New York Law Journal
By Barry J. Pollack and Steven F. Reich. Reprinted by permission of the New York Law Journal.
The pressure on executives of publicly traded companies to put the best face possible on their companies' prospects is intense. Indeed, on a quarterly basis, high-level corporate officials face investors and analysts who demand to know how they assess their companies' financial performance.
In the past, federal securities laws seemed to give corporate officials breathing room for making factually based, optimistic predictions about their companies' prospects—so called "optimistic puffing." Such puffery typically has been immune from prosecution under the securities laws on the theory that a reasonable investor would not consider such statements in a decision whether to buy or sell a security.
However, courts have begun to construe the federal mail and wire fraud statutes in a manner that appears to relax the government's burden of proving materiality and that may lead prosecutors to charge puffery under those more general statutes rather than under the securities laws. We discuss below recent developments in the law of mail and wire fraud and potential implications of those changes on the defense of optimistic puffing.
Securities Fraud Cases
To prove securities fraud, the government must establish that the defendant: (1) in connection with the purchase or sale of securities, employed a device, scheme or artifice to defraud, made an untrue statement of material fact or omitted to state a material fact, or engaged in fraud upon a purchaser; (2) acted willfully, knowingly and with the intent to defraud; and (3) knowingly used, or caused to be used, any means of transportation or communication in interstate commerce in furtherance of the fraudulent conduct.1
The U.S. Supreme Court has held that the materiality requirement in securities cases is measured by whether there is a substantial likelihood that a "reasonable investor" would consider the disputed statement or omission important in making an investment decision.2 Materiality can also be established if there is a substantial likelihood that an omitted fact would have been viewed by the "reasonable investor" as having significantly altered the "total mix" of information made available.3
In the U.S. Court of Appeals for the Second Circuit, juries routinely are instructed that "[a] material fact is one that would have been significant to a reasonable investor's investment decision."4 Thus, materiality under the securities laws includes an objective component focused on the ability of a statement or omission to influence reasonable investors.5
Puffery Under Securities Laws
The puffery doctrine has long been recognized as a defense to federal securities fraud claims because no reasonable investor can claim a right to rely on vague statements of corporate optimism or future projections.6 The justification for the defense was articulated by Judge Learned Hand:
There are some kinds of talk which no sensible man takes seriously, and if he does he suffers from his credulity. If we were all scrupulously honest, it would not be so; but, as it is, neither party usually believes what the seller says about his own opinions, and each knows it.7
As the puffery doctrine has evolved in the context of federal securities laws, courts have concluded that corporate statements generally are not actionable when they are so vague or generally optimistic about the future that they do not alter the total mix of information available.8 For example, courts have found it to be non-actionable puffery when corporate officials state that the company is "basically on track,"9 that "sales continue to be strong,"10 or that they are "optimistic" and expect "income growth consistent with historically superior performance."11 Similarly, statements that "business will be good this year"12 or that a company expects an "annual growth rate of 10 percent to 30 percent over the next several years,"13 have been found to constitute non-actionable puffery.
However, what appears to be a current trend toward a more relaxed materiality standard under the mail and wire fraud statutes may undermine the vitality of "the puffery defense" and offer prosecutors a means for charging corporate statements that previously had been thought immune under the securities laws.
Mail or Wire Fraud Cases
To prove mail or wire fraud under 18 U.S.C. §§1341, 1343, the government must establish that: (1) there was a scheme or artifice to defraud or to obtain money or property by materially false and fraudulent pretenses, representations or promises; (2) the defendant knowingly and willfully participated in the scheme or artifice to defraud, with knowledge of its fraudulent nature and with specific intent to defraud; and (3) in execution of that scheme, the defendant used or caused the use of the mails or wires.14 The Second Circuit pattern jury instruction for these statutes provides that "[a] material fact is one which would reasonably be expected to be of concern to a reasonable and prudent person in relying upon the representation or statement in making a decision."15 It is not clear the pattern instruction reflects the most recent decisions construing the meaning of "material" under these statutes.
