2Cir Remands to EDNY Disparate Sentence in Boiler Room Pumping

April 17, 2023

There's crime and then there's punishment. On Wall Street, there seems to be an abundance of the former and a dearth of the latter -- then again, that's a view of society at large these days, so, who knows, maybe it's just the zeitgeist. Be that as it may, after a federal jury convicted Defendants of a number of crimes, the District Court may have gone a tad light on some prison sentences in order to facilitate the payment of restitution to the victims. The theory being that if you put someone in prison for a number of years, that's detracting from their ability to get a job and start repayment. That may be an enlightened bit of adjudication but did it come at too high a cost for deterrence? 

2020: Five-Day Jury Trial

As set forth in the Syllabus for United States of America v. Michael Watts, Defendant (Memorandum and Order, United States District Court for the Eastern District of New York, 17-CR-00372 / October 19, 2020)

After a five-day trial, a jury convicted defendant Michael Watts ("Defendant") of conspiracy to commit securities fraud in violation of 18 U.S.C. §§ 371, 3551 et seq., conspiracy to commit wire fraud in violation of 18 U.S.C. §§ 1349, 3351 et seq., securities fraud in violation of 15 U.S.C. §§ 78j(b) and 78ff, 18 U.S.C. §§ 2, 3551 et seq., conspiracy to commit money laundering in violation of 18 U.S.C. §§ 1956(h), 3551 et seq., and three counts of money laundering in violation of 18 U.S.C. §§ 1957(a), 1957(b), 2, and 3551 et seq., arising out of is participation in a stock manipulation scheme. Currently before the Court is Defendant's motion for a new trial pursuant to Federal Rule of Criminal Procedure 33. (Def. Mot., D.E. 812; Def. Br., D.E. 812-1; Gov't Opp., D.E. 822; Def. Reply, D.E. 828.) For the reasons that follow, Defendant's motion is DENIED.

HECC with that

For those readers who are industry/regulatory lawyers or active market participants, I urge you to read this beautifully crafted Memorandum/Order by EDNY District Judge Joanna Seybert. About as professional a bit of judicial drafting as you will come across. Offered for our reading pleasure is the tale of Hydrocarb Energy Corporation ("HECC"):

HECC was a publicly traded "petroleum exploration and production" company that owned "21,000 square kilometers that borders Angola," Libya. (Superseding Indictment ¶ 5; Tr. 736.) Defendant's brother, who testified in his defense at trial, formed HECC around September 2009. (Tr. 734.) Galveston Bay Energy ("Galveston Bay") was a subsidiary of HECC and operated 18,000 acres of oil producing fields in Texas. (Tr. 735.) Defendant invested $15 million in HECC and served as a consultant who sought financing from investors or public and investor relations firms. (Tr. 769; 771-72.) Gleckman also invested in HECC and was a large shareholder. (Tr. 436:14-21.) By the end of 2014, oil prices started to decline and affected the oil and gas industry, including Galveston Bay's cash flow. (Tr. 409:22-410:15; 740-42; 752-53.) To raise capital at this time, HECC entered into a consulting agreement with Defendant, dated June 27, 2015, "to create awareness and hire investor relation firms and public relation firms." (Tr. 755; 760; DX E.) On April 13, 2016, HECC filed for bankruptcy. (GX 94.)

at Page 5 of the EDNY Memo 

The Old Boiler Room Pump

Ah yes, the old bankrupt oil company and the equally familiar investor who took a bath in said worthless company. As Judge Seybert offers her narrative [Ed; footnotes omitted]:

Around the end of July 2014, Isen introduced Defendant and Matz via conference call.3 (Tr. 72:24-73:12; 78:5-16; 778.) Matz testified that Defendant inquired as to how the Boiler Room operated and Matz provided examples of two companies he "previously promoted" and explained that he "increased volume, [ ] increased share price, and [ ] g[ave] support when it was needed." (Tr. 80:17-20; 86:6-14.) Matz expressed interest in promoting HECC but required "cash and possibly stock in the company" and that any agreement with the Boiler Room would reflect Keith Miller's signature because Matz was "kicked out of the stock industry." (Tr. 86:23-87:9.) Matz further explained to Defendant that the Boiler Room "supports" the stocks it promotes (Tr. 87:25-88:5), meaning that if a stock price dropped, the Boiler Room would buy the stock "back up, [and] bring it back to exactly where the price was, if exactly not where it was, as close as where we can get it so it looked like it never happened and then later on, we would cross those shares out to an investor" (Tr. 88:12-17, 89:14-24.) By "crossing shares with an investor," Matz elaborated that as a stock price dropped, the Boiler Room used trading accounts to "buy the stock back up" while it aggressively pushed the stock to investors to purchase. (Tr. 89:11-24.) As unknowing investors purchased the stock, the Boiler Room sold, or "cross[ed] out," the recently purchased stock. (Tr. 89:11-24.) 

