New York Federal Criminal Practice Blog
November 12, 2008

Connecticut Judge Issues Notable Ruling in AIG/Gen Re Fraud Case on Loss Calculation, Number of Victims and Restitution

In the closely-watched Aig/Gen Re fraud case, Connecticut Judge Droney has issued an opinion deciding several key sentencing issues prior to the actual sentencing.  Most notably, in United States v. Ferguson, 06 CR 137 (CFD), 2008 WL 4763238 (D.Conn. October 31, 2008), he rejected both the Probation Department’s loss estimate of $5M and the defendants’ estimate of zero, in favor of one of the government’s estimates, namely $544 - $597 million.  This means that under the Sentencing Guidelines, at least, the five defendants face sentences of life in prison.  For students of guideline loss calculations, the case is notable for its refusal to embrace civil fraud principles in their entirety where to do so conflicts with the requirement under the Guidelines to make a reasonable, if not exact, measure of loss.  [Disclaimer: Murray Law LLC represented one of the government’s witnesses at trial.]

Loss Calculation

The amount of loss associated with a fraud crime is a critical determinant of the length of the sentence dictated under the Guidelines.  The Second Circuit has held in United States v. Rutkoske, 506 F.3d 170 (2d Cir.2007), previously discussed here, that “considerations relevant to loss causation in a civil fraud case” should surely apply at least as strongly in criminal cases, where an individual’s liberty is at stake.  In particular, in securities fraud cases, any loss calculated must exclude losses caused by market forces under the fraud itself.

At issue in Ferguson, was to what extent, if any, the decline in AIG’s stock price should be attributed to a fraudulent reinsurance contract between AIG and Gen Re.  The Probation Department punted, saying loss was incalculable, and therefore should be based on Gen Re’s $5 million gain from the fraud.  Both the defense and the government agreed that a more sophisticated “event study” – which examines the relationship between news about the fraudulent transaction and AIG’s stock price – was the appropriate methodology to use, but differed on what such a study would reveal here.   The prosecution, using both a “leakage” (stock price over a specific period) and “standard” (stock price on specific dates) event study, concluded loss ranges of respectively $1.2 to $1.4 billion or $544 to $597 million, all losses well in excess of the highest level of loss specified in the Guidelines ($400 million).  The defense argued that neither approach yielded a reliable loss figure here – the leakage approach did not account for other non-fraud-related factors, and the standard approach failed to incorporate the civil standard of “corrective disclosure,” which holds that “a disclosure is not ‘legally cognizable’ unless it ‘reveals to the market the falsity of the prior misrepresentation.’”  None of the announcements highlighted by the government amounted to “corrective disclosures,” they argued, and therefore loss causation has not been properly established. 

In the end, Judge Droney adopted the government’s “standard” event study but also rejected the defendants’ reliance on “corrective disclosures.”  Agreeing that “the principles that guide civil loss causation should also guide sentencing courts in determining loss,” the court held nonetheless, drawing from Rutkoske’s caveat that calculating shareholders’ losses cannot be “an exact science,” that “the strict standard of ‘corrective disclosure’ . . .  can be incompatible with the guidelines instruction of a ‘reasonable estimate of the loss.’”

Judge Droney’s conclusion adds 30 levels to the defendants’ base offense level of 7.

Number of Victims

Under the Guidelines, a victim is “any person who sustained any part of the actual loss.”  Here, 154 institutional investors, including 103 mutual funds, held the “damaged” shares.  The court agreed with the government that the thousands of investors in the mutual funds that held AIG shares during this period were victims, and accordingly added the maximum 6-level increase for 250 or more victims of the fraud.  This brings the defendants’ final guideline without any further adjustments to 43 (i.e. life in prison). 


Finally, the court held that restitution was inapplicable here, where the issues of identifying victims and calculating losses were complicated enough and victims already had a route to compensation through pending civil cases. 

Judge Droney gave the defendants 21 days to submit additional papers addressing their sentencing.  
Lawyers: Alan M. Vinegrad, Douglas B. Bloom, Olivia A. Radin, Pamela A. Carter, Covington & Burling LLP, Frederick P. Hafetz, Michael S. Chernis, Susan R. Necheles, Tracy E. Sivitz, Hafetz & Necheles, Richard L. Spinogatti, Robert J. Cleary, William C. Komaroff, Proskauer Rose, New York, NY, Hope Ivy Hamilton, Covington & Burling, LLP, Peter H. White, Mayer Brown LLP, Washington, DC, Jonathan E. Rich, Anthony Pacheco, Keith L. Butler, Proskauer Rose LLP, Los Angeles, CA, William F. Dow, III, Jacobs, Grudberg, Belt, Dow & Katz, P.C., New Haven, CT, Richard A. Reeve, George Gust Kouros, Sheehan & Reeve, New Haven, CT, Richard R. Brown, Brown, Paindiris & Scott, Hartford, CT (Defendants); AUSAs Eric J. Glover, Henry K. Kopel, Paul E. Pelletier, Adam G. Safwat, Raymond E. Patricco.

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