Third Circuit Strikes Blow For Sensible White-Collar Money Laundering Decisions

Last month the United States Court of Appeals for the Third Circuit (overseeing district courts in Pennsylvania, New Jersey, Delaware, and the U.S. Virgin Island), took the extraordinary step of overturning a federal white-collar money laundering conviction. In doing so, the court limited the government’s ability to simply tack on § 1956 money laundering to major fraud cases.

The case, United States v. Fallon, — F.4th —- (2022), provides a bulwark against unnecessary money laundering charges and convictions.

What is Money Laundering

As a refresher, there are two main types of federal money laundering charges: less serious use money laundering under 18 U.S.C. § 1957, and much more serious concealment, evasion, and promotion money laundering under 18 U.S.C. § 1956. This case concerns the latter.

Section 1956 prohibits financial transactions designed to, inter alia, conceal the source of illicit income, promote the continued operation of illegal money-making activities, or structure financial transactions to avoid tax and reporting requirements. This statute goes after the activities people typically associate with money laundering: front businesses, buying and selling loads of goods, fake inheritance, or really any scheme people could imagine on Breaking Bad, The Wire, or The Sopranos. Section 1956 is distinct from § 1957 money laundering (which prohibits any transaction so long as a person knows the funds originate from criminal activities) and carries harsher penalties and increased sentencing guideline sentences.

In complex white-collar cases, a § 1957 conviction can also taint otherwise “clean” funds used to facilitate the laundering process. Some courts have found that clean transactions, which merely provide a bank account with a patina of legitimacy, can all be tainted. This means that if a CEO of a large corporation commits a fraud and inserts the funds into the corporate payroll account to look like legitimate salary, then some courts will authorize forfeiture of the entire corporate payroll account. These courts will use the logic that the real payroll served as cover for the fake payments and thus is “involved in” money laundering.

The Third Circuit knows forfeiture is a tempting source of funds and has pressured the government to make certain white-collar defendants are really actively concealing, promoting, or structureing, before charging money laundering and seizing accounts worth far more than the original crime.

The Fraud

The case concerned Devos LTD LLC (d/b/a “Guaranteed Returns”) and several members of its leadership. Guaranteed Returns was a pharmaceutical “reverse distributor,” which served as a middleman allowing medical providers to return unused or expired drugs to manufacturers for a refund. Guaranteed Returns earned a percentage fee on each return. Sometimes Guaranteed Returns would collect nonrefundable unexpired drugs (called “indates”) and track/hold them until they became refundable.

Drugs from different clients but made by the same manufacture are returned in batches and the refunds are distributed to the individual clients out of a lump sum payment to Guaranteed Returns.

The lump sums were all deposited in a single operating account. From there, Guaranteed Returns would subtract its fee and distribute payments to healthcare providers based on the drugs returned. This account was also used to pay venders, make payroll, and cover other operating expenses.

One of Guaranteed Returns’ clients was the federal government. When the district of Columbia noticed that it did not receive a full refund for returned Anthrax medication, the department of Defense opened an investigation and uncovered several schemes to defraud Guaranteed Returns’ clients.

In one scheme, the CEO had his inventory system reprogramed to distinguish between clients believed to closely audit their indate refunds and clients who failed to do so. Guaranteed Returns’ management software would occasionally reclassify indates from the less careful clients as belonging to “GRX Stores”—these refunds went to Guaranteed Returns. In order to steal from more careful clients, the CEO had his program reclassify every 13th indate as property to GRX Stores (if the value was less than $3,000). And he simply stole indates over three years old. On top of this, he would also skim extra money out of refunds that were paid to clients.

The Money Laundering

The money that would eventually go to “GRX Stores” was part of the lump sums deposited in the operating account. After the clients were paid, the government alleged that the money went from the operating account to the CEO’s personal account “through a series of complex transactions designed to conceal the nature, location, source, ownership, and control of these proceeds”—i.e., money laundering.

The District Court Case

The company and several officers were indicted, tried, and convicted on several counts of fraud and money laundering.

The government sought forfeiture for both fraud and money laundering. The fraud forfeiture was straight forward, the government wanted the stolen funds back. The court ordered Guaranteed Returns and the CEO to jointly and severally pay $94,737,868.16; an additional $515,221.89 in restitution also included a lesser executive; and finally, the court ordered Guaranteed Returns to forfeit $114,832,445.62.

Appeal

The defendants appealed on several grounds. Pertinently, they argued that the government did not prove “that they conspired to engage in financial transactions designed to conceal the nature or source of the proceeds from the fraud schemes,” as needed for a § 1956 conviction. The Circuit Court agreed.

The court drew a fine distinction “between the concealment inherent in fraud offenses and concealment money laundering.” It reasoned that the money laundering statute was not imply an additional penalty for fraud: it requires more.

And the court is deeply concerned with the perverse incentives that a loose definition of money laundering could cause:

At best, it could subject companies to enormous forfeiture obligations based on relatively minor fraud schemes. At worst, it could motivate prosecutors to bring money laundering charges in almost every fraud case. For example, if a company commits a relatively small fraud, treats the proceeds of that fraud as revenue, and circulates that money through several accounts within the company just as it would with legitimate revenue, every account through which the fraud proceeds pass could be subject to forfeiture under  18 U.S.C. § 982 for being “involved in” money laundering.

The court further distinguished between white-collar money laundering and the “classic” variety. True, a drug trafficker or thief who runs the fruits of their crime through a legitimate business or deposits them in a bank account under false pretenses is taking extra steps to conceal their crime. But in many white-collar offenses, movement of funds between accounts is simply part of the underlying crime.

In this case, the government argued that Guaranteed Returns’ normal movement of funds was co-mingled with illicit proceeds and made those proceeds appear legitimate. Thus, they argued, the company’s legitimate business was a money laundering operation disguising the illegal business.

The court did not buy this argument. It explained that the co-mingling occurred before Guaranteed Returns possessed the funds—in the lump sum payments from manufacturers. That money would have been deposited in exactly the same way if Guaranteed Returns was operating entirely legitimately. It was not until after the lump sums were deposited that their programs distributed individual payments to healthcare providers. Thus, the funds only became “proceeds” of fraud when they were separated out from the lump sum payments. After that, the government was unable to show that the defendants took steps to conceal their proceeds. So, the court reversed the money laundering convictions.

Having reversed the money laundering conviction, the circuit court also ordered the district court to recalculate the forfeiture award. This new calculation will not be able to seek “money involved” in legitimating the alleged money laundering transactions. Consequently, it should be lower.

Takeaways

This case supplies some valuable insights:

  • In the Third Circuit at least, the government cannot simply tack on § 1956 money laundering to every white-collar crime simply because fraud and money laundering both involve concealment and financial transactions.

 

  • The Third Circuit did not rule on whether § 1957 laundering (which simply prohibits use of known illicit funds) can attached where transactions are part of the underlying fraud.

 

  • Proving a case at trial requires more than simply challenging the facts. Even if all the facts the government proved in this case were correct, they still misunderstood the theory of money laundering.
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