C. Consulting Agreements between Defendant and the Boiler Room 

After the initial call, the Boiler Room entered into a consulting agreement, by Keith Miller, with Geoserve Marketing LLP,5 by Defendant, effective August 1, 2014. (GX 101A at 2.) The consulting agreement required that Geoserve issue the Boiler Room 75,000 restricted HECC shares and pay $25,000 a month in six biweekly installments of $12,500. (Tr. 156:7-21; GX 101A.) The Boiler Room and Defendant entered into three similar consulting agreements: (1) effective November 1, 2014, for 50,000 restricted HECC shares and $25,000 a month to be paid in bi-weekly installments of $12,500 (GX 161A); (2) effective February 1, 2015, for 125,000 restricted HECC shares (GX 155A); and (3) effective July 17, 2015 for 400,000 restricted HECC shares (GX 144A). Although the consulting agreements state that the Boiler Room was an "independent consultant and has knowledge and experience to provide marketing as the Client believes can assist it in furthering execution of its public awareness" (see, e.g., GX 101A at 1), Matz testified that the Boiler Room did not actually perform any of those services but was "promoting, pushing penny stocks, increasing volume, and giving support when needed" (Tr. 168:2- 172:12).6 Matz also explained that the consulting agreements were required to clear the restricted HECC shares received as compensation with a brokerage firm. (Tr. 172:13-21; 246:15-21; see GX 113; GX 113A.)

D. The HECC Stock Manipulation Scheme 

The Boiler Room pushed HECC stock to potential investors--victims--from approximately August 2014 through April 2016. (Tr. 90:12-15.) Matz described the Boiler Room's promotional activity in two phases. Initially, the Boiler Room increased HECC trade volume to keep the price "stable" and provided support where needed. (Tr. 90:16-23.) Eventually, the Boiler Room's operations "morphed into a different kind of animal" where the Boiler Room, with Defendant, Isen, among others, purchased free trading HECC shares and pushed a large volume of shares at a "fast and heavy pace." (Tr. 90:24-91:5; 91:13-92:5.) 

at Pages 6 - 8 of the EDNY Memo 

Mechanics of Getting a New Trial

Notwithstanding the above fact pattern and the Judge's well-written rationale, the convicted fraudsters still appealed. Preliminarily, consider this:  

Side Bar: Federal Rule of Criminal Procedure: Rule 33. New Trial

(a) Defendant's Motion. Upon the defendant's motion, the court may vacate any judgment and grant a new trial if the interest of justice so requires. If the case was tried without a jury, the court may take additional testimony and enter a new judgment.

(b) Time to File.

(1) Newly Discovered Evidence. Any motion for a new trial grounded on newly discovered evidence must be filed within 3 years after the verdict or finding of guilty. If an appeal is pending, the court may not grant a motion for a new trial until the appellate court remands the case.

(2) Other Grounds. Any motion for a new trial grounded on any reason other than newly discovered evidence must be filed within 14 days after the verdict or finding of guilty.

Co-Defendant/Cooperating Witness Matz argued that under FRCP 33, he was entitled to a new trial because the Government had argued in its closing an "alternative theory of guilt" that was not charged in the Superseding Indictment. The Government argued to the contrary. Judge Seybert rejected the appeal. As such, the Defendants appealed higher up the federal court chain to the United States Court of Appeals for the Second Circuit ("2Cir").

2Cir Appeal

On appeal to the 2Cir, Watts argued that:

(1) the government constructively amended his indictment, and the district court abused its discretion in denying Watts’s motion for a new trial; and (2) the district court erroneously calculated the amounts of forfeiture and restitution owed. 

On its cross-appeal, the government argued that:

the district court’s sentence of one year and one day,which represents approximately a 95% downward variance from the advisory Sentencing Guidelines range of 235 to 293 months, was substantively unreasonable.

at Page 2 of Michael Watts, Defendant/Appellant/Cross-Appellee, v. The United States of America, Appellant/Cross-Appellant (Summary Order, United States Court of Appeals for the Second Circuit ("2Cir"), 21-2925 and -3028 / April 12, 2023) ("2Cir Summary Order")

Initially, the 2Cir's Summary Order shreds through Watt's arguments on appeal finding that the government did not constructively amend the Indictment merely because the charging instrument failed to identify each and every sham document used by the conspirators. Further, 2Cir found that EDNY Judge Seybert did not abuse her discretion when denying Watts' Rule 33 motion for a new trial because the Court:

properly concluded that the jury was entitled to find, based on ample trial evidence, that Watts hired the Boiler Room first to keep afloat the share price of Hydrocarb Energy Corporation (“HECC”) – the company in which his personal fortune was invested – and then to help him unload his shares when the company’s failure became inevitable. . . .

