Second Circuit Holds Civil Loss Causation Principles Apply to Loss Calculations in Criminal Fraud Case

The lengthy sentences meted out in securities fraud cases over recent years are driven by the extensive financial losses incurred in those cases, which yield very high Guidelines ranges. Yesterday, the Second Circuit provided some relief to defendants in this situation, remanding a case for resentencing so that the loss calculation underpinning the sentence and restitution order could be redetermined "to exclude causes other than the fraud." 

In United States v. Rutkoske, 2007 WL 3102187 (2d Cir. October 25, 2007), the owner of a brokerage firm was convicted after trial of securities fraud arising out of a scheme to manipulate the market for certain shares.  He was sentenced to 108 months in custody, 87 months of which stemmed from the Guidelines enhancement applied for a loss exceeding $10 million.  The district judge had based the loss figure on the decline in the relevant share price from the time of the fraud to sometime around the revelation of the fraud, thus implicitly attributing the total decline to Rutkoske's offense conduct.  On appeal, the defendant challenged the sentence in part on the grounds that the district court had not properly determined the amount of the shareholders' loss.

The Second Circuit agreed, citing Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), in which the Supreme Court rejected the theory that loss causation is automatically established in civil stock fraud cases merely by proving that the purchase price was inflated by the defendant's misrepresentations.  As the Second Circuit noted, quoting Dura, "although an articially inflated price might cause an investor's loss when the investor sells his shares 'after the truth makes its way into the marketplace,' other factors, such as changed economic conditions, might also contribute to a stock's decline in price."  Thus, although not "an exact science," the sentencing judge must endeavor "to approximate the extent of the loss caused by the defendant's fraud," utilizing "expert opinion and some consideration of the market in general and relevant segments in particular."

The Court expressly rejected the government's argument that the holding in Dura, a civil case, should not appy in a criminal case:  "we see no reason why considerations relevant to loss causation in a civil fraud case should not apply, at least as strongly, to a sentencing regime in which the amount of loss caused by a fraud is a critical determinant of the length of the defendant's sentence."  It will be interesting to see if this statement encourages additional litigation seeking to import loss causation principles from the civil context into the criminal sphere, including issues related to the victim's notice of the misconduct, ratification of the misconduct, contribution to the loss or reckless assumption of risk.