White Collar Watch: When Lies Are Allowed in a Business Deal

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René Descartes has been called the father of modern philosophy. Credit Hulton Archive/Getty Images

The French philosopher René Descartes wrote that “all deception or fraud involves some imperfection.” How much imperfection is required to be convicted of the federal crimes of mail and wire fraud has been clarified, at least a little bit, by recent appeals court decisions recognizing that some lying is acceptable, and even expected, in the business world.

The United States Court of Appeals for the Seventh Circuit in Chicago overturned the conviction of David Weimert, a former vice president of AnchorBank in Wisconsin. He was charged with wire fraud for his role in the sale of the bank’s share of a commercial real estate development in Texas in which he took a minority position in the deal along with the buyers.

It turns out that Mr. Weimert misled both sides about his role in the deal. He told the buyers that AnchorBank wanted him to take a piece of the transaction, while informing the bank that the buyers insisted he come in as a partner in the deal. When the sale closed, the bank got about a third more than it expected to make.

That’s a pretty nice outcome, but once the bank learned about Mr. Weimert’s deception, it fired him. To make matters worse, AnchorBank had received federal bailout funds during the financial crisis, so the Justice Department pursued the case because of the potential misuse of taxpayer money.

He was convicted of five counts of wire fraud at trial and sentenced to 18 months in prison. But the appeals court concluded there was not enough evidence to show any fraud despite his not telling the truth to either side, taking the rare step of ordering that Mr. Weimert be acquitted of the charges.

The appeals court focused on the fact that there were ongoing negotiations between the bank and the buyers, so that “it is not unusual for parties to conceal from others their true goals, values, priorities, or reserve prices in a proposed transaction.” In other words, no one tells the truth when they are negotiating a deal.

Indeed, the opinion went even further in analyzing what can amount to a fraud during negotiations.

“To state the obvious, they will often try to mislead the other party about the prices and terms they are willing to accept. Such deceptions are not criminal,” the court found.

To violate the wire fraud statute, any deception must be “material,” which means a reasonable person would consider it important in the transaction. Statements like “this is my final offer” or “I can’t go any lower than this” are not something on which the other side is likely to rely. The appeals court asserted that “negotiating parties, and certainly the sophisticated businessmen in this case, do not expect complete candor about negotiating positions.”

Can it really be that lies are acceptable in a negotiation? No less than Professor James J. White, a renowned commercial law scholar, once wrote that “to conceal one’s true position, to mislead an opponent about one’s true settling point, is the essence of negotiation.” You cannot lie about whether you will pay the amount promised, or mislead about the condition of property, but telling the truth about what it will take to get the deal done appears to be acceptable.

Mr. Weimert lied to his employer, but that was not enough to turn this into a successful wire fraud case because AnchorBank had been informed that he was acting on both sides of the deal, even if it was misled about how he came to be an investor in the transaction.

This type of breach of an employee’s duty of candor was once prosecuted under the “right of honest services” form of fraud, which let prosecutors reach dishonesty in business dealings. But the Supreme Court limited that type of prosecution to only those involving a bribe or kickback in 2010 in Skilling v. United States, something that was missing in Mr. Weimert’s case.

The finding that there was no fraud despite the deception is consistent with two decisions issued last December in other federal appeals courts that considered what rises to the level of fraud.

The United States Court of Appeals for the Second Circuit in Manhattan overturned the securities fraud conviction of Jesse C. Litvak, a former Jefferies & Company trader, over lying to buyers about the prices the firm paid for residential mortgage-backed securities he sold.

The appeals court found that the trial judge improperly excluded evidence to support the defense that institutional investors like those Mr. Litvak dealt with did not care about what Jefferies paid for the securities.

“A jury could reasonably have found that misrepresentations by a dealer as to the price paid for certain R.M.B.S. would be immaterial to a counterparty that relies not on a ‘market’ price or the price at which prior trades took place, but instead on its own sophisticated valuation methods and computer model,” the judges explained.

Unlike Mr. Weimart’s case, however, the appeals court ordered a retrial of the charges because the buyers might have considered what he said to be important. The second trial is scheduled to begin in July, so Mr. Litvak will get another chance to convince the jury that not telling the truth was immaterial to sophisticated buyers.

The United States Court of Appeals for the First Circuit in Boston overturned a finding by the Securities and Exchange Commission that one statement in a presentation with 20 slides made to investors that described a “typical” portfolio rather than the actual holdings of a bond fund was fraudulent.

Even if it were misleading, the statement was hardly material in a detailed discussion with sophisticated institutions that could inquire further about the fund’s holdings if they were interested. “Context makes a difference,” the appeals court pointed out, so what might appear to be misleading may in fact not be of much consequence.

Do these decisions give a judicial imprimatur to lying? No judge will ever take a position against telling the truth, but in a criminal fraud prosecution, the government must do more than just show a deception, even one that helps make money.

Fraud is a type of larceny, so there must be a victim who has been improperly deprived of something of value. If one side should expect to be lied to, then the message is to take any representations with a large dollop of salt, and not complain too much about somehow being deceived when trying to make a deal.

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