United States v. Elaine Martin , 796 F.3d 1101 ( 2015 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
UNITED STATES OF AMERICA, No. 14-30034
Plaintiff-Appellee,
D.C. No.
v. 1:13-cr-00065-
BLW-1
ELAINE MARTIN,
Defendant-Appellant.
OPINION
Appeal from the United States District Court
for the District of Idaho
B. Lynn Winmill, Chief District Judge, Presiding
Argued and Submitted
May 5, 2015—Seattle, Washington
Filed August 7, 2015
Before: Ronald M. Gould and Morgan Christen, Circuit
Judges, and Frederic Block,* Senior District Judge.
Opinion by Judge Gould
*
The Honorable Frederic Block, Senior District Judge for the U.S.
District Court for the Eastern District of New York, sitting by designation.
2 UNITED STATES V. MARTIN
SUMMARY**
Criminal Law
The panel vacated the defendant’s convictions for
subscribing false federal tax returns, vacated her sentence for
those convictions and fraud-related convictions, and
remanded for further proceedings.
The panel held that the district court abused its discretion
by admitting evidence about the defendant’s audits by Idaho
state tax authorities. The panel explained that the evidence
was not relevant on the federal tax claims and should have
been excluded under Fed. R. Evid. 404(b), and even if
relevant, was unduly prejudicial and not admissible under
Fed. R. Evid. 403. The panel held that the error was not
harmless as to the defendant’s convictions for subscribing
false tax returns but was harmless as to her fraud and
obstruction of justice convictions.
The panel addressed how the district court at sentencing
should have calculated loss resulting from the defendant’s
fraud, where the defendant’s company was awarded
government contracts under programs meant to aid
disadvantaged businesses, for which the defendant’s company
did not legitimately qualify. The panel held that neither the
“government benefits” rule of application note 3(F)(ii) to
U.S.S.G. § 2B1.1, nor the “regulatory approval” rule of
application note 3(F)(v), applies, and held that the
procurement fraud rule of application note 3(A)(v)(II)
**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
UNITED STATES V. MARTIN 3
applies. The panel rejected the defendant’s contention that
because the defendant’s company performed the contracts,
the loss amount is nothing. The panel remanded on an open
record to let both the government and the defendant submit
further evidence and argument on the loss amount. The panel
wrote that on remand, the government may attempt to prove
any actual or intended losses resulting from the defendant’s
fraud, including whether there was any pecuniary harm to the
government from paying a premium on top of the normal
contract price for services comparable to those the
defendant’s company provided.
The panel affirmed the defendant’s fraud-related
convictions in a concurrently filed memorandum disposition.
COUNSEL
Andrew G. McBride (argued), Brett A. Shumate, and John R.
Prairie, Wiley Rein LLP, Washington, D.C., for Defendant-
Appellant.
Frank P. Cihlar, Chief, Criminal Appeals & Tax Enforcement
Policy Section, Gregory Victor Davis and Alexander P.
Robbins (argued), Attorneys, Tax Division, United States
Department of Justice, Washington, D.C., for Plaintiff-
Appellee.
4 UNITED STATES V. MARTIN
OPINION
GOULD, Circuit Judge:
Elaine Martin appeals her convictions for subscribing
false federal tax returns and her sentence for those
convictions and several fraud-related convictions.1 First, we
address Martin’s contention that the district court abused its
discretion in admitting evidence that, years before the
conduct underlying this case, she had submitted Idaho state
tax returns on which she improperly characterized several
thousand dollars in personal expenses as deductible farm
expenses and had been audited by Idaho tax authorities.
Second, we address whether the district court misapplied the
Sentencing Guidelines in calculating the losses that resulted
from Martin’s fraud, where her company was awarded
government contracts under programs meant to aid
disadvantaged businesses, for which Martin’s company did
not legitimately qualify. We have jurisdiction under
28 U.S.C. § 1291. For the reasons that follow, we vacate
Martin’s tax convictions, vacate her sentence, and remand for
further proceedings.
I
Martin owned a construction company, MarCon, which
specialized in installing steel guardrails and concrete barriers
on public highways. MarCon also earned revenue by selling
used materials the company removed from its construction
1
In a concurrently filed memorandum disposition, we affirm Martin’s
fraud-related convictions, including those that underlie the loss
calculations discussed below, in the face of evidentiary and due process
challenges.
