GOVERNMENT ENFORCEMENT AND CORPORATE COMPLIANCE Securities- Related Crime By Juliane Balliro Criminal Provisions and Implications of the Dodd-Frank Act While Congress has virtually ensured that investigations and prosecutions will increase, it remains to be seen if the new enforcement tools will survive the inevitable challenges to come. The Dodd-Frank Wall Street Reform and Consumer Protection Act signed by President Barack Obama on July 21, 2010, contains numerous provisions that have generated widespread concern among criminal defense lawyers. Critics argue that the Dodd-Frank Act contains inadequate mens rea standards, criminalizes or excessively criminalizes behavior that we should consider civil wrongs punishable through civil justice, duplicates criminal enforcement tools already available to federal prosecutors, and provides risky and substantial financial incentives to would-be whistleblowers that could result in unjust investigations or prosecutions. This article examines those provisions of the Dodd-Frank Act that have raised concerns among criminal defense bar members, as well as the potential impact of those provisions on the prosecution of financial crimes. While few of the Dodd-Frank Act s provisions explicitly impose criminal fines or incarceration, many create reporting and other requirements that will inevitably increase the number of reports referred to outside agencies for prosecution and, thus, correspondingly will increase the number of criminal indictments. Provisions Containing Inadequate Mens Rea Standards Criminal defense organizations increasingly have more vocally criticized Congress for enacting criminal statutes that erode the traditional requirement of mens rea or criminal intent. Proof of either specific or general intent as a prerequisite of a criminal conviction is fundamental to our criminal justice system. As a result, criminal offense penalties and fines have traditionally been reserved for knowingly or intentionally committed criminal acts, while conduct committed with reckless disregard, for example, has typically been penalized by civil fines and penalties. When Congress decouples recklessness or reckless disregard from proof that someone committed an act knowingly or intentionally, it dilutes the principles of both general and specific intent. The Dodd-Frank Act contains numerous provisions that criminalize reckless behavior without requiring proof of criminal intent. Juliane Balliro is a partner in Nelson Mullins Riley & Scarborough s Boston office who has been trying cases in the areas of white collar criminal defense and employment law for nearly 30 years. Ms. Balliro represents companies, executives, and individuals in complex business, employment, and criminal cases. Ms. Balliro has tried in excess of 100 cases in various state and federal courts and has authored many appellate briefs and argued dozens of appeals. She is a member of the steering committee of DRI s Government Enforcement and Corporate Compliance Committee. 50 For The Defense July 2011 2011 DRI. All rights reserved.
Section 202(a)(1)(C), Criminal Penalties Section 203(b) of the Dodd-Frank Act, Systemic Risk Determination Determination by the Secretary, permits the secretary of the U.S. Treasury to appoint a corporation or financial company as receiver if, upon a written recommendation, the secretary, in consultation with the president, determines that a covered financial company meets certain risk criteria. The criteria are (1) the financial company is in default or in danger of default; (2) the failure of the financial company and its resolution under otherwise applicable federal or state law would have serious adverse effects on the financial stability of the United States; (3) no viable private sector alternative is available to prevent the default of the financial company; (4) any effect on the claims or interests of creditors, counterparties, and shareholders of the financial company and other market participants as a result of actions taken under this title is appropriate, given the impact that any action taken under this title is appropriate, given the impact that any action taken under this title would have on financial stability in the United States; (5) any action under section 204 would avoid or mitigate adverse effects, taking into consideration the effectiveness of the action in mitigating potential adverse effects on the financial system, the cost to the general fund of the secretary of the U.S. Treasury, and the potential to increase excessive risk taking on the part of creditors, counterparties, and shareholders in the financial company; (6) a federal regulatory agency has ordered the financial company to convert all of its convertible debt instruments that are subject to the regulatory order; and (7) the company satisfies the definition of a financial company under section 201. The procedure by which this appointment takes place is strictly confidential and a breach of confidentiality results in substantial criminal penalties. Specifically, section 202(a)(1)(C) specifies that a person who recklessly discloses a determination of the Secretary under section 203(b) or a petition of the Secretary or the pendency of court proceedings shall be fined not more than $250,000, or imprisoned for not more than 5 years, or both. (emphasis supplied). The absence of notice, knowledge, or intent requirements in the above provision sets it apart from other criminal disclosure provisions passed by Congress and also from the criminal penalty provisions of 7 U.S.C. 13(a)(5). As one defense organization recently noted, other existing disclosure prohibitions are far more limited in scope, require a knowing or willful act, or establish civil as opposed to criminal penalties. See Nat l Ass n of Criminal Defense Lawyers & the Heritage Found., Without Intent: How Congress Is Eroding the Criminal Intent Requirement in Federal Law (2010), http://www.nacdl.org/withoutintent (citing 42 U.S.C. 299b-22 (civil penalty resulting from unlawful disclosure of privileged patient health information), 42 U.S.C. 300i-2 (misdemeanor for knowingly and recklessly revealing a vulnerability assessment by a certain class of individuals), & 42 U.S.C. 3537a ( willful advance disclosure of HUD funding decisions by applicants and their agents criminal penalties)). When challenged, proponents of section 202(a)(1)(C) of the Dodd-Frank Act will, no doubt, argue that the criminal penalties and relaxing the mens rea requirement are justified by the tremendous impact that premature disclosure could have on the financial stability of the United States. The flaw in this argument is that the prohibition affects the timing of the disclosure, not its existence, and the numerous prerequisites to filing a petition, even under seal, are sufficient to ensure that a petition will have considerable merit even if disclosed prematurely. Under the Dodd-Frank Act, a petition that a court ultimately sustains is subject to disclosure regardless of the consequences of disclosure to the U.S. economy. In challenging a prosecution stemming from a violation of this provision on the ground that it lacks a criminal intent requirement, opponents of the section may argue that for a provision to have an appropriate deterrent effect, criminal penalties should only apply to those who act with knowledge of the consequences or with the requisite criminal intent. However, the attacks likely will not end there. Challengers will also likely argue that the provision constitutes an unlawful restraint on free speech and as such is unconstitutional. The disclosure that this section prohibits is not inherently criminal. In a society such as ours, which generally favors disclosure over secrecy in matters other than national Other existing disclosure prohibitions are far more limited in scope, require a knowing or willful act, or establish civil as opposed to criminal penalties. security, a well- meaning person could run afoul of this section simply by exercising his or her right to free speech. Prosecutors will probably argue that premature disclosure is akin to shouting fire in a crowded theatre so restraint is both permissible and necessary to protect the public interest. Prosecutors may also point to the penalty provisions of 7 U.S.C. 13(a)(5) as providing protection against conviction and penalty without proof of intent. And 7 U.S.C. 13(a)(5) does provide some measure of protection to individuals accused of violating section 202(a)(1) (C) of the Dodd-Frank Act. Although section 202(a)(1)(C) of the Dodd-Frank Act requires only proof of recklessness, 7 U.S.C. 13(a)(5) protects against felony convictions for a violation of section 202(a)(1)(C) that is not willful: Felonies generally. It shall be a felony punishable by a fine of not more than $1,000,000 or imprisonment for not more than 10 years, or both, together with the costs of prosecution, for: Any person willfully to violate any other provision of this Act [7 U.S.C.S. 1 et seq.], or any rule or regulation thereunder, the violation of which is made unlawful or the observance of which is required under the terms of this Act [7 U.S.C.S. 1 et seq.], but no person shall be subject to imprisonment under this paragraph for the violation of any rule or regulation is such person proves that he had no knowledge of such rule or regulation. 7 U.S.C.S. 13(a)(5) (emphasis supplied). Congress did not amend 7 U.S.C. 13(a)(5) when it enacted the Dodd-Frank Act, and none of the other felony provisions in that section encompass the violation described in Dodd-Frank s section For The Defense July 2011 51
GOVERNMENT ENFORCEMENT AND CORPORATE COMPLIANCE 202(a)(1)(C). This may have been an oversight, but it is unclear how the courts will resolve the conflicting penalty provisions of these two sections. Prosecutions based upon the Dodd-Frank Act s amending section 747 are likely to spawn arguments that the section not only dispenses with mens rea, but the section s language also is unconstitutionally vague. Amendments to 7 U.S.C. 6. The Dodd-Frank Act contains several provisions that add sections to 7 U.S.C. 6, which deals with contracts for sale of commodities and establishes civil enforcement of and penalties for violation of that section. Section 746 of the Dodd-Frank Act, Insider Trading, adds four new subsections to 7 U.S.C. 6c(a). These include subsection (3), Contract of Sale, which makes it unlawful for a federal employee to use information that hasn t been made generally publically available that may affect or tend to affect the price of any commodity in interstate commerce, or for future delivery, or any swap, in his personal capacity and for personal gain to enter into, or offer to enter into (A) a contract of sale of a commodity for future delivery (or option on such a contract); (B) an option (other than an option executed or traded on a national securities exchange registered pursuant to section 6(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78f (a)); or (C) a swap. Similarly, subsection (4), Nonpublic Information, makes it unlawful for a federal employee who acquires such information to impart the information in his personal capacity and for personal gain with intent 52 For The Defense July 2011 to assist another person, directly or indirectly, to use the information to enter into, or offer to enter into the transactions listed above. Further, it is unlawful for a person who receives such information imparted by a federal employee to knowingly use such information to enter into, or offer to enter into the described transactions. Finally, it is unlawful for a person to steal, convert, or misappropriate, by any means whatsoever, information held or created by any department or agency of the Federal Government that may affect or tend to affect the price of any commodity in interstate