Arguably, the most important piece of office equipment to a lawyer defending against accusations of financial crime in federal court is a calculator. Not a fancy one, with sine, cosine and tangent, but your basic model, provided it’s got enough room on the screen for lots of zeroes. That’s what we used to figure out what the government is talking about when it comes up with the bizarre and outrageous loss calculations tossed out to the judge at arraignment and again at sentence.
Bruce Karatz, former CEO of KB Homes, found that out when he saw the government’s response to the calculations by his probation officer in the presentence investigation report.
On Wednesday [meaning today], the former chief executive is scheduled to be sentenced in Los Angeles federal court for his April conviction for fraud and making false statements in connection with an options-backdating scandal. Karatz, who the government alleges tried to make nearly $11 million from backdating, has denied wrongdoing and plans to appeal his conviction.
The U.S. Probation Office, an arm of the courts, has recommended that Judge Otis Wright give Karatz probation and eight months of home confinement. But the U.S. Attorney’s office wants a 6.5-year prison sentence.
A key issue in the case revolves around how much financial loss KB Home and its shareholders suffered. The Probation Office believes there was no loss. Prosecutors argue that the $11 million, representing gains Karatz made or hoped to make at KB Home’s expense, qualifies him for a multiyear prison term.
It’s unusual that the PSR rejected the government’s loss calculation, and this reflects either a great effort on the part of Karatz’s counsel or a particularly independent probation officer. Calculating loss is required under the fraud table of the Sentencing Guidelines, but how one calculates loss is another matter.
The idea that the loss caused by fraudulent conduct be actual loss, the net amount of money gained as a direct result of the conduct, is archaic. Actual loss is often tiny, even non-existent, in most cases, and that does the government no good at all. The loss amount is used to determine the guidelines sentence, and by coming up with a loss in the multi-millions, if no billions, the government wields a huge club over the head of a defendant, forcing a choice when deciding to roll the dice and fight, of staring down decades in prison if the court adopts the government’s calculations.
The dispute is part of a growing debate over whether the sentencing system for white-collar crimes has come to rely too heavily on calculations of financial losses to fraud victims. Under the sentencing guidelines, legal experts say, an executive of a large public company convicted of a crime like securities fraud could be sentenced to life imprisonment on a first offense.
Pretty much anything a senior executive in a public company does will give rise to ramifications, to even the most unimaginative prosecutor, in the millions of dollars. Spend $100 on a half decent lunch to befriend the decision-maker on a foreign contract, and bear the gazillion dollar consequences of the revenue derived from the contract over ten years, replete with assumptions of market hegemony. Forget the cost of the meal. Forget even the cost of performance of the contract, or market share. Assume only revenue, with terms so favorable that your favorite deity would be asking for a job, and every person in the world signing up for your service, and then we’re talking loss.
It’s not that the government’s overzealous calculations necessarily turn judges’ heads. Judges often have a far better grasp of the real loss than do prosecutors, who have little, if any, understanding of business, and whose flights of fancy can be ludicrous.
But some judges are balking. Last month in New York, U.S. Judge John Gleeson gave a convicted securities swindler five years even though the guidelines called for 17 to 22 years. “Here in the trenches where fraud sentences are actually imposed, there is a more nuanced reality,” he wrote.
But you can’t count on it, either. Post-Enron, when Congress responded to public outcry and trebled the guideline sentences for corporate fraud because it got congressfolk elected, there were plenty of judges who felt the pain inflicted upon thousands of people by the greedy fraudsters. Screwing with loss calculations was one way, an easy way, to jack up sentences to meet expectations that these criminals would suffer long and hard for what they did. Some judges generally accept the government’s accounting. It’s the new GAAP.
But not every financial and corporate crime meets the Enron and Madoff bar. Many are trivial in themselves, often without any discernible harm to anyone, except through rhetorical gamesmanship and wild speculation. Yet sentences equivalent to murder are in the offing. I can’t tell you how many times I’ve heard a corporate executive mutter, “it’s not like I killed anybody.”
The play for sympathy, ironically, is on the government’s side when it comes to loss calculations. This is what they had to say about Karatz:
The U.S. Attorney’s office here wants a 6.5-year prison sentence. In a filing, the prosecutors argue that confining Mr. Karatz in his “24-room Bel-Air mansion,” would suggest “a two-tiered criminal justice system, one for the affluent….and a second for ordinary citizens.”
A 24 room Bel-Air mansion (and no mention of the cost of his shower curtain)? Well, clearly he should go to prison instead. It’s not like he studied hard to get into good schools, worked hard to make his way up the corporate ladder. Served well to achieve the position of CEO. And was very well compensated along the way. After all, it’s a crime in America to be successful. Or so the government contends when it uses its very own version of GAAP to calculate loss under the guidelines.