UNITED STATES V. MARTIN 5
sites. But Martin never reported the income from the used
material sales to the IRS, and instead kept it off the company
books and sent it to a bank account hidden from her external
accountants.2 By keeping several hundred thousand dollars
of this income off of her personal and company tax returns
between 2002 and 2008, Martin avoided paying about
$100,000 in income taxes.
Martin also fraudulently obtained government contracts
by misrepresenting her assets to qualify for programs
designed to aid disadvantaged businesses. A federal program
run by the Small Business Administration (“SBA”) qualifies
small businesses owned by socially and economically
disadvantaged persons for certain federal contracts without
going through the normal competitive bidding process.
Martin also obtained contracts through a state-administered
Disadvantaged Business Enterprise (“DBE”) program, which
sets targets for awarding a percentage of federally-funded
contracts to participants. Between 1999 and 2006, MarCon
received nearly $20 million from 85 contracts awarded
through the DBE program, and successfully performed each
contract. MarCon was admitted to the SBA program and
awarded three contracts worth nearly $3 million, all of which
the company successfully performed.
To prove that Martin knew she had a duty to truthfully
report her income on her tax returns, the government was
allowed to introduce evidence that Idaho tax authorities had
audited Martin and that in tax years 1996 and 1997 she had
improperly claimed less than $3,000 as deductible farm
expenses on her state tax returns. Martin was accused of
2
The facts about Martin’s tax convictions are drawn from the district
court’s findings of facts in a forfeiture order.
6 UNITED STATES V. MARTIN
incorrectly characterizing student loan payments for her
children and expenses related to her divorce as farm
expenses. Martin settled the issue without conceding liability.
During closing arguments, the government reminded the
jury in its rebuttal of the Idaho audits and argued that Martin
knew what she was doing when she subscribed false tax
returns because she had tried it before:
The government is focused obviously on the
used materials, but the same thing was
brought up and Elaine Martin agreed it was
wrong . . . when she tried to charge various
things as a farm expense. Things like her
divorce fees. Things like her children’s health
insurance and payment of student loans.
Remember that. Remember how you were
told that she tried this before. That she tried
to say those were farm expenses. Now a farm
needs fertilizer, it needs seed, it needs
equipment, but does it really need to pay for
student loans? Well, in Elaine Martin’s book
it does.
The jury convicted Martin of the tax counts and of several
fraud-based counts.
At sentencing, Martin, relying on the “procurement fraud
rule” found in application note 3(A)(v)(II) of § 2B1.1 of the
Sentencing Guidelines, argued for a loss amount of zero.
Relying on the “government benefits rule” found in
application note 3(F)(ii), the government advocated for a loss
amount equal to the total value of the contracts—about $22
UNITED STATES V. MARTIN 7
million—and the resulting 22-level enhancement that loss
amount permitted.
The district court held that the government benefits rule
applied. It disagreed, however, that the loss under that rule
was $22 million and instead set the loss amount at $3 million,
the profit from Martin’s fraudulently obtained contracts.
Acknowledging that its focus on profit was possibly
erroneous, it invoked application note 20(C) and found that
a higher loss amount would “overstate the actual loss.”
The district court’s loss calculation led to an 18-level
enhancement. With a base offense level of 7 and additional
enhancements for defendant’s role and sophisticated means,
the adjusted offense level was 31, for which the Guidelines
range for someone in criminal history category I is 108 to 135
months. The district court imposed a sentence of 84 months.
The district court also entered an order of forfeiture,
pursuant to the parties’ stipulation, requiring Martin to forfeit
over $3 million.
Martin timely appealed her convictions and sentence.
II
We review a district court’s evidentiary decisions for an
abuse of discretion. United States v. McFall, 558 F.3d 951,
960 (9th Cir. 2009). Even if an evidentiary ruling was
incorrect, we will vacate a conviction only if that ruling
“more likely than not affected the verdict.” United States v.
8 UNITED STATES V. MARTIN
Pang, 362 F.3d 1187, 1192 (9th Cir. 2004) (internal quotation
marks and citation omitted).3
The district court’s interpretation of the sentencing
Guidelines is reviewed de novo. United States v. Treadwell,
593 F.3d 990, 999 (9th Cir. 2010).
III
We first address Martin’s argument that the district court
abused its discretion by admitting evidence about her audits
by Idaho state tax authorities. We agree and conclude that the
error was not harmless. As a result of this substantial error,
we vacate Martin’s convictions for subscribing false tax
returns.
