Friday, September 20, 2013

Knowingly, Willfully and Materiality (9/20/13)

In United States v. Phillips, ___ F.3d ___, 2013 U.S. App. LEXIS 18430 (7th Cir. 2013) (en banc), here, the Seventh Circuit reversed convictions under "18 U.S.C. § 1014, which criminalizes 'knowingly mak[ing] any false statement ... for the purpose of influencing in any way the action of' any specified private and public entity that provides, or regulates the provision of, financial services; among the entities are federally insured banks."  The charged misconduct, as submitted to the jury, was lying on the loan application signed by one of the defendants and submitted to a lender which blatantly exploited so-called "liar's loans" -- stated income loans without regard to whether the income was correctly stated because the loans would then be packaged as securities, thus transferring the risk of default from the nominal lender to unwitting investors.  (This genre of loan was at the center of the financial crisis starting in 2008.)  There is no question that, on an objective level, the information in the loan application the signing defendant signed and submitted to the bank was incorrect.  The defendants wanted to show, however, that based on the information they received from the loan broker, the information requested used terms of art (e.g., the stated income of the applicant could include the income of other persons who will contribute to servicing the loan) and hence they (1) did not make false statements at all and certainly did not knowingly do so for the purpose influencing the loan.  The trial judge excluded the testimony.  The Seventh reversed in an opinion by Judge Posner.

I am going to essentially quote Judge Posner's reasoning in full.  I think it is helpful to focus on the tax crime discussion I include after the quote:
We take up the issue of influencing first, and then the issue of knowing falsehoods. Suppose you're an actress and you habitually subtract three years from your true age because you're worried about movie producers' discriminating against aging actresses. You're 40 but pretend to be 37. You know the bank doesn't care whether you're 40 or 37—you're wealthy and the bank is eager to have you as a customer—but you don't like your true age to appear on any document; a bank employee might read it and discover the lie and post his discovery on Facebook or Twitter, and within hours the whole world would be privy to your secret. You would have made a knowingly false statement on your bank application by listing your age as 37, and rather than just pinning the application to your wall you had submitted it to the bank. Under the district judge's interpretation of section 1014—an erroneous interpretation that warped the trial in this case—you would be guilty of a felony punishable by a prison sentence of up to 30 years and a maximum fine of up to $1,000,000. 
What is true is that if you make a knowingly false statement intending to influence a bank, it's no defense that you didn't succeed in influencing it or even that you couldn't have succeeded. Materiality is not an element of the offense punished by section 1014. United States v. Wells, 519 U.S. 482, 484, 117 S. Ct. 921, 137 L. Ed. 2d 107 (1997); United States v. Lane, 323 F.3d 568, 582-83 (7th Cir. 2003). But it is relevant. If the loan applicant doesn't think his falsehood would influence the bank it is unlikely that in making it he intended to influence the bank; as in our example of the actress, he would have had a different motive. As the Supreme Court explained in Wells, "a statement made 'for the purpose of influencing' a bank will not usually be about something a banker would regard as trivial, and 'it will be relatively rare that the Government will be able to prove that' a false statement 'was ... made with the subjective intent' of influencing a decision unless it could first prove that the statement has 'the natural tendency to influence the decision.' Hence the literal reading of the statute will not normally take the scope of § 1014 beyond the limit that a materiality requirement would impose." United States v. Wells, supra, 519 U.S. at 499 (emphasis added), quoting Kungys v. United States, 485 U.S. 759, 780-81, 108 S. Ct. 1537, 99 L. Ed. 2d 839 (1988).
Wells declined to read a requirement of proving materiality into the statute not because materiality is irrelevant but because "the literal reading of the statute"—the reading that excludes materiality as an element of the offense—nevertheless allows immateriality to be used as evidence that the false statement was not intended to influence the bank. 
If the defendants believed that all the bank cared about was that the applicant for a loan have a decent credit rating, as did Phillips, who alone signed the application as borrower, they wouldn't have thought the statement of income would influence the bank's decision any more than pinning Phillips's baby pictures to the application would have done so. And if one believes the defendants' version of what their mortgage broker told them—a version they were forbidden to present to the jury—they didn't think that including in the space for "borrower's income" a non-borrower's income would affect the bank's decision, as all the bank cared about was the total income available to service the loan—and the non-borrower was the applicant's "significant other" and future spouse. What can it mean to intend to influence a bank by telling it something you're confident won't influence it? 
