THE INTENT ELEMENT IN A CRIMINAL SECURITIES CASE
The Second Circuit reversed the securities fraud convictions of Mark Kaiser arising out of the financial fraud at Royal Ahold subsidiary U.S. Food Services, concluding that the instructions regarding a key intent element were error. Mr. Kaiser is a former executive of U.S. Food Services who for years supervised employees in the purchasing department. After its acquisition by Royal Ahold, he held the position of Chief Marketing Officer. U.S. v. Kaiser, Case No. 07-2365-cr (2nd Cir. Decided July 1, 2010). The related case brought by the SEC is discussed here.
The five count the indictment charged Mr. Kaiser with conspiracy to commit securities fraud, falsifying the books and records in violations of the federal securities laws and securities fraud. Mr. Kaiser is alleged to have devised a scheme to fraudulently inflate the income of U.S. Food Services in 2001 and 2002. The indictment also claims that he concealed the scheme from the outside auditors.
The scheme centered on the improper recognition of payments from vendors known as “promotional allowance.” The allowances are a type of rebate paid to the company upon the satisfaction of certain purchasing targets. The allowances, which were an important source of revenue, were recognized immediately rather than at the appropriate time under the contracts. By the beginning of 2002, the accounts receivable balance for these payments had grown to $300 million. By the end of the year, the balance had increased to more than $700 million.
To conceal the scheme, Mr. Kaiser lied to the auditors and used fraudulent confirmations, according to the indictment. The scheme unraveled when Mr. Kaiser sent a letter to a vendor regarding a claimed promotional allowance balance. The CFO of the vendor became suspicious and contacted the outside auditors of U.S. Food Services. An investigation ensured during which it was discovered that promotional allowance accounts had been improperly inflated.
At trial, the government relied primarily on the testimony of three cooperating witnesses. The jury returned a verdict of guilty on each count. Mr. Kaiser was sentenced to 84 months imprisonment and directed to pay a $50,000 fine.
Two key issues on appeal concerned the adequacy of the intent instructions, one regarding “willfulness” and the other on “conscious avoidance.” First, the Court found the willfulness instruction adequate. The Exchange Act requires that the government prove “willful” conduct to establish a criminal violation. For misstatements in public filings, the government must also prove that the defendant acted with knowledge of the falsity of the statements. The government is not required to establish “specific intent to violate the law.” Rather it is sufficient if it proves the defendant intended to commit the act. Section 32(a) of the Exchange Act, which sets forth the willfulness requirement, also provides that a defendant can avoid prison by establishing that he or she did not know the law.
Willfulness does not, in view of the provisions of Section 32(a), require proof that the defendant knew he was violating the law, the court held. To establish the element, the government must prove “that a defendant had an awareness of the general wrongfulness of his conduct.” The Court thus drew a distinction between knowing that acts violate the law and that they are wrongful.
Here, the jury was told that it had to find Mr. Kaiser knew that his statements were “false and fraudulent.” In addition the proof had to demonstrate that Mr. Kaiser made the statements “with intent to create a deception.” In this regard, the prosecution was required to prove “the contrary of the idea of mistake or good faith,” the district court told the jury. This instruction was sufficient, the Second Circuit concluded, because to convict the defendant the jury would have to conclude that he knew his acts were wrongful.
Second, the Court held that the instruction on “conscious avoidance” was incorrect. Under this instruction, the jury may infer knowledge under certain circumstances. Here, the district court told the jury that “[i]n determining whether the defendant acted knowingly, you may consider whether the defendant deliberately closed his eyes to what otherwise would have been obvious . . . there are times that a person can consciously avoid looking at facts that are available and that, in the law, is the equivalent of knowledge . . .” if there was conscious avoidance, “that is deliberate failure to learn information, then that is the equivalent of actual knowledge . . .” In a separate instruction on knowledge, the jury was told that Mr. Kaiser “cannot be convicted of mistake, he cannot be convicted if he in good faith thought that these results were correct.”
The Second Circuit concluded that this charge is error. Under the Court’s prior decisions, as the government conceded, two points must be made clear in a conscious avoidance charge: “(1) that a jury may infer knowledge of the existence of a particular fact if the defendant is aware of a high probability of its existence, (2) unless the defendant actually believes that it does not exist.” The “high probability” and “actual belief” components are critical to the instruction. Both were absent here. An instruction such as the one given here, stating that the jury cannot find knowledge on the basis of mistake or accident, is not an adequate substitute the Court concluded. This is particularly true in this case where there is a risk in view of the instruction that the jury used a negligence theory to convict the defendant. Under these circumstances, the court concluded that the instruction is erroneous.
Finally, the court concluded that the conscious avoidance instruction constituted error despite the fact that the defense did not object. The court informed counsel at the charging conference that it intended to give such an instruction without making available the text. The government furnished the court with a proposed instruction that contained the two key elements required by Second Circuit precedent which the court modified by omitting those elements. The defense objected. The court then supplemented it and no objection was made. Here, although the defense did not present on a conscious avoidance theory, much of the evidence demonstrates that Mr. Kaiser relied on others with regard to the contracts used to inflate revenue and the false confirmations. There was also good reason for the jury to question the credibility of the government’s witnesses. Accordingly, there is a reasonable probability that the jury convicted Mr. Kaiser on a conscious avoidance theory based on an erroneous instruction. This required the reversal of the convictions.