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From Securities Regulation Daily, September 3, 2013

Morrison also applies to criminal prosecutions under 10(b)

By Rodney F. Tonkovic, J.D.

A Second Circuit panel has held that criminal liability under Exchange Act Section 10(b) does not extend to conduct in connection with an extraterritorial purchase or sale of securities. This question was left open by the U.S. Supreme Court in Morrison v. National Australia Bank Ltd. (2010), and the panel here concluded that the antifraud provisions of the Exchange Act do not apply to extraterritorial conduct, regardless of whether criminal or civil liability is sought (U.S. v. Vilar, August 30, 2013, Cabranes, J.).

Background. Alberto Vilar and Gary Alan Tanaka were convicted in February 2010 after a jury found that they had lied to clients about the nature and quality of certain investments. The two investment advisers managed billions of dollars in investments for their clients through their “Guaranteed Fixed Rate Deposit Accounts” (GFRDAs), which promised investments in high-quality, short-term deposits, resulting in a high, fixed rate of interest over a set term.

Despite Vilar and Tanaka's promises, investor funds were put into technology and biotech stocks. When the dot-com bubble burst in 2000, the value of the investments dropped, and Vilar and Tanaka could not pay the promised rates of return. Several of the GRFRDA investors lost millions of dollars.

In 2002, Vilar and Tanaka used a client's account to pay their personal and corporate obligations. The client was told that her funds were safely in escrow. When the suspicious client reported Vilar and Tanaka to the SEC, Vilar made several false statements to the Commission in an effort to conceal the scheme.

Vilar and Tanaka were indicted and charged in twelve counts, including conspiracy, securities fraud, wire fraud and making false statements to the SEC. Vilar was convicted on all counts, and Tanaka was convicted of conspiracy, securities fraud, and investment adviser fraud. Both received prison sentences and both were ordered to pay $35 million in restitution.

Extraterritoriality. On appeal, Vilar and Tanaka argued that the conduct underlying their convictions for securities fraud was "extraterritorial," and therefore not criminal under the Exchange Act fraud provisions. Morrison, which was decided after Vilar and Tanaka were convicted, limits the application of the antifraud provisions to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities.” The government argued that Morrison only applied in the civil context.

The panel concluded that Morrison applies to criminal cases brought under Section 10(b) and Rule 10b-5. The convictions were affirmed because the record showed that Vilar and Tanaka's conduct occurred in connection with domestic securities transactions. In support of its conclusion, the court noted Supreme Court precedent recognizing the presumption against extraterritoriality in criminal statutes, unless explicitly stated otherwise.

Even if there were no presumption against extraterritoriality in criminal statutes, the court continued, Section 10(b) would not apply extraterritorially in criminal cases. “A statute either applies extraterritorially or it does not” the court stated, and has the same meaning regardless of the specific facts of the case. The only question, the court said, was “whether the relevant conduct occurred in the territory of a foreign sovereign.”

The panel then held that there was no plain error in Vilar and Tanaka’s convictions with respect to the territoriality of their conduct. The record showed that the GFRDA fraud occurred domestically, and that irrevocable liability was incurred in the United States. Therefore, a jury would have found that Vilar and Tanaka engaged in fraud in connection with a domestic purchase or sale of securities.

Sufficiency of the indictment. Next, Vilar and Tanaka claimed that the conspiracy count was “duplicitous” because there were really two small conspiracies. The court disagreed, finding that the schemes were all part of one conspiracy to defraud investors. Vilar and Tanaka also asserted that the investment adviser fraud count was not sufficiently definite, but the court found that they were sufficiently on notice of the “core of criminality” alleged in that count.

Jury instructions. The defendants then claimed that the district court erred in omitting a reliance element from the securities fraud charges. The panel held that since reliance is not an element of a criminal case brought by the government under Section 10(b), the district court did not err by not instructing the jury on the issue of reliance. Vilar also argued that the instructions concerning mail fraud erroneously “lowered the government’s burden of proof,” but the panel concluded that the instructions “did not impermissibly amend the mail fraud count or improperly broaden the basis for Vilar’s conviction on that count.”

Evidentiary issues. Vilar and Tanaka also raised challenges to evidence they claimed should have been suppressed by the district court. The panel found no abuse of discretion. According to the panel, documents obtained in one of the challenged searches would have been validly discovered anyway, and the other search, performed in the U.K., was “reasonable.” There was also no clear error in admitting statements made by Tanaka's wife.

Vilar and Tanaka raised a number of challenges to the sufficiency of the evidence against them. The panel found that the evidence as to each count was sufficient to support the jury's verdict.

Sentencing. Finally, the panel remanded the action to the district court with directions to vacate Vilar and Tanaka's sentences and resentence them in terms consistent with this opinion. According to the panel, the district court must reconsider in the first instance whether losses suffered by victims who purchased GFRDAs abroad may constitute “relevant conduct” under the sentencing guidelines. Next, the district court must recalculate restitution because it cannot be awarded for investors who purchased GFRDAs abroad. Third, a forfeiture order was vacated because its calculation was clearly erroneous.

The case is Docket Nos. 10-521-cr(L), 10-580-cr(CON), 10-4639-cr(CON).

Attorneys: Michael Alexander Levy (United States Attorney's Office) for U.S. Nathan Z. Dershowitz (Dershowitz, Eiger & Adelson, P.C) and Vivian Shevitz, Esq (Vivian Shevitz Law Office) for Gary Alan Tanaka. Joanna Eftychiou, Esq (Joanna Eftychiou Law Office, Vivian Shevitz, Esq (Vivian Shevitz Law Office), Jane Simkin Smith (Jane Simkin Smith Law Office and Susan C. Wolfe, Esq (Hoffman & Pollok LLP) for Alberto Vilar.

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