Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 1 of 15

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1 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 1 of 15 UNITED STATES OF AMERICA IN THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF TEXAS MIDLAND-ODESSA DIVISION VS. NO. MO-14-CR-001 STEPHEN HILLIARD, MICHAEL DURAINE COWAN, II, CYNTHIA GAYLE HIRSCH, BERTA LAURA MCFADDIN UNITED STATES S MOTION IN LIMINE TO EXCLUDE EVIDENCE OR ARGUMENT OF VICTIM BANKS NEGLIGENCE, GULLIBILITY OR COMPLICITY, AND TO EXCLUDE EVIDENCE REGARDING RELIANCE I. Introduction Defendants have indicated an intent to introduce evidence or make argument that some or all of the victim banks were negligent or complicit in the misrepresentations and lies told by Defendants to obtain the loans. Alternatively, Defendants might try to introduce evidence or make argument that the victim banks did not actually rely on the misrepresentations and thus such lies by Defendants were not material. Essentially, Defendants seek acquittal under a theory that blames the victim. The United States seeks to preclude Defendants from introducing these categories of evidence because it improperly shifts the focus from the question of whether the defendants engaged in a scheme to defraud to the question of whether the banks should have seen red flags. II. Background From on or about March 7, 2003 to on or about August 23, 2011, Stephen Mark Hilliard, Michael Duraine Cowan, II, Cynthia Gayle Hirsch, Berta Laura McFaddin, and others, all

2 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 2 of 15 worked together to engage in a real estate investment scheme, involving approximately 800 real properties and about $45 million in loans, to defraud multiple banks. The principal objective of the real estate investment scheme was for Hilliard and/or Cowan to purchase a specific property from A utilizing one of their respective investment companies. A first sales contract would be produced indicating A as the seller and the investment company as the buyer B. McFaddin, as the title company representative, would assist in the completion of the HUD-1 form on the A-to-B transaction. Next, Hilliard and/or Cowan would re-sell (flip) the same property at an inflated selling price on the same day to another Hilliard and/or Cowan investment company, thereby creating a fraudulent second sales contract between the seller B and the new buyer, C, which was also a Hilliard and/or Cowan investment company. McFaddin would similarly assist in the completion of the fraudulent HUD-1 form on the B-to-C transaction taking place the same day. To obtain mortgage loans or access to established lines of credit at the various banks, Hilliard and/or Cowan would submit to the bank only the documentation regarding the second, fraudulent, property sale (B-to-C) with the inflated price. In order to substantiate the inflated price on the fraudulent (B-to-C) documentation, Hilliard and/or Cowan would obtain a Broker s Price Opinion (BPO), most often from Cynthia Gayle Hirsch. Typically, Hilliard and/or Cowan would contact Hirsch and direct her to manufacture a BPO for a specific property address and further direct her to manufacture the BPO at or above a certain price so as to justify the B-to-C fraudulent sales price that was to be presented to the bank for credit extension. In hundreds of instances, Hilliard, Cowan, Hirsch, and McFaddin were all aware of all of the material details of both the A-to-B and B-to-C transactions occurring on the same day. Once Hilliard and/or Cowan received the funds from the bank for the second, inflated,

3 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 3 of 15 fraudulent sales contract, (B-to-C) they would use the monies to close on the first sales contract with the bona fide seller A at the lower selling price (A-to-B). The banks had no knowledge of the first sales contract, nor that Hilliard and/or Cowan were re-selling (flipping) the property to themselves. Consequently, Hilliard and Cowan were able to retain the difference between the price paid to A and the monies received from the bank based upon the B-to-C sales contract by providing false and materially misleading information to the bank. III. Argument & Authorities The new Fifth Circuit Pattern Jury Instructions (Criminal) issued in 2012 set forth the elements for bank fraud, which is Count One in the pending Indictment: First: That the defendants knowingly executed a scheme or plan to obtain money or property from certain banks by means of false or fraudulent pretenses, representations, or promises; Second: That the defendants acted with a specific intent to defraud the specified banks; Third: That the false or fraudulent pretenses, representations, or promises that the defendant used were material; Fourth: That the defendant placed the financial institution at risk of civil liability or financial loss; and Fifth: That the specified banks were insured by the Federal Deposit Insurance Corporation. (5th Circuit Pattern Instruction 2.61.) Certain defendants, through their filings, arguments in court, and discussions with undersigned counsel, have signaled an intent to present evidence and argument suggesting that the

