Physicians and Pharmacies Must Be Aware of the Dangers and Potential Penalties Associated with Importing Prescription Drugs

Introduction

As the price of healthcare continues to increase, healthcare practitioners have become more innovative and creative in their attempts to keep costs affordable for their patients. One technique which has increased in its popularity is doctors purchasing prescription drugs from foreign sources, particularly online pharmacies. However, while such techniques may provide for less expensive medical care, the importation of drugs from foreign sources can expose healthcare practitioners to a variety of criminal and civil penalties, and according to the FDA, can seriously endanger patients.

The risks associated with imported prescription drugs

For years, FDA has warned businesses and individuals about the risks associated with buying prescription drugs from foreign sources, specifically Canada. Recently, on September 28, 2012, the FDA issued a news release launching a national campaign called BeSafeRx that is designed to raise public awareness about the dangers of ordering prescription drugs from foreign unapproved sources. According to the FDA, the National Association of Boards of Pharmacy has found that less than three percent (3%) of online pharmacies meet the licensing requirements under federal law. A copy of the BeSafeRx announcement can be read here.

The FDA has taken the position that the dangers consumers face when purchasing foreign prescription drugs include consumption of expired, subpotent, contaminated or counterfeit drugs. Further, because foreign drugs may be manufactured for sale in non-English speaking countries, consumers may receive drugs without adequate directions for use. See South Florida Access to Affordable Prescription Drugs: Costs and Benefits of Alternative Solutions, Hearing before Subcomm. on Oversight and Investigations of H. Comm. on Energy and Commerce, 108th Cong. (2003).  Additionally, as many of these foreign drugs are produced in non-FDA approved facilities, the FDA cannot assure that they were manufactured in compliance with current good manufacturing practice (cGMP) standards. See generally, 21 U.S.C. § 360; 21 C.F.R. part 207.  Thus, per the FDA, consumers are exposed to numerous risks when purchasing drugs from internet pharmacies that dispense foreign drugs.

An example of the dangers consumers and healthcare practitioners face when importing foreign drugs played out earlier this year. In February, the FDA issued Warning Letters to numerous healthcare professionals that may have purchased counterfeit copies of the cancer drug Avastin from Canadian internet pharmaceutical distributors. According to reports, the fake Avastin, which was manufactured in unapproved facilities in Europe then distributed into the United States through Canadian internet pharmacy CanadaDrugs.com, contained no active cancer fighting ingredients. As a result of these events, healthcare practitioners who imported the counterfeit products may face criminal and civil penalties for having participated in adulteration and misbranding violations. See 21 U.S.C. § 351, 21 U.S.C. § 352.

More recently, on September 21, 2012, the FDA issued Warning Letters to over 4,100 identified websites that sell drugs or medical devices to American consumers. The Warning Letter, which was addressed to Canadadrugs, explained that these online pharmacy websites “offer unapproved and misbranded new drugs for sale” and requested each website to “immediately cease marketing violative drug products to United States consumers.” (To read the FDAs Warning Letter, click here.) Furthermore, the FDA sent notices to Registries, Internet Service Providers (ISPs), and domain Name Registrars (NDRs) informing them of the websites allegedly violative practices.

Additionally, on October 4, 2012, the FDA announced the details of Operation Pangea V, a global effort to combat the online sale and distribution of potentially counterfeit and illegal medical products. For the full text of the FDAs press release, please click here. In executing Operation Pangea V, the FDA collaborated with INTERPOL, the World Customs Organization, Permanent Forum of International Pharmaceutical Crime, Heads of Medicines Agencies Working Group of Enforcement Officers, the Medicines and Healthcare products Regulatory Agency of the United Kingdom, the Irish Medicines Board, the London Metropolitan Police, the U.S. Department of Homeland Security, the Center for Safe Internet Pharmacies, and the national health and law enforcement agencies from 100 other participating countries. The cooperative investigations conducted by these law enforcement, customs, and regulatory authorities resulted in civil and criminal charges, seizure of illegal produces, and removal of websites. For more information regarding Operation Pangea V, please see our previous report here.

The following discussion contains an outline of the penalties practitioners may face when importing foreign pharmaceutical drugs. This outline, however, is not exhaustive, as different penalties may be applicable to different importation activities under different circumstances.

1. Criminal Penalties under the FDCA

Under the FDCA, it is unlawful to import unapproved, misbranded, and adulterated drugs into the United States. This includes the importation of foreign versions of U.S. approved pharmaceuticals as well as those drugs that are manufactured in the United States, exported to other countries, and then subsequently reimported.

Two of the more typical FDCA violations which healthcare practitioners may face as a result of importing misbranded drugs are: 1) introduction or delivery for introduction into interstate commerce of any drug that is adulterated or misbranded; and 2) the receipt in interstate commerce of any drug that is adulterated or misbranded, and the delivery or proffered delivery thereof for pay or otherwise. See 21 U.S.C. § 331 (a), (c). The penalties and punishments associated with these crimes are governed by 21 U.S.C. § 333 and depend on whether the government charges the defendant with committing a violation “with the intent to defraud or mislead.”

Pursuant to 21 U.S.C. § 333(a)(1), a first misbranding violation is a strict liability offense and is a misdemeanor. Thus, no criminal intent need be established by the Government in order to sustain a conviction. However, 21 U.S.C. § 333(c) provides several good-faith exceptions, of which, if the healthcare practitioner qualifies, would absolve them from liability.

The maximum sentence provided by statute for a violation of 21 U.S.C. 331(a) or (c) is 1-year imprisonment, a supervised release of one year; and a maximum fine not in excess of $100,000. 21 U.S.C. § 333(a)(1); 18 U.S.C. § 3571. In addition, section 2N2.1 is the Sentencing Guideline applicable to misdemeanor violations of biological products, devices, cosmetics, and usually used in FDA prosecutions of statutes and regulations relating to foods, drugs, agricultural products.

However, if a healthcare practitioner is charged with violating either 331(a) or (c) with the intent to defraud or mislead, enhanced penalties do exist and such cases are prosecuted as felonies. The penalties associated with a violation of 21 U.S.C. § 333(a)(2) are a term of imprisonment of not more than 3 years and a fine of not more than $250,000. See 21 U.S.C. § 333(a)(2); 18 U.S.C. § 3571.

A violation of 21 U.S.C. § 333(a)(2) is a specific intent crime, see United States v. Mitcheltree. The specific intent requirement in § 333(a)(2) requires:

  1. Proof of misbranding; and
  2. Proof of intent to mislead or defraud “which is connected to the misbranding violation.”

Id. In other words, because “knowledge of the essential nature of the alleged fraud is a component of the intent to defraud, a defendant cannot act with an intent to mislead or defraud under § 333(a)(2) without some knowledge of the misbranding.” Id. (citing United States v. Hiland, 909 F.2d 1114, 1128 (8th Cir. 1990)).

As previously explained, “felony criminal responsibility requires a knowing violation with the specific intent to defraud or mislead.” Mitcheltree, 940 F.2d at 1350. A violation of 333(a)(2) “may be proved with facts indicating knowledge of the misbranding activity and a concomitant intent to defraud or mislead the FDA or its state counterpart.” Id.; see also United States v. Patwardhan,422 Fed. Appx. 614 (9th Cir. 2011); United States v. Bradshaw, 840 F.2d 871 (11th Cir. 1988) (sustaining a conviction under 333(a)(2) where defendant: 1) knowingly sold steroids without a prescription for unapproved use; 2)mislabeled the steroids as vitamins to avoid detection; and 3) made affirmative misrepresentations and omissions to state drug authorities while attempting to obtain a drug wholesalers permit.).

