U.S. v. Rosby, 05-2270.

• Decision Date: 19 July 2006
• Docket Number: No. 05-2483.,No. 05-2270.,05-2270.,05-2483.
• Citation: 454 F.3d 670
• Parties: UNITED STATES of America, Plaintiff-Appellee, v. Thomas J. ROSBY and John M. Franklin, Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

454 F.3d 670

UNITED STATES of America, Plaintiff-Appellee, v. Thomas J. ROSBY and John M. Franklin, Defendants-Appellants.

No. 05-2270.

No. 05-2483.

United States Court of Appeals, Seventh Circuit.

Argued June 2, 2006.

Decided July 19, 2006.

COPYRIGHT MATERIAL OMITTED

David E. Hollar (argued), Office of U.S. Attorney, Hammond, IN, for Plaintiff-Appellee.

James A. Shapiro (argued), Shapiro & Schwartz, Chicago, IL, Joseph P. Franklin (argued), Winston & Strawn, Chicago, IL, for Defendants-Appellants.

Before POSNER, EASTERBROOK, and ROVNER, Circuit Judges.

EASTERBROOK, Circuit Judge.

Monon Corporation once was among the largest manufacturers of over-the-road semi-trailers, containers, and container chassis, producing about 150 units a day. Early in 1996, however, Monon's principal customer cut back on orders and the lost business could not be replaced. Production fell to about 100 units a day in January 1996, dropping to 60 in April and 50 in August. This decline in sales produced a liquidity crisis, as the firm's fixed obligations and payroll could not be cut as fast as the order book shriveled. Thomas Rosby, Monon's CEO and holder of 72% of its equity, and John Franklin, its CFO and holder of 14%, watched the finances closely.

Much of Monon's working capital came from Congress Financial Corporation, a factor that advanced credit on the security of Monon's inventory and receivables. Monon could draw on the credit as soon as it started production of each new unit. During 1996 Monon began a bill-ahead fraud. It would, for example, report starting 60 units on a day when only 50 actually entered production. As sales continued to decrease, however, Monon had to report more and more early starts, so that it could retire older advances. Congress was left unsecured for the difference between actual and reported production. The unsecured draw against the revolving credit increased from about $2 million in March 1996 to $5.9 million in August, when Congress discovered the fraud. After Monon filed for bankruptcy on September 1996, Congress completed many of the falsely reported units at its own expense and risk. Its net loss was about $1.8 million.

Monon also borrowed from A.I. Credit Corporation and Anthem Premium Finance. These firms made loans that Monon was supposed to use to prepay insurance policies; Monon agreed to retire the loans with monthly payments roughly equal to the cost of insurance for that month, and the balance was secured by the policies' cash value. (For simplicity we refer to all of this as "insurance" even though some workers' compensation coverage was arranged through other devices.) If, for example, Monon secured workers' compensation coverage for $5 million a year, the premium finance company would advance that money; the unearned portion of the premium (that is, the premium attributable to future months) would be returned if Monon should cancel the policy and thus could be used as security for the loans. During 1996 Monon reported making larger prepayments than it actually had done. This left A.I. Credit and Anthem unsecured for the difference, and after Monon's bankruptcy Anthem was saddled with net losses of about $4.9 million and A.I. Credit about $2 million.

A grand jury charged Rosby and Franklin with mail and wire fraud for making (or causing to be made) the misrepresentations that persuaded the lenders to advance funds without the promised security. Michael Peterson, Monon's insurance broker, was indicted at the same time and pleaded guilty; he testified for the prosecution. Following the jury's guilty verdict, both Rosby and Franklin were sentenced to 87 months in prison plus restitution of about $8.7 million (the sum of the three lenders' net losses).

Defendants' principal arguments in this court collapse to a single contention: that the false representations were not material because, by making prudent inquiries, the lenders could have figured out what Monon was doing. (To the extent defendants maintain that they did not know what the lenders were being told, the jury's contrary conclusion is unimpeachable.) They do not contend that the jury was bound to find that the lenders actually under-stood the truth, and they did not ask for an instruction presenting the knowledge question to the jury, but they do say that even taken in the light most favorable to the prosecution the evidence compels a conclusion that cautious lenders ought to have done more, or better, checking, and that these inquiries would have turned up the truth.

