinarily be limited to the factualinternal investigation and any contemporaneousadvice given to the corporation concerning theconduct at issue. Except in unusual circumstances,prosecutors should not seek a waiver with respectto com mun ication s and work prod uct rela ted toadvice concerning the government’s criminalinvestigation.” Corporate Prosecution Principlesat VI.B. n.2 (emphasis add ed).

It is highly unlikely that the possibility of afuture waiver will result in the host of problemspredicted by the corporate bar, even if waiverswere routinely requested. Corp orations areunlikely to avoid seeking legal advice for fear ofhaving to disclose it down the road. Only a foolishcorp orate b oard wou ld cho ose to proce ed blin dlydown complex regulatory and legal paths in thehope that its employees would manage either notto viola te the law or no t to get ca ught d oing it.Further, discerning what advantage a corporationwould obtain by excluding lawyers from meetingsconc ernin g com plianc e issue s is diffic ult.Assuming that the corporation wishes to obey thelaw, someone will presumably have to advise it onhow to do so. The advice received, if it came froma non -lawy er, wo uld be disco verab le in bo thcriminal and civil proceedings and would not evenprovide the cloak of an advice of counsel defense.Finally, as former Assistant Attorney General forthe Criminal Division, James Robinson noted,“[H]a ving be en a co rporate attorney myse lf, Idoubt that any competent and ethical attorneywou ld des troy re cord s or atte mpt to give a dvice ina complex area based solely upon his recollectionof inter view s and mee tings sim ply to a voiddiscovery.” Reader Offers Some Clarifications ofPrnciples of Federal Prosecution of Corporations,7 No. 4 BUS. CRIMES BULL., May 2000 at 3.

IV. Compliance programs

In talking with an attorney representing acorpo ration in a c riminal inv estigation, aprose cutor will inev itably h ear the talisma nicphra se, “ro gue e mplo yee.” Corp orate c ouns el willargue that, although, in the words of formerPreside nt Reag an, “m istakes w ere ma de,”charg ing the corpo ration , even if it is tech nicallyliable, for the acts of one or more rogueemp loyee s who were acting again st corp oratepolicy and w ithout th e app rova l of suf ficientlysenior management is not appropriate. In makingthis argument, corporate counsel will point to theexistence of a corporate compliance program asevidence of the corporation’s efforts to be a law-abiding corporate citizen.

Such arguments should not be dismissed outof hand. The rogu e employee is truly a rareanimal, but, as the Corporate ProsecutionPrinciples recognize, the existence or the remedialimplementation of a corporate complianceprogram are only relevant factors in determiningwheth er to cha rge a co rporation . Corp orateProsecution Principles at II.A(5 & 6). Acorp oration sho uld be perm itted, in m ost cas es, toattempt to demonstrate to the prosecutor’ssatisfaction that the wrongdoer was truly on a“frolic,” such that the corporation should not beheld lia ble for his or h er con duct.

What, then, is a corporate complianceprog ram? For th e mo st part, e ach p rogra m istailored to the lines of business and organizationalstructure of its corp oration. G enerally , howe ver, acompliance program is a corporate policy,togeth er with imple men ting m echa nism s, that isintended to detect and deter, and if possible,prevent altogether, wrongful conduct by acorporation’s employees and agents. Althoughparticular programs may vary depending upon thesize and complexity of the corporation,compliance programs will include, at a minimum,the following components: (1) a designatedcompliance officer or department, which may ormay not be within the general counsel’s office,that is charged with monitoring complianceissues, conducting or reviewing due diligence onbusiness opportunities, and investigating allegedwron gdoin g; (2) a training prog ram to educ ateemp loyee s and agen ts con cernin g corp orate


policies and applicable laws, rules, andregulations; and (3) a mechanism for reportingwrongdoing to management or the Board ofDirectors for appropriate action. The programshould be designed to detect “red flags,” whichwould indicate the potential for running afoul ofthe law and provide appropriate mechanisms forinvestigation.

Whether a corporation has a complianceprogram and whether it is effective is relevant atthree stages of a prosecution: charging, pleanegotiations, and sentencing. As noted, theCorporate Prosecution Principles specif icallyrefer to com plianc e prog rams as a fa ctor indetermining whether to cha rge a corporation. Inadditio n, a pro secu tor wh o has alread y dec ided tocharge or has obtained an indictment of acorporation, may wish to impose compliancerequ ireme nts in a c orpo rate ple a agre eme nt.Finally , the Se ntenc ing G uidelin es spe cificallyrefer to the existence of a compliance program asone factor in determining whether to reduce acorpo ration’s s entenc e. See U.S.S.G . § 8C2 .5(f).

At the charging stage, which is the focus ofthis artic le, sev eral fa ctors a re wo rthremembering. First, the Department, as a whole,encou rages se lf-policing . Corporate ProsecutionPrinciples at VI.A. Of course, committing nocrime is better than seeking forgiveness for onelater. Second, the existence of a complianceprogram, whether adequate or not, is not, in and ofitself, sufficient to prevent a corporation frombeing charged for criminal conduct by its officers,directors, employees, or agents, nor is it a legaldefens e. Id. Indeed, the fact that a crime wascommitted, notwithstanding the existence of acompliance program, may call into question theadequacy of the pro gram or the corpora tion’scommitment to compliance. Third, although theexistence of compliance programs is a factor inthe charging decision, no uniform Departmentpolicy on the weig ht that m ust be acco rded thiselement exists. For instance, although theAntitrust Division, as a matter of policy, will notconsider compliance programs in determiningwhether to bring charges, it neverthelessencourages corporations to implement suchprograms to detect wrongdoing early enough for

the corporation to take advantage of the AntitrustDivision ’s amn esty pro gram . Id.

In evaluating a corporation’s plea for leniencybased on the existence of its compliance program,i.e., that it had a stated policy against the wrongfulconduct and a program to detect, deter, andprev ent su ch co nduc t, the pro secu tor sho uldapproach the issue in three stages: threshold,substantive, and retrospective.

First, at the threshold level, the prosecutorshou ld ask : Is the nature of the crime, or thecorporate conduct that led to it, such that little orno w eight s hould be giv en to th e existe nce o f acorporation’s compliance program? Somecrimes, for whatever reaso n, simply requireprosecution, and the prosecutor need not engagein a pointle ss exerc ise. See Corporate ProsecutionPrinciples at II.A(1) and III. For other crimes, theprosecutor should first attempt to determine thepervasiveness of wrongdoing within thecorp oration and the inv olvem ent of m anag eme nt.See id. at II.A(2) and IV. Obviously, if theconduct was a tacitly accepted common practicewithin the corporation as a whole, or within therelevant business unit, the corporation was notcom mitted to com plianc e and shou ld get n o cred itfor a paper compliance program. Similarly, if thecorp oration’s m anag eme nt, wh ich is ultim atelyrespo nsible for the corpo ration ’s con duct, n ot tomention implementing and monitoring anycom plianc e prog ram, p articipa ted in th e con duct,the compliance program cannot be deemed to betrue expression of corporate po licy. Indeed, wherecorporate manag ement is involved, further inquiryis usually u nnece ssary.

Othe r facto rs that a re rele vant a t this thre sholdlevel include the corporation’s prior history ofsimilar conduct and whether it was prosecuted, orotherw ise sanc tioned, fo r such c onduc t. See id . atII.A(3) and V. For som e crimes, a corporation’sremed ial actions m ay be re levant. See id. atII.A(6) and VIII. For instance, in the context ofenvironmental crimes, the Environmental andNatural Resources Division places a premium on acorporation’s willingness promptly to implementvoluntary remedial clean-up and decontaminationefforts. Finally, the corporation’s self-reporting ofthe w rong ful con duct a nd its w illingne ss to


cooperate in the governm ent’s investigation arerelevan t factors. See id. at II.A(4) and VI.

If the c orpo ration surm ounts this thre sholdevalu ation, th e nex t step is to cond uct asubstantive review of the corporation’scom plianc e prog ram a nd to a sk: Does a truecorp orate com mitme nt to co mplia nce e xist? Inpractic e, this m eans giving the co rpora tion an d itsattorneys an opportunity to persuade you that theprogram is not merely a paper program — that thecorporation really means what it says and is, andhas been, willing to back it up with resources andcommitment. In evaluating this claim, theprosecutor should evaluate whether: (1) theprog ram is an off -the-s helf pr ogram or isspecifically tailored to detect and deter conductwithin this corporation; (2) the corporation hasdevoted sufficient resources, including audit andinves tigative staff; (3 ) it has c ondu cted a dequ ateand periodic training; (4) it provides for reportingto the highest levels of management; and (5) it hasimposed discipline upon officers, employees, andagents found to have violated its compliancepolicies.