Federal Rule of Evidence 404(b) “provides that evidence
of ‘other crimes, wrongs, or acts’ is inadmissible to prove
character or criminal propensity but is admissible for other
purposes, such as proof of intent, plan or knowledge.” United
States v. Rizk, 660 F.3d 1125, 1131 (9th Cir. 2011) (quoting
Fed. R. Evid. 404(b)).
3
We reject the government’s contention that the evidentiary rulings
should be reviewed for plain error. When testimony about the state tax
returns was introduced, Martin objected, noting when the conduct
occurred and arguing that it was irrelevant. At sidebar, the government
argued that the evidence was admissible under Federal Rule of Evidence
404(b). Martin argued that the evidence was forbidden character evidence
and was too remote in time to go toward Martin’s state of mind. The
district court overruled the objection, reasoning that the evidence was
relevant to proving Martin’s state of mind. The district court was on
notice of Martin’s concerns and gave reasons for its rulings. Cf. United
States v. Palmer, 3 F.3d 300, 304 (9th Cir. 1993) (“[W]here the substance
of an objection has been thoroughly explored and the trial court’s ruling
was explicit and definitive, the issue is preserved for appeal.”).
UNITED STATES V. MARTIN 9
This general rule reflects our concern that a person
charged with a crime be convicted only if its elements are
proved beyond a reasonable doubt. A person should not be
convicted merely because he or she has done prior bad acts.
Rule 404(b) will not be violated if the prior bad acts are
relevant on some issue in the current prosecution, such as
“motive, opportunity, intent, preparation, plan, knowledge,
identity, absence of mistake, or lack of accident.” Fed. R.
Evid. 404(b). But when bad acts are not relevant, they can
only be viewed as being presented to inflame prejudice in the
trier of fact, in which case they are at odds with our
fundamental premises on the need for a fair trial. And even
when relevant on some issue, evidence of prior bad acts
should not, under Federal Rule of Evidence 403, be admitted
when its “probative value is substantially outweighed by
dangers of unfair prejudice, confusion on issues, waste of
time, or needlessly presenting cumulative evidence.” Fed. R.
Evid. 403.
In United States v. Bailey, 696 F.3d 794 (9th Cir. 2012),
the government, prosecuting a defendant for the sale of
unregistered securities, introduced an SEC civil complaint
alleging that the defendant had previously issued securities in
violation of the same SEC rules as those at issue in the
criminal trial. We held that the admission of the complaint
was an abuse of discretion that required a new trial. Id. at
800–05. We outlined the four part test for admitting evidence
under Rule 404(b): the government must show that “(1) the
evidence tends to prove a material point; (2) the other act is
not too remote in time; (3) the evidence is sufficient to
support a finding that defendant committed the other act; and
(4) (in certain cases) the act is similar to the offense charged.”
Id. at 799 (quotations omitted). “If the evidence meets this
test under Rule 404(b), the court must then decide whether
10 UNITED STATES V. MARTIN
the probative value is substantially outweighed by the
prejudicial impact under Rule 403.” Id. (quotation omitted).
Under these standards, admitting evidence of the prior
state tax audit for a prosecution of federal tax violations was
serious error. Here, the state tax auditors described their
investigation and the settlement agreement that Martin had
signed, providing more information than merely the civil
complaint introduced in Bailey. But this is a distinction that
makes no substantive difference. The government introduced
evidence that Martin was accused of incorrectly deducting
farm expenses on a state tax form in 1996 and 1997,
apparently to show her knowledge of federal tax laws related
to reporting income in the mid-2000s. But we can perceive
no relevant connection between Martin’s awareness of rules
about the characterization of farm expenses under Idaho tax
law, and whether she had knowledge of federal tax law
governing the reporting of income. Moreover, there is a
substantial probability that the jury took this evidence as
proof that Martin is a liar who does not want to pay taxes and
will cheat to avoid them—a theme the government
emphasized at closing, and a line of thinking the evidence
rules are meant to discourage. The government has failed to
meet its burden under our normal four-part test for admitting
evidence under Rule 404(b). Also, even if relevant,
introducing this evidence fails the Rule 403 balancing test.
