United States v. Michael Gluk

Case: 14-51012 Document: 00513355230 Page: 1 Date Filed: 01/25/2016
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 14-51012 United States Court of Appeals
Fifth Circuit
FILED
UNITED STATES OF AMERICA, January 25, 2016
Lyle W. Cayce
Plaintiff - Appellee Clerk
v.
MICHAEL GLUK; MICHAEL BAKER,
Defendants - Appellants
Appeals from the United States District Court
for the Western District of Texas
Before JOLLY and JONES, Circuit Judges, and MILLS*, District Judge.
E. GRADY JOLLY, Circuit Judge:
Michael Baker and Michael Gluk appeal their convictions for securities
fraud. Because we agree with their evidentiary challenges, we vacate their
convictions and remand for a new trial. 1
I.
Michael Baker and Michael Gluk were, respectively, the CEO and CFO
of ArthroCare, a medical device company. Under their tenure (and, allegedly,
*District Judge for the Northern District of Mississippi, sitting by designation.
1 Because we reverse based on the evidentiary challenges, we do not reach the
defendants’ other challenges to their convictions.
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with their knowledge) ArthroCare practiced “channel stuffing” with a related
entity, DiscoCare.
“Channel stuffing” is a fraudulent scheme companies sometimes
attempt, in an effort to smooth out uneven earnings—typically to meet Wall
Street earnings expectations. Specifically, a company that anticipates missing
its earnings expectations will agree to sell products to a coconspirator. The
company will book those sales as revenue for the current quarter, increasing
reported earnings. In the following quarter, the coconspirator returns the
products, decreasing the company’s reported earnings in that quarter.
Effectively, the company fraudulently “borrows” earnings from the future
quarter to meet earnings expectations in the present. Thus, in the second
quarter, the company must have enough genuine revenue to make up for the
“borrowed” earnings and to meet that quarter’s earnings expectations. If the
company does not meet expectations in the second quarter, it might “borrow”
ever-larger amounts of money from future quarters, until the amounts become
so large that they can no longer be hidden and the fraud is revealed.
ArthroCare carried out exactly this fraud, with DiscoCare playing the
role of coconspirator. Over several years, ArthroCare fraudulently “borrowed”
around $26 million from DiscoCare. This “borrowing” occurred by directing
DiscoCare to buy products from ArthroCare on credit, with the agreement that
ArthroCare would be paid only when DiscoCare could sell those products.
Although this can be a legitimate sales strategy, it was fraudulent here
because DiscoCare purchased medical devices that it knew it could not sell
reasonably soon for the sole purpose of propping up ArthroCare’s quarterly
earnings. This fraud was carried out under the day-to-day supervision of John
Raffle, the Vice President of Strategic Business Units, and of David Applegate,
another DiscoCare executive.
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DiscoCare’s business model (apart from the accounting fraud) was
potentially wrongful, though no charges were brought. DiscoCare provided a
medical device for which most insurers refused reimbursement. To sell its
device, DiscoCare reached an agreement with plaintiffs’ attorneys; this
agreement resulted in the majority of DiscoCare’s sales. Under this
agreement, DiscoCare would treat clients of the attorneys. The plaintiffs’
attorneys would then cite the expense of their clients’ treatment as a reason
for defendants to settle personal injury lawsuits. DiscoCare also allegedly
illegally coached doctors on which billing codes to use, in an effort to increase
insurance reimbursements. This practice allegedly went as far as instructing
doctors to perform an unnecessary surgical incision to classify the treatment
as a surgery. No charges were filed on any of this conduct.
ArthroCare subsequently purchased DiscoCare for $25 million, a price
that far exceeded its true value (DiscoCare had no employees at the time).
During this purchase, the fraud began to unravel, with media reports alleging
accounting improprieties. To reassure investors, Gluk and Baker made several
false statements during a series of conference calls. As evidence mounted, the
audit committee of ArthroCare’s board of directors commissioned an
independent investigation by forensic accountants and the law firm Latham &
Watkins. As a result of this investigation, the board determined that Raffle
and Applegate had committed fraud and had misled Gluk and Baker. The
board restated earnings, resulting in a significant drop in the value of
ArthroCare stock, and fired Raffle and Applegate for their roles in the fraud.