commerce, or for future delivery, or any swap, where such person knows, or acts in reckless disregard of the fact, that such information had not been disseminated to the trading public [or otherwise publically disclosed] or to impart such information with the intent to assist another person, directly or indirectly, to use such information to enter into, or offer to enter into the transactions listed above. None of these provisions require that a person act willfully or with knowledge that the information has not been made publically available. The new section (4)(C) specifically criminalizes conduct committed in reckless disregard of the fact. Section 747, Antidisruptive Practices Authority This section amends 7 U.S.C. 6c(a) partly by adding two sections, section (5), which prohibits disruption of the orderly execution of transactions during the closing period, and section (7), which prohibits the use of swaps to defraud. Both suffer from defects. Both sections criminalize reckless conduct by specifying that knowing, intentional, or reckless conduct can form the basis of liability. Section (5)(B) suffers from an additional flaw. The Dodd-Frank Act fails to define orderly execution of transactions during the closing period. As a result, prosecutions based upon the Dodd-Frank Act s amending section 747 are likely to spawn arguments that the section not only dispenses with mens rea, but the section s language also is unconstitutionally vague. While it is difficult to predict whether either of those challenges to the law would result in the demise of the amendments, Congress could have easily avoided them by requiring both proof of intent and defining the unlawful conduct of Dodd-Frank Act section 747. The vaguely worded amendments of section 747 coupled with the broad whistleblower and referral provisions of the Dodd-Frank Act also create the possibility that the government will investigate and criminally prosecute matters that Congress actually intended would receive civil treatment. Even when they do not result in prosecution, criminal investigations can ruin the reputations and finances of the targets. Section 741, Enforcement This Dodd-Frank Act provision adds, among others, a subsection (e) to the existing 7 U.S.C. 6b, which reads as follows: (e) It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any registered entity, in or in connection with any order to make, or the making of, any contract of sale of any commodity for future delivery (or option on such a contract), or any swap, on a group or index of securities (or any interest therein or based on the value thereof) (2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or This Dodd-Frank Act section 741 amendment to 7 U.S.C. 6b, subsection (e)(2), prohibits someone from making an untrue statement or omitting a material fact without requiring that the statement maker or factomitting person have knowledge that it is false or misleading. Subsection (e)(2) is one of three new subsections falling under (e), and the two other new subsections do require an intentional act to defraud. As the only subsection in section 741 of the Dodd-Frank Act that does not require proof of knowledge, it is vulnerable to attack by both defense counsel and prosecutors. Prosecutors will argue that proof of knowledge is either unnecessary on its face, or a court can infer the requirement of knowledge from reading the entire provision. Defense counsel will argue that a court should bar criminal prosecution given the absence of mens rea in subsection (2), particularly when compared to the other subsections, (1) and (3).
Various Swap Provisions The Dodd-Frank Act contains seven separate provisions relating to registering or filing swap transactions. They are 1. Section 723, Clearing, which makes it unlawful for any person, other than an eligible contract participant, to enter into a swap that is not covered by a board of trade designated as a contract market; 2. Section 724, Swaps, Segregation and Bankruptcy Treatment, which makes it unlawful to accept anything of value from a swaps customer unless registered as a futures commissions merchant; 3. Section 728, Swap Data Repositories; Registration Requirement, which makes it unlawful to use the mails or engage in interstate commerce as a swap data repository unless registered; 4. Section 730, Large Swap Trader Reporting, which governs the record keeping and report filing; 5. Section 731, Registration and Regulation of Swap Dealers and Major Swap Participants, which requires registration of swap dealers; 6. Section 733, Swap Execution Facilities, which requires registration of a swap execution facility; and 7. Section 764, Registration and Regulation of Security- Based Swap Dealers and Major Security- Based Swap Participants, which bars association with a swap dealer under a cease- and- desist order pursuant to section 753, Anti- Manipulation Authority, (b) Cease and Desist Orders, Fines. Each of these sections either amend or add to 7 U.S.C. 2 and 6 and are governed by 7 U.S.C. 13(a)(5), which, as discussed earlier, criminalizes willful violations but prohibits imposing a sentence of incarceration if the person proves that he had no knowledge of such rule or regulation. Section 929O, Aiding and Abetting Standard of Knowledge Satisfied by Recklessness This section amends section 20(e) of the Securities Exchange Act of 1934, 15 U.S.C. 78t(e), by inserting the words or recklessly after knowingly, and leaves little doubt about the intent of the drafters. Section 929N holds an aider and abettor to any violation of the Dodd- Frank Act accountable to the same extent as the person who committed the violation. Provisions That Duplicate Existing Law Enforcement Tools Critics argue that section 741 of the Dodd- Frank Act largely duplicates existing mail and wire-fraud statutes that already impose criminal penalties upon those who commit fraud in interstate commerce, through