The defendants wanted but were forbidden by the district judge to testify that Bowling had told them, first, that Phillips should be the only applicant for the stated-income loan because her credit history was good while Hall's was bad because of his recent bankruptcy; second that Hall's income should be added to hers on the line in the application that asked for the borrower's gross monthly income; and third that this was proper in the case of a stated-income loan because what the bank was asking for was the total income from which the loan would be repaid rather than just the borrower's income. Phillips and Hall were a couple (they have since married) and so both their incomes would be available to contribute to the mortgage payments. And nowadays of course many unmarried couples live together indefinitely in a state functionally equivalent to marriage, sharing joint expenses, such as mortgage expenses, as a married couple would do. 
The judge forbade the defendants to testify to these things because she didn't see the relevance of such testimony. The government adds that it would have been hearsay. Not so (a surprising mistake for a Justice Department lawyer to make); the defendants were offering the testimony about Bowling's alleged statements not to prove that a stated-income loan does permit what Bowling told them it did, but to explain what they had heard him tell them (and that they believed what he told them) when they made the application.  It is not hearsay to testify to what someone told you and what you thought the person meant, as long as you're not insisting on "the truth of the matter asserted in the [out-of-court] statement." Fed. R. Evid. 801(c)(2); Talmage v. Harris, 486 F.3d 968, 975 (7th Cir. 2007); United States v. Hanson, 994 F.2d 403, 406-07 (7th Cir. 1993); United States v. Thompson, 279 F.3d 1043, 1047, 350 U.S. App. D.C. 60 (D.C. Cir. 2002). The defendants wanted to testify not that Bowling had told them the truth but that his lies, undetected by them, had made them misunderstand the meaning of "borrower's income" in an application for a stated-income loan. 
The evidence they were prevented from giving was pertinent both to whether they had knowingly made a false statement and to whether, if so, their intention had been to influence the bank to grant them a mortgage. They wanted to testify that Bowling had told them that in a stated-income loan the line for the borrower's income on the application form really means the borrower's income plus the income of a spouse, or parent, or a person one is cohabiting with in a committed relationship whether marital or nonmarital, or anyone else whose income will be an additional source of repayment of the mortgage. On this interpretation, which financial naïfs like these defendants could well believe, they weren't trying to influence the bank by means of a false statement, because on that interpretation what the bank was asking for in the line for borrower's income was the total income out of which the mortgage would be repaid. The defendants must have known that in a literal sense Hall's income was not part of the borrower's, Phillips's, income. But literal meanings are not the only true meanings of phrases or sentences or other linguistic units. If Phillips told Hall that she had a toothache that was killing her, it would not have been an intelligent response for Hall to call 911 for an ambulance. Or if she had told him that he was a "cool cat," this would not be a lie just because he lacks whiskers and a nictitating membrane. 
These examples illustrate, what should be obvious, that even the simplest sentences require interpretation. Francis Lieber gave the following example almost two centuries ago in his celebrated book Legal and Political Hermeneutics, Or, Principles of Interpretation and Construction in Law and Politics: With Remarks on Precedents and Authorities 28-30 (1839): "Suppose a housekeeper says to a domestic: 'Fetch some soupmeat,' accompanying the act with giving some money to the latter." That sounds straightforward, but Lieber explains that the domestic 
will be unable to execute the order without interpretation, however easy, and, consequently, rapid the performance of the process may be. Common sense and good faith tell the domestic, that the housekeeper's meaning was this: I. He should go immediately, or as soon as his other occupations are finished; or, if he be directed to do so in the evening, that he should go the next day at the usual hour; 2. that the money handed him by the housekeeper is intended to pay for the meat thus ordered, and not as a present to him; 3. that he should buy such meat and of such parts of the animal, as, to his knowledge, has commonly been used in the house he stays at, for making soups; 4. that he buy the best meat he can obtain, for a fair price; 5. that he go to that butcher who usually provides the family, with whom the domestic resides, with meat, or to some convenient stall, and not to any unnecessarily distant place; 6. that he return the rest of the money; 7. that he bring home the meat in good faith, neither adding any thing disagreeable or injurious; 8. that he fetch the meat for the use of the family and not for himself. Suppose, on the other hand, the housekeeper, afraid of being misunderstood, had mentioned these eight specifications, she would not have obtained her object, if it were to exclude all possibility of misunderstanding. For, the various specifications would have required new ones. Where would be the end? We are constrained, then, always, to leave a considerable part of our meaning to be found out by interpretation. [Emphasis added.] 