The government argues that unlike the securities violation
in Bailey, the government in criminal tax cases must prove
that the defendant knew the tax laws, and that extending
Bailey to prohibit evidence of prior audits in criminal tax
cases would impair the government’s ability circumstantially
to prove a defendant’s knowledge of the tax laws. We
disagree. When the government seeks to admit evidence of
UNITED STATES V. MARTIN 11
a defendant’s knowledge, we have “emphasized that the
government must prove a logical connection between the
knowledge gained as a result of the commission of the prior
act and the knowledge at issue in the charged act.” United
States v. Mayans, 17 F.3d 1174, 1181–82 (9th Cir. 1994).
Mayans instructs that in cases such as this one, the materiality
and similarity prongs of the four-part test merge essentially
into one: “similarity is necessary to indicate knowledge and
intent because it can furnish the link between knowledge
gained in the prior act and the claimed ignorance of some fact
in the offense charged.” Id. at 1182 (internal quotation marks
omitted).
Evidence of an audit by, or settlement with, state
authorities for unrelated conduct is only minimally—if at
all—probative of Martin’s knowledge of the federal tax laws
at issue in this case, and there is “an insufficient connection,
for Rule 404(b) purposes, between [the prior audit] and the
knowledge, in the context of the crime charged,” of federal
tax laws governing the reporting of income. Id.
To show that the admission of the evidence here was not
an abuse of discretion, the government cites several criminal
tax cases where evidence of prior encounters with tax
officials was used. But all of the cases the government cites
involve prior run-ins with the IRS, not state authorities. See
United States v. Jackson, 565 Fed. App’x 662, 662 (9th Cir.
2014) (evidence that defendant continued filing false returns
after IRS instructed him that his conduct was illegal used to
show willfulness); United States v. Matthies, 319 Fed. App’x
554, 557 (9th Cir. 2009) (introduction of IRS publication
related to tax protestor arguments used to show defendant
was on notice of legal duty to pay income taxes); United
States v. Voorhies, 658 F.2d 710, 715 (9th Cir. 1981)
12 UNITED STATES V. MARTIN
(evidence that defendant was put on notice of tentative tax
deficiencies by IRS audit used to prove willfulness when
defendant moved assets overseas the next year). None
suggests that learning about obligations related to claiming
personal expense deductions for state tax purposes shows
knowledge of federal tax laws barring the under-reporting of
income. We conclude that the state tax audit evidence was
not relevant on the federal tax claims and so should have been
excluded under Rule 404(b). But even if relevant, it was
unduly prejudicial and not admissible under Rule 403. The
government in substance told the jury that Martin had lied on
her taxes before and should be convicted of doing so
again—an argument not supported by the facts and barred
under the rules of evidence.
Was this mistake harmful or harmless? The evidence
about the audit was introduced through the testimony of two
witnesses and several documents and the government
emphasized its importance in closing. Rather than merely
arguing that the evidence showed Martin’s knowledge of
federal tax laws, the government also insinuated,
impermissibly, that it showed Martin to be a dishonest
person: “[D]oes [a farm] really need to pay for student loans?
Well, in Elaine Martin’s book it does.” Cf. United States v.
Brooke, 4 F.3d 1480, 1488 (9th Cir. 1993) (stating that
evidentiary ruling was not harmless in light of the volume of
testimony and references to it in the government’s closing
argument). The government was permitted to argue at
closing that Martin knew what she was doing when she
under-reported her income because “she had been there
before,” and “she tried this before.” The government
incorrectly used the state audit to make a propensity argument
that more likely than not affected the verdict on the false tax
return charges. Cf. Bailey, 696 F.3d at 805 (noting
UNITED STATES V. MARTIN 13
government’s numerous references to the prior SEC civil
complaint at closing); United States v. Brown, 880 F.2d 1012,
1016 (9th Cir. 1989) (stating that “continued references to
[defendant’s] prior bad acts at the Government’s closing
arguments make it impossible . . . to say” the error was
harmless).4 Martin’s convictions for subscribing false tax
returns must be vacated.
Considering the totality of the circumstances, however,
we reach a different conclusion on the fraud and obstruction
of justice convictions. There are several reasons for this.