the U.S. mail, or by wire. Specifically, section 741 of the Dodd-Frank Act adds a subsection (e) to the existing 7 U.S.C. 6b, which reads as follows: (e) It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any registered entity, in or in connection with any order to make, or the making of, any contract of sale of any commodity for future delivery (or option on such a contract), or any swap, on a group or index of securities (or any interest therein or based on the value thereof) (1) to employ any device, scheme, or artifice to defraud; (3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. The mail and wire-fraud statutes, 18 U.S.C. 1341 and 1343 are very broadly worded and encompass virtually every type of scheme involving property that includes the use of mail or wires. However, the potential penalties of the mail and wirefraud statutes are significantly more onerous than those of the Dodd-Frank Act, codified in a new section, new 13(a)(5), as amended by the act. The newly added sections may actually benefit violators because prosecutors will have the option of pursuing charges that carry maximum penalties of a lesser period of incarceration, up to 10 years, as opposed to 20 or 30 years, for the same offense. The risk of duplicative prosecutions under both statutes exists but probably will not yield the longer sentences of prosecutions pursued under the preexisting mail and wire-fraud statutes. Provisions Requiring Actual Knowledge and Intent The above sections of the Dodd-Frank Act contrast with section 929V of the act, Security Investor Protection Act Amendments, which, as the title implies, amend section 14 of the Securities Investor Protection Act of 1970, 15 U.S.C. 78jjj, by adding a new subsection establishing a potential fine of up to $250,000 and imprisonment for up to 5 years for Any person who falsely represents with actual knowledge and with an intent to deceive or cause injury to another that such person is a member of SIPC [Securities Investor Protection Corporation] or that any person or account is protected or is eligible for protection under this Act or by SIPC. Overall, the whistleblower provisions of the Dodd-Frank Act could easily increase the level of misconduct reporting and in turn the number of misconduct reports referred to outside agencies for prosecution. Provisions Relating to a Duty to Report Crimes Dodd-Frank Act section 934, Referring Tips to Law Enforcement or Regulatory Authorities, amends section 15E of the Securities Exchange Act of 1934, 15 U.S.C. 780-7, by adding a section, Duty to Report Tips Alleging Material Violations of Law. Each nationally recognized statistical rating organization bears this duty, which mandates each organization to refer to the appropriate law enforcement or regulatory authorities any information that an organization receives from a third party and finds credible that an issuer of securities rated by the nationally recognized statistical rating organization has committed or is committing a material violation of law that has not been adjudicated by a federal or state court. This section raises the question whether the credibility of the information is judged according to an objective or a subjective standard. The language tends to suggest the latter, but it leaves open the risk that a court would apply an objective standard. It also raises the question Dodd-Frank, continued on page 77 For The Defense July 2011 53
Dodd-Frank, from page 53 whether a nationally recognized statistical rating organization has a duty to investigate such information and how far that duty, if in fact it exists, extends. Finally, the section raises the questions what constitutes a finding of credibility, how is that finding made, and who is responsible for making it? That section 934 of the Dodd-Frank Act does not contain criminal penalties does not mean that an organization that fails to comply with its duty is immune from prosecution. A failure to report as required by section 15E of the Securities Exchange Act could provide the basis for a prosecution for aiding and abetting securities fraud or even for obstruction of justice if the government had started a criminal investigation but a federal or state court has not yet adjudicated the case. Whistleblower Provisions The whistleblower protection provisions of the Dodd-Frank Act are too extensive to review in detail here, but they establish substantial monetary awards for innocent whistleblowers who provide original information, establish an Investor Protection Fund to use to pay awards to whistleblowers, and considerably protect the identity of whistleblowers and attempt to protect them from retaliation. Overall, the whistleblower provisions of the Dodd- Frank Act could easily increase the level of misconduct reporting and in turn the number of misconduct reports referred to outside agencies for prosecution. Conclusion The criminal penalties of the Dodd-Frank Act are controversial. Many of the provisions that omit reference to criminal intent appear to conflict with corresponding penalty provisions that require knowing or willful behavior. This raises the question whether Congress intended to broaden the scope of conduct that is considered criminal, or whether Congress intended to rely on the penalty provisions to define the nature of conduct that could result in felony convictions. Other provisions clearly require proof of criminal intent and still others equally clearly offer a lesser standard of recklessness as an enforcement guideline. By creating a duty to report certain crimes and coupling that duty with extraordinary whistleblower incentives and protections, Congress has virtually ensured that criminal investigations and prosecutions will increase for securities- related crimes. It remains to be seen whether and to what extent the new enforcement tools will survive the inevitable challenges to come. For The Defense July 2011 77