Additionally, while “the cases construing § 333(a)(2) have ordinarily been based on a sellers intent to defraud or mislead purchasers,” a prosecution under 333(a)(2) may be “based upon an intent to mislead or defraud not only natural persons, but also government agencies if there is evidence that a defendant consciously sought to mislead drug regulatory authorities such as the FDA or a similar governmental agency.” Mitcheltree, 940 F.2d at 1347, 1348 (10th Cir. 1991). As described by the Court in Mitcheltree, “if the government proceeds on this theory, there must be a demonstrated link between the § 331 violation and an intent to mislead or defraud an identifiable regulatory agency involved in consumer protection. Id. at 1349 (emphasis in original); see also United States v. Cattle King Packing Co., 793 F.2d 232 (10th Cir. 1986) (finding that the specific intent requirement of the statute could be satisfied by a showing that defendant intended to mislead or defraud the government agency charged with federal meat inspection); Bradshaw, 840 F.2d 871 (11th Cir. 1988) (finding defendant could satisfy the specific intent requirement of the statute by showing that defendant intended to mislead or defraud state agency in charge permitting and licensing). Additionally, “similar governmental agency” is interpreted to include agencies of foreign governments. See United States v. Industrial Laboratories, 456 F.2d 908 (10th Cir. 1972) (finding that the specific intent requirement of the statute could be satisfied by a showing that defendants intended to mislead or defraud Canadian authorities).

2. Additional criminal and civil liabilities

In addition to violations of the FDCA, practitioners who import foreign pharmaceuticals can face a variety of other criminal penalties. For example, according to the Centers for Medicare and Medicaid Services fact sheet, Medicare will not pay for health care or supplies obtained outside the U.S., which includes prescription drugs imported from Canada. 42 U.S.C. § 1395y. As such, doctors could face criminal and civil liability for knowingly importing drugs in violation of the FDCA and submitting a claim to Medicare for the illegally imported drugs.

Such charges may include:

  • Health care fraud for defrauding or obtaining money from a health care benefit program. 18 U.S.C. § 1347. Notably, the doctor does not need to have actual knowledge or specific intent to violate this section. Violations of the health care fraud statute are punishable by fines or imprisonment of no more than 10 years, or both.
  • False claims for knowingly presenting a false claim for payment or approval to the government. 31 U.S.C. § 3729. Violations for false claims are punishable by civil penalty of not less than $5,000 and not more than $10,000.Further, healthcare practitioners could be subject to various fraud charges related to importing drugs from overseas. Such charges may include:
  • Mail and wire fraud for the use of mails or wire communications in furtherance of a scheme to defraud. See 18 U.S.C. § 1341; 18 U.S.C. § 1343.  Violations of the mail and wire fraud statutes are punishable by imprisonment of no more than 20 years, or fines, or both.
  • Bank fraud for obtaining money held by a financial institution through false representations pursuant to 18 U.S.C. § 1344. Violations of the bank fraud statute are punishable by no more than $1,000,000 or imprisonment of no more than 30 years, or both. Section 2B1.1 is the Federal Sentencing Guideline applicable to fraud perpetrated by individuals. Under this guideline, although the “victims loss is usually used as the proxy for the severity of thr crime, the offenders gain, i.e. the proceeds from the illicit activity, can provide an adequate, alternative method of gauging the crimes just penalty when the loss is incalculable. See United States v. Haas, 171 F.2d 259, 269, 270 (5th Cir. 1999) (finding that while “the loss sustained by either the FDA or Haass customers is, for all practical purposes, incalculablethe district court can, however, estimate the gain that Haas received from defrauding the FDA. Thus, Haass gain from his fraudulent importation scheme appears to have been the monies received [from his company] by way of salary and profits.”). Therefore, under the sentencing guideline, the more money involved in a fraud scheme involving  the sale or distribution of misbranded or adulterated drugs, the greater the potential sentence.
  • Smuggling or clandestinely introducing goods because of failure to comply with other statutes. 18 U.S.C. § 545. Violations are punishable by fines or imprisonment of no more than 30 years, or both.Healthcare practitioners must also be aware of the potential liabilities they face if they engage in the re-importation of drugs.
  • Drug re-importation involves exporting U.S. manufactured prescription drugs to a foreign country, then subsequently importing the same drug back into the U.S. by someone other than the U.S. manufacturer, and carries additional penalties under the FDCA. The  FDCA prohibits anyone other than the U.S. manufacturer of a drug to re-import the drug into the U.S. even if the drug was approved and manufactured in the U.S; 21 U.S.C. § 381 (d)(1).The FDA has found that, because it does not have oversight over other countries drug distribution systems, insufficient safeguards in foreign handling and shipping exist to prevent the introduction and retail sale of substandard, ineffective, or counterfeit drugs. 59 Fed. Reg. 11842 (March 14, 1994). Thus, products that are re-imported by anyone other than the manufacturer will be denied entry into the U.S. 21 U.S.C. § 381(d)(3)(B).If a business or individual knowingly violates 21 U.S.C. § 381 (d)(1) by causing prescription drugs manufactured in the U.S. to be re-imported by persons other than the manufacturer of the drug, they may be subject to criminal liability consisting of a maximum of 10 years in prison and a maximum $250,000 fine. 21 U.S.C. § 333(b)(1)(A).It is important to note that those who aid and abet in a criminal violation of the FDCA, or conspire to violate the FDCA, can also be found criminally liable. 18 U.S.C. §§ 2, 371. Thus, businesses or individuals that import drugs from foreign sources in violation of the FDCA could potentially be charged with these offenses as well.

3. Exclusion from participation in federal health care programs

In addition to criminal penalties, practitioners may also face various administrative penalties. For example, 42 U.S.C. §1320a-7b(a) empowers the Secretary of Health and Human Services to exclude certain convicted individuals from participation in any “Federal Health Care Program.” In particular, § 1320a-7(b)(1)(a) authorizes the Secretary to exclude individuals convicted of a criminal offense consisting of a misdemeanor relating to fraud, theft, embezzlement, breach of fiduciary responsibility, or other financial misconduct in connection with the delivery of a health care item or service.

Additionally, § 1320a-7(b)(3) authorizes the Secretary to exclude any individual who has been convicted of a criminal offense consisting of a misdemeanor relating to the unlawful manufacture, distribution, prescription, or dispensing of a controlled substance. See Friedman v. Sebelius, Case No. 11-5028 (D.C. Cir. July 27, 2012).  Further, “items and services furnished, ordered, or prescribed by [an excluded person] will not be reimbursed under Medicare, Medicaid and all other Federal health care programs until [that person] is reinstated by the OIG.” 42 C.F.R. § 1001.2. For more information regarding exclusion from federal health care programs under 42 U.S.C. § 1320a-7b, please see our previous report here.

Conclusion

Healthcare practitioners are in a never-ending struggle to control the costs of patient care, but must nevertheless ensure that the methods they choose comply with federal law. For more information regarding the importation of drugs from foreign sources, our FDA litigation practice, or how to ensure that your business maintains regulatory compliance, contact Fuerst Ittleman David & Joseph PL at (305) 350-5690 or contact@fidjlaw.com.

