The calculation of loss amount drives sentencing decisions in many white collar cases. The higher the loss amount, the longer the sentence.
Courts always seem to take an expansive view of what counts as a “loss” for sentencing. In a recent Third Circuit case, however, the court rejected the government’s argument in favor of heightened loss amounts in a contracting fraud case.
In short, the Third Circuit held that the loss amount in a government contracting case is not the face value of the contract that was illegally obtained but that amount minus the fair market value of the services provided.
The case separately limits Fourth Amendment challenges made by executives of closely held family corporations. (You can’t win them all, right?)
The DBE Scheme
I’ve written about this case before. I even wrote an update. It’s the largest government contracting fraud case ever. Here’s a quick overview.
Defendants Joseph Nagle and Ernest Fink were co-owners of a concrete manufacturing and construction business. The corporate structure contained an S-corp called Schuylkill Products Inc. (“SPI”), as well a construction company, CDS Engineers.
Mr. Nagle’s father was originally the CEO/president of the company; however Mr. Nagle took over after his death in 2004. Mr. Nagle owned 50.1% and Mr. Fink owned 49.9%.
Around 1993, SPI/CDS developed a relationship with a company called Marikina, which was owned by an American of Filipino decent (Romeo Cruz). Because of the owner’s diversity status, Marikina was able to bid on government projects established for Disadvantaged Business Enterprises (DBEs). As the Third Circuit explained:
A DBE is a for-profit small business that is at least 51% owned by an individual or individuals who are both socially and economically disadvantaged and whose management and daily operations are controlled by one or more of the disadvantaged individuals who own it.
SPI/CDS created an agreement whereby Marikina would bid on certain projects as a DBE, and SPI/CDS would complete the work. Marikina then received a fixed fee from SPI/CDS for these projects, and SPI/CDS would retain the rest of the profits.
SPI and CDS had offices on the same “compound” in Cressona, Pennsylvania. Both were on private property. Each had multiple computers, which were on a shared network that was separated into drives. Only select executives had access to the drives.
In October 2007, the FBI executed a search warrant on the SPI and CDS offices, where they imaged eleven computers and the network server. Nagle and Fink, along with several other employees, were indicted on multiple charges associated with the DBE fraud.
Mr. Nagle was convicted after a jury trial. He was sentenced to 84 months in prison. Mr. Fink pleaded guilty and was sentenced to 51 months in prison.
Do the Owners of a Closely-Held Corporation Have Standing Under the Fourth Amendment to Challenge Its Search?
Mr. Nagle filed a motion to suppress the electronic evidence that was seized by the FBI at the SPI/CDS offices. (Mr. Fink had filed a motion to suppress as well, but then pleaded guilty.)
The district court found that he had no reasonable expectation of privacy either in the places searched or the items seized. It reasoned that while Mr. Nagle may have had an expectation that the contents of the seized computer server would remain private, that expectation was in his capacity as CEO/president of SPI/CDS and not in his capacity as an individual.
Before the Third Circuit, Mr. Nagle argued that because his company was a closely-held family corporation, the seizure was a violation of his personal Fourth Amendment rights and he therefore had standing. According to the opinion:
In other words, Nagle says, because the Government physically intruded on the corporations’ property and otherwise invaded their legitimate expectations of privacy, and because he is the majority owner of the corporations, the Government physically intruded on his property and otherwise invaded his legitimate expectation of privacy.
The court examined decisions from other circuits, however, and rejected his position. It explained that a search on commercial premises is different from the search of one’s home.
[A] shareholder may not challenge a search of corporate property merely because he is a shareholder, but he may challenge the search if he “show[ed] some personal connection to the places searched and the materials seized,” (citation omitted), and protected those places or materials from outside intrusion.
According to the Third Circuit, Mr. Nagle did not have a sufficient connection to the places searched and/or the materials seized, even though he was the majority owner.
This was a fact-specific inquiry (read: you may be able to distinguish it in your case). With respect to the seized computers of his employees, there was no evidence that Mr. Nagle used those particular machines or used the offices from which the FBI retrieved them.