Finally , havin g revie wed the spe cificcom plianc e prog ram, th e pros ecuto r shou ldcond uct a re trospe ctive re view and a sk: If theprogram was properly designed, supported bycorp orate man agem ent, an d pro perlyimplemented, what went wrong? Thecorporation’s easy answer at this stage, of course,will be that this was a rogue employee whoignor ed the corpo ration rules a nd pr oced ures. F airenou gh, if tru e. The prose cutor , how ever, shou lddemand that the corporation demonstrate someevidence that the so-called rogue employeedeliberately evaded the safeguards imposed by thecompliance program and that the corporation wasnot pu t on no tice of th is con duct in time toprevent the wrongdoing. For instance, theprosecutor should inquire w hether any calls weremade to the compliance program’s “hot line” orwhether any audit uncovered unexplained orunauthorized transactions. Did the corporationconduct adequate due diligence and did it followup on red flags? Did the program provide forongoing due diligence and monitoring, such as byperiodic audits, and did the corporation conductsuch continuing due diligence in this instance?

Finally , as a re sult of d iscov ering this con duct,albeit perhaps too late, has the corporationidentified gaps in its compliance program, and hasit taken steps to close those gaps?

The bottom line comes back to the very firstques tion in th e thres hold s tage o f the re view : Doesthis corporation need to be charged? It may bethat the crime or underlying conduct was notenough for the prosecutor to dismiss the relevanceof the compliance program out of hand, but, afterhearing the corporation out, the prosecutorremains unconv inced that the corporation’scompliance program, even if coupled with otherfactors such as cooperation and remediation,justifies not charging it for the crime. In suchcases, the corporation shou ld be charged, and thecorporation will receive credit for its complianceprogram at sentencing.

V. Conclusion

Corporations are valid targets of criminalinvestigations and valid defendants in criminalprosecutions. An appro priate prosecution of acorp oration ma y serv e the g oals o f both specif icand ge neral de terrence , i.e., it may deter th iscorporation (and its employees) from continuingto commit the same crime in the future, and it maypersuade other corporations not to start. Such aprosecution may be necessary to change a corruptcorporate culture or to remove corruptmanagem ent from an otherwise clean company. Inthe end, the decision whether to charge is that ofthe prosecutor. The Corporate ProsecutionPrinciples help provide a framework within whichto make this decision.�

ABOUT THE AUTHOR

�Philip Urofsky is a Sen ior Tria l Attorn ey w iththe Cr imina l Divisio n’s Fr aud S ection . He isresponsible for the investigation and prosecutionof violations of the Foreign Corrupt Practices Actand other white collar crime offenses andparticipates as one of the United States’designated experts in the Organization forEconomic Cooperation and DevelopmentWorking Group on B ribery’s peer review process.Mr. Urofsky was also the principal drafter of theFederal Principles of Corporate Prosecution and


often acts as an adviser on attorney-client andcorporate criminal responsibility issues.a

Ex Parte Contacts with CorporateEmployeesEdward I. HagenAttorney-Advisor and Assistant DirectorPublications UnitNational Advocacy Center

I. Introduction

Difficult ethical issues arise in cases where acompany that is the subject of a criminalinvestigation seeks to extend the coverage of theattorney-client privilege to cooperatingemp loyee s. Gen eral gu idanc e on th is topic isprovide d in an ar ticle in last No vemb er'sUnite d State s Attor neys ' Bulletin , "Know theProfessional Responsibility Issues that You MayConfront," by Claudia J. Flynn, D irector,Professional Responsibility Advisory Office(PRAO), and Joan L. Goldfrank, Senior LegalAdvisor, PRAO. The authors of that article notedthat the applicable ethical rules differ, dependingon the state and local rules adopted by federaldistrict courts, so there can't be any hard and fastguida nce. T he sam e app roach is taken here. T hisarticle will take a closer look at some of the rules,and two recent cases discussing the rules, but thereade r shou ld reco gnize that the final de cision inany c ase w ill be clo sely tied to a stud y of the factsof the instant case, local practice, and advice fromyour local ethics officer and the PRAO.

II. ABA Model Rules

Most jurisdictions follow the American BarAssociation Model Rules. Rule 4.2 provides:

In representing a client, a lawyer shall notcommunicate about the subject of therepresentation with a person the lawyer knowsto be represented by another lawyer in thematter, unless the lawyer has the consent of

the other lawyer or is authorized by law to doso.

This wording is substantially identical to DR7-10 4(A) (1). T he ap plicatio n of R ule 4.2 toconta cts with corpo rate em ploye es is co nfirm ed inthe official commentary to the Rule:

[4] In the ca se of a n org aniza tion, this Ruleprohibits communications by a lawyer foranother person or entity concerning the matterin representation with persons having amanagerial responsibility on behalf of theorganization, and with any other personwhose act or omission in connection with thatmatter may be imputed to the organization forpurposes of civil or criminal liability or whosestatement may constitute an admission on thepart of the organization. If an agent oremp loyee of the o rgan ization is repr esen ted inthe matter by his or her own counsel, theconsent by that counsel to a communicationwill be sufficient for purposes of this Rule.

It should also be noted that Rule 8.4(a)prohibits an attorney from violating the rulesthrough the acts of another. This means thatagents working on the case with a Departmentattorney may also be bound by Rule 4.2. Finally,ABA Model Rule 4.4 prohibits methods ofobtaining evidence that violate the legal rights ofanother. This may prevent communications thatseek the disclosure of information that is protectedby a lega l privilege o r a contra ctual agr eeme nt.

The Rule does not prohibit contact with formeremployees. ABA Opinion 91-359 (March 22,1991).


III. The "Authorized by Law" exception and28 C.F.R. Part 77

In the past, the Department of Justice hasattem pted to expa nd the range of per missib lecontacts by publishing administrative rules in 28C.F.R. Part 77. The idea was that the conductoutline d by th ose ad minis trative r ules w ould f allunde r the "a uthor ized b y law " exce ption in Rule4.2. The Department could not be bound bystricter state rules, because the Supremacy Clauserequ ires tha t feder al offic ers be free fr om s tatecontr ol in the perfo rman ce of th eir dutie s. Cou rtswere g enerally unsym pathetic to the Dep artmen t'sposition. See, e.g., United States v. Ferrara, 54F.3d 8 25 (D .C. Cir . 1995 ); In re Howes, 940 P.2d159 (D.N.M. 1997). In any event, this approachwas abandoned on April 19, 1999, when 28U.S.C. § 530B (the "McDade Amendm ent") tookeffect. McDade requires prosecutors to abide bythe laws and ethical rules of the state where theyare carr ying ou t their pros ecutoria l duties. SeeUnited States v. Talao, 222 F .3d 11 33, 11 39 (9 thCir. 2000).

Note: On October 21, 2001, the Departmentpromulgated 28 C.F.R. §§ 500 and 501, whichexpand previous regulations regarding themonitoring of certain communications ofinmates. Seehttp://www.epic.org/privacy/terrorism/bop_rule.htm l for the full text.

IV. Pre-indictment contacts; reports of perjuryand obstruction of justice—United States v. Talao

Litigation in United States v. Talao, 222 F.3d1133 (9th Cir. 2000), began when employees ofthe San Luis Gonzaga Construction, Inc. (SLGC)filed a complaint with the United StatesDepartment of Labor alleging that SLGC did notpay th e prev ailing w age, h ad req uired them tokick back a portion of their wages, and had madefalse statements to the government. Virgilio Talaowas th e sole o wne r of the corpo ration , and h iswife, Gerardina Talao, wa s the secretary/treasurer.The local United States Attorney's Office initiateda criminal investigation of SLGC and the Talaosafter a referral from its civil division. The Talaoswere represented by an attorney namedChristop her Bro se.

A Department of Labor Special Agent serveda subpoena on SLGC's boo kkeeper, Lita Ferrer,directing her to testify before the grand jury.Virgilio Talao learned of the subpoena andinstructed Brose to be pre sent for F errer'stestimony. Brose telephoned Ferrer and arrangedto meet with her prior to her grand juryappearance. After the call Ferrer went to theUnited States Attorney's Office and asked to havethe date of her grand jury appearance changed asshe did not want Brose to be present before orduring her grand jury testimony. She further statedthat she would feel pressured to give falsetestimony if Brose was there, and recounted ateleph one c onve rsation she had w ith Mr . Talao inwhich he told her to "stick with the story" she hadtold while testifying in a related administrativeaction. Ferrer was told that the schedule would notbe changed, but that Brose would not be in thegrand jury room during her testimony.

Ferrer later met with Brose, discussed hergran d jury appe aranc e, and mad e plan s to talkagain at the federal building before she testified.Before that meeting could occur Ferrer saw theAUSA and Agent in the hallway outside the grandjury courtroom, and told them that she did notwish to be represented by Brose. They adjournedto a witness room, where Ferrer told them that shewas not (and did not want to be) represented byBrose. The AUSA told Ferrer that she had a rightto be re prese nted b y an a ttorney, and offer ed toarrange for a public defender at no cost, but Ferrerdeclined representation. Ferrer stated that shewished to tell the truth, that she did not believeshe cou ld do so if s he had to testify in B rose'spresence, and that the Talaos had been pressuringher to testify falsely. Ferrer then gave themdetailed information about SLGC's payroll recordsand o ther co rpora te doc ume nts, an d their p ossib ledestruction. While this was going on, Broseknoc ked o n the d oor d ema nding an op portu nity tospeak with Ferrer. Ferrer was told that Brosewan ted to ta lk to he r, but sh e insiste d that sh e didnot wa nt to see h im.