- Cases Requiring Proof That the Scheme to Defraud Was Designed to Deceive Reasonable Persons. The seminal historical statement of the standard for materiality under the mail and wire fraud statutes was set forth in Silverman v. United States, where the U.S. Court of Appeals for the Fifth Circuit held: "[i]t is only necessary [for the government] to prove that [the charged] scheme [was] reasonably calculated to deceive persons of ordinary prudence and comprehension…."16 Silverman has been interpreted in the Second Circuit to mean that an objective standard may be used to determine whether the defendant acted with fraudulent intent.17
Relying on Silverman, defendants have attempted to argue that a mail or wire fraud conviction requires evidence the victim was a person of ordinary prudence or comprehension.18 Courts have rejected that contention, instead holding that Silverman's "ordinary prudence" language refers only to a type of evidence that would be sufficient (but not necessary) to sustain a conviction, and have declined to assess whether victims of a scheme to defraud were reasonable in their reliance. For example, the U.S. Court of Appeals for the First Circuit has explained that "whether the persons the schemers intended to defraud are gullible or skeptical, dull or bright" or whether the schemes "will ensnare the ordinary prudent investor and those that attract only those with lesser mental acuity" is not dispositive. 19 Likewise, the D.C. Circuit has said that it is "simply wrong" to assert that the wire fraud statute applies only where the persons defrauded reasonably believed the misrepresentations made to them.20 And, the U.S. Court of Appeals for the Third Circuit has held: "[t]he negligence of the victim in failing to discover a fraudulent scheme is not a defense to criminal conduct."21
At least until recently, then, the focus of the materiality inquiry appeared to be on whether the defendant participated in a scheme designed to defraud a person of ordinary intelligence, regardless of whether the actual victim was such a person. As the Second Circuit has explained, "[t]o establish a violation of the federal fraud statutes, the government must prove a scheme to defraud. Critical to this showing is evidence that the defendant possessed a fraudulent intent. The role of the ordinary prudence and comprehension standard is to assure that the defendant's conduct was calculated to deceive, not to grant permission to take advantage of the stupid or careless."22
- Cases Finding "Materiality" So Long as the Scheme to Defraud Was Designed to Deceive Any Person, Regardless of Reasonableness. Several circuits have made clear that materiality under the mail and wire fraud statutes can be found even where the defendant did not intend to deceive reasonable people. For example, in United States v. Drake, the U.S. Court of Appeals for the Tenth Circuit rejected an argument that the defendant's actions were not calculated to deceive persons of ordinary prudence because the "focus of the language defining a scheme to defraud is on the violator, not the victim."23 As such, the court found, the "ordinary prudence" definition was merely used to determine whether a defendant's actions were "calculated to deceive," not whether the defendant "targeted the proper victim."24 Otherwise, "a party who fully intends to deceive a victim may avoid criminal liability by designing a scheme sufficiently unusual that the law would deem it unbelievable by a reasonably prudent person."25 Similarly, in United States v. Coffman, the U.S. Court of Appeals for the Seventh Circuit disavowed earlier decisions adopting a "reasonable person" standard on grounds that such a standard "would invite con men to prey on people of below-average judgment or intelligence…."26
The most recent, and perhaps most far-reaching, example of the trend toward a purely subjective and lesser standard of materiality is the U.S. Court of Appeals for the Eleventh Circuit's en banc decision in United States v. Svete, which overruled thirteen-year-old circuit precedent and held that the focus of the materiality inquiry under the mail fraud statute is not on the tendency of a defendant's statement to mislead the person to whom the statement is made.27 The Eleventh Circuit explained that, regardless of the ability of a statement to mislead a reasonable person, a scheme intended to defraud anyone suffices to establish materiality: "[b]ecause the focus of the mail fraud statute, like any criminal statute, is on the violator, the purpose of the element of materiality is to ensure that a defendant actually intended to create a scheme to defraud."28
In a concurring opinion, Chief Judge J.L. Edmondson recognized that the majority opinion had eviscerated any objective component to the element of materiality: "I believe that the pertinent mail-fraud statute requires the government ordinarily to show that the pertinent scheme or misrepresentation was capable of inducing reliance on the part of a reasonable person…."29
As this review suggests, there appears to be a trend in the case law under the mail and wire fraud statutes that increasingly finds the objective reliability of a disputed statement to be irrelevant and, instead, focuses on whether the statement was intended to lead any victim to be defrauded, no matter how unreasonable that victim's reliance might have been.
The evolution in the law of materiality under the mail and wire fraud statutes has clear implications for the defense of optimistic puffing that has been an established doctrine under the securities laws. The focus of the puffery defense has been on the objective reasonableness of the purported victim in relying on rosy corporate pronouncements and we have not yet seen evidence that, under the securities laws, courts have begun to retreat from this objective focus.