The seized computer server was a harder question. Ultimately, though, the court concluded that Mr. Nagle’s widespread access to the server was not enough to give him standing.
Nagle must show a personal connection to the electronic files located on the server and that he kept them private in order to demonstrate a reasonable expectation of privacy. Nagle failed to show that he ever accessed other employees’ files and emails on the server and, therefore, failed to establish a personal connection to their files. Although Nagle certainly had a personal connection to his own files and emails located on the server, he failed to show what efforts he made to keep his materials private from others.
Although the server was password protected and only five individuals, including Nagle, had access to every drive on the server, Nagle did not establish where his files and emails were located on the server and how many people had access to those drives. Thus, Nagle did not meet his burden of proof to demonstrate a subjective expectation of privacy in his files and emails on the server.
The Third Circuit held that the evidence was admissible and refused to reverse Mr. Nagle’s conviction on these grounds.
Calculating Losses in DBE Fraud Case
The Third Circuit then turned to Mr. Nagle and Mr. Fink’s challenges to their sentences. The district court determined that the loss amount was the face value of the DBE contracts that SPI/CDS received, with no credit for the work that was actually performed by the defendants’ companies or the benefit that the government received from the project.
Using that method, Mr. Fink was responsible for $135.8 million in losses and Mr. Nagle was responsible for $53.9 million in loses.
On appeal, Mr. Nagle and Mr. Fink argued that the proper method to calculate the loss amount should be the financial harm suffered by an actual DBE that did not receive the contract. In other words, the loss is the profit earned on the contract, not the face value of the contract.
They argued that there was no evidence that there were other DBEs willing to perform the contracts, that the state received what they paid for under the contracts (the work performed by SPI/CDS), and that the only conceivable loss was the value of the contract minus the overhead and expenses.
Under the Guidelines, loss is typically calculated to be the greater of actual or intended loss. Actual loss is “the reasonably foreseeable pecuniary harm that resulted from the offense”; intended loss “means the pecuniary harm that was intended to result from the offense.”
For cases involving government entitlements or benefits, however, there is a special rule for loss calculation in the Guidelines:
[L]oss shall be considered to be not less than the value of the benefits obtained by unintended recipients or diverted to unintended uses, as the case may be. For example, if the defendant was the intended recipient of food stamps having a value of $100 but fraudulently received food stamps having a value of $150, loss is $50.
Mr. Nagle and Mr. Fink argued that the special rule should not apply to DBE contracting schemes. The Third Circuit declined to reach this issue, holding instead that:
we conclude that under either application note, the amount of loss Nagle and Fink are responsible for is the face value of the contracts Marikina received minus the fair market value of the services they provided under the contracts.
The court reasoned that loss in these types of cases should be determined using basic principles of remedying fraud, where “rescission of any agreements and restitution of the reasonable value of what the parties exchanged.”
The case was remanded for a recalculation of losses. The “fair market value of the services provided”
includes, for example, the fair market value of the materials supplied, the fair market cost of the labor necessary to assemble the materials, and the fair market value of transporting and storing the materials.
Demonstrating its usual find-harmless-error approach, the government argued that the error was harmless because the defendants had been given a break at sentencing already. The Third Circuit disagreed, finding that “the record must be unambiguous that miscalculation of range had no effect.”
A Win for Future Defendants
This is the right decision with respect to the sentencing issue. Also, it’s a well-reasoned opinion, which may mean that other circuits will follow its lead. It is bizarre that the government would argue that the “loss” was the full amount of the contract when the government unquestionably received value in return. SPI and CDS expended legitimate funds and effort to complete the projects and there was no indication the opinion that the government contested that it received this value.
Given the prevalence of government contracting fraud cases, this opinion offers helpful guidance for defendants facing sentencing.
Of course, this ruling begs the question of what is the loss if the fair market value of the services provided equals the face value of the contracts? Is the loss zero? I can imagine a true battle of the experts on this point.
In the interest of full disclosure, I’m friends with one of the lawyers, the excellent Ellen Brotman. Congratulations to the entire defense team!
[…] At least one court of appeals has pushed back on the government’s theory of loss in criminal cases. I wrote about the Third Circuit’s 2015 decision here. […]