At this point the AUSA decided to seekguidance from her Criminal Chief. He told herthat, in his opinion, Brose was tampering with herwitness, and instructed her to continue theinterview. As the interview continued, Ferrer gave


examples of dishonest conduct by the Talaos thatconcealed the truth from federal investigators andBrose. Ferrer further stated that Virgilio Talao hadtold her to give false testimony to the grand jury,and th at Tala o had sent B rose to the gra nd jur y tointimidate her. She went directly from thatmee ting to th e gran d jury , whe re thes e statem entswere made under oath. The grand jury returned a20-count indictment against the Talaos andSLG C.

The Talaos and SLGC later filed a JointMotion to Dismiss the indictment, arguing that thecontact between the AUSA and Ferrer hadviolated California's Ethical Rule 2-100 (whichsubs tantially tracks the lan guag e of A BA R ule4.2). The motion was denied, but the judge foundthat Rule 2-100 had been violated, and indicatedan intent to inform the jury o f the AU SA'smisco nduc t and in struct th e jury to take it intoaccount in assessing Ferrer's credibility if the casewent to trial. The AUSA (o n her own beh alf)appealed the order, and the government filed apetition for a w rit of m anda mus befor e the N inthCircuit Court of Appeals to prevent the districtcourt from giving its proposed remedialinstruction at trial.

The court first had to deal with a jurisdictionalissue; m ere cr iticism o f an atto rney by a ju dge isnot an ap pealab le sanction . See Weis sman v. Qu ailLodge, Inc.,179 F.3d 1194, 1200 (9th Cir.1999)(wor ds alo ne w ill cons titute a sa nction only "ifthey are expressly identified as a reprimand ").Here, however, the district judge made a findingand reached a legal conclusion that the AUSAknowingly and wilfully violated a specific rule ofethical conduct. "Such a finding, per se,constitutes a sanction . . . .We have no reluctancein concluding that the district court's finding of anethical vio lation . . . is an ap pealab le sanction ."Talao, id. at 1138.

The court then turned to question of whetherRule 2-100 had been violated at all, since thecontact involved pre-indictment and non-custodialcommunications, i.e., it occurred before aconstitutional right to counsel had attached. Thecour t adop ted the reaso ning o f a Sec ond C ircuitcase, United States v. Hammad, 858 F.2d 834 (2dCir.1988). The Hammad court rejected the notionthat the ethical rule was "coextensive" with the

Sixth Amendment, and indicated an intent to takea case -by-c ase ap proa ch, ba lancin g the n eed topolice prosecutorial misconduct while recognizingthat pro secu tors ar e "auth orized by law " toemplo y legitima te investiga tive techn iques. Id. at838-39.

Applying the Hammad appro ach to the fac tsin Talao, the Ninth Circuit found that the ethicalrule applied; the parties were in "fully definedadversarial roles" even if the events were pre-indictme nt. Talao, id. at 1139. Nevertheless, theNinth Circuit concluded that Rule 2-100 did notprohibit the AUS A's con duct.

Despite the apparent conundrum created byFerrer's dual role as employee/party andwitne ss, the in terests in the in ternal in tegrityof and public confidence in the judicialsystem weigh heavily in favor of theconclusion that [the conduct of the AUSA]was at all times ethical. We deem manifestthat when an employee/party of a defendantcorporation initiates communications with anattorney for the government for the purpose ofdisclosing that corporate officers areattempting to suborn perjury and obstructjustice, Rule 2-100 does not bar discussionsbetween the employee and the attorney.Indeed, under these circumstances, anautom atic, un critical a pplica tion of Rule2-100 would effectively defeat its goal ofprotecting the administration of justice. Itdecidedly would not add meaningfully to theprote ction o f the atto rney -client r elation ship ifsubornation of perjury, or the attempt thereof,is imminent or probable.

Id. at 1140 (footnote omitted).

Talao does not suggest that a proper attorney-client relationship may not exist betweencorp orations an d em ploye es wh o wish tocooperate with the government. However, "[o]ncethe employee makes known her desire to givetruthful information about potential criminalactivity she has witnessed, a clear conflict ofinterest exists between the employee and thecorp oration. Un der the se circ ums tance s, corp oratecounsel cannot continue to represent both theemployee and the corporation." Id. at 1140-41(footnote omitted). That conflict would have


prevented further sharing of information betweenthe employee and an attorney representing thecorporation. "Under these circumstances, becausethe corporation and the employee cannot share anattorney, ex parte contacts with the employeecannot be deemed to, in any way, affect theattorney-client relationship between thecorporation and its counsel." Id. at 1141.

The court concluded by approving theconduct of the prosecutor in advising Ferrer of herright to conta ct sub stitute co unse l. Altho ugh itwould be improper to approach an employeerepre sente d by c orpo rate co unse l and in itiatecommunications just because the prosecutorsuspects a possible conflict of interest between theemployee and the corporation, in this case therewas no prior notice of the representation, andFerrer initiated the communications with theUnited States Attorney's office. Far from being anethical violation, the court formally approved ofthe AUSA's conduct. The sanction against theAUSA was consequently reversed, and thegovernment's petition for writ of mandamus wasdism issed a s mo ot.

V. Conflicts with other federal statutes;application to lower levelemployees— Weibrec ht v. So uther n Illino isTransfer

Rule 4 .2 is som etime s attack ed as b eing inconflict with federal laws encouraging employeesto report information to federal agencies, or asbeing inapplicable to lower level employees.Weibrecht v. Southern Illinois Transfer, 241 F.3d875 (7th Cir. 2001), a wrongful death suit broughtafter the drowning death of a deckhand employedby the defendant, deals with both of these issues.Two days before a scheduled deposition, theplaintiff and h is attorn ey initia ted co ntacts withthe pilo t of the b oat inv olved in the a ccide nt.These contacts formed the basis of a defensemotion to dismiss. The motion was allowed andthe plaintiff appealed.

Title 45 U.S.C. § 60 makes void any"contract, rule, regulation, or device whatsoever,the pu rpose , intent, o r effec t of wh ich sh all be toprevent employees of any common carrier fromfurnishing voluntarily information . . . as to thefacts incident to the injury or death of any

emp loyee . . . ." The plaintiff argue d that th isprovision superceded the ex parte contact rule;here, a local version of Rule 4.2 adopted by thelocal federal court. The Seventh Circuit noted thatdistrict courts are authorized to promulgate localrules under both Fed. R. Civ. P. 83 and 28 U.S.C.§ 2071, but that both of these provisions state thatlocal rules must be "consistent with Acts ofCongress." Consequently, a local rule thatconf licts with a fede ral statu te is inva lid. The re isprecedent for the view that 45 U.S.C. § 60 trumpsRule 4.2 . See Harper v. Missouri Pacific R.R. Co.,636 N.E.2d 1192 (D.Ill. 1994). Other courts havefound that no co nflict exists. White v. IllinoisCentral R.R. Co., 162 F.R.D. 118 (S.D.Miss .1995 ); Branham v. Norfolk and Western Ry.Co., 151 F .R.D. 67 (S .D.W .Va.1 993) ; State e x rel.Atchison, Topeka & Sante Fe R.R. v. O'Malley,888 S.W.2d 760 (D.Mo. App.1994). TheWeibrecht court found the latter cases morepersua sive. Weibrecht, id. at 880.

The p laintiff th en arg ued th at, eve n if ther e isno direc t conflict be tween th e provis ions, Ru le 4.2was still not violated, because 45 U.S.C. § 60brought him under the "authorized by law"exce ption. O nce a gain th e cou rt disag reed. Title45 U .S.C. § 60 do es no t "autho rize" c ondu ct,rather it pro hibits con duct. Id.

This left the plaintiff with the argument thatthe pilot was not a "represented party." The cou rtbega n by n oting th at there are a n umb er of te stsused in different jurisdictions that determine whenan em ploye e is a "re prese nted p arty". S ome courtswill ban contacts with any employe e, while othersonly allow coverage of top managementemployees who have decision-makingrespon sibility. Id. at 881-82.The court below hadapplie d the th ree pa rt test su gges ted in C omm ent 4to American Bar Association Rule 4.2 (quoted atthe beg inning o f this article). A defend ant'semployee is considered to be represented by thedefendant's lawyer if:

1. He or she has "managerial responsibility" in thedefen dant's organ ization ;

2. His o r her a cts or o missio ns can be im puted tothe organization for purposes of civil or criminalliability; or


3. The emp loyee 's statem ents co nstituteadmiss ions by the orga nization.

Under that test, the pilot fit factors two andthree. The appellate court, approving the use ofthe ABA three part test, consequently affirmed thedecision that the pilot was a represented party.Nevertheless, the order dismissing the case wasreversed as "too harsh a resp onse to what appearsto hav e bee n an h ones t but m isguid ed atte mpt tocomply with the ethical rules." Id. at 883.