First, except for a brief reminder that income and net worth
matter with regard to the DBE and SBA programs at the close
of the discussion of the Idaho audit, the government’s
remarks at closing about the audit related only to the charges
of subscribing false tax returns. Second, this propensity
evidence likely affected the jury’s decision differently on the
tax charges than on the other charges. If jurors think that a
person cheats on state taxes, they are likelier to infer that such
a person cheats on federal taxes than to infer that the person
is guilty of a more complex fraud scheme. Third, during a
trial that lasted twenty-seven days, there was overwhelming
evidence presented that Martin had fraudulently qualified her
business for the DBE and SBA programs and had obstructed
justice by concealing her true net worth. We see no realistic
possibility that a jury would have reached a different
conclusion on the fraud and obstruction charges if the state
audit had not been mentioned. We conclude that unlike
Martin’s tax convictions, it was not more likely than not that
4
The absence of a limiting instruction that the jury should only consider
the evidence for its tendency to show Martin’s knowledge, see Mayans,
17 F.3d at 1183–84, bolsters our conclusion that the error more likely than
not affected the verdict.
14 UNITED STATES V. MARTIN
the evidence of the Idaho tax audit affected the jury’s
decision on Martin’s other charges.
Martin is entitled to a new trial on the tax charges, but not
on the other convictions.
IV
Because we vacate Martin’s tax convictions, we vacate
Martin’s sentence. See United States v. Bennett, 363 F.3d
947, 955 (9th Cir. 2004) (vacating defendant’s entire sentence
where one count of conviction was vacated). Martin must be
re-sentenced after liability on a potential re-trial for tax
violations is resolved. But because we affirm Martin’s fraud
convictions in a memorandum disposition, the issue of
calculating the losses from Martin’s fraud is certain to come
up again at re-sentencing, and any error by the district court
in interpreting the Guidelines may likely be repeated unless
we provide guidance here. Accordingly, we next address how
the district court should have calculated loss where MarCon
gave valuable construction services under the contracts that
it gained, but Martin defrauded the government into wrongly
concluding that MarCon was qualified to participate in the
DBE and SBA programs.
A district court must correctly calculate the Sentencing
Guidelines range before imposing a reasonable sentence. See
Gall v. United States, 552 U.S. 38, 51 (2007). The
“commentary in the Guidelines Manual that interprets or
explains a guideline is authoritative unless it . . . is
inconsistent with, or a plainly erroneous reading of, that
guideline.” Stinson v. United States, 508 U.S. 36, 38 (1993);
see also United States v. Jackson, 697 F.3d 1141, 1146 (9th
Cir. 2012) (per curiam).
UNITED STATES V. MARTIN 15
As the general rule for fraud cases, the Guidelines define
loss as “pecuniary harm.” U.S.S.G. § 2B1.1 cmt. nn.3(A)(i,
ii). Pecuniary harm is “harm that is monetary or that
otherwise is readily measurable in money.” Id. cmt.
n.3(A)(iii). They further state that “[l]oss shall be reduced”
by “the fair market value of . . . the services rendered . . . by
the defendant . . . to the victim before the offense was
detected.” Id. cmt. n.3(E)(i). This is consistent with the idea
that fraud is not always the same as theft. Sometimes, the
scheme is to obtain a contract or other opportunity; the
scheme still amounts to fraud if a person gains by deceit
something to which the person was not entitled, “but [the
person] means to perform the contract (and is able to do so)
and to pocket, as the profit from the fraud, only the difference
between the contract price and [the person’s] costs.” United
States v. Schneider, 930 F.2d 555, 558 (7th Cir. 1991); see
also United States v. Kopp, 951 F.2d 521, 529 (3d Cir. 1991);
United States v. Smith, 951 F.2d 1164, 1167 (10th Cir. 1991).
Although the value of the contracts in this case is a matter
of record, the government does not argue that the United
States suffered that amount of “pecuniary harm.” It is
uncontested that MarCon successfully performed the
contracts. Rather, the government contends that one of the
“special rules” of loss calculation applies. It invokes the
“government benefits” rule of application note 3(F)(ii), which
the district court applied, and also invokes the “regulatory
approval rule” of application note 3(F)(v). See U.S.S.G.
§ 2B1.1 cmt. nn.3(F)(ii, v). These special rules apply
“[n]otwithstanding” the general rules of application note
3(A). Id. cmt. n.3(F). But in our view, neither special rule
applies.
16 UNITED STATES V. MARTIN
The government benefits rule says that “[i]n a case
involving government benefits (e.g., grants, loans, entitlement
program payments), loss shall be considered to be not less
than the value of the benefits obtained by unintended
recipients or diverted to unintended uses, as the case may be.”