at Pages 3 - 4 of the 2Cir Summary Order

It All Adds Up

Further, 2Cir said as to EDNY's:

calculation of the forfeiture and restitution amounts, we identify no clear error or abuse of discretion, respectively, as to either calculation. For the reasons explained by the district court at sentencing, the court properly included the trades of HECC shares by co-conspirators, as well as the value of private placements in which Watts personally sold inflated HECC shares, resulting in foreseeable losses, in these calculations. As to Watts’s argument that the district court failed to account for losses caused by the decline in the price of oil generally, we have not generally required the kind of “event study” used in the securities litigation context to disaggregate loss amounts in the restitution or forfeiture contexts. . .

at Page 4 of the 2Cir Summary Order

Substantially Unreasonable Sentence

In contrast with denying Watts' appellate motion, 2Cir agreed with the government that EDNY's imposition of a one year and a day sentence was substantially unreasonable because, in part, Watts's sentence was about 95% below the low end of the 235 to 293 months Sentencing Guidelines.

SIDE BAR: 18 U.S. Code § 3553: Imposition of a sentence

(a) Factors To Be Considered in Imposing a Sentence.—The court shall impose a sentence sufficient, but not greater than necessary, to comply with the purposes set forth in paragraph (2) of this subsection. The court, in determining the particular sentence to be imposed, shall consider—

(1) the nature and circumstances of the offense and the history and characteristics of the defendant;
(2) the need for the sentence imposed—

(A) to reflect the seriousness of the offense, to promote respect for the law, and to provide just punishment for the offense;
(B) to afford adequate deterrence to criminal conduct;
(C) to protect the public from further crimes of the defendant; and
(D) to provide the defendant with needed educational or vocational training, medical care, or other correctional treatment in the most effective manner;

(3) the kinds of sentences available;
(4) the kinds of sentence and the sentencing range established for—

(A) the applicable category of offense committed by the applicable category of defendant as set forth in the guidelines—

(i) issued by the Sentencing Commission pursuant to section 994(a)(1) of title 28, United States Code, subject to any amendments made to such guidelines by act of Congress (regardless of whether such amendments have yet to be incorporated by the Sentencing Commission into amendments issued under section 994(p) of title 28); and
(ii) that, except as provided in section 3742(g), are in effect on the date the defendant is sentenced; or

(B) in the case of a violation of probation or supervised release, the applicable guidelines or policy statements issued by the Sentencing Commission pursuant to section 994(a)(3) of title 28, United States Code, taking into account any amendments made to such guidelines or policy statements by act of Congress (regardless of whether such amendments have yet to be incorporated by the Sentencing Commission into amendments issued under section 994(p) of title 28);

(5) any pertinent policy statement—

(A) issued by the Sentencing Commission pursuant to section 994(a)(2) of title 28, United States Code, subject to any amendments made to such policy statement by act of Congress (regardless of whether such amendments have yet to be incorporated by the Sentencing Commission into amendments issued under section 994(p) of title 28); and
(B) that, except as provided in section 3742(g), is in effect on the date the defendant is sentenced.[1]

(6) the need to avoid unwarranted sentence disparities among defendants with similar records who have been found guilty of similar conduct; and
(7) the need to provide restitution to any victims of the offense.

. . .

When 2Cir fully considered the requirements set out in Section 3553, the appellate court found that EDNY had:

overemphasized restitution to the detriment of the other Section 3553(a) factors, and to such a degree that the court ended up placing more weight on this factor than it could reasonably bear. See Mumuni, 946 F.3d at 106.

The district court reasoned that, “[i]n order for the defendant to pay back his victims, he needs to work.” A477. “[A] year and a day,” the court suggested, “would be sufficient and allow the defendant an opportunity to make restitution” given “the amount of monies that he’s now earning.” A502. But undue emphasis on the need for restitution in sentencing can result in a substantively unreasonable outcome. . . .

at Page 6 of the 2Cir Summary Order

Inadequate Deterrence

In considering the sentencing factors set out in Section 3553(a), 2Cir found that EDNY did not meaningfully weigh 

the needs “to afford adequate deterrence of criminal conduct,” to reflect “the nature and circumstances of the offense,” and “to avoid unwarranted sentence disparities among defendants.”  18 U.S.C. § 3553(a). 

at Page 7 of the 2Cir Summary Order

2Cir found that EDNY had simply rejected the need to consider "general deterrence," and had "misweighed – indeed, entirely failed to meaningfully weigh – the need to “afford adequate deterrence to criminal conduct” as required by the statute. Id. at 200; 18 U.S.C. § 3553(a)(2)(b)." at Page 8 of the 2Cir Order.

Seriousness of Watts' Offense

As to EDNY's failure to adequately consider the nature and circumstances of Watt's offense, 2Cir went for the jugular:

The evidence at trial showed that Watts fully understood the Boiler Room’s sales pitches were false and fraudulent. Watts was aware that the leaders of the Boiler Room had been “kicked out of the stock industry,” Tr. 87. He had been told how the stock matching scheme worked, Tr. 88–89; had visited the Boiler Room and witnessed the high-pressure tactics it employed, including seeing telemarketing scripts and hearing phone calls relaying false information, Tr. 102–21, 138–44; and had knowingly entered into false consulting agreements to pay the Boiler Room, even employing an intermediary to compensate it with restricted 144A stock. Tr. 155–73, 274–75, 471–76. The FBI and FINRA analyzed
hundreds of calls between Watts and the Boiler Room, the timing of which strongly suggested that Watts personally coordinated matched trades. Tr. 556–64; 646–66. And tellingly, Watts agreed
to pay the Boiler Room fully half of his proceeds to line up victims – evidencing his awareness that market participants, free of the Boiler Room’s manipulative practices, would be unwilling to buy HECC shares at the inflated prices that he pursued. Tr. 301–06.

These facts are not mitigating in nature. As the company’s financial prospects faltered while the price of oil declined, Watts contacted the Boiler Room “a lot more often” as he sought “to get out [of] as much stock and make as much money . . . as quick as possible.” Tr. 299. He never told the Boiler Room or its victims when Hydrocarb stopped producing oil, failed to obtain new financing, could not meet payroll, or later expected to file for bankruptcy. Tr. 329. Certainly Watts’s motive – to protect his own investment by dumping shares at artificially inflated prices – was not of a sort to mitigate his culpability for victimizing others. The district court’s
conclusion otherwise, even equating Watts with his victims, failed to adequately reflect the seriousness of Watts’s offense. See A490 (the district court insisting that, like the “hundreds of victims who lost their life savings in this case,” so “did Mr. Watts”).

At pages 8 - 9 of the 2Cir Summary Order

Disparate Sentences

Finally, 2Cir found that EDNY had imposed unwarrantedly disparate sentences among the Defendants, who had similar records and were found guilty of similar conduct. In reaching that conclusion, 2Cir did concede that EDNY had [Ed: footnotes omitted]:

deemed Watts to be less culpable than other participants in pump-and-dump schemes because he was a corporate insider who endeavored to manipulate the penny stock he owned in order to protect and then salvage his investment in his family’s business. In its statement of reasons, the district court explained that

Defendant’s initial investment of $15,000,000.00 demonstrates Hydrocarb (HECC) was a viable company prior to the 2014 oil crisis, therefore, while the defendant is guilty of the charges for which he was convicted, his initial investment into a legitimate company mitigates in his favor for his subsequent crimes.

United States v. Chartier et al., No. 17-cr-372 (JS) (E.D.N.Y.) (“District Court Docket”), Docket No. 1057 at 3. The district court determined that the Sentencing Guidelines “overstate[ ] the harm caused by a defendant [like Watts], as compared certainly to [Erik] Matz and some of the other defendants who did not own any stock,” A478–79, suggesting that Watts was less culpable merely due to his personal investment in HECC and the fact that he, like his many victims, suffered financial loss.

This explanation for Watts’s “extraordinarily low sentence,” however, does not bear analysis. Watts was not substantially less culpable than the operators of the Boiler Room merely because his family company was a supposedly “legitimate” enterprise and because Watts, as the district court concluded, “committed these frauds and money laundering because he knew his stock would be devalued with the impending oil market collapse, which it was, and essentially he wanted to protect his and his family’s investment.” A480. Indeed, the record reveals little reason to conclude that Watts, who expressed little remorse at sentencing, was less culpable than any other person conspiring to pump-and-dump stock.  The government elicited testimony that Hydrocarb was a highly speculative enterprise from the beginning, and it was for that reason that Watts hired the Boiler Room to artificially “pump” HECC stock by cold-calling potential investors, often elderly people, who were falsely told that Hydrocarb could soon be listed on the NASDAQ or receive major institutional investment. Tr. 220–21. Though the company had some producing wells in Texas, it claimed to have vast, but undeveloped, lease rights in Africa worth billions of dollars and which would dramatically increase profitability if the oil could ever be extracted with “new drilling technology.” Tr. 104–07, 323. No wells were ever drilled. Tr. 409. The scheme caused victims to be forced out of retirement and return to work; lose their homes; suffer divorce; and attempt suicide. GA381–83. That Watts used his insider status, knowledge of commodity markets, and awareness of Hydrocarb’s financial condition to dump his shares as they collapsed in value could easily make him more culpable, not less.

at Pages 10 - 12 of the 2Cir Summary Order

In conclusion, 2Cir affirmed Watts's convictions in part and remanded with instruction for resentencing.


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