The board also fired Gluk, determining that he had been remiss in not
detecting the fraud earlier. The board did not fire Baker.
The SEC investigated ArthroCare (both informally and formally) to
determine the extent of the fraud. During this investigation, Raffle and
Applegate exercised their Fifth Amendment right against self-incrimination to
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decline to answer questions. After its investigation, the SEC sued ArthroCare,
Raffle, and Applegate for securities fraud; it did not sue Gluk or Baker. It did
file a “claw-back” complaint against Gluk and Baker; this complaint stated
that the SEC “does not allege that Baker and Gluk participated in the wrongful
conduct” but instead determined that Raffle and Applegate “intentionally
withheld” information from Gluk.
The government subsequently brought criminal charges, initially only
against Raffle and Applegate. Raffle and Applegate pled guilty and agreed to
testify against Gluk and Baker; the government then indicted Gluk and Baker
for the channel stuffing. At trial, Raffle and Applegate testified that Gluk and
Baker knew of the fraud; Gluk and Baker testified that they did not. The
district judge excluded evidence of the Latham and SEC investigations.
Conversely, the judge overruled objections from the defendants and allowed
testimony about the uncharged medical fraud that allegedly took place at
DiscoCare. The jury returned a guilty verdict. At sentencing, the court
determined that Baker must forfeit his net proceeds (a different amount than
the proceeds directly traceable to the fraud, see note 3 below) from selling
ArthroCare stock during the period of the fraud, an amount equal to
$22,165,030.78. This appeal followed.
II.
Gluk and Baker argue that the district court’s evidentiary rulings were
incorrect in two ways: they kept evidence out that should have been let in, and
it let in evidence that should have been kept out. We agree on both counts,
and accordingly reverse the defendants’ convictions.
We review the district court’s evidentiary rulings for abuse of discretion,
subject to harmless error review. United States v. El-Mezain, 664 F.3d 467,
494 (5th Cir. 2011).
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We first consider the evidence the district court excluded. The district
court excluded both the SEC and Latham investigations as more prejudicial
than probative. Both investigations determined that Raffle and Applegate hid
the fraud from Gluk and Baker; as all parties admit, the reports could have
significantly affected the jury’s view of the case. The debate is only over
whether that effect would have been proper (in which case the reports were
highly probative and should have been admitted) or improper (in which case
the reports were highly prejudicial and were correctly excluded).
The government argues that the reports’ influence would have been
improper because both Latham and the SEC examined no more information
than the jury did. According to the government, Latham and the SEC were
essentially fact-finding bodies, no more capable than the jury of determining
whether Gluk and Baker had committed accounting fraud. The government
worried that the “jury may have [incorrectly] believed that the SEC and
Latham attorneys were better positioned to make factual findings” and thus
been improperly influenced by the Latham and SEC reports. In short, the jury
may have been intimidated into relinquishing its judgment when its fair
judgment should be the sole determinant of guilt or innocence.
Gluk and Baker respond that Latham and the SEC indeed were better
positioned to make factual findings and that professional findings would have
been highly probative of the defendants’ culpability. Latham and the SEC are
experts in understanding and evaluating financial fraud. The defendants
point to multiple cases where the Fifth Circuit has held that administrative
findings are admissible in subsequent criminal trials precisely because
administrative expertise might aid the jury.
These cases trace back to Smith v. Universal Services, Inc., 454 F.2d 154
(5th Cir. 1972). In Smith, the court held that EEOC reports are admissible,
even though they are not binding on the subsequent trial. “The fact that an
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investigator, trained and experienced in the area of discriminatory practices
and the various methods by which they can be secreted, has found that it is
likely that such an unlawful practice has occurred, is highly probative of the
ultimate issue involved in such cases.” Id. at 157 (emphasis added). Gluk and
Baker point out numerous cases that have followed this same reasoning, both
for the EEOC and other agencies. E.g., Hodge v. Seiler, 558 F.2d 284, 288 (5th
Cir. 1977) (admitting a HUD report).
The government responds that these cases should be limited to the
EEOC context, and should not apply to SEC investigations. We disagree.