However, the same is not true for cases decided under the mail and wire fraud statutes. Applied to optimistic puffing, recent mail and wire fraud decisions, with their focus solely on the defendant's intent to defraud anyone, could well make statements that were immune as a matter of law from prosecution under the securities laws subject to prosecution under the mail and wire fraud statutes. Moreover, charging such conduct under the mail and wire fraud statutes would result in the defendant receiving the same sentence as would have resulted from a charge under the securities fraud statutes, since the governing section of the Sentencing Guidelines remains the same.30
Barry J. Pollack is a member of the white collar and internal investigations group at Miller & Chevalier Chartered in Washington, D.C. Steven F. Reich is the co-chair of the corporate investigations and white collar defense practice group at Manatt Phelps & Phillips, where he is a partner in the New York office. Diana M. Kwok, an associate at Manatt, assisted in the preparation of this article.
1 3 Leonard B. Sand, John S. Siffert, Walter P. Loughlin, Steven A. Reiss, Steven W. Allen & Jed S. Rakoff, Modern Federal Jury Instructions—Criminal, ¶57.02, Instruction 57-14 (2009) ("Sand and Siffert").
2 TSC Indus. Inc. v. Northway Inc., 426 U.S. 438, 449 (1976). The puffery doctrine has also been applied in criminal cases. See, e.g., United States v. Bilzerian, 926 F.2d 1285, 1298 (2d Cir. 1991). More generally, courts have not hesitated to import civil case law standards for securities fraud into criminal cases. See, e.g., United States v. Rigas, 490 F.3d 208, 234 (2d Cir. 2007). Accordingly, we rely on civil cases as well as criminal cases throughout this article.
3 TSC Indus., 426 U.S. at 449.
4 Sand and Siffert, supra, ¶ 57.02, Instruction 57-15. The Second Circuit Instruction goes on to add what appears to be a subjective materiality component by noting: "[t]his is not to say that it is a defense to the crime if the material misrepresentation would not have deceived a person of ordinary intelligence. Once you find that there was a material misrepresentation (or omission of a material fact), it does not matter whether the intended victims were gullible buyers or sophisticated investors, because the securities laws protect the gullible and unsophisticated as well as the experienced investor." Id. (emphasis added).
6 See, e.g., Ganino v. Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir. 2000).
7 Vulcan Metals Co. v. Simmons Mfg. Co., 248 F. 853, 856 (2d Cir. 1918).
8 See, e.g., Parnes v. Gateway 2000 Inc., 122 F.3d 539, 547 (8th Cir. 1997); Glassman v. Computervision Corp., 90 F.3d 617, 635-36 (1st Cir. 1996).
9 Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1219 (1st Cir. 1996).
10 Greebel v. FTP Software Inc., 194 F.3d 185, 189 (1st Cir. 1999).
11 San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 806 (2d Cir. 1996).
12 In re Syntex Corp. Sec. Litig., 95 F.3d 922, 931 (9th Cir. 1996).
13 Raab v. Gen. Physics Corp., 4 F.3d 286, 288 (4th Cir. 1993).
14 Sand and Siffert, supra, ¶44.01, Instruction 44-3.
15 Id. at Instruction 44-4.
16 213 F.2d 405 (5th Cir. 1954).
17 United States v. Thomas, 377 F.3d 232, 242-43 (2d Cir. 2004).
19 United States v. Brien, 617 F.2d 299, 311 (1st Cir. 1980).
20 United States v. Maxwell, 920 F.2d 1028, 1036 (D.C. Cir. 1990).
21 United States v. Coyle, 63 F.3d 1239, 1244 (3d Cir. 1995).
22 Thomas, 377 F.3d at 242 (internal quotations and citations omitted).
26 94 F.3d 330, 334 (7th Cir. 1996).
27 556 F.3d 1157 (11th Cir. 2009) (en banc).
28 Id. at 1165.
29 Id. at 1170 (Edmondson, C.J., concurring).
30 The sentences for securities fraud, mail fraud, and wire fraud are all calculated using section 2B1.1 of the Sentencing Guidelines. Although the statutory maximum penalty for securities fraud is 25 years, and only 20 years for mail or wire fraud (compare 18 U.S.C. §§1341 and 1343 with 1348), the majority of cases do not result in sentences reaching the statutory maximum. Further, where the government chooses, it can charge multiple counts and "stack" the statutory maximum sentences for each count, thereby effectively exposing the defendant to life in prison without regard to the statutory maximum for any single count of the charged offenses.