It is for a jury to determine what the defendants understood to be the meaning that Bowling attached to "borrower's income." In finance as in law, words and phrases in everyday use often bear a specialized meaning of which ordinary people are ignorant. Won't the typical reader of a typical mortgage application form (such as "Uniform Residential Loan Application," (visited Sept. 3, 2013)) sense that such words as "liquid," "delinquent," "delinquency," "successors," "title," "discount," "vested interest," and "improvements" are not being used in their everyday sense? Couldn't a loan applicant believe—if told by a professional whom the applicant has reason to trust—that "borrower's income" on such a form also may not bear its everyday meaning?
Indeed the bank, given its business model, may have been asking for either an individual's income or a combined income, rather than just for the former. If Phillips was trying to influence the bank not by concealing the existence of Hall (with his bad credit record) but by reporting an income from which the mortgage would be repaid that was large enough to persuade the bank that the loan would not be unduly risky, and she thought the loan application asked for that measure of income, she was trying to influence the bank by saying something she believed to be true. 
An FBI agent who interviewed Hall quoted him as saying that "Bowling mentioned that [Phillips] would need to change her [job] title to make her income look a little better." (So on the loan application she was listed as a "sales manager," which was false.) But there was also evidence, consistent with Fremont's business model, that the bank didn't give a fig about the couple's ability to repay the loan. It planned to sell the loan, which would then be folded with many other loans into a mortgage-backed security that would be sliced and the slices sold around the world, the premise being that the security would be safe because of diversification—the mortgages bundled into the security would be on properties scattered across the United States. A nationwide collapse of the housing market was not foreseen. 
It's true that even if the bank didn't care what was on the loan application, the defendants could have thought they were influencing the bank—and a purpose to influence is an element of the crime (though, to repeat, only if the influence is exerted through knowingly false statements). But a jury could find that the defendants believed the bank had approved the loan to the couple, and was telling them through Bowling what to put on the loan application, or what he should put on it in their name, and that in complying with his directives the defendants were not trying to influence the bank because they knew the bank had already made up its mind to make the loan and were just following Bowling's directions, which they may not have understood. What if he told them that the bank wouldn't even read their application, that all it cared about was having a signed application? Then in authorizing Bowling to fill in the application the defendants would not have been trying to influence the bank. 
The jury rendered a general verdict, simply finding the defendants guilty of both counts of the indictment (the second being the conspiracy count). The verdict did not reveal what false statements the jury attributed to the defendants. For all we can know, the only false statement to the bank that the jury found that Phillips and Hall had known to be false (given that Hall hadn't signed the application and that neither of the defendants may have read it) was the statement of income in the borrower's line on the form—for they admitted to having known their incomes would be combined on that line, while denying knowledge of the other falsities charged—those they attributed to Bowling. Had they been allowed to testify to what Bowling had told them the phrase "borrower's income" meant, the jury might well have concluded that the couple had believed that combining their income on the "borrower's income" line of the loan application was precisely what the application called for. 
It's true that the combined income was inflated on the application and that Phillips's job was falsely listed as that of a sales manager rather than a hairdresser in order to make the income figure more credible. Phillips testified, however, that the application was filled out by Bowling and that neither she nor Hall read it or was aware of the inaccuracies in it. Bowling had told them he would add Hall's income to Philipps's in the line for the borrower's income but not that he would inflate their combined income. 
The jury may well have believed the FBI agent's testimony that Hall had acknowledged having been told by Bowling that Phillips's job title would be inflated on the application. But alternatively the jury may not even have considered the agent's testimony; the judge's evidentiary ruling left the jury with little choice but to convict the defendants on the basis of the (literal) meaning of "borrower's income" alone. 
The government does not argue that by signing the form Phillips adopted the false statements in it that she was unaware of. Nor would that be a plausible reading of a criminal statute that forbids only false statements made "knowingly." It is careless to sign a document without reading it, but it is a knowing adoption of its contents only if the signer is playing the ostrich game ("willful blindness"), that is, not reading it because of what she knows or suspects is in it. In re Aimster Copyright Litigation, 334 F.3d 643, 650 (7th Cir. 2003); United States v. Azubike, 564 F.3d 59, 66-67 (1st Cir. 2009); United States v. Aina-Marshall, 336 F.3d 167, 170-71 (2d Cir. 2003). 
Because Hall didn't sign the application form, the bank could not have sought a deficiency judgment against him when the mortgage was defaulted. But there is no evidence that Hall was kept off the application form in order to avoid being potentially subject to a deficiency judgment. It would be highly implausible. Deficiency judgments are rarely sought in Wisconsin because Wisconsin law allows mortgagees to foreclose six months after obtaining a default judgment if they waive their right to a deficiency judgment. Wis. Stat. 846.101(2). Otherwise they must wait a year. Id., 846.10. Anyway what bank would think it worth the expense of suing to obtain a deficiency judgment against a barber? And remember that Fremont's business model involved selling the mortgages it issued, not servicing and if necessary foreclosing on them. 
But the district court's key error was forbidding the defendants to testify to what Bowling told them when he instructed Phillips to sign the application for the mortgage loan. He may have said to them: "Your application isn't illegal." Or: "Whatever you write on it won't affect the bank's lending decision because it doesn't read the applications—they're just window dressing." Or: "combining your income isn't a misstatement under Fremont's stated-income loan program." The first statement would not have helped the defendants because mistake of law is rarely allowed as a defense to a criminal charge, Cheek v. United States, 498 U.S. 192, 199, 111 S. Ct. 604, 112 L. Ed. 2d 617 (1991); United States v. Dimitrov, 546 F.3d 409, 414 (7th Cir. 2008); United States v. Allen, 670 F.3d 12, 18 (1st Cir. 2012), and we are given no reason to think that 18 U.S.C. § 1014 is an exception. The second statement, however, would have helped negate the element of intent to influence. And the third if believed would have refuted the prosecution's claim that the defendants had knowingly made a false statement to the bank, unless the jury believed that other false statements on the application were made by the defendants or (as may have been the case with the change in Phillips's job title) with their knowledge, rather than by Bowling without his telling them. Had the jury believed either that the defendants lacked the intent to influence the bank or that they did not make any knowingly false statements, it would have acquitted them. 
The erroneous exclusion of evidence favorable to the defendants could thus have been decisive in the jury's decision to convict. The judgment is therefore reversed and the case remanded for a new trial.
Now, with that line of analysis, let's consider Tax Perjury, § 7206(1), which criminalizes the conduct of a person who
(1) Declaration under penalties of perjury
Willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter; 
Read literally, the crime is for the defendant not to "believe" that the return is "true and correct as to every material matter;"  It is solely the defendant's subjective belief that the return has some element of falsity (not true and correct) as to some material matter.  The question I raise here is who makes the determination of materiality for the element of the crime.  In other words, does the defendant have to believe that there is both a lie and (conjunctive as to belief) that the lie is material?  Or is the crime if the defendant believes that there is a lie and, on an objective level (rather than the defendant's subjective level), the lie is material.

The Fifth Circuit Pattern Jury Instruction (2012) for Tax Perjury is, here:
Title 26, United  States Code,  Section 7206(1), makes it a crime for anyone willfully to make a false material statement on an income tax return. 
For  you to find the defendant guilty of this  crime, you must be convinced  that the government has proved each of the following  beyond a reasonable doubt: 
First: That  the defendant  signed an income  tax return that contained  a written declaration that it was made under penalties of perjury; 
Second: That  in this  return  the defendant falsely stated that ——————————— (state material matters asserted, e.g., the defendant  received gross income of
——————————— during the year —————); 
Third: That the defendant knew the statement was false; 
Fourth: That the false statement was material; and 
Fifth: That the defendant made the statement will- fully,  that is, with intent to violate  a known legal duty.
So, as presented in this jury instruction, the lie must be material but there is no requirement that the defendant have believed or have had any reason to believe that the lie is material.  I think that is consistent with the case law (although that is based on memory rather than current research).

I wonder, however, if that is a correct interpretation of the statutory text.  (Note Posner's key point that it is all about interpretation.)  Why couldn't the text enacted by Congress be interpreted to mean that the taxpayer's belief as both the lie and materiality is required.  If, to lift the facts from Philips, a taxpayer were to state on Schedule C that she is a sales manager rather than a hair dresser, but otherwise the return is correct, has the taxpayer committed tax perjury even though she thought the "lie" would be immaterial in any meaningful way to anybody and the IRS in particular?  I think that, on the standard instruction of materiality, it would probably be considered as having the potential to hinder the IRS efforts with respect to the taxpayer's liability.  But can or should the taxpayer be guilty of the crime.  Certainly, under the Fifth Circuit pattern instruction, she can.  Should she?

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