VI. Conclusion

The rules governing contacts with employeesof defendant corpora tions are complex, and varyfrom jurisdiction to jurisdiction. Althoughexce ptions to the g enera l no co ntact ru le exist,extrem e cau tion in in terpre ting the se rule s isessen tial. A pr uden t attorne y will ca refullyresearch local rules and case authority, andconsult with the local ethics officer and theProfessional Responsibility Advisory Office.�

ABOUT THE AUTHOR

�Ed Hagen is an Attorney-Advisor and AssistantDirector of Publications for the EOUSA's Officeof Legal Education at the National AdvocacyCenter in Columbia, South Carolina. He is the co-author of The Prosecution Function (LexingtonBooks 1984) and The Law of Confessions, SecondEdition (Westgroup 1 994).a

Navigating the Evolving Landscape ofMedical Record PrivacyIan C. Smith DeWaalSenior CounselCriminal Division, Fraud Section

I. Introduction

The first compliance deadline for the"Stan dard s for P rivacy of Ind ividua lly Iden tifiableHealth Information"(45 C.F.R. Parts 160 and 164)(the “Medical Privacy R ule") looms little morethan a year from now. Health care providers,health care clearinghouses, and large health plans,mus t com ply by April 1 4, 200 3, wh ile sma llhealth plans must comply by April 14, 2004. Nowis an opportune time to preview the MedicalPrivacy Rule, as well as review current law andDepartmental guidelines conc erning the disclosureand handling of individually identifiable medicalinform ation in the co urse o f adm inistrativ e, civil,and c rimina l matter s han dled b y the D epartm ent.Importantly, this discussion applies not just to the

inves tigation of hea lth care fraud , but als o to alllitigating and investigative components of theDepartment, which seek or present evidence ofwritten or ora l med ical info rmatio n. This articlepresents a "nutshell" overview of the medicalprivacy arena for these components.

The M edica l Priva cy Ru le gov erns o nly“cove red entities " and the ir “busine ss assoc iates,"as defined in the Rule. Typically, these are entitiesthat actually create medical records, such asmedical providers and insurance companies(including the Medicare an d Medicaid prog rams).While certain offices or components of theDepartment may actually be “covered entities" asdefined in the Medical Privacy Rule, and thereforemust directly comply with the provisions of therule, m ost co mpo nents of the D epartm ent are not.For example, the Bureau of Prisons provideshealth care services to inmates and generatesmed ical rec ords. N everth eless, th e Ruleeffectively governs the Department’s access to


medical records maintained by covered entitiesand th eir bus iness a ssocia tes and theref ore af fectsthe D epartm ent’s a ffirm ative a nd de fensiv e effo rtsin all areas which require access to medicalrecords. Health care fraud matters constitute alarge, but not exclusive segment of these areas.This a rticle do es no t purp ort to pr esen t a guid e tothose offices or components that are coveredentities. Rathe r, this ar ticle foc uses o n the a bilityof the Department to obtain medical records underthe Rule.

As w ith any overv iew, th is article will on lyprovide a general guide. In individual situations,spec ific refe rence to pote ntially a pplica bleprovisions will be required. However, awarenessof these issues is of paramount importance.

II. Federal statutes and regulations in themedical privacy arena

A. "S tand ards for P rivac y of In dividu allyIdentifiable Health Information" (MedicalPrivacy Rule)

The most recent federal statutes governingmed ical rec ord p rivacy are fo und in the “H ealthInsurance Portability and Accountability Act of1996." Pub. L. 104-19 1 (8/21/1996) (HIPA A).The Secretary of Health and Human Servicesprom ulgate d the M edica l Priva cy Ru le purs uant toseveral provisions of HIPAA, namely §§ 262 and264, f ound at 42 U .S.C. § 1320 d-2 an d the N otethereto, respectively.

The Medical Privacy Rule provides anexten sive re gulato ry fra mew ork, w hich w illgovern when and how the "covered entities," thehealth care providers, health care clearinghouses,and health plans will be permitted to discloseindivid ually id entifiab le hea lth info rmatio n intheir po ssess ion, termed "prote cted h ealthinform ation." The c over ed en tities are requir ed tocomply with the Privacy Rule by April 14, 2003,with the exception of small health plans, whichmust comply by April 14, 2004. 45 C.F.R.§ 164.534 (as amended 66 Fed. R. 12434(2/26 /2001 )). Th e Me dical P rivacy Rule p rohib itscove red en tities fro m disc losing protec ted he althinformation to any third parties, including lawenforcement agencies, unless the rules otherwisepermit the disclosure. Therefore, while theMedical P rivacy Rule d oes n ot direc tly app ly to

law en force men t, cove red en tities will c ertainlycite provisions of these rules in support of theasser tion tha t they e ither pe rmit or proh ibitdisclosures requested by law enforcementagencies.

Covered entities, from whom we seekprote cted h ealth in form ation, m ay no t be fullyconversant with the nuances of the regulationswhich permit disclosures to law enforcement or beaware that d ifferen t disclo sure r ules ap ply indifferent situations. Prime examples are when lawenforcement investigates a health care fraudmatter, governed by the health oversightprovisions contained in § 164.52 (d), and whenlaw enforcement investigates a violent drug gang,governed by the general law enforcementprovision § 164.512 (f). The entities may also beconfused over the provisions of the regulationwhich state that the federal medical privacyregulations do not pre-empt certain more stringentstate laws and regulations (§160.203), eventhoug h the c ourts h ave c onclu ded c onsis tently inthe past that the Supremacy Clause of theUnited States Constitution insulates federalagencies from state and local laws.

As a general proposition, the covered entitiesare pe rmitted to disclo se pro tected healthinformation to law enforcement for purposes of“health care oversight," (45 C.F.R.. 164.512 (d)).This includes administrative, civil, and criminalinvestigations of health care payment or treatmentfraud , gove rnme nt pro gram fraud whe re hea lthinformation is necessary to determine eligibility orcompliance, and investigations of violations ofcivil righ ts laws whe re hea lth info rmatio n isreleva nt. 45 C .F.R. § § 164 .510 ( defin ing "he althoversight agency") and 1 64.512(d).

The R ule also perm its cov ered e ntities todisclose protected health information for othertypes of investigations, unrelated to health carefraud. The provisions of 45 C.F.R. § 164.512 (f)govern general law enforcement investigations.This p aragr aph p ermits disclo sure, f or exa mple , inresponse to grand jury sub poenas and cou rtorde rs, but lim its disclo sures that m ay be mad e tolocate or identify suspects, material witnesses,missing persons, or fugitives.


Other provisions will permit the disclosure ofprotected health information in variouscircumstances important to law enforcement. 45C.F.R. § 164.512 (f) perm its disclosure necessaryto avert a serious threat to health and safety. 45C.F.R . § 164 .512 ( g) auth orizes disclosures tocoroners and medical examiners. 45 C.F.R.§ 164.512 (b) gov erns disclosures in mattersinvolving child abuse, while 45 C.F.R.§164.512(d) gov erns disclosures in mattersinvolving abuse, neglect, or domestic violence,which, in some instances, may require consent ofthe vic tim, ab sent a s tate law whic h com pelsdisclo sure w ithout c onse nt. A sp ecial ru le perm itscove red en tities to m ake d isclosu res tocorrectional institutions or in other lawenforcement custodial situations. 45 C.F.R.§ 164.512 (k)(6).

The Rule urges caution when an importantneed to protect the secrecy of an investigationexists. U nder the M edica l Priva cy Ru le, allcovered entities must keep an “accounting" or logof each disclosure of a medical record, in theaffected patient’s file. 45 C.F.R. § 164.528. Theentity must disclose that log to the patient onrequest. The Me dical Privacy Rule provides for adelay in logging disclosures that are made to lawenfo rcem ent, pr ovide d that th e cov ered e ntitymakes an oral request for delay in an urgentsituation (e.g. hot pursuit tracking of an injuredfugitive by contacting hospital emergency rooms),which will expire after thirty days unless followedup by a written request specifying the length ofthe delay sought, or the covered entity provides awritten request which specifies the length of thedesired delay in the first instance in non-urgentcircumstances,. Law enforcement will have to actin a timely manner to protect the secrecy.Furthermore, the request will have to meet thestrict requirements of the rule by stating thatrelease of an “accounting" to the patient would bereasonably likely to impede the De partment’sactivities, and by setting forth the length of thedelay re quested . 45 C.F .R. 164 .528 (a) (2)(i).

B. HIPAA penalties: 42 U.S.C. § 132 0d-5and 1320d -6

For v iolation of the p rovisio ns of th e statuteand implementing regulations, HIPAA includesboth civil monetary penalties and criminal

penalties. The Office of Civil Rights of theDepartment of Health and Human Servicesinvestigates violations and assesses civil monetarypenalties. 65 Fed. Reg. 82381 (12/28/2001).Section 1320d-5 of Title 42, United States Code,provides that civil monetary penalties may beassessed by the Secretary of Health and HumanServices in the amount of $100 per offense. Theymay not ex ceed $25,0 00 ag ainst a s ingle p erson ina single calendar year for violations of an identicalrequirement or provision. Section 1320d-5 furtherprovides that civil monetary penalties may not beassessed when an act would constitute an offenseunder 42 U.S.C. § 1320d-6, the criminal statute.

For purposes of this discussion, the relevantportion of Section1320d-6 provides that: "(a) Aperso n wh o kno wing ly and in viola tion of thispart– . . .(2) ob tains in dividu ally ide ntifiablehealth information relating to an individual; or (3)disclo ses ind ividua lly iden tifiable h ealthinformation to another person, shall be punishedas prov ided in su bsection (b) of this s ection."Subsection (b) provides the penalties which maybe ass essed :

A pe rson d escrib ed in su bsec tion (a) of thissection shall– (1) be fined not more than$50,000, imprisoned not more than 1 year, orboth; (2) if the offense is committed underfalse pretenses, be fined not more than$100,000, imprisoned not more than 5 years,or both; and (3) if the offense is committedwith in tent to se ll, transf er, or u se ind ividua llyidentifiable health information for commercialadvantage, personal gain, or malicious harm,be fined not more than $250,000, imprisonednot more than 10 years, or both.

C. Substance Abuse Patient MedicalRecords Privacy statute and regulations (42U.S.C. § 290dd-2 and 42 C.F.R. Part 2).

These provisions place strict limits on thedisclosures which covered entities may make ofsubstance abuse patients’ medical records.Essentially, all disclosures of medical recordscreated by federally-related substance abusetreatment programs are prohibited unlessotherwise permitted by the regulations of theSecretary of HHS. 42 U.S.C. § 290dd-2 (b). Thescop e of m edica l recor ds co vered is broa dly


interpreted, such as including billing for medicalservices with a diagnosis or treatment code forsubstance abuse. A federally assisted program oractivity, or anyone releasing or receivingconfidential substance abuse medical recordswithout authorization, is subject to a fine. 42U.S.C. § 290dd-2 (f); 42 C.F.R. § 2.4.

The mere rendering of substance abusetreatment or counseling does not, of itself, mean aprovider's records are protected by this provision.A provider does not qualify as a covered"program" unless it is a physician, a group ofphysicians, or a unit within a facility, that "hold[s]itself out as providing and provides alcohol ordrug abuse diagnosis, treatment, referral fortreatment." 42 C.F.R. § 2.11. A "general medicalcare facility," viz., a hospital, will not beconsidered a covered "program" merely becausehospital records may show that the patient is adrug o r alcoho l abuser , unless those records comefrom "[a]n identified unit within a general medicalfacility which holds itself out as providing, andprovides, alcohol or drug abuse diagnoses,treatment or referral for treatment." 42 C.F.R.§ 2.11. Therefore, the key inquiry is whether theprovider, or the unit in a facility, holds itself outto the community as rendering substance abusetreatme nt and/or couns eling.

The statute permits disclosure only if thepatient consents, if necessary for treatment in abona fide m edica l eme rgen cy, fo r scien tificresearch, for program audits or evaluation (subjectto limitations on re-disclosure), or if authorized bycourt order upon a strict showing of good cause.Different standards for obtaining a court orderapply to use of substance abuse records: (1) in acriminal proceeding against the patient; (2) in acriminal proceeding against someone other thanthe patient; (3) in a civil proceeding; or (4) whenplacing an undercover agent in a substance abuseprog ram. I n add ition, un der the regula tions, w hilea court order may authorize the disclosure of"confidential communications," but only if thedisclosure is necessary " . . . to protect against anexisting thr eat to life or o f serious bodily h arm . . ." as en ume rated, o r " . . . in co nnec tion w ithinvestigation of an extremely serious crime, suchas one which directly threatens loss of life orserious bodily injury, including homicide, rape,

kidna ping, a rmed robb ery, as sault w ith a de adlyweapon, or child abuse and neglect ". 42 C.F.R.§ 2.63 (a). The court order must set forth howpatients, whose records are disclosed, are to benotified of the d isclosu re and given an op portu nityto challenge the disclosure.

Gen erally, b efore the co urt ma y gran t adisclo sure o rder, th e prov ider m ust giv e notic e tothe patients whose records are sought, with animportant exception – notice is not requiredbefore a disclosure order is granted in a criminalinvestigation of a program or the person holdingthe records. 42 C.F.R. § 2.66 (b). However “uponimplementation" of the order, the provider mustafford the program, the person who held therecords, or the patients whose record s aredisclosed, an opportunity to seek revocation oramendment of the order. Likewise, an orderpermitting the use of undercover agents orinformants, may also be granted without notice ona showing of certain enumerated circumstances.42 C.F.R. § 2.67 (b).

A court order is not necessary for agovernment entity to perform an “audit orevaluation" of a program to which it providesfeder al assis tance or is au thorized by law toregulate. 42 C.F.R. §§ 2.12, 2.53. Federalassistance can include tax exempt status,certification to participate in the Medicareprogram, direct grants, or a license to dispensecontrolled substances or operate a methadoneclinic. Further, the term “audit or evaluation"includes a civil or administrative investigation ofa prog ram b y the D epartm ent w ith resp ect to itsobligation to exercise oversight of the Medicare orMed icaid pro gram s. 42 C.F .R. § 2.53 (c).

Finally, even if disclosure of protectedsubstance abuse medical records would otherwisebe permitted, special rules apply to "confidentialcommunications," which may be included in theprotected records, and which limit thecircumstances under which confidentialcommunications may be disclosed. 42 C.F.R.§ 2.63. One court has ruled that fraudulent billingis not "automatically" an "extremely dangerouscrime" warranting the enforce ment of a grand jurysubpoena seeking records which includeconf identia l com mun ication s and that it is hig hlyunlikely that the government could ever make a


factua l show ing tha t fraud is suffic ient toovercome the bro ad prohibition against disclosureof con fiden tial com mun ication s con tained in§ 2.63(a). In re The August, 1993 Regular GrandJury, 854 F. Supp. 1380, 1384-85 (S.D. Ind.1994). A recent decision by the United StatesCourt of Appeals for the Seventh Circuit held thateven in the c ontex t of disc over y in a c ivilproceeding, discovery orders issued by the districtcourt must comply with the substance abusepatient medical records privacy regulations.United States, ex rel Chandler v. Cook County,Illinois , 277 F. 3d 969, 981-83 (7th Cir. 2002).

D. The Fed eral Privacy Act o f 1974 (5U.S.C. 552a)

While the Privacy Act does not single outindivid ually id entifiab le me dical in form ation h eldby Federal Government agencies for any uniqueprotection beyond other records maintained onindividuals, it is relevant when the Departmentseeks identifiable medical information from otherFederal Government agencies. The Privacy Actprote cts info rmatio n abo ut an “ individ ual," tha t iscollected and maintained by government agenciesin a “system of records" (“covered records"). TheAct d efines a syste m of r ecord s as a s ystem inwhich the information stored about an individualis retrieved by means of a personal identifier, suchas a name, social security num ber, or driver’slicense registration number.

The Privacy Act protects covered recordsfrom disclosure, unless a specific provision of thePrivacy Act permits disclosure. An individualmay file a written request or provide a writtenconsent for disclosure of his or her own coveredrecor ds. Oth erwis e, auth orizatio n to dis close isprovided by a statutory provision of the Act or bya “routine use," published by the agency holdingthe covered records. When Department attorneysor investigators seek medical information from anagency which maintains it in a covered system ofrecords, then the Department’s request and thedisclo sure b y the a genc y, mu st com ply w ithPrivacy Act requirements.

Currently, agencies may disclose informationsubject to the Privacy Act, including medicalinformation, to the Department under a number ofprovisions: 1) pursuant to 5 U.S.C. § 552a (b)(3)

for a routine use as defined in §552a (a)(7) anddescribed in § 552a (e)(4)(D); 2) for a civil orcrimin al law e nforc eme nt activ ity, pro vided that awritten request specifying the particular portion ofthe record which is needed and the lawenfo rcem ent ac tivity for whic h the re cord issought, § 552a (b)(7); or 3) pursuant to the orderof a court of competent jurisdiction. § 552a(b)(11).

Some federal agencies have publishedadditional routine uses for disclosing evidence ofcriminal activity to a law enforcement agency. Forexample, the Department of Health and HumanServices has published a routine use whichpermits the disclosure of personal informationconcerning individuals to the Department ofJustice, as needed for the evaluation of potentialviolations of civil or criminal law and fordetecting, discovering, investigating, litigating,addressing, or prosecuting a violation or potentialviolation of law, in health benefits programsadministered by the Center for Medicare andMedicaid Services (fo rmerly the Health CareFinanc ing Ad ministratio n or HC FA). See 63 Fed.Reg. 38414 (July 16, 1998) (adding new routineuses).

Another important provision of the PrivacyAct concerns computer database matching ofcovered records. A Privacy Act covered computerdatabase may not be disclosed to the Departmentby another federal agency for use in a computermatching program, except pursuant to a writtenagreement m eeting the enumerated statutoryrequirements between the source agency and therecipien t agency . 5 U.S.C . § 552a (o). A“matching program" includes the computerizedcomparison of two or more automated systems ofrecords or a system of records, with a non-federalsystem of records, to establish or verify theeligibility of, or c ontinu ing co mplia nce w ithstatutory and regulatory requirements byapplicants, recipients or beneficiaries, participants,or providers of services with respect to Federalbenefit programs, or for recouping payments ordelinquent debts under Federal benefit programs.§ 552a (a)(8). However, the term “matchingprogram" does not include matches done by anagen cy w hich p erfor ms an y fun ction re lating tothe en force men t of the c rimina l laws a s its


principle function, subsequent to the initiation of aspecific criminal or civil law enforcementinvestigation of a named person or persons for thepurpose of gathering evidence against that personor persons. 5 U.S.C. § 55 2a (a)(8)(B)(iii).Questions of whether the computer databasematc hing p rovisio ns of th e Priv acy A ct app ly inspecific situations, should be directed to BarbaraBush, Deputy General Counsel of the JusticeManagemen t Division. Covered databasematc hing p rojects are re view ed by the Da taInteg rity Bo ard in th e Dep artme nt.

E. Peer Review Organizations 42 U.S.C.§ 1320c:

Peer Review O rganizations (“PRO") aretasked with reviewing and evaluating theperformance of certain medical institutions orproviders, and therefore, may have medicalinformation that could be useful to Departmentattorneys or investigators. The Department canobtain the information held by peer revieworganizations only in a limited number ofcircumstances.

The general rule prohibits disclosure of anydata or information acquired by a PRO in theexercise of its duties and functions, except whereotherwise permitted. 42 U.S.C. § 13 20c-9 (a).Nevertheless, an organization having a contractwith the Secretary of HHS to engage in PROactivities, is permitted to disclose data andinformation which identifies specific providers orpractitioners as may be necessary: “to assistFederal and State agencies recognized by theSecretary as having responsibility for identifyingand investigating cases or patterns of fraud orabuse, which data and information shall beprovided by the peer review organization to anysuch agency at the request of such agency relatingto a specific case or pattern". 42 U.S.C. § 1320 c-9(b)(1)(A). However, a patient record in thepossession of a PRO operating under a contractwith th e Sec retary shall N OT b e sub ject tosubpoena in a civil proceeding. 42 U.S.C.§ 1320c-9 (d).

F. Executive Order 13181

While Congress included rules governing thederivative use of medical records against a patientwhich were disclosed to the Department, in the

first instance, in response to an administrativesubp oena issued unde r 18 U .S.C. 3 486 toinvestigate health care fraud offenses, it did notextend this protection to medical records disclosedin response to other compulsory process during ahealth care fraud investigation, such as a grandjury subpoena or a search warrant. ExecutiveOrder 13181, signed on December 20, 2000, filledthis gap. 65 Fed. Reg. 8132 1-3 (12/26/2000).

Because of concern expressed by privacy

advocates about potential re-use of data obtainedby the Department of Justice in health care fraud

investigations against patients, President Clinton

issued an Executive Order on December 28, 2000,gove rning the “re -use" by D OJ of protec ted he althinformation obtained during the course of aninvestigation. This Executive Order requires,amon g other th ings, that an individua l patient'sprotected health information, discovered duringthe course of health oversight activities, shall notbe used against that individual patient in anunrelated civil, administrative, or criminalinvestigation of a non-health oversight matterunless the Deputy Attorney General or, insofar asthe protected health information involvesmembers of the Armed Forces, the GeneralCounsel of the Department of Defense, hasauthorized such use.

The Executive Order applies to federal lawenfo rcem ent ag encie s that ob tain pe rsona llyidentifiable health information disclosed during ahealth oversight investigation, by means otherthan a § 3486 administrative subpoena for theinvestigation of health care offenses. It imposes anadministrative approval process on the derivativeuse of personally identifiable health information,similar to the ju dicial a ppro val pro cess in§ 3486(e). Within the Department, only theDeputy Attorney General can grant approval. TheGeneral Counsel of the Department of Defensemust approve the de rivative use of militarymedical records involving members of the ArmedForces. However, the Executive Order, does notapply to prote cted h ealth in form ation in itiallyobtained by a federal law enforcement agency in anon-health oversight investigation.

The Executive Order includes a standard forapproving an application, namely, does thebalance of relevant factors weigh clearly in favor


of its us e? Dis closu re for the de rivative use sh allbe permitted "if the public interest and the needfor disclosure clearly outweigh the potential forinjury" to the patient, which includes injury to theprivacy of the patient, to the physician-patientrelationship, or to the treatment services. 65 Fed.Reg. 81321-3. Finally, a decision to permit thederiv ative u se mu st inclu de ap prop riatesafeguards against unauthorized use.

III. Federal case law:

A. General medical records

Despite some variance in the caselaw fromcircuit to circuit, the federal courts, with theimportant exception of the Suprem e Courtdecision in Jaffee v. Redmond , 518 U.S. 1 (1996),which created a privilege under Fed. R. Evid. 501for psychotherapy counseling records, includingrecords of counseling sessions with licensedpsyc hiatric s ocial w orke rs, hav e bee n reluc tant toadopt broad-reaching medical privacy rights.How ever, whe n the M edica l Priva cy Ru lebecomes enforceable in 2003 and 2004 asdescribed above, it will supercede existing caselaw to the extent that the case law providedweaker protection to medical records than the newMedical Privacy Rule.

In light of modern med ical practice and thirdparty payors, an individual no longer possesses areasonable expectation that his or her medicalhistory will rem ain co mple tely co nfide ntial.Whalen v. Roe, 429 U.S. 589 (1977) (rejecting achallenge by physicians and patients to a NewYork State sta tute, w hich re quire d cop ies of a llprescriptions for controlled substances to be sentto the New York Department of Health to berecorded in a centralized computer file). TheCourt observed that disclosures to the N ew YorkState Department of public health were

not meaningfully distinguishable from a hostof other unpleasant invasions of privacy thatare associated with many fa cets of health care. . . disclosures of private medical informationto doctors, to hospital personnel, to insurancecompanies and to public health agencies areoften an essential part of modern medicalpractice, even when the disclosure may reflectunfa vora bly on the ch aracte r of the patien t.

Id. at 602.

In the course of investigating health care fraud,the government interest in combating fraudoutwe ighs patie nt privac y interests . In reSubpoena Duces Tecum, 51 F. Supp.2d 726, 738(W.D. Va. 1999). In fact, by authorizing the use ofadm inistrativ e sub poen as to cr imina lly inve stigatehealth care offenses, Congress explicitly evincedits intent to override patient privacy by includinga provision which limits the derivative use ofrecords which w ere disclosed for a health carefraud investigation against the patient. 18 U.S.C.§ 3486 (e).

Some courts have held that a search warrantor subpoena seek a qualified privilege for medicalrecords. This protection is not absolute and mustbe balanced against the legitimate interests ofothers in obtaining disclosure. E.g., United Statesv. Polan, 970 F.2d 1280, 128 5 (3d Cir. 1992).Other courts have adhered to the Whalenconclusion, that in light of modern medicalpractic e wh ich req uires m ultiple d isclosu re todocto rs, hos pital pe rsonn el, pub lic hea lthagen cies, an d pres uma bly, a h ost of th ird-pa rtypayors as well, patient charts have a public aspectnot prote cted by a right of p rivacy. In re GrandJury Proceedings, 867 F.2d 562, 565 (9th C ir.1989)(per curiam).

B. Psychiatric medical records

In Jaffee v. Redmond , 518 U.S. 1(1996), theSupreme Court recognized a psychotherapistprivilege under Fed. R. Evid. 501 forpsychotherapy counseling records, includingrecords of counseling sessions with licensedpsychiatric social workers. The Court rejected thelower court’s adoption of a case by case balancingtest to determine whether psychotherapy notesshou ld be d isclose d bec ause “ . . . an u ncerta inprivilege, or one which purports to be certain butresults in widely varying application by the courts,is little better than no privilege at all." Id at 18,citing, Upjohn Co. v. United States, 449 U.S. 383,393 (1 981). T hus, Jaffee prohibited the compelledtestimony of the “psychotherapist" through thetherapist’s case notes of confidentialcommu nications against the patient. However,Jaffee does not ere ct an im pene trable b arrier toobtaining psychiatric records in civil or criminalhealth care fraud cases where the patient is not thetarget. A lso, as e lsewh ere, if th e patie nt con sents


to the disclosure of therapeutic counselingrecord s, then the privilege is waived . Jaffee alsostates that, notwithstanding the Court’s discussionof the need for a predictable and reliable privilege,". . . we d o not d oubt th at there are situ ations inwhich the privilege must give way. . .," such as aserious threat of harm to the patient or to otherswhich can only be averted by means of disclosure.116 S. Ct. at 1932, n.19. In addition, a crime-fraudexception to the Jaffee privilege has beenrecogn ized. In re Grand Jury Proceedings(Gregory P. Violette), 183 F.3d 71 (1st Cir. 1999).

IV. Interaction of fed eral and stateconfidentiality protections under the MedicalPriva cy R ule

Onc e the M edica l Reco rd Priv acy R ulebeco mes e nforc eable , it will pro vide th at stateprivacy rules, which are mo re stringent and moreprotective of privacy rights, will not bepreempted. This should not have a significantimpact on the Department’s conduct ofinvestigations or litigation, insofar as it will notoperate to suspend the Supremacy Clause of theUnited States Constitution.

State laws do not ordinarily limit or governthe action s of fede ral agen cies. See Gibbons v .Ogden , 22 U.S. (9 Wheat.) 1, 210-11 (1824)(stating that the Supremacy Clause invalidatesstate law s that "in terfere with, o r are c ontra ry, tothe law s of C ongr ess."); Hine s v. Da vidow itz, 312U.S. 5 2, 67 ( 1941 ); Jones v. Rath Packing Co.,430 U.S. 519, 526, 540-41 (1977) (finding aconf lict whe re state law "s tands as an o bstac le tothe ac com plishm ent an d exe cution of the f ullpurposes and ob jectives of Congress." );United States ex rel. Agency for InternationalDevelopment v. First National Bank of Maryland ,866 F. Supp. 884, 886-87 (D. Md. 1994) (statingthat a fe deral s ubpo ena n eed n ot com ply w ithnotice requir eme nts in M arylan d’s R ight toFinan cial Priv acy A ct); St. Luke's RegionalMedical Center, Inc. v. United States, 717 F.Supp. 665, 666 (N.D. Iowa 1989) (stating thatfederal subpoena for medical peer review recordsneed not comply with Iowa state prohibitionagainst peer review records d isclosure); In reGrand Jury Matter, 762 F. Supp. 333, 334-35(S.D . Fla. 19 91) (f inding that a F lorida statestatute prohibiting state government from

disclosing names of physician's patients did notaffec t a gran d jury subp oena ); United States v.Wetts tein , 733 F . Supp . 1212 , 1214 (C.D . Ill.1990) (finding that Illinois state protection forpsychologist client lists did not affect a grand jurysubp oena ); In the Matter of Grand JuryProc eedin gs (K rynic ki), No. 92 -2227 1993, W L318867 (7th Cir. Aug. 20, 1993) (findingmeritless a physician's assertion that compliancewith a federal grand jury subpoena for medicalrecor ds wo uld be oppr essive beca use it w ouldforce him to violate a state medical record privacylaw. The Supremacy Clause of the United StatesConstitution renders state law without effect in thecontext of a federal grand jury investigation,citing, Memorial Hospital for McHenry County v.Shadur, 664 F.2d 1058, 106 3-64 (7th Cir. 1981)).

The new Privacy Rule specifically providesthat, if the Secretary of HHS determines that the

state laws are necessary to prevent fraud andabus e, ens ure ap prop riate re gulatio n of sta tehealth and insurance plans for state reporting onhealth delive ry and “othe r purp oses, " then sta te

laws may control. 65 Fed Reg. 82462, 82480.Relev ant inq uiries w ill includ e wh ether th e state

laws are more stringent in protecting protectedhealth inform ation, a nd if the state sta tute

addresses controlled substances. Id.

V. DOJ guidelines and guidance on medicalrecord privacy

Beginning in 1996, the Department adoptedguidelines and guidance on protecting medicalrecord privacy, which apply to all theinvestigative and litigating components of theDepartment. Links to these guidelines can befoun d in the “Hea lth Car e Frau d Polic y M anua l"(HCF Manual), which can be accessed from a linkon the Health Care Fraud page of the USA Bookintranet page.

The HIPAA Fraud and Abuse ControlProgram Guidelines (1/1997) (HIPAA FraudGuidelines) (HCF Manual, Tab D) jointly adoptedby the Attorney General and the Secretary ofHealth and Human Services, imposed a number ofprivacy practices on health care fraudinves tigation s. The se gu ideline s may be fou nd inSection VI “Confidentiality Procedures: Provisionand Use of Information and Data" of Tab D.


Thes e guid elines prov ide ap prop riateconfidentiality by maintaining informationsecurely and by limiting access. When disclosinginform ation to an ex pert, w itness, o r cons ultant,redac t identify ing inf orma tion w hen p ractica bleand in corp orate th e guid elines into co ntractsconcerning medical records.

The HIPAA Fraud Guideline suggests theredac tion of perso nally id entify ing inf orma tion incourt documents and in trial, when practicable,subje ct to Co urt app rova l, and w hen a ppro priatefor the purp ose o f minim izing p ublicdissemination of personal information. Whendisclo sure is requir ed in a ny jud icial,administrative, court, or public proceeding, redactwhen practicable, seek a court order limitingpublic disclosure, get patient consent, return ordestroy the information when the need for theinformation ends.

The reach of the HIPAA Fraud Guidelinesconfidentiality section was extended by theMemorandum of the Deputy Attorney Generaltitled “Protection and Confidentiality ofIndividu ally Iden tifiable He alth Infor mation ,"dated Octo ber 15 , 1998 , beyo nd pr otecte d hea lthinformation disclosed to the Department and usedin health care fraud matters, to all uses anddisclosures involving the litigating andinvestigating components of the Department. HCFManual, Tab Z-1. This Memorandum directed thatthe H IPAA confid entiality guide lines ap ply to a llcases, not just our health care fraud cases. TheMemo randum exp lained that the term“individually identifiable health information" wasbroadly defined beyond traditional concepts, andwould include billing records with diagnostic andtreatm ent co des. T he M emo rand um a ddition allyprovided suggestions regarding the minimizationof publically-disclosed individually identifiedhealth information by redacting medical recordsattached to motions, filing pleadings with suchinformation under seal, or blind coding patientinformation entered in evidence, but including aconversion table, in some instances. For example,a conversion table is included when necessary forthe jury to compare and contrast pieces ofdocumentary evidence.

Finally, a further Memorandum from theDeputy Attorney General, titled “Suggested

Practices for Maintaining the Confidentiality ofMedical Records" (“Suggested Practices"), wassigned on August 30, 2000 (HCF Manual Tab Z-4). It sta tes: “T aking all prac ticable steps toprote ct the co nfide ntiality o f indiv iduallyidentifiable pieces of medical information is theresponsibility of each and every Departmentemployee." The Suggested Practices include areview of legal requirements concerning medicalrecor d con fiden tiality, which m ust be follow ed; acatalogue of concerns with respect to handling,storing , review ing an d usin g indiv iduallyidentifiable medical records; a discussion ofespecially sensitive medical information, such aspsychiatric records, substance abuse records, andother sensitive medical conditions and treatments;and a discussion of issues related to the PrivacyAct of 1974. The Suggested Practicesmemorandum states that it is not for creating anyprivate rights or defenses, or a right of judicialreview.

VI. Conclusion

Special care and planning is requiredwhenever personally identifiable medicalinformation is sought or used by Departmentattorneys and investigators in any type ofinvestiga tion or litigative forum . In particu lar, areview of statutory and regulatory requirements,Department memorandum and guidance, and up-to-da te case law re gard ing ind ividua llyidentifiable health information is required. Also,be prepared to confront and address a newconstellation of medical privacy issues after theenforcement date for the Medical Privacy Rule.Specific up-to-date expertise on med ical recordpriva cy pra ctice iss ues is a vailab le in the CivilDivision by contacting Dan Anderson, SeniorCounsel, Commercial Litigation Branch, (202)616-2451, or the author of this article, Ian C.Smith DeWaal, Senior Counsel, Fraud Section,Criminal Division: (202) 514-0669.�

ABOUT THE AUTHOR

�Ian C . Smit h De Wa al came to the FraudSection in July, 1990, from the Insurance Divisionof the Massachusetts’ Attorney General Officeswhich was responsible for enforcing consumerprotections against the insurance industry and


representing consumer interests at rate settinghearings. After three years with the Dallas BankFrau d Tas k For ce, M r. DeW aal wa s assig ned in1993 to health care matters including litigation,and legislative and regulatory analysis. Mr.DeW aal developed an exp ertise in medical recordprivacy issues and regularly provides advice to theOUSAs and other agencies which obtain and usehealth records. He represented the Department atseveral interagency working groups on medical

record privacy issues, and testified on lawenforcement concerns at a roundtable to theSubcommittee on Privacy and Confidentiality ofthe N ationa l Com mittee on V ital and HealthStatistics. Mr. DeWaal was also a member of theHIPAA Interagency Working Group which hasdrafted the regulations on the confidentiality ofmedical Records and participated in the draftingof medical record privacy best practicesrecomme ndations for the AGA C Health CareFraud Subcommittee.a

Primer for Using SentencingGuidelines Enhancement for IdentityTheft-Related ConductPaula J. DesioDeputy General CounselUnited States Sentencing Commission

Donald A. Purdy, Jr.Chief Deputy General CounselUnited States Sentencing Commission

In the November 2001 issue of theUnited States Attorney's Bulletin, identity theftand re lated o ffens es we re fea tured in an a rticlethat examined this emerging crime problem andthe response of the federal law enforcementcommunity. Late last year, the United StatesSentencing Commission consolidated the fraud,theft, and property sentencing guidelines. Thearticle below offers a timely and concise overviewof rele vant s enten cing p rovisio ns for identitytheft-related crimes under the revised guidelines.

I. Historical context

The Identity Theft and Deterrence Act of1998 (ITDA), Pub. L 105-318(b)(1), Oct. 30,1998, 112 Stat. 3007, codified at 18 U.S.C.§ 1028(a)(7), criminalized the unauthorized use ortransfer of a means of identification with theintent to commit or to aid or abet any federal

violatio n or sta te felon y. This new law isextremely broad; it can apply to a wide range ofoffen se con duct, w hich c an also be ind epen dentlyprosecuted under numerous existing statutes(upwards of 18 0 by an informal cou nt).