Update: Online Poker Executives Guilty Plea Highlights the Additional Penalties Payment Processors When Processing Illicit Gambling Proceeds

On September 19, 2012, Nelson Burtnick, former director of the payment processing department of Full Tilt Poker and PokerStars, pled guilty to charges of conspiracy to commit violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), Bank Fraud, and Money Laundering, stemming from the April 15, 2011 indictment of eleven people in connection with their involvement in PokerStars, Full Tilt Poker, and Absolute Poker.

The Department of Justice had charged Burtnick with multiple charges including violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), conspiracy to commit bank fraud and wire fraud, operating an illegal gambling business, and money laundering. In his plea deal, Burtnick pled guilty to one count of conspiracy to accept funds in connection with unlawful internet gambling, bank fraud, and money laundering, and two counts of accepting funds in connection with unlawful internet gambling. As a result of his guilty plea, Burtnick faces a maximum of 15 years in prison. A copy of the U.S. Department of Justices press release announcing the guilty plea can be read here.

As we have previously reported here, here and here, ongoing federal prosecutions have targeted internet poker operators and their payment processors for violations of federal law under UIGEA 31 U.S.C. §§ 5361-5366 and the Illegal Gambling Business Act (“IGBA”) found at 18 U.S.C. § 1955. However, as exemplified by Mr. Burtnicks indictment and guilty plea, payment processors face various other violations of federal law when accused of processing illicit gambling proceeds. These violations include bank fraud, found at 18 U.S.C. § 1344, which makes it a crime for “whoever knowingly executes, or attempts to execute, a scheme” to either: 1) defraud a financial institution; or 2) obtain any of the moneys under the custody or control of a financial institution by means of a false or fraudulent representation. Here, prosecutors alleged that Burtnick violated 18 U.S.C. § 1344 by deceiving U.S. financial institutions into processing payments for Poker companies from U.S. gamblers through disguising such payments as payments to non-existent online merchants and non-gambling businesses.

Another federal law of which payment processors must be aware is the prohibition against money laundering found at 18 U.S.C. § 1956. Generally speaking, “money laundering” is the act of concealing or disguising the nature, location, source, or ownership of money begotten through illicit means in order to make such funds appear as if earned through legitimate and lawful activity. More specifically, 18 U.S.C. § 1956(a)(2)(A) prohibits the transportation, transmission, or transfer of a monetary instrument or funds from a place in the U.S. to or through a place outside of the U.S. (or vice versa) “with the intent to promote the carrying on of a specified unlawful activity.” In its Indictment, the Government alleged that Burtnick violated 18 U.S.C. § 1956(a)(2)(A) by disguising payments by U.S. gamblers to Full Tilt and Poker Stars, both offshore entities, as payments to phony internet merchants. Bank accounts in the fake merchants names were opened in U.S. banks through which the poker companies could receive payments from the U.S. based gamblers.

More importantly, each of these crimes is separate and distinct from the illegal gambling activities themselves. Thus, regardless of whether a payment processor is charged under IGBA or UIGEA, acts of payment processors in disguising or misrepresenting the source of funds they process can subject the processor to criminal liability.

If you have questions pertaining to UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about FIDJs experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com

Florida’s Concurrent Cause Doctrine May Be a Valuable Tool to Overcome Insurance Policy “Intentional Acts” Exclusions

Plaintiff “V” is yet another victim of unscrupulous business practices perpetrated by the evil Defendant B. V retains counsel to investigate and prosecute its claims to the fullest extent permitted by law. V’s counsel reviews the facts and serves a carefully crafted, professionally envious demand letter, filled with details of every facet of wrongdoing, backed with volumes of evidence sure to drive any wrongdoer into imminent capitulation. B’s counsel responds not with a denial, not with excuses, but rather with a curt response indicating that B is no longer in business, and its key principal has fled the country. In other words, “Go ahead and shoot ‘cause there’s nothing here to hit!”

In the not-so-distant past, victims such as V could look to B’s errors and omissions insurance coverage and recover most of the losses, depending only on the amount of coverage available.  Errors and omissions policies are, after all, designed to protect, defend and indemnify the insured from acts of negligence and accidental misconduct, thus ensuring that the insured’s business can continue without serious interruption and further that victims will be compensated for their losses. However, in this world of Ponzi-perpetrated losses, insurance companies have fought back, and are now more than ever exploiting their Policy’s “Intentional Acts” exclusions to avoid paying for either coverage or indemnification for the losses. The insurer’s aggressive tactics have left victims holding the bag in the long line of trustee-driven check-out registers.

“Intentional Acts” exclusions typically allow the insurer to avoid defending against or paying for claims based on an insured wrongdoer’s conduct which was intentionally designed to cause injury. The “Intentional Act” exclusion most heavily litigated typically includes claims centered on allegations of the insured’s intentional fraud. Thus, where Plaintiff V is the victim of Defendant B’s fraud, Defendant B’s insurer will escape paying against any of the policy’s protections.

All may not be lost. What if Plaintiff V had not only suffered from B’s fraud, but also suffered from Defendant B’s separate, independent claims of negligence? In other words, what happens when an insured is sued for a covered claim and an excluded claim? Florida courts traditionally construe insurance policies to afford the greatest degree of coverage.

Florida has adopted the concurrent cause doctrine to dispose of this very scenario. See Wallach v. Rosenberg, 527 So.2d 1386 (Fla. 3d DCA 1988); see further Paulucci v. Liberty Mut. Fire Ins. Co., 190 F.Supp.2d 1312, 1318-19 (M.D. Fla. 2002). The concurrent cause doctrine mandates that coverage shall be provided when a loss would not have occurred but for the joinder of independent covered and excluded causes. Wallach, 527 So.2d 1387. The Court must find coverage “where an insured risk constitutes a concurrent cause of the loss even where ‘the insured risk [is] not … the prime or efficient cause of the accident.’” Id. (quoting 11 G. Couch, Couch on Insurance 2d § 44:268 (rev. ed.1982)).

The Wallach Court reviewed a homeowner’s policy which insured against “physical loss to the property.” The property included a sea wall. The policy excluded coverage for “for loss resulting directly or indirectly … water damage.” After a flood, the sea wall collapsed, causing damage to the Property. The coverage issue was whether the loss was caused by the negligent construction of the sea wall, which would be a covered loss, or by the flood, which was excluded. Ultimately, the court found it unnecessary to find causation by one over the other causes, because under the doctrine of concurrent causes, coverage existed because a covered event contributed to the loss. The insurer then argued that it would inequitable to provide coverage if an excluded event was “one of the causes” of the occurrence. The Third District disagreed and held:

We reject that theory and adopt what we think is a better view”that the jury may find coverage where an insured risk constitutes a concurrent cause of the loss even where “the insured risk [is] not … the prime or efficient cause of the accident.”

Wallach, 527 So.2d at 1387. The court, relying on authority from other jurisdictions, explained:

Where a policy expressly insures against loss caused by one risk but excludes loss covered by another risk, coverage is extended to a loss caused by the insured risk even though the excluded risk is a contributory cause.

Id. at 1388.

Like everything in the law, the clarity of this doctrine is the color of mud. What, for example, would happen if a victim has a claim against a securities lawyer for professional negligence and statutory securities fraud? Is the covered claim for malpractice sufficiently separate and independent from the excluded claim for securities fraud to allow coverage?

While there are no Florida cases directly on point, the plaintiff would need to show that the defendant’s underlying negligence “resulted in and was the proximate cause of actual loss to the plaintiff. If the client cannot show that it would have suffered harm ‘but for’ the [professional] negligence, the client will not prevail.” KJB Vill. Prop., LLC v. Craig M. Dorne, P.A., 36 Fla. L. Weekly D2557 (Fla. 3d DCA 2011). Thus, the plaintiff must prove that its asserted claim of negligence was the contributing cause of actual loss in order to prevail.

Guideone Elite Ins. Co. v. Old Cutler Presbyterian Church, Inc., 420 F.3d 1317, 1330 (11th Cir. 2005), is particularly illustrative. In Guideone, the defendant sought insurance coverage when the loss was the result of a crime involving both robbery and rape.  The court reviewed an insurance policy where sexual assault was expressly excluded from the insurance policy, but other criminal acts, including robbery, were deemed to be covered losses. Applying Florida law, the court held, “Florida’s concurrent cause doctrine permits coverage under an insurance policy when the loss can be attributed to multiple causes, ‘as long as one of the causes is an insured risk.’” In noting the independence of the two criminal acts which took place at the same time by the same actor, the Court explained:

Causes are dependent when one peril instigates or sets in motion the other. In this case, the perils were independent. Robbery and rape have separate objectives that can work in tandem to cause one loss Where two crimes combine to cause a loss, it seems ‘logical and reasonable to find the loss covered … even if one of the causes is excluded from coverage.’

Id. Explaining its rationale, the Court reasoned:

Robbery is not part and parcel to the crime of rape, and the same is true of kidnapping, assault, imprisonment, and battery. Perhaps the confusing element here is that the same actor committed all of the crimes. If the actions perpetrated that day, however, were only parts of one larger crime, that would obviate the rationale behind multiple criminal statutes under which an offender could be charged.

Id.

Thus, if the plaintiff can prove that the claims for professional negligence are not dependent upon or arise from any claim for securities fraud, the insurer will not likely be able to escape from meeting its duties and obligations owed under the insurance policy. In other words, at every stage of representing the plaintiff-victim, plaintiff’s counsel must plot the litigation strategy by focusing not only on the defendant, but on the underlying insurance policy which may be the only source of recovery.

Seventh Circuit: FBAR Forms Governed by Required Records Doctrine, Not Protected by Fifth Amendment

On August 27, 2012, the United States Court of Appeals for the Seventh Circuit decided In Re: Special February 2011-1 Grand Jury Subpoena Dated September 12, 2011, available here, holding that the “Required Records Doctrine” requires a taxpayer asserting a Fifth Amendment privilege over documents which the taxpayer is required to maintain pursuant to the Bank Secrecy Act to produce the documents.

In its decision, the Seventh Circuit’s wrote as follows: “In this appeal, we are asked to decide whether compulsory production of foreign bank account records required to be maintained under the Bank Secrecy Act would violate appellee T.W.’s Fifth Amendment privilege against self-incrimination. Because we find the Required Records Doctrine applicable to this case, we hold that T.W. must produce the subpoenaed records.” The Seventh Circuit’s holding is consistent with the Ninth Circuit’s holding in M.H. v. United States (In re Grand Jury Investigation M.H.), 648 F.3d 1067 (9th Cir. 2011), available here.

As discussed by the Seventh Circuit, the Required Records Doctrine can be traced to Shapiro v. United States, 335 U.S. 1 (1948), available here. In Shapiro, a fruit wholesaler invoked his Fifth Amendment privilege in response to an administrative subpoena that sought business records which were required to be maintained under the Emergency Price Control Act (EPCA), which was passed immediately following the outbreak of World War II to prevent inflation and price gouging.  The Court revisited its decision in Shapiro twenty years later in Marchetti and Grosso v. United States, 390 U.S. 62 (1968), available here.

In holding that the Required Records Doctrine was inapplicable to the circumstances before it in both Shapiro and Grosso, the Court articulated the following three requirements for determining the applicability of the Required Records Doctrine: (1) the purposes of the government inquiry must be essentially regulatory; (2) information is to be obtained by requiring the preservation of records of a kind which the regulated party has customarily kept; and (3) the records themselves must have assumed public aspects which render them at least analogous to a public document. Grosso, 390 U.S. at 67-68. When the requirements of the Required Records Doctrine are met, a witness cannot resist a subpoena by invoking the Fifth Amendment privilege against compelled, testimonial self-incrimination.

That the act of producing documents may be testimonial and incriminating is not a phenomenon unique to this case. The act of production privilege recognizes that, while the contents of the documents may not be privileged, the act of producing them may be. See, e.g., Fisher v. United States, 425 U.S. 391 (1976); United States v. Doe (Doe I), 465 U.S. 605 (1984); Braswell v. United States, 487 U.S. 99 (1988); Doe v. United States (Doe II), 487 U.S. 201 (1988). In other words, producing incriminating documents under government compulsion may have testimonial aspects”aside from the contents of the documents”that are protected under the Fifth Amendment.

One of the rationales, if not the main rationale, behind the Required Records Doctrine is that the government or a regulatory agency should have the means, over an assertion of the Fifth Amendment Privilege, to inspect the records it requires an individual to keep as a condition of voluntarily participating in that regulated activity.  That goal would be easily frustrated if the Required Records Doctrine were inapplicable whenever the act of production privilege was invoked.

The Seventh Circuit remarked that:
Recently, in a case nearly identical to this one, the Ninth Circuit held that records required under the Bank Secrecy Act fell within the Required Record Doctrine. In re M.H., 648 F.3d 1067 (9th Cir. 2011) cert. denied, No. 11- 1026, (U.S. June 25, 2012). In the Ninth Circuit’s case, the court held that the witness could not resist a subpoena”identical to the one in this case”on Fifth Amendment grounds because the records demanded met the three requirements of the Required Records Doctrine. Id. We need not repeat the Ninth Circuit’s thorough analysis, determining that records under the Bank Secrecy Act fall within the exception. It is enough that we find”and we do” that all three requirements of the Required Records Doctrine are met in this case.

The takeaway from this case is that the IRS and the Department of Justice will continue to assert that there are no viable 5th Amendment protections to taxpayers producing evidence of their foreign bank accounts.  However, as only the Ninth and the Seventh Circuits have ruled on this issue it remains to be seen whether the other Circuits will follow.

The attorneys at Fuerst Ittleman David & Joseph have extensive experience in both the civil tax and the criminal tax litigation before the U.S. District Courts and the U.S. Circuit Courts of Appeal.  You may contact us by calling 305.3560.5690 or by emailing us at contact@fidjlaw.com

Update: Eastern District of New York Judge Finds Poker to be Game of Skill Not Chance Under Illegal Gambling Business Act

On August 21, 2012, Judge Jack Weinstein of the United States District Court for the Eastern District of New York dismissed the indictment against Lawrence Dicristina under 18 U.S.C. § 1955, the Illegal Gambling Business Act (“IGBA”) for Mr. Dicristina’s operation of a poker room. Judge Weinstein found that poker does not fall under the definition of gambling, as that term is defined under IGBA because poker is a game of skill as opposed to chance. In so holding, the Court’s opinion may mark a sea change in the ability of federal prosecutors to prosecute online pay-for-play poker operators and the payment processors who transmit funds between those sites and their customers. A copy of the Court’s opinion can be read here. 

As we have previously reported here, here and here, ongoing federal prosecutions have targeted internet pay-for-play poker operators and their payment processors for violations of federal law under IGBA, the Unlawful Internet Gambling Enforcement Act of 2006 “UIGEA” 31 U.S.C. §§ 5361-5366 and various other violations of federal law including wire fraud and money laundering. Under IGBA, it is a felony for anyone to conduct, finance, manage, supervise, direct, or own a gambling business which is prohibited by the State in which the business is operating. IGBA defines “gambling” as: “includ[ing] but is not limited to pool-selling, bookmaking, maintaining slot machines, roulette wheels or dice tables, and conducting lotteries, policy, bolita or numbers games, or selling chances therein.”

The heart of Dicristina’s argument turned on the basic premise that merely because something is defined as “gambling” at the state level does not automatically make it “gambling” for purposes of federal prosecution under IGBA. In his Motion to Dismiss, Dicristina argued that IGBA was not designed to regulated poker because: 1) a business must involve games sufficiently similar to the games enumerated in the federal definition in order to be prosecuted as a “gambling business” under the IGBA; and 2) a game run by a “gambling business” must be both: a) house-banked, and b) predominated by chance. In its opposition, the Government argued that the statute’s plain language does not restrict what kinds of games constitute gambling under IGBA. The Government further argued that when the statute’s broad language is read in the context of its purposes of bolstering state efforts at reducing organized criminal gambling activity, any gambling activity that is illegal under state law should be considered gambling under IGBA.

In its decision, the Court noted that, based on the text and legislative history of IGBA, both Dicristina’s argument, that “gambling” under IGBA is restricted to those games predominated by chance, and that of the government’s, that “gambling” under IGBA is co-extensive with how gambling is defined in the state in which the business operates, were plausible. Therefore, the Court found that the rule of lenity placed the burden on the government to prove that its position was the correct interpretation of IGBA. As explained by the United States Supreme Court in United States v. Santos, when interpreting ambiguous criminal statutes, “[t]he rule of lenity requires ambiguous criminal laws to be interpreted in favor of the defendants subjected to them. This venerable rule not only vindicates the fundamental principle that no citizen should be held accountable for a violation of a statute whose commands are uncertain, or subjected to punishment that is not clearly prescribed. It also places the weight of inertia upon the party that can best induce Congress to speak more clearly and keeps courts from making criminal law in Congress’s stead.”

In evaluating skill versus chance, the Court stated that “chance (as compared to skill) has traditionally been thought to be a defining element of gambling and is included in dictionary, common law, and other federal statutory definitions of it.” The Court found that the fundamental question in determining whether poker was a game of chance or skill “is not whether some chance or skill is involved in poker, but what element predominates.” (emphasis in original). In finding that skill, not chance, predominates poker, the Court noted that poker involved more than the luck of the draw. Instead “expert poker players draw on an array of talents, including facility with numbers, knowledge of human psychology, and powers of observation and deception.” Thus, the Court found that the Government failed to show that it is more likely than not that chance predominates over skill in poker and therefore poker is not considered “gambling” under IGBA.

While this decision may have removed an arrow from the quiver of federal prosecutors in their efforts to prohibit pay-for-play poker, the Court expressly noted that prosecution at the federal level for organized criminal poker operations could still be prosecuted under other federal statutes, such as RICO, and states were free to prohibit poker site operations within their own jurisdictions.

Fuerst Ittleman will continue to monitor these developments. If you have questions pertaining to IGBA, UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about Fuerst Ittleman’s experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com.

Class Action Lawsuits Allege Deceptive “Natural” Labeling Claims

As we previously reported here and here, there has been a noticeable increase in the number of lawsuits filed by consumers aiming to challenge “natural” advertising and labeling claims for dietary supplements and food products over the past year. Most recently, on July 26, 2012, a class action lawsuit was filed in the U.S. District Court for the Northern District of California alleging that General Mills, Inc. (“GM”) deceived consumers by marketing its Nature Valley granola bars as natural “when they are not wholly natural.” The complaint alleges GM deceptively uses the term “natural” to describe products containing ingredients that have been fundamentally altered from their natural state.

GM is the maker of Nature Valley food products including granola bars and other snack food items. According to the complaint, GM’s advertising and labeling Nature Valley products as “natural” violates several California consumer protection laws, including the California Legal Remedies Act, the Unfair Competition Law, and the False Advertising Law, because the products contain non-natural, highly processed ingredients such as high fructose corn syrup (“HFCS”), high maltose corn syrup (“HMCS”), maltodextrin, and rice maltodextrin.

Detailed in our previous report, many consumers feel they are being deceived by “natural” marketing claims and have urged the U.S. Food and Drug Administration (“FDA”) to adopt a formal definition for the term “natural.” In 1991, the FDA solicited comments on a potential rule regarding the definition. However, the FDA ultimately declined to adopt a formal definition. Currently, the FDA’s policy states that it considers “natural” to mean “merely that nothing artificial or synthetic (including colors regardless of source) is included, or has been added to, the product that would not normally be there.” 58 F.R. 2302. The informal policy regarding the use of the term “natural” does not carry the force of law. However, the FDA has sent Warning Letters to companies whose products claim to be “natural” yet contain ingredients the Agency regards to be synthetic which caused the product to be deemed to be misbranded pursuant to 21 U.S.C. 343(a)(1).

The uncertainty over the meaning of the term “natural” has brought a wave of recent class action lawsuits. Other products that have also faced consumer class action lawsuits for the use of “natural” claims on advertising and labeling include: ConAgra‘s Wesson Oils, Skinnygirl Margaritas, Kellogg’s Kashi, Tropicana’s not-from-concentrate orange juice, Frito Lay’s Tostitos and SunChips, Snapple beverages, and Ben & Jerry’s ice cream.

The plaintiffs’ attorneys in these cases argue that the “all natural” claim at issue is false and misleading because the product contains unnaturally processed, synthetic substances, or, in the case of Kashi, that the cereal contains genetically modified ingredients. While some products may technically be in compliance with FDA’s policy statement, they are not insulated against private actions because there is a lack of formal FDA or other government definition for “natural” claims. See, e.g., Holk v. Snapple Beverage Corp., 575 F.3d 329 (3rd. Cir. 2009). Without an FDA or other government definition, the plaintiffs’ attorneys can bring these suits and the food manufacturers must prove the claims are not false or misleading. Id. A formal FDA definition of “natural” could set a definitive standard for “natural” and eliminate these lawsuits. Id. For more information regarding what food manufacturers should know about “natural” claims, see please our previous report here.

A formal FDA definition of natural would not only benefit food companies, but it would also provide consumers with a clearer understanding and less confusion. For more information about the regulation of food advertising and labeling claims, please contact us at contact@fidjlaw.com or (305) 350-5690.

Sixth Circuit Court of Appeals Vacates Sentence for Violating Constitution’s Ex Post Facto Clause

On August 2, 2012, the United States Court of Appeals for the Sixth Circuit vacated a criminal defendant’s sentence, because it violated the ex post facto clause of the U.S. Constitution.  The case was United States of America v. Welch,  ___ F.3d ___, (6th Cir. Aug. 2, 2012), available here.

The facts of the case are fairly straightforward.  The defendant in the case, Welch, was charged with counterfeiting after bleaching genuine, small denomination federal reserve notes and then using the bleached notes to print notes bearing higher denominations.  Welch was arraigned on March 30, 2010, in federal court on the counterfeiting charges. He pleaded guilty without a plea agreement to four violations of counterfeiting, including one count of conspiracy to manufacture and pass counterfeit obligations or securities with intent to defraud the United States in violation of 18 U.S.C. § 371, available here, and three counts of falsely making, forging, counterfeiting or altering, as well as passing, obligations or securities of the United States with intent to defraud in violation of 18 U.S.C. §§ 471, available here, and 472, available here.

Following his guilty plea, Welch was sentenced in the United States District Court for the Northern District of Ohio on August 5, 2010, to concurrent 42-month sentences on each of the four counts.

The question on appeal was whether the district court erred in using the United States Sentencing Guideline ("U.S.S.G.") § 2B5.1 (pre-2009), instead of U.S.S.G. § 2B1.1, available here, to calculate Welchs offense level. Generally, courts use the Guidelines in effect at the time of sentencing, which in this case (August 2010) would be the 2009 version of the Guidelines Manual. 

However, the Guideline language before November 1, 2009 raised a problem. Application Note 3 to § 2B5.1 expressly excluded altered genuine notes, which was what Welch used in his counterfeiting scheme, from the purview of § 2B5.1. The application note provided in pertinent part as follows:

3. Inapplicability to Genuine but Fraudulently Altered Instruments. “Counterfeit,” as used in this section, means an instrument that purports to be genuine but is not, because it has been falsely made or manufactured in its entirety. Offenses involving genuine instruments that have been altered are covered under § 2B1.1 (Theft, Property Destruction, and Fraud). 

In response to the confusion as to whether § 2B1.1 or § 2B5.1 applied to altered genuine currency, the Sentencing Commission issued Amendment 731, which amended § 2B5.1 to expressly include alterations of currency by bleaching within its purview.  Amendment 731, which became effective on November 1, 2009, provides in pertinent part: 

Section 2B5.1(b)(2)(B) is amended by inserting “(ii) genuine United States currency paper from which the ink or other distinctive counterfeit deterrent has been completely or partially removed;” after “papers”; and by striking “or (ii)” and inserting “Or (iii)”.

Based on these inconsistent guideline provisions, Welch argued at sentencing that because he “altered” federal reserve notes and did not “manufacture” them in their entirety, § 2B1.1 should apply under the plain language of Application Note 3 to § 2B5.1, as it existed at the time he committed the offense.  Welch further argued that using the 2009 version of § 2B5.1, which took effect between the time of his offense conduct and his sentencing, violates the Ex Post Facto Clause of the United States Constitution, available

here, because it was not in effect at the time of his offense and it subjectedhim to a significantly higher penalty.

Relying on Miller v. Florida, 482 U.S. 423 (1987) available here, the Sixth Circuit agreed. In Miller, the Supreme Court unanimously concluded that a revision in Floridas sentencing guidelines that went into effect between the date of the defendants offense and the date of his conviction violated the Ex Post Facto Clause of the U.S. Constitution. The Courts conclusion that the new guideline was more onerous than the prior law rested entirely on an objective appraisal of the impact of the change on the length of the defendants presumptive sentence. 482 U.S. at 431 (“Looking only at the change in primary offense points, the revised guidelines law clearly disadvantages petitioner and similarly situated defendants.”).

In this case, because the difference between the sentence (as a result of the change in the Guidelines) was 37-46 months versus 21-27 months, the Sixth Circuit concluded that the Ex Post Facto Clause had been violated, vacated the sentence and remanded for resentencing.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in both Federal and State Courts at the trial and appellate levels handling a variety of white-collar criminal cases. You can reach at attorney to discuss your case by calling us at 305.350.5690 or by emailing us at:  contact@fidjlaw.com.

Federal Circuit Invalidates Section 263A Regulation Under the Chevron Test

On May 31, 2012, the U.S. Court of Appeals for the Federal Circuit concluded that the associated property rule in Treas. Reg. § 1.263A-11(e)(1)(ii)(B) as applied to property temporarily withdrawn from service was not a reasonable interpretation of 26 U.S.C. Section 263A (“Section 263A”).  The Federal Circuit also found that the Treasury Department failed to provide a reasoned explanation when it promulgated that regulation.  Dominion Resources, Inc. v. United States, 97 Fed. Cl. 239 (Fed. Cir. 2012) is available here.  The Treasury Regulation at issue is available here while Section 263A is available here.

The factual background is incorporated in the opinion.  Dominion Resources is in the business of providing electric power and natural gas to individuals and businesses.  In 1996, it replaced coal burners in two of its plants.  While making those improvements, it temporarily removed the units from service “ one unit for two months and the other for three months.  During this period, Dominion incurred interest on debt unrelated to these improvements.  Dominion deducted some of this interest from its taxable income.  The IRS disagreed with the deduction computation under Treas. Reg. § 1.263A-11(e)(1)(ii)(B) and applied the regulation to capitalize $3.3 million of that interest instead of deducting it.  This distinction is notable because a deduction occurs immediately in the tax year, while capitalization occurs over later years.  In a settlement between the IRS and Dominion, the IRS allowed Dominion to deduct 50% and capitalize 50% of the disputed amount.  Dominion nonetheless disputed the amounts and sought to invalidate Treas. Reg. § 1.263A-11(e)(1)(ii)(B) in court.

Section 263A is comprised of five subsections, which the court described as “circular” because each rule referred to another rule in a progression such that the reader ends at the beginning.  Nevertheless, as a general rule, Section 263A requires capitalization of certain costs incurred in improving real property, instead of deduction.   Subsection (f) provides the general rule that interest is a cost requiring capitalization when the cost is allocable to the property.  Furthermore, the section states that “[s]ubsection (a) shall only apply to interest costs which are (A) paid or incurred during the production period, and (B) allocable to property which is described in subsection (b)(1)”  For determining what interests costs are allocable, subsections (f)(1) and (f)(2) provide that interest is allocable “to the extent that the taxpayers interest costs could have been reduced if production expenditures had not incurred.”  In determining the amount of interest required to be capitalized under Section 263A(f)(2), interest on any other indebtedness is assigned to such property that the taxpayers interest costs could have been reduced if production expenditures had not been incurred.  This subsection is generally considered the “avoided-cost principle.”

The regulation at issue defined what constituted production expenditures and determined the amount of interest capitalized. Under Treas. Reg. § 1.263A-11(e)(1), production expenditures subject to capitalization include not only the amount of allocable portion of the cost of land but also the adjusted basis of the entire unit being improved that is temporarily withdrawn from service, known as associated property.  Thus, by including the adjusted basis amount, the regulation increased the amount of interest to be capitalized.

The issue on appeal from the decision of the U.S. Court of Federal Claims, available here here, was whether the inclusion of the adjusted basis of the unit violates various statutory provisions.  Because Treas. Reg. § 1.263A-11(e)(1)(ii)(B) required a larger base amount, it resulted in a larger amount of interest to be capitalized.  The challenge to the regulation was only as applied to property that was temporarily withdrawn from service and not as applied to property that was not placed in service. 

The court analyzed the validity of Treas. Reg. § 1.263A-11(e)(1)(ii)(B) under what is commonly referred to as the “two-step test” set forth in Chevron, USA v. NRDC, 467 U.S. 837 (1984), available here.  Step one is whether Congress has directly spoken to the precise question at issue.  If the statute is silent or ambiguous, the second step resolves the question of whether the agencys answer is based on a permissible construction of that statute. 

In the present case, the regulation did not contradict the text of the statute but only because the statute is opaque, or as previously explained, circular.  Therefore, the Federal Circuit determined that the statute was ambiguous and was forced to turn to the second step of the Chevron test.

Under step two, the Court concluded that the regulation directly contradicted the “avoided-cost rule” which implemented Congresss concern with the avoided cost principle.  This rule recognizes that if the improvement had not been made, those funds could have been used to pay down the debt and therefore reduce interest that accrued on the debt.  In the instant case, the improvement was made and that amount was not used to pay down the debt and interest consequently accrued on that amount. 

Moreover, the adjusted basis did not represent an avoided amount because a property owner does not expend funds in an amount equal to the adjusted basis when making the improvement.  Instead, a property owner expends funds in an amount equal to the cost of the improvement itself.  Additionally, the statute uses the term “expenditures,” the plain meaning of which is an amount actually expended or spent on the improvement.  The Court explained that a property owner would not expend or incur an amount equal to the adjusted basis when making the improvement, and as a result, the regulation unreasonably linked the interest capitalized when making an improvement to the adjusted basis. It reasoned that the only way an amount equal to the adjusted basis could potentially satisfy the avoided-cost rule was by assuming that the property owner did not expend funds in an amount equal to the adjusted basis when making the improvement.  Even so, the Court stated that there was no reasonable explanation that assumed that a property owner would have sold the same unit that it removed from service for the sole purpose of improving.  Accordingly, the federal regulation unreasonably linked the interest capitalized when making an improvement to the adjusted basis.  Therefore, the associated property rule in Treas. Reg. § 1.263A-11(e)(1)(ii)(B) as applied to property temporarily withdrawn from service was not a reasonable interpretation of Section 263A(f)(2)(A)(ii) and was deemed to be invalid.

The Court further held that the associated property rule in Treas. Reg. § 1.263A-11(e)(1)(ii)(B) violated the State Farm requirement that the Treasury provide reasoned explanations for adopting regulations.  State Farm requires the Treasury to articulate a satisfactory explanation for its action, including a rational connection between the facts found and the choice made.  See Motor Vehicles Mfrs. Assn of the U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).  The Court stated that the IRS failed to provide guidance that mentioned adjusted basis as part of the interest-capitalization method.  There was no rationale other than the general statement that the regulations were intended to implement the avoided-cost method. 

In conclusion, the IRS failed to provide any explanation for the way that the use of an adjusted basis implemented the avoided-cost rule and it did not satisfy the rule.  The Treasury did alert the interested public how the basis of the property being improved would be treated, but the explanation was not sufficient to satisfy the State Farm requirement that the regulation articulate a satisfactory or cogent explanation.

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

Federal Appeals Court Affirms Collateral Consequences of Park Doctrine

On July 27, 2012, the United States Court of Appeals for the D.C. Circuit in Freidman v. Sebelius upheld the U.S. Department of Health and Human Services (“HHS“) determination to exclude three former Purdue Pharma executives from participating in federal healthcare programs after they pled guilty to misdemeanor misbranding violations under the Federal Food, Drug, and Cosmetic Act (“FDCA”) based on the Park Doctrine. The Freidman case is an example of the potential collateral consequences of Park Doctrine prosecutions.

The Park Doctrine, also known as the “Responsible Corporate Officer Doctrine” (“RCO”), allows corporate officials to be convicted of misdemeanors based entirely on his or her position and responsibility in a corporation. Notably, the Governments burden to support a misdemeanor conviction under Park is relatively low. The Government must only show that the violation occurred and that the alleged person to be the responsible corporate official occupied a position of responsibility where the official could have prevented or corrected the violation. There is no requirement that a person had any criminal intent or acted personally in any wrongdoing, or for that matter, was even aware of a violation. We have previously blogged about the recent use of the Park Doctrine by the U.S. Food and Drug Administration (“FDA“), here and here.

Background

As we previously reported, in 2007, Purdue Pharma L.P. and Purdue Frederick Company, Inc. (hereinafter “Purdue”) pled guilty to one felony count of misbranding in violation of 21 U.S.C. § 331(a) for knowingly and intentionally marketing OxyContin, a schedule II controlled substance, as less addictive, and less subject to abuse and diversion, and less likely to cause tolerance and withdrawal than other pain medications. Additionally, three Purdue executives pled guilty to one count of misdemeanor misbranding in violation of 21 U.S.C. § 331(a) and for their admitted failure to prevent Purdues fraudulent marketing of OxyContin under the Park Doctrine. At sentencing, the three executives were sentenced to probation and disgorged millions of dollars of income.

However, soon after the executives entered their guilty pleas, HHS excluded them from any participation in federal health care programs for 12 years because their convictions were based on fraud and the unlawful manufacture of a controlled substance. As a consequence of this exclusion, the corporate officers will be unable to engage any in business which participates in federal health care programs such as Medicare and Medicaid. HHSs decision was upheld by the U.S. District Court for the District of Columbia.

Appeals Court Decision

On appeal to the United States District Court of Appeals for the D.C. Circuit, the executives argued that (1) their misdemeanor misbranding convictions did not rise to the level of "relating to fraud" as to warrant the penalty of exclusion under 42 U.S.C. § 1320a-7(b)(1), and (2) the length of their exclusions was not supported by substantial evidence and thus was arbitrary and capricious.

In its decision, available here, the Court of Appeals held that HHS has the authority to exclude individuals convicted of a misdemeanor if the conduct underlying the conviction is related to fraud, even if the individual is an executive that had no knowledge of the underlying fraudulent conduct based on the Park Doctrine. However, the Court of Appeals also found that the 12 year exclusion of the Purdue executives was arbitrary and capricious because HHS failed to justify the unprecedented length of the exclusion as required by the Administrative Procedure Act. The Appeals Court therefore remanded the case to the District Court with instructions to remand the matter on to HHS for further consideration of the length of the exclusions.

Significantly, the exclusions in Friedman, even if reduced, constitute a severe penalty for executives facing a misdemeanor prosecution under the Park Doctrine. As we previously reported, the FDA has expressly stated that it will seek to increase the amount of Park Doctrine criminal prosecutions of corporate executives whose companies commit FDCA violations.

The FDA and white collar criminal defense lawyers at Fuerst Ittleman are experienced in handling even the most complex cases where clients are facing allegations of criminal actions. Fuerst Ittleman attorneys have represented clients in a variety of FDA-related criminal investigations and prosecutions including violations of the FDCA under 21 U.S.C. §§ 331 and 333 as well as prosecutions of corporate officials under the Park Doctrine. For more information regarding Fuerst Ittlemans white collar criminal defense practice, contact an attorney today at contact@fidjlaw.com

IRS Win in Appellate Case Portends Bigger FBAR crackdown

On July 20, 2012, the U.S. Court of Appeals for the Fourth Circuit concluded that the district court clearly erred in finding that the Government failed to prove that J. Bryan Williams willfully violated 31 U.S.C. § 5314 by failing to report his interest in two foreign bank accounts for the tax year 2000 and reversed the district courts opinion.  United States v. J. Bryan Williams, case no. 10-2230 (4th Cir. 2012), an unpublished opinion, is available here.