Id. cmt. n.3(F)(ii). Several circuits have held that this rule
applies to DBE programs. See United States v. Maxwell,
579 F.3d 1282, 1306 (11th Cir. 2009) (citing United States v.
Leahy, 464 F.3d 773, 790 (7th Cir. 2006), and United States
v. Brothers Constr. Co. of Ohio, 219 F.3d 300, 317–18 (4th
Cir. 2000)).
Leahy reasons that the DBE program “was an affirmative
action program aimed at giving exclusive opportunities to
certain women and minority businesses. The contracts which
these businesses received pursuant to this type of program
constitute government benefits.” 464 F.3d at 70. “Unlike
standard construction contracts, these contracts focus mainly
on who is doing the work.” Maxwell, 579 F.3d at 1306.
We agree that an “exclusive opportunity” might be a
benefit in some sense, but the Guidelines’ focus on pecuniary
harm suggests a more concrete meaning. The examples
given—loans, grants, and entitlement program payments—
confirm that this comment deals with unilateral government
assistance, such as food stamps, not a fee-for-service business
deal. Had Martin been issued food stamps—an entitlement
program payment—due to her fraud, the government’s loss
would be the full value of the stamps. But here Martin
obtained contracts, albeit contracts reserved for a special class
of contractors of which Martin and her company were not
legitimately a part.
UNITED STATES V. MARTIN 17
It is a “basic canon of statutory construction that when
general and specific words are associated . . . , then the
general words are construed to embrace things similar to
those enumerated by the specific words.” Hamilton v.
Madigan, 961 F.2d 838, 840 (9th Cir. 1992); see also Cal.
State Legislative Bd., United Transp. v. Dep’t of Transp.,
400 F.3d 760, 763 (9th Cir. 2005). Moreover, if there is any
lingering ambiguity as to whether a DBE program is a
“government benefit,” then the application note cannot apply.
See United States v. Leal-Felix, 665 F.3d 1037, 1040 (9th Cir.
2011) (“If, after applying the normal rules of statutory
interpretation, the Sentencing Guideline is still ambiguous,
the rule of lenity requires us to interpret the Guideline in
favor of [the defendant].”).
Here, the government received significant value from the
contracts with Martin because MarCon fully performed. The
government has offered no persuasive reason to impose a rule
whereby the entire value of the contract would be deemed
losses for the government, with no credit given for the value
of the services returned. We conclude that the government
benefits rule does not apply.
We reach the same conclusion regarding the “regulatory
approval” rule, which provides:
In a case involving a scheme in which
(I) services were fraudulently rendered to the
victim by persons falsely posing as licensed
professionals; (II) goods were falsely
represented as approved by a governmental
regulatory agency; or (III) goods for which
regulatory approval by a government agency
was required but not obtained, or was
18 UNITED STATES V. MARTIN
obtained by fraud, loss shall include the
amount paid for the property, services or
goods transferred, rendered, or
misrepresented, with no credit for the value of
those items or services.
U.S.S.G. § 2B1.1 cmt. n.3(F)(v).
The Seventh Circuit has held that the use of fraud to
secure minority-business certification fits “squarely within
the scheme considered by Application Note 3(F)(v).” United
States v. Giovenco, 773 F.3d 866, 871 (7th Cir. 2014). While
the analogy is fairly arguable, we disagree with the Seventh
Circuit’s decision to apply that rule. Martin did not falsely
pose as a licensed professional or supply goods without
obtaining required regulatory approval. Here, too, the rule of
lenity counsels against an expansive interpretation of the
application note, particularly where, as discussed below,
another application note is a closer fit to these circumstances.
We agree with Martin that fraudulently obtaining
contracts for disadvantaged businesses falls under the
procurement fraud rule, which says:
In the case of a procurement fraud, such as a
fraud affecting a defense contract award,
reasonably foreseeable pecuniary harm
includes the reasonably foreseeable
administrative costs to the government and
other participants of repeating or correct [sic]
the procurement action affected, plus any
increased costs to procure the product or
service involved that was reasonably
foreseeable.