4 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 4 of 15 mortgage lenders from whom the defendants fraudulently obtained loans, or the employees of those lenders, (1) did not actually rely on the defendants false statements; (2) did not care whether the defendants representations were true; (3) knew the defendants statements were false; (4) should have known the defendants statements were false; or (5) were negligent in not discovering that the defendants statements were false. Under the defendants theory, these allegations would be relevant to the issue of materiality. In other words, it is anticipated that Defendants will attempt to defend their fraudulent conduct by claiming the lenders were negligent in failing to exercise the requisite due diligence in their review of the mortgage loan applications in this case. That due diligence, so goes the argument, had it been completed, would have uncovered the false information contained on the loan applications submitted by Defendants as part of this mortgage fraud scheme. Consequently, Defendants believe they should be able to avoid the criminal liability altogether based on the victims conduct. The defense is not valid as a matter of law and efforts to establish the defense should be precluded. A. The Court should preclude any evidence or argument suggesting that the victim financial institutions invited or could have prevented the fraud. It is not a defense to mortgage fraud to blame the victim of negligence, just as it is no defense to burglary charges that the victim left his door unlocked. See United States v. Coyle, 63 F.3d 1239, 1244 (3d Cir. 1995) ( The negligence of the victim in failing to discover a fraudulent scheme is not a defense to criminal conduct. ). Thus, any negligence by the mortgage lenders is irrelevant, and the United States respectfully requests that the Court preclude the defendants from presenting evidence or argument suggesting that the victim mortgage lenders were negligent or could have been more diligent, in their dealings with the defendants. The Fifth Circuit, in United States v. Kreimer, rejected a defense based on the victim s failure to have taken steps to uncover the fraud, holding [t]he victim s negligence in not a

5 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 5 of 15 defense to criminal conduct. Kreimer, 609 F.2d 126, 132 (5th Cir. 1980). More recently, the Fifth Circuit, in United States v. Davis, affirmed the district court s use of the following jury instruction: You are instructed that the naivety, carelessness, negligence, or stupidity of a victim does not excuse criminal conduct, if any, on the part of a defendant. The laws protecting against fraud are most needed to protect the careless and the naive from perpetrators of fraud. Even the monumental credulity of a victim does not excuse a defendant's fraud, if any. United States v. Davis, 226 F.3d 346, 358 (5th Cir. 2000) (citing United States v. Kreimer, 609 F.2d 126, 132 (5th Cir.1980)); see also United States v. Patterson, 196 F.3d 1256, 1999 WL , *1 (5th Cir. 1999) (affirming district court s ruling that victim s negligence was not a defense to fraud). Other circuits have also reached the same holding regarding defendants attempts to blame the victim. For example, in United States v. Moore, 923 F.2d 910 (1st Cir. 1991), the First Circuit approved a jury instruction that it is not a defense to claim that the bank might have prevented its losses had it had better internal controls or procedures. Id. at 917. Similarly, the Third Circuit has held that the fraud victim s negligence or lack of diligence in uncovering the fraud is not a defense. United States v. Rennert, 374 F.3d 206, 213 (3d Cir. 2004). In United States v. Callipari, the First Circuit approved the exclusion of what it termed blame the victim line of cross-examination, noting that [t]he court was well within its discretion to exclude evidence suggesting that [the victim], rather than [the defendant] and his co-conspirators, was to blame for the loss, 368 F.3d 22, 37 (1st Cir. 2004). As the Eleventh Circuit has held, whatever role, if any, a victim s negligence plays as a bar to civil recovery, it makes little sense as a defense under a criminal statute that embraces any scheme or artifice to defraud. United States v. Svete, 556 F.3d 1157, 1165 (11th Cir. 2009) (quoting 18 U.S.C. 1341); United States v.

6 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 6 of 15 Serfling, 504 F.3d 672, 679 (7th Cir. 2007) (approving exclusion of expert testimony that investigation by mortgage lender would have prevented loan from closing because the perpetrator of a fraud may not defend himself by blaming the victim for being duped ). Indeed, [t]he focus of the language defining a scheme to defraud is on the violator, not the victim. United States v. Drake, 932 F.2d 861, 864 (10th Cir. 1991). The Sixth Circuit, applying this principle, upheld a district court s refusal to admit into evidence an FDIC report which criticized the bank fraud victim s failure to detect the fraudulent scheme, noting that the relevance of the report is questionable. See United States v. Winkle, 477 F.3d 407, 418 (6th Cir. 2007). In mortgage fraud prosecutions, the relevant inquiry for the jury is whether the defendants had the requisite knowledge and intent to defraud the lenders. The lenders vigilance is irrelevant, and challenges to the lenders conduct runs the risk of confusing the jury. United States v. Biesiadecki, 933 F.2d 539, 544 (7th Cir. 1991) (affirming in limine because [t]he excluded testimony... would have improperly shifted the jury s attention away from the knowledge and intent of [defendant] and focused instead on the beliefs of the victims of the alleged scheme to defraud ). The federal fraud statutes do not put victims on trial because [t]hose who are gullible, as well as those who are skeptical, are entitled to the protection of the mail statute. Biesiadecki, 933 F.2d at 544. Again, because the focus of the mail fraud statute, like any criminal statute, is on the violator, the purpose of the element of materiality is to ensure that a defendant actually intended to create a scheme to defraud. Svete, 556 F.3d at Because the negligence of the victim is not a defense to a criminal fraud charge, the defendants should be precluded from referring to it at trial. The blame the victim line of argument is particularly inappropriate here because in any

7 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 7 of 15 mortgage fraud case it is the lending institutions and their shareholders 1 not the mortgage lenders agents or employees that are the victims of the fraud. It is also irrelevant if an underwriter for a lender overlooked a red flag associated with a fraudulent loan application, or even encouraged the fraud. United States v. Saks, 964 F.2d 1514, 1518 (5th Cir. 1992) ( It is the financial institution itself not its officers or agents that is the victim of the fraud the statute [ 1344 bank fraud] proscribes. ); see also United States v. Jimenez, 513 F.3d 62, 74 (3d Cir. 2008) ( [T]he defendants argue that they could not have defrauded [the bank] because the bank was aware of the numerous and sizable overdrafts and consented to them. However, it is not a defense to the charge that an account holder colluded with a bank officer to commit bank fraud. It is the financial institution itself not its officers or agents that is the victim of the fraud 1344 proscribes. ) (quoting Saks, 964 F.2d at 1518); Winkle, 477 F.3d at 414 n.3 ( [T]he victim of a bank fraud is the bank, not the CEO of the bank, and approval of a bank officer does not relieve a defendant of liability for bank fraud. ). Fraud remains fraud even if the victim should have acted more prudently. United States v. Catalfo, 64 F.3d 1070, 1078 (7th Cir. 1995). Even where the victim engaged in misconduct, evidence of the victims actions remains irrelevant. See United States v. Thomas, 377 F.3d 232, 243 (2d Cir. 2004) (victim s criminal background is not relevant to whether the defendant was properly convicted). Therefore, it would be improper to allow argument to the jury that an employee of the lender failed to do the required due diligence to avoid the fraud, or even assisted in the fraud. The actions of the instant defendants themselves in helping to conceal their fraud from the mortgage lenders further demonstrate the need to preclude Defendants from introducing comparative negligence evidence. Accordingly, a victim s lack of caution or diligence in 1 Ultimately, the federal taxpayers are most at risk because they, through the FDIC, are the ones insuring depositors money that is used to fund these fraudulent loans, hence the basis for federal jurisdiction under 18 U.S.C

8 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 8 of 15 discovering a scheme to defraud is irrelevant and does not constitute a defense to a criminal charge. In addition, improper or criminal conduct by other employees of the lenders should not be bases for cross-examination of the lender representatives in the present case. In sum, the lenders actions are irrelevant to whether the defendants perpetrated a scheme to defraud on the lenders, and therefore, the defendants should be precluded from referring to any perceived or actual negligence, complicity, or lack of diligence by the victim mortgage lenders. B. The Court should preclude any evidence or argument suggesting that Defendants misrepresentations were not material because a particular lender subjectively did not rely upon such misrepresentations. It is anticipated that Defendants will attempt to set forth the following theory: The mortgage lenders knew or should have known that the loan applications they were receiving contained false statements, or knew that such false statements were likely, but the lenders did not care. Thus, Defendants would argue, because the lenders did not care if the application statements were true, or perhaps even had employees who solicited applications that likely had false statements, the false statements could not have been material. The theories on materiality that the defendants want to advance have been squarely rejected by the Fifth Circuit, as well as other circuits. There is no defense that misrepresentations were not material because a particular lender did not subjectively or actually rely on the misrepresentations. [A] false statement is material if it has a natural tendency to influence, or [is] capable of influencing, the decision of the decisionmaking body to which it was addressed. Neder v. United States, 527 U.S. 1, 16 (1999) (internal quotation omitted). On remand from the Supreme Court, the Eleventh Circuit held that: Because the issue is whether a statement has a tendency to influence or is capable of influencing a decision, and not whether the statement exerted actual influence,

9 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 9 of 15 a false statement can be material even if the decision maker did not actually rely on the statement. United States v. Neder, 197 F.3d 1122, 1128 (11th Cir. 1999). The Eleventh Circuit, in Neder, rejected the notion that there is no materiality where the recipient knew the statements were false, or even encouraged the statements to be false. Neder involved several different fraudulent schemes by which the defendant sought to deceive real estate lenders. On remand from the Supreme Court, the Eleventh Circuit evaluated whether a reasonable jury could have found a lack of materiality. The first scheme was a land-flipping scheme whereby the defendant had a nominee corporation he controlled simultaneously buy a piece of land and then sell it to a partnership he controlled at a highly inflated price. Neder, 197 F.3d at The defendant would obtain a loan for the inflated price and pocket the difference between the loan amount and the land s original purchase price, without disclosing his interest in the selling corporation, the original price the corporation was paying for the land, the fact that he was keeping the excess loan proceeds in a personal account, and other pertinent information. Id. The defendant argued that the lenders either knew or should have known that he was land-flipping and appropriating the loan proceeds for personal use. See id. at The defendant also introduced evidence that his land-flipping practices were common in the 1980s and argued that lenders had a duty to investigate whether he was engaging in such practices. See id. The defendant in Neder argued that his statements were not material because he personally guaranteed his loans, fully securing the lenders. Id. The Eleventh Circuit rejected these arguments because they are really about what the lenders knew or should have known and whether the lenders reasonably relied on Neder s representations not whether Neder s representations were material. Id. By this reasoning, in the instant case whether lenders knew or should have known that the defendants applications contained misrepresentations does

10 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 10 of 15 not affect whether those misrepresentations were material. Neder also rejected the defendants materiality argument in the more nefarious situation where the lender s employees allegedly actively solicited false information. In one of the defendants schemes in Neder, he submitted false invoices to a lender falsely representing that he had paid for construction work on a property. He presented evidence that two of the lender s representatives had authorized and encouraged Neder to make false construction draw requests and knew that he was doing so. Id. at The defendant thus argued that, had the jury believed that the lender employees knew his statements were false but disbursed the funds anyway, the jury could have found that the representations did not actually influence the lender and thus were not material. Id. Again, the court rejected this argument, finding that a statement can be material even if the decision maker is not actually influenced and knew the statement was false. Id. [W]hat is relevant to materiality is whether the statements have a natural tendency to influence, or are capable of influencing, the decision of the decisionmaking body to which they are addressed. Id. In fact, a false statement can be material even if the decisionmaker actually knew or should have known that the statement was false, United States v. Johnson, 139 F.3d 1359 (11th Cir. 1998), or even if the false statement was ignored. United States v. Gray, 367 F.3d 1263 (11th Cir. 2004). See also United States v. Boffil-Rivera, 607 F.3d 736, (11th Cir. 2010) (statement need not be relied upon or even read in order to be material). On the issue of materiality, the false statement statute is interpreted identically as the bank fraud statute. Kungys v. United States, 485 U.S. 759, (1988) ( The federal courts have long displayed a quite uniform understanding of the materiality concept as embodied in such statutes. ); see also United States v. Mann, 161 F.3d 840, 866 n.85 (5th Cir. 1998). The Fifth Circuit, in United States v. Abrahem, in a false statement case, held that the issue of

11 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 11 of 15 materiality turns on whether the statement... has the natural tendency to influence or be capable of influencing the decision maker, not whether it actually influenced the decision on this one occasion. Abrahem, 678 F.3d 370, 374 (5th Cir. 2012) (citing United States v. McIntosh, 655 F.2d 80, 83 (5th Cir. 1981)). In another false statement case, the Fifth Circuit similarly held that [a]ctual influence or reliance by a government agency is not required. The statement may still be material even if it is ignored or never read by the agency receiving the misstatement. United States v. Richardson, 676 F.3d 491, 505 (5th Cir. 2012) (internal citations and quotations omitted). In United States v. Heath, 970 F.2d 1397, (5th Cir. 1992), our Court of Appeals rejected, in a real estate fraud context, the defendant s argument that a misrepresentation could not be material if a third party had a duty to independently investigate. Similarly, in a perjury case, the Fifth Circuit, utilizing the Kungys definition of materiality, held that [t]he Government does not have to demonstrate that the grand jury was actually hindered in any way by the falsehood. (citing United States v. Abrams, 568 F.2d 411, 421 (5th Cir. 1978) ( Actual impediment of the investigation is not required. )). The relevant question is the objective tendency or capability of a false statement to influence a decision, and not the subjective or actual reliance on that statement by the victim, because the focus of the criminal statute is on the behavior and intent of the criminal perpetrator, not the victim. Indeed, the Fifth Circuit recently explained that the standard is not whether a particular statement actually influenced a decision, but instead the standard is whether the misrepresentation was capable of influencing the decision. Richardson, 676 F.3d at 505 (emphasis in original). Importantly and relatedly, [b]ecause the focus of the mail fraud statute, like any criminal statute, is on the violator, the purpose of the element of materiality is to ensure that a defendant actually intended to create a scheme to defraud. United States v. Svete, 556

12 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 12 of 15 F.3d 1157, 1165 (11th Cir. 2009). Similarly, the materiality requirement does not exist to put the victim s intent, knowledge or behavior at issue. Rather, [t]he purpose of the materiality requirement is to insure that the reach of 1001 is confined to reasonable bounds and not allowed to embrace trivial falsehoods. Johnson, 139 F.3d at (quoting United States v. Gafyczk, 847 F.2d 685, 691 (11th Cir. 1988)). Because it is not relevant to materiality whether the lenders cared about the truth or falsity of the defendants statements, whether the lenders knew or should have known the statements were false, whether the lenders actually relied on the statements being true, or even whether their employees might have encouraged them to be false, this Court should prohibit the defendants from presenting evidence or argument on these issues. Federal Rule of Evidence 401 defines [r]elevant evidence as evidence having any tendency to make the existence of any fact that is of consequence to the determination of the action more probable or less probable than it would without the evidence. Fed. R. Evid In other words, for evidence to be relevant (1) [t]he evidence must be probative of the proposition it is offered to prove, and (2) the proposition to be proved must be one that is of consequence to the determination of the action. United States v. Glasser, 773 F.2d 1553, 1559 n.4 (11th Cir. 1985) (quotation omitted). If the evidence does not meet both of these relevancy requirements, then Rule 402 says that it is not admissible. Fed. R. Evid As the above analysis shows, even if the defendants could prove that the mortgage lenders did not care, did not actually rely on, or actually disbelieved the defendants false statements, those propositions would not make the determination of their materiality more or less likely. See United States v. Biesiadecki, 993 F.2d 539, 544 (7th Cir. 1991) (affirming district court's decision precluding testimony from customers who were not misled by defendant's

13 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 13 of 15 statements; holding that the excluded testimony of the other... customers would have improperly shifted the jury's attention away from the knowledge and intent of [the defendants] and focused instead on the beliefs of the victims of the alleged scheme to defraud. ). Thus, evidence of such propositions would not be relevant. Because it would not be relevant, such evidence and argument would serve only to confuse or inflame the jury. IV. Conclusion The United States respectfully requests that this Court issue an Order expressly precluding Defendants and their counsel from making argument, introducing evidence (in documentary or testimonial form) that the victim banks were negligent, gullible or complicit in failing to identify the misrepresentations told by Defendants. In addition, the United States requests that this Court issue an Order expressly precluding Defendants and their counsel from making argument, introducing evidence (in documentary or testimonial form) that the victim banks did not actually rely on the misrepresentations. Respectfully submitted, ROBERT PITMAN UNITED STATES ATTORNEY By: /s/ Austin M. Berry AUSTIN M. BERRY Assistant United States Attorney 400 West Illinois, Suite 1200 Midland, Texas FAX Certificate of Service I hereby certify that a true and correct copy of the foregoing was filed Friday, April 18, 2014 via CM/ECF, which will cause a copy to be sent to Defendants Attorneys:

14 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 14 of 15 Hal Brockett Attorney of record for Defendant Stephen Hilliard William R. Turner Attorney of record for Defendant Stephen Hilliard Charles M. Meadows, Jr Attorney of record for Defendant Michael Cowan, II E. Jason Leach Attorney of record for Defendant Michael Cowan, II Jason Brent Freeman Attorney of record for Defendant Michael Cowan, II David P. Zavoda Attorney of record for Defendant Cynthia Gayle Hirsch Richard Alvarado Attorney of record for Defendant Berta Laura McFaddin /s/ Austin M. Berry AUSTIN M. BERRY Assistant United States Attorney

15 Case 7:14-cr RAJ Document 69 Filed 04/18/14 Page 15 of 15 UNITED STATES OF AMERICA IN THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF TEXAS MIDLAND-ODESSA DIVISION VS. NO. MO-14-CR-001 STEPHEN HILLIARD, MICHAEL DURAINE COWAN, II, CYNTHIA GAYLE HIRSCH, BERTA LAURA MCFADDIN ORDER After due consideration, the Court finds the United States s Motion In Limine meritorious, and Orders as follows: Defendants are instructed not to make any mention in opening or closing statements, nor introduce documentary evidence or elicit testimony on the following issues: First, that the banks were negligent, gullible or complicit in the fraud; and Second, that the banks did not actually rely on the misrepresentations, SIGNED this day of, THE HON. ROBERT JUNELL UNITED STATES DISTRICT JUDGE