The matter was before the Fourth Circuit following the Governments appeal of the decision of the U.S. District Court for the Eastern District of Virginia, available here, which had ruled that the IRS lacked evidence to prove Williams willful violation of the FBAR filing requirement.

The background and facts are incorporated in the opinion.  Pursuant to § 5314, taxpayers are required to report annually to the Internal Revenue Service (IRS) any financial interests the taxpayer has in any bank, securities, or other financial accounts in a foreign country.  The report is made by filing and completing form TD F 90-22.1, otherwise known as “FBAR.”  Section 5314 is available here. The FBAR must be filed on or before June 30th of each calendar year and the Secretary of Treasury may impose civil money penalties on any person who fails to timely file the report.  Under 31 U.S.C. § 5321, the Secretary may impose a maximum penalty of up to $100,000 or 50% of the balance in the account at the time of such violation if the taxpayer “willfully” fails to file the FBAR, which was the issue in the Williams case. 

The controversy began in 1993 when Williams opened two Swiss bank accounts in the name of ALQI Holdings, Ltd.  From 1993 through 2000, Williams deposited more than $7,000,000 into the ALQI accounts, earning more than $800,000 in income on the deposits.  Williams, in violation of § 5314, did not report to the IRS the income from the ALQI accounts or his interest in the accounts.  By late 2000, the Swiss and U.S. authorities became aware of the assets in the ALQI accounts, and froze the accounts after meeting Williams and his attorneys.

In January 2001, Williams completed a tax organizer, which had been provided to him by his accountant in connection with the preparation of his 2000 tax return.  The tax organizer included a question regarding whether Williams had “an interest in or a signature or other authority over a bank account, or other financial account in a foreign country.”  Williams answered “No.”  Williams 2000 Form 1040, line 7(a), asked the identical question and included instructions for exceptions and filing requirements for the FBAR.  Williams once again checked “No” and did not file an FBAR by the June 30, 2001 deadline. 

In January 2002, upon the advice of his attorneys and accountants, Williams fully disclosed the ALQI accounts to an IRS agent.  In October 2002, he filed his 2001 tax return that acknowledged his interest in the ALQI accounts. In 2003, Williams amended his 1999 and 2000 tax returns, which disclosed details about his ALQI accounts.

In June 2003, Williams pled guilty to conspiracy to defraud the IRS, in violation of 18 U.S.C. § 371, and criminal tax evasion, in violation of 26 U.S.C. § 7201, available here, for his connection with the ALQI accounts from 1993 to 2000.  Williams submitted an allocution, however, and received a three-level reduction under the Sentencing Guidelines for the acceptance of responsibility. In his allocution, Williams admitted to: (1) choosing not to report the income from the ALQI accounts until he filed his 2001 tax return; (2) knowing that he had an obligation to report to the IRS and/or the Department of Treasury the existence of the Swiss accounts but chose to hide his true income and evade taxes; and (3) knowing that what he was doing was wrong and unlawful and therefore admitting guilt of evading the payment of taxes for the tax years 1993 through 2000. 

In January 2007, Williams finally filed FBARs for each tax year from 1993 through 2000.  The IRS assessed two $100,000 civil penalties against him pursuant to § 5321(5), available here, for his failure to file an FBAR for the tax year 2000.  The IRS only assessed penalties for the tax year 2000 because the statute of limitations for assessing penalties for the other tax years had expired.  Williams subsequently failed to pay these penalties and the Government brought this enforcement action to collect them. 

All parties agree that Williams violated § 5314 by failing to timely file an FBAR for tax year 2000.  Thus, the only question is whether the violation was willful.  In holding that Williams violation was not willful, the district court explained that (1) Williams lacked any motivation to willfully conceal the accounts because the authorities were already aware of such accounts and (2) his failure to disclose the accounts “was not an act undertaken intentionally or in deliberate disregard for the law, but instead constituted an understandable omission given the context in which it occurred.”

In analyzing whether Williams conduct was willful, the opinion explains that willfulness “may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information,” and it “can be inferred from a conscious effort to avoid learning about reporting requirements.”  United States v. Sturman, 951 F.2d 1466, 1476 (6th Cir. 1991).  Likewise, “willful blindness” may be inferred where “a defendant was subjectively aware of high probability of the existence of a tax liability, and purposefully avoided learning the fats point to such liability.”  United States v. Poole, 640 F.3d 114, 122 (4th Cir. 2011).  Importantly, in cases “where willfulness is a statutory condition of civil liability, [courts] have generally taken it to cover not only knowing violations of a standard but reckless ones as well.”  Safeco Ins. Co. of America v. Burr, 551 U.S. 47, 57 (2007).  Whether a person failed to comply with a tax reporting requirement is a question of fact.  Rycoff v. U.S., 40 F.3d 305, 307 (9th Cir. 1994); accord U.S. v. Gormley, 201 f.3d 290, 294 (4th Cir. 2000). 

The Courts review of the district courts decision is narrow under the clearly erroneous standard set forth in Federal Rule of Civil Procedure 52(a).  If the district courts account of the evidence is plausible, the court of appeals may not reverse even though convinced that had it been sitting as the trier of fact, it would have weighed the evidence differently.  However, the district courts findings are not conclusive if they are plainly wrong and the appellate court is allowed to engage in meaningful appellate review.  The dissenting opinion points out that there was evidence to support the district courts ruling, and therefore the circuit court should not reverse. 

Nonetheless, the majority opinion did in fact believe, with a definite and firm conviction, that the district court clearly erred in finding that Williams did not willfully violate § 5314.  In support thereof, the Court explained that Williams signed his 2000 tax return, thereby declaring under penalty of perjury that he had examined this return and accompanying schedules and statements and that, to the best of his knowledge, the return was true, accurate, and complete.  His signature was prima facie evidence that he knew the contents of his return and at minimum, line 7(a)s directions for the FBAR requirements put Williams on inquiry notice of the FBAR requirement. 

As the Fourth Circuit wrote, nothing in the record indicated that Williams ever consulted the FBAR or its instructions. Williams testified that he did not read line 7(a) or paid attention to any of the written words on his tax return.  According to Sturman, Williams made a conscious effort to avoid learning about reporting requirements.  Thus, according to the Fourth Circuit, Williamss false answers on both the tax organizer and his tax return further indicated conduct that was meant to conceal or mislead sources of income or other financial information.  Struman, 951 F.2d at 1476.  This conduct also constituted willful blindness to the FBAR requirement.  Poole, 640 F.3d at 122.

Moreover, the Fourth Circuit held that Williamss guilty plea allocation confirmed that his violation of § 5314 was willful.  Williams acknowledged that he willfully failed to report the existence of the ALQI accounts to the IRS or Department of the Treasury as part of his larger scheme of tax evasion.  Thus, the Court held that that acknowledgement was itself an admission of violation § 5314, because a taxpayer complies with § 5314 by filing an FBAR with the Department of Treasury.  Accordingly, Williams could not claim that he was unaware of, inadvertently ignored, or otherwise lacked motivation to disregard the FBAR reporting requirement.

In conclusion, the Fourth Circuits majority was convinced that, at a minimum, Williamss actions established reckless conduct, which satisfied the proof requirement under § 5314.  Safeco Ins., 551 U.S. at 57.  Thus, the Court ruled that the district court clearly erred in finding that willfulness had not been established. 

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.