This line of argument starts with Neder v. United States, 527 U.S. 1, 20-25, 119 S.Ct. 1827, 144 L.Ed.2d 35 (1999), which held that materiality is an element of the mail-fraud offense under 18 U.S.C. § 1341. The Court observed that "fraud" is a staple term of the common law and should be read to include its common-law constituents, including materiality, unless Congress provides otherwise (which it did not in § 1341). See also, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (securities fraud entails proof of scienter, because this is required at common law); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976) (discussing the materiality requirement); Dirks v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983) (drawing on common law to conclude that securities fraud entails proof of duty to disclose). Having established that materiality is essential, defendants maintain that at common law a party cannot close his eyes to a known risk or act with indifference to that risk but must make reasonable attempts at self-protection. (For this proposition defendants cite only cases in the Illinois state courts; the significance of that choice will become clear later.) According to defendants, some of the lenders' employees had their suspicions yet failed to follow up. This means, defendants insist, that the representations were not material.

Defendants recognize that under other federal statutes a representation may be material even though the hearer strongly suspects that it is false. A witness commits the crime of perjury, for example, if he lies under oath about a subject important to the proceeding, even though the grand jury believes that it knows the truth. United States v. Kross, 14 F.3d 751, 755 (2d Cir.1994); United States v. Goguen, 723 F.2d 1012, 1019 (1st Cir.1983); United States v. Richardson, 596 F.2d 157, 165 (6th Cir.1979). See also, e.g., United States v. R. Enterprises, Inc., 498 U.S. 292, 111 S.Ct. 722, 112 L.Ed.2d 795 (1991) (that grand jury already thinks it knows the truth is no defense to a subpoena, for evidence may be material if it can corroborate or refute existing beliefs); Kungys v. United States, 485 U.S. 759, 776-80, 108 S.Ct. 1537, 99 L.Ed.2d 839 (1988) (false statement to immigration officials violates 8 U.S.C. § 1451(a) even if agency readily could have discovered the truth); United States v. Whitaker, 848 F.2d 914, 916 (8th Cir.1988) (material false statement to investigating agency violates 18 U.S.C. § 1001 even if agency knows the truth). A representation is material if it has a tendency to influence the decision of the audience to which it is addressed. See Neder, 527 U.S. at 22-23, 119 S.Ct. 1827, citing Restatement (2d) of Torts § 538 (1977); Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). By referring to the common law, however, Neder departed from the approach of perjury and other false-statement statutes by imposing on the audience a duty to investigate for its self-protection — or so defendants maintain.

This confuses materiality with reliance. At common law, both materiality (in the sense of tendency to influence) and reliance (in the sense of actual influence) are essential in private civil suits for damages. That's why, if the issuer of securities furnishes an investor with the truth in writing, the investor cannot claim to have been defrauded by an oral misrepresentation: whether the writing actually conveys the truth or just calls the oral statement into question, the investor is on notice. See, e.g., Acme Propane, Inc. v. Tenexco, Inc., 844 F.2d 1317 (7th Cir.1988). It is also why an investor's disclaimer of reliance on certain representations, as part of a declaration that the investor has done and is relying on his own investigation, defeats a private damages action for securities fraud. See, e.g., Rissman v. Rissman, 213 F.3d 381 (7th Cir.2000); Jackvony v. RIHT Financial Corp., 873 F.2d 411, 415-17 (1st Cir.1989) (Breyer, J.); One-O-One Enterprises, Inc. v. Caruso, 848 F.2d 1283, 1286-87 (D.C.Cir.1988) (R.B. Ginsburg, J.).

Reliance is not, however, an ordinary element of federal criminal statutes dealing with fraud. Neder so holds for § 1341 in particular. "[T]he Government is correct that the fraud statutes did not incorporate all the elements of common-law fraud. The common-law requirements of `justifiable reliance' and `damages,' for example, plainly have no place in the federal fraud statutes." 527 U.S. at 24-25, 119 S.Ct. 1827 (emphasis in original). Once the Supreme Court excludes reliance as a separate element of the mail-fraud offense, it will not do for appellate judges to roll reliance into materiality; that would add through the back door an element barred from the front. Reliance is not an aspect of the materiality element in mail-fraud prosecutions. Accord, United States v. Fernandez, 282 F.3d 500, 508 (7th Cir. 2002); United States v. Gee, 226 F.3d 885, 891 (7th Cir.2000).

Defendants do not argue that by extending credit, despite Monon's noncompliance with some of the contracts' written terms, the lenders agreed to modify their arrangements and forego the promised security. Maybe such an argument has been withheld because those employees of the lenders who suspected (or should have suspected) what was afoot lacked authority to change the deal. Episodes modeled on...