Prior to ITDA, only the unauthorized use ortransfer of docu men ts was illegal under 18 U.S.C.§ 1028(a)(1)-(6), while the unauthorized use ofcredit cards, PINs, ATM codes and otherelectronic access devices was illegal under 18U.S.C . § 1029 . Unde r ITDA , identification meansinclude information, such as soc ial secu ritynum bers, d ates of birth, as well as electro nicacce ss dev ices an d rou ting co des u sed intelecommunications and financial sectors. 18 U.S.C. § 1028(d)(4 ).

The United States Sentencing Commissionsolicited public comment on whetherenhancements relating to identity theft should beconfined to the context of the fraud and relatedeconomic crime guidelines, or should apply alsoto conduct such as immigration fraud and firearmsviolations. No strong support was voiced in favorof the broader approach, and most executiveagencies and DOJ supported proposed guideline


language for identity theft within the context ofexisting economic crime guidelines.

In addition, despite the broad statutorylanguage enacted, the legislative history of theITDA, and witness testimony before Congress,focused on individuals whose credit history andgeneral reputation had been damaged by unknownand unauthorized use of their identificationmeans. As a result, on May 1, 2000, theSentencing Commission provided enhancedpunish ment u nder the fraud g uideline a t §2F1.1for those offenders who obtain identificationmea ns in an other individ ual’s n ame or iden tity, inessence, for those who “breed” identificationmeans, and those w ho take over another’sidentity.

The ide ntity theft en hance ments u nder §2 F1.1became effective on November 1, 2000. TheCom missio n’s da ta files fo r FY 2 001, w hich w illbe available in mid-2002, will contain informationon the use o f this gu ideline by sentenc ing co urtsduring the first year of its implementation.

II. Current app lication highlights

On Novemb er 1, 2001, three guidelines –Theft (§2B1.1), Property Destruction (§2B1.3)and Fr aud (§2 F1.1) – were c onsolida ted at §2B 1.1as part of the “Ec onom ic Crime Packa ge.”

A. Fundamental aspects of §2B1.1 guidelinethat may apply to identity theft offenses

Some of the key aspects of the consolidatedguideline, as it applies to identity theft offenses,are as follow s:

The Base Offense Level is set at 6.

The “more-than-minimal planning”enhancement has been deleted.

The alternative prong of “more than minimalplanning” for “more than one victim” has beenreplaced with a specific offense characteristic foroffenses that involve large numbers of victims.See §2B1.1(b)(2)(A ) and (B). Thus, if there are

• 10 to 49 victims or “mass-marketing,” atwo-level enhancement applies; or

• 50 or more victims, a four-levelenhancement applies.

There is a two-level enhance ment, or a “floor”(minimum of 12) if any of the followingcircum stanc es are prese nt:

• reloca tion to a nothe r jurisd iction to avoiddetection;

• a substantial part of the scheme wascommitted from outside the United States;or

• the offense otherwise involved“soph isticated m eans.”

See §2B1.1(b)(8) and Application Note 6.

In addition to the changes noted above, theloss tables have been revised. The new tables:

• expand previously existing one-levelincrements to two levels;

• provide substantial increases in penaltiesfor moderate and h igher loss amounts (>$70,000);

• apply some smaller increases even whenlosses are under $40,000 due to theelimination of the more than minimalplanning enhancement; and

• reduce levels for some lower lossoffenders who previously would havereceived the two-level enhancement formore than minimal planning.

The definition of “loss” has been revised in anumber of significant ways. Under the revised“loss” definition:

• the core rule that loss is the greater ofactual or intended loss is retained (seeApplication Note 2(A));

• intended loss includes intended pecun iaryharms that would have been impossible orunlikely to occur (see App lication Note2(A)(ii));

• “actu al loss” is defin ed as “ reaso nablyforeseeable pecuniary harm” that resultedfrom the offense (see App lication Note2(A)(i));

• “reasonably foreseeable pecuniary harm”includes pecuniary harm that thedefendant knew, or under thecircumstances, reasonably should have


known, was a potential result of the offense (seeApplication Note 2(A)(iv));

• “pecuniary harm” excludes emotionaldistress, harm to reputation, and othernon-economic harm (see ApplicationNote 2(A)(iii));

• credits against loss include money andproperty returned and services renderedby the defendant to the victim, before theoffense was detected (see ApplicationNote 2(E)(i);

• certain credits are not allowed in Ponziand other investment schemes (seeApplication Note 2(F)(iv); and

• no crediting at all is allowed in schemesin wh ich (i) s ervice s wer e frau dulen tlyrend ered to the vic tim by perso ns fals elyposin g as lice nsed profe ssionals; (ii)goods were falsely represented asapproved by a g overnmental regulatoryagency; or (iii) goods for whichregulatory approval by a governmentalagency was required but not obtained, orwas obtained by fraud (see ApplicationNote 2(F)(v)).

Finally, loss excludes interest, late fees,finance charges, and costs to government ofprosec ution and aid to victim s. See ApplicationNote 2(D). A reasonable, not exact, estimate ofthe loss, re mains th e standa rd. See ApplicationNote 2(C).

B. Additional §2B1.1 guideline provisionsspecifically applicable to identity theft offenses

A co nvictio n und er 18 U .S.C. § 1028 (a)(7 ) isnot necessary to apply the identity theft-relatedenhancements. Once Appendix A send s astatutory violation to a particular Chapter Twoguide line, the senten cing g uidelin es gen erallyapply on the basis of the offense conduct, ratherthan the statute of conviction. As long as aconviction is obtained under any of the manyfederal criminal laws that refer to the fraud andtheft guidelines (now consolidated at §2B1.1), thefollowing enhancements and principles will apply.For e xam ple, a c onvic tion ob tained unde r the m ailfraud statute at 18 U.S.C. § 1341 that involves

identity theft offense conduct, as defined in theguide lines, is e ligible fo r the fo llowin g treatm ent.

There is an enhancement of two levels ORfloor (minimum level) of 12 if:

the offense involved the unauthorized transferor use of any means of identification of anactual individual, other than the defendanthimself or herself, to produce or obtain anyother means of identification. “Means ofidentification” has the meaning defined in 18U.S.C. § 1028(d)(4 ).

Ther e are tw o pro ngs to the ap plicatio n of thisenha ncem ent for identity theft:

1) the defendant must transfer or use theidentification means of another personwithout that person’s authority, and

2) the defendant must use the initialidentific ation m eans to prod uce o r obtainanother different means of identification.

This activity has been described as “breeding”documents. For ex ample, using the defendan t’spicture and another person’s name, address, anddate of birth to obtain a state driver’s licensewould qualify for this enhancement, if it occurredin the course of any federal crime that is sentencedunder the theft and fraud guideline at §2B1.1.This conduct is distinguished from merely using astolen credit card and signing the card holder’sname in order to purchase goods and services. Thelatter, w hile a cr ime, d oes n ot con stitute“breeding” documents so as to qualify for theidentity thef t enhan ceme nt. See Application Notes7 (A), (B), and (C).

This two-level enhancement, or floor of 12,also applies if the offense involved the possessionor five or more me ans of identification that wereunlawfully produced or obtained by use of anothermeans of identification. For example, a defendantmight be arrested before actually using the “bred”docu men ts, but h as, in h is or he r poss ession , sixdriver’s licenses from six different states thatcontain the defendant’s picture but som eone else’sname and ad dress.

If the primary purpose of the offense under 18U.S.C . § 102 8 wa s to vio late the law pe rtaining tonaturalization, citizenship, or legal resident status,


apply §2L2.1 rather than the §2B1.1 guideline.See Application Note 7(B) to §2B1.1.�

ABOUT THE AUTHORS

�Pau la J. D esio is Dep uty G enera l Coun sel tothe U nited S tates S enten cing C omm ission inWashington D.C., where she is responsible formoney laundering, identity theft, and othereconomic crime issues, as well as organizationalsentencing and compliance issues under thefederal Sentencing Guidelines. She is a frequentspeaker and author on matters relating to businessand organizational ethics.

Prior to joining the Se ntenc ing Co mm ission inJanuary 1997, Ms. Desio was Of Counsel to theWashington, D.C. law firm of Crowell & Moring,where for ten years she specialized in internalinvestigations and the defense of businessesinvolved in federal criminal and agencyenforcement proceedings and congressionalhearing s.

�Donald A. (Andy) Purdy, Jr. is the ChiefDeputy General Counsel to the United StatesSentencing Commission, where he has workedsince 1987. He served as Acting General Counselfrom November 1999 to January 2001. He servedas Chair of the Commission’s Economic PolicyTeam that formulated the Economic Crimepackage of amendments that went into effectNove mber 1, 2001 .

Mr. Purdy served as an AssistantUnited States Attorney in Philadelphia, SpecialCounsel to the House Ethics Committee, Counselto the Senate Impeachment Trial Committee, andAssistant Attorney General in Missouri. He alsoworked as Senior Staff Counsel to the HouseSelect Committee on Assassinations' investigationof the assassination of President Kennedy.a

Disclaimer: This primer is provided byCommission staff for general backgroundinformation and reference. The informationcontained herein is not binding upon theCommission, the courts, or the parties in any case.


Notes


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