Investigations into accounting fraud, like investigations into employment
discrimination, can involve complex legal intricacies where expert
administrative guidance can properly inform the jury. As this case
demonstrates, financial-fraud cases can turn on credibility determinations, a
key providence of the jury. The same, however, is true of discrimination cases,
where liability so frequently turns on disputed questions of intent. The
EEOC’s expertise can be helpful; so can the SEC’s expertise.
We accordingly hold that the Latham and SEC reports are likely to have
a proper and appropriate influence on a jury’s deliberations by providing it
with expert assistance regarding the plausibility of expert testimony. The
government acknowledges that the reports could have held significant weight
to the jury. We agree, and thus conclude that the exclusion of these reports
was not harmless error. We therefore hold that the district court abused its
discretion and committed reversible error by refusing to admit the reports. 2
Accordingly, we reverse and remand based on this error.
2 The parties also disagree about whether the SEC report is hearsay or is admissible
under Federal Rule of Evidence 803(8)(A)(iii). See Beech Aircraft Corp. v. Rainey, 488 U.S.
153 (1988). We need not reach this issue because, even if the reports were inadmissible for
their truth, they would still have been admissible to impeach Raffle and Applegate. Even as
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Second, Gluk and Baker argue that the district court erred by admitting
evidence of uncharged fraud that purportedly took place at DiscoCare. Baker
argues that:
The [government’s] strategy, from evidence to argument, was
clear. The government recognized an obvious truth: accounting
fraud is bland. A straightforward attempt to prove an accounting
fraud case would be difficult, both because the rules of accounting
contain ample gray area and also because jurors might well be too
bored to care. In order to convict, jurors need to be outraged, and
few jurors are so moved by outsized accounts receivable and
improper revenue recognition. In order to spark a sense of outrage,
the prosecution went outside the charges proper. It went to the
DiscoCare fraud and its lurid details of needless incisions
performed at the behest of Florida ambulance chasers.
The defendants argue that this evidence was impermissible character evidence
and, in any event, was more prejudicial than probative. The government
arguably intended to create the improper inference that Gluk and Baker were
bad people involved in shady operations and thus were the sort of people who
might have tolerated accounting fraud. This type of attempt to demonstrate
the character of the defendant is not permissible under Federal Rule of
Evidence 404.
The government, however, responds that activities at DiscoCare were
intrinsic to the charges of wire fraud and were highly relevant. The
government argues that details about the activities at DiscoCare explain why
Gluk and Baker would make misleading statements to investors (i.e., to hide
those salacious details). Further, evidence about how involved Gluk and Baker
were with the DiscoCare model helps show that they were involved in day-to-
day operations; this involvement is relevant to the credibility of their claim to
have known nothing about Raffle’s and Applegate’s fraud.
impeachment evidence, the reports may have had a decisive effect and thus it was error to
exclude them.
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At least some evidence of the DiscoCare conduct is undeniably relevant
to ArthroCare’s accounting fraud. At the same time, however, admitting
limited evidence does not license the government to introduce the magnitude
of testimony it elicited, nor to emphasize the DiscoCare fraud, not chargeable
to the defendants, in jury arguments. Allowing this breadth of testimony was
error. The district court could have done more to police the line between proper
and improper evidence; it should have been careful to prevent the government
from dwelling on the salacious details of DiscoCare’s business practices that
could not be charged to the defendants. Because we reverse on other grounds,
we need not determine whether this error independently justifies reversal or,
conversely, whether it would have been harmless error in the absence of the
reversible error we previously identified.
III.
Accordingly, for the reasons stated, we VACATE Baker and Gluk’s
convictions, and REMAND for a new trial. 3
VACATED and REMANDED.
3 Because we reverse the convictions, we do not reach Baker’s challenge to the
forfeiture calculation. Forfeiture is not a fine. The purpose of a forfeiture is to require
defendants to give up the proceeds of their crimes, not to punish them for those crimes. See
United States v. Hatfield, 795 F. Supp. 2d 219 (E.D.N.Y. 2011). Requiring forfeiture of the
entire value of stock sold would require forfeiting compensation, even when that
compensation is not traceable to fraud.
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