UNITED STATES V. MARTIN 19
U.S.S.G. § 2B1.1 cmt. n.3(A)(v)(II). The application note’s
example of “fraud affecting a defense contract award” is a
close fit for the circumstances here. Moreover, the
procurement fraud’s rule placement within application note
3(A), rather than in note 3(F) with the special rules, indicates
that procurement fraud cases fall under the general rule for
calculating actual and intended loss. We have said that
district courts should “take a realistic, economic approach to
determine what losses the defendant truly caused or intended
to cause, rather than the use of some approach which does not
reflect the monetary loss.” United States v. Crandall, 525
F.3d 907, 912 (9th Cir. 2005) (quotations omitted). We have
also said that “district courts should give credit for any
legitimate services rendered to the victims.” United States v.
Blitz, 151 F.3d 1002, 1012 (9th Cir. 1998). Applying the
general rule in this and similar cases lets district courts do just
that. Applying the special rules, which apply notwithstanding
application note 3(A), would not. By fully performing all of
the contracts, Martin gave the government considerable
value. It would be unjust to set the loss resulting from her
fraud as the entire value of the contracts, as the district court
itself recognized.
Having decided that the procurement fraud rule, which
falls within the general rule for loss calculation, applies, we
also reject Martin’s contention that the loss amount is nothing
because MarCon performed the contracts. The government
concedes that the procurement fraud rule’s reference to
administrative costs is inapplicable because there were no
such costs in this case. But neither that nor MarCon’s
performing the contracts necessarily means that there was no
pecuniary harm to the government. The DBE and SBA
programs are designed to benefit disadvantaged businesses.
It is conceivable that the government paid a premium contract
20 UNITED STATES V. MARTIN
price above what it would pay for other contracts under
normal competitive bidding procedures. Any such difference
would be an actual loss resulting from Martin’s fraud. There
was some evidence at trial suggesting that prices paid on
DBE and SBA contracts may be higher than those paid for
similar services outside those programs. But the government
did not show whether there was any such price difference for
the contracts awarded to MarCon, or what that difference
was. In these circumstances, it is in the interest of justice to
remand on an open record to let both the government and
Martin submit further evidence and argument on loss amount.
On remand, the government may attempt to prove any actual
or intended losses resulting from Martin’s fraud, including
whether there was any pecuniary harm to the government
from paying a premium on top of the normal contract price
for services comparable to those MarCon provided.
If it is not feasible to determine the actual or intended
loss, district courts may use the defendant’s gain as another
way to measure the loss. See U.S.S.G. § 2B1.1 cmt. n.3(B)
(“The court shall use the gain that resulted from the offense
as an alternative measure of loss only if there is a loss but it
reasonably cannot be determined.”). In this case, the
government stated below that “the loss from Defendant
Martin’s fraud can be determined . . . .” This may be a
binding admission that precludes reliance on Martin’s gain as
an alternative measure for loss on remand. Or, in context, it
may have been premised on the applicability of the
government benefits rule, under which the total value of the
contracts awarded to MarCon—a known quantity—would be
the loss amount.
Because we conclude that the government benefits rule
does not apply, the district court should decide in the first
UNITED STATES V. MARTIN 21
instance whether the government may use the gain rule as an
alternative measure for loss. The premium, if any, paid by
the government on the contracts in this case is presumably a
determinable amount. If that proves to be the case—and if
there is no other theory of loss for the district court to
consider—the gain rule would not apply.
Finally, there may be other, non-pecuniary losses to the
government insofar as Martin’s fraud harmed the integrity of
the programs, which were designed to help legitimately
disadvantaged businesses. There may also be harm,
pecuniary or otherwise, to legitimate program participants
whose businesses might have received the contracts that were
awarded to MarCon. The Guidelines themselves recognize
that “there may be cases in which the offense level
determined under [§ 2B1.1] substantially understates the
seriousness of the offense,” U.S.S.G. § 2B1.1 cmt. n.20(A),
and give as an example warranting an upward departure a
scheme that “caused or risked substantial non-monetary
harm,” id. cmt. n.20(A)(ii). Even without the authority to
depart, district courts have the ability to base an upward
variance on a broader concept of harm than the Guidelines
contemplate. Nothing in our ruling today is meant to limit
district courts’ discretion to depart or vary from the
Guidelines in appropriate cases, but a sentence must begin
with a proper calculation of the Guidelines sentencing range.
The district court misinterpreted the Guidelines and
applied the wrong rule. On remand, the losses resulting from
Martin’s fraud should be calculated under the general rules of
application note 3(A) of § 2B1.1 rather than under any of the
special rules of application note 3(F), and re-sentencing
should be on an open record to permit both the government
22 UNITED STATES V. MARTIN
and Martin to submit evidence supporