3rd Circ. Undoes Wilmington Trust Fraud Convictions

The Third Circuit Court of Appeals reversed the convictions for four former Wilmington Trust Corp. executives Tuesday, ruling that prosecutors hadn't proven that the bank's failure to report loans with extensions as "past due" during the 2007-08 financial crisis violated the only reasonable interpretation of federal regulations.

The three-judge panel said that when a regulation is ambiguous, the government has the burden of proving a defendant knowingly made false statements either under the only reasonable interpretation of that regulation or under all possible reasonable interpretations.

As a result, the panel said the government hadn't proven its case against former Wilmington President Robert V.A. Harra or three other former bank leaders, and the case was remanded to the Delaware District Court for a retrial on two other charges.

"An ambiguous reporting requirement is not necessarily fatal to a false statement conviction. But to prove a statement in response to that requirement false, the government must prove either (a) that its interpretation is the only objectively reasonable interpretation and that, under this interpretation, the defendant's statement was false, or (b) that the defendant's statement was false under each alternative, objectively reasonable interpretation," wrote Circuit Judge Cheryl Ann Krause for the panel.

"Put another way," she wrote, "if the Government cannot prove beyond a reasonable doubt that a defendant's statement was false under each objectively reasonable interpretation of an ambiguous reporting requirement, it cannot prove the element of falsity."

The court reversed the false statements convictions for Harra, David Gibson, William B. North and Kevyn Rakowski and remanded the case for retrial on charges of conspiracy and fraud. The men had been convicted by a federal court and sentenced to three to six years in prison in 2018 in one of the government's first prosecutions related to the alleged misuse of federal bailout funds related to the Great Recession.

At issue was the bank's alleged practice of generously granting extensions to loans that were current on interest payments but approaching their "maturity" date.

While U.S. Securities and Exchange Commission regulations required banks to report what they were owed for "past due" loans, Wilmington allegedly failed to include any of the extended loans, misrepresenting its financial health as a wave of loans would have come due in 2009 were it not for the bank pushing back their deadlines en masse.

But the defendants argued before the panel in June that the federal government's definition of "past due" was unclear, and the panel agreed. And where a requirement was unclear, the government was bound by the due-process principles of fair warning and proving every element of an offense to show that the defendants understood their interpretation of the rules to be wrong and followed their own way, the panel said.

"The Government must show not merely that a defendant subjectively intended to lie, but also that the statement in question was objectively false," Judge Krause wrote. "Where falsity turns on how an agency has communicated its reporting requirements to the entities it regulates and those communications are ambiguous, fair warning demands that the Government prove a defendant's statement false under each objectively reasonable interpretation of the relevant requirements."

She noted that if a regulator failed to give "fair warning," it could still succeed in a false-statement prosecution if it proves its interpretation of the regulation is the only reasonable one, or if the defendant's statement were false under any reasonable interpretation.

In cases like this, the panel said it could be up to a judge to determine whether a regulation is unclear, but it should be up to the jury to find whether the defendant's interpretation was also reasonable.

Because the government's case for the fraud and conspiracy charges relied so heavily on the government's interpretation of what was "past due," and the district court judge's jury instructions had also leaned into that definition, the Third Circuit also undid those convictions. But there was enough evidence that the mass extension of $338 million worth of loans may have been an intentional effort to conceal the bank's true circumstances to warrant a new trial under a separate theory not tied to the ambiguous regulations, Judge Krause wrote.

"While the evidence limited to mass extensions is indeed thin, we cannot say, viewing the record in the light most favorable to the government, that no rational jury could have found the essential elements of conspiracy to commit securities fraud and securities fraud beyond a reasonable doubt," she wrote. "Considering the totality of this evidence, a rational juror could conclude that defendants had knowingly caused maturing loans to be extended in order to push them off the books for 2009 and conceal the poor financial health of the bank from investors, and that they had knowingly joined an agreement to do so."

The revelations about the bank's bad debt load led to Wilmington's near collapse and deeply discounted sale in 2011 to M&T Bank Corp., with stockholders suffering steep losses, according to prosecutors.

Harra and Gibson had been sentenced to six years in prison and $300,000 fines. North was sentenced to four and a half years in prison and a $100,000 fine, while Rakowski received a three-year term, with the fine waived.

Wilmington agreed to pay a $44 million civil penalty to the U.S. Department of Justice and a $16 million SEC fine.

"The federal banking regulator overseeing Wilmington Trust admitted at trial that the bank notified the Fed Reserve several times, in writing, how the bank was reporting these loans. The Bank's auditor, KPMG, also admitted the same during trial. So, how could there be any 'Fraud' committed with respect to reporting?" said Michael Kelly of McCarter & English LLP, representing Harra. "In my view, this case was an incredible waste of taxpayer dollars that literally ruined the lives of four innocent people. Rob and his family have endured nothing less than a nightmare for almost 10 years now."

Gibson's attorney likewise hailed the decision as the right one.

"We are pleased that all counts of conviction have been overturned on this issue of first impression and that our client has been exonerated on the prosecution's main case," said Kenneth Breen of Paul Hastings LLP.

George Hicks of Kirkland & Ellis LLP, representing North, said he hoped the case would now be dropped rather than retried.

"We are gratified with the Third Circuit's decision, which correctly recognized the fatal flaws in the government's case against Mr. North," he told Law360. "The unanimous opinion demonstrates that this prosecution should never have been brought in the first place and should no longer proceed."

Counsel for Rakowski called the ruling a "vindication."

"After eight years of investigation, trial and appeal, Kevyn Rakowski is no doubt gratified, but the personal toll on her has been incalculable," said Henry Klingeman of Klingeman Cerimele Attorneys. "At Wilmington Trust, she came to work each day, conscientiously, to do her job during the worst economic crisis since the Depression. She committed no crime, and it was never the defendants' fault that the bank struggled."

Representatives of the U.S. Attorney's Office did not immediately respond to requests for comment Tuesday.

Judges Morton I. Greenberg, Cheryl Ann Krause and Peter J. Phipps sat on the panel for the Third Circuit.

The government is represented by Robert F. Kravetz, Lesley F. Wolf and Jamie M. McCall of the U.S. Attorney's Office for the District of Delaware.

Harra is represented by Michael P. Kelly, Dawn Kurtz Crompton, Geoffrey N. Rosamond and Steven P. Wood of McCarter & English LLP; Andrew M. Lawler and Sharon Feldman of Andrew M. Lawler PC; and Lawrence S. Lustberg, Avram D. Frey and Megan M. Admire of Gibbons PC.

Gibson is represented by Kenneth M. Breen, John P. Nowak, Phara Guberman and Stephen Kinnaird of Paul Hastings LLP.

North is represented by David E. Wilks, R. Stokes Nolte and Andrea S. Brooks of Wilks Lukoff & Bracegirdle LLC; Thomas A. Foley of Thomas A. Foley Attorney at Law; and George W. Hicks Jr. of Kirkland & Ellis LLP.

Rakowski is represented by Henry E. Klingeman of Klingeman Ceremele Attorneys and Bartholomew J. Dalton, Ipek K. Medford and Andrew C. Dalton of Dalton & Associates PA.

The cases are U.S. v. Gibson, case number 19-1136; U.S. v. Harra, case number 19-1105; U.S. v. North, case number 19-1190; and U.S. v. Rakowski, case number 19-1237, in the U.S. Court of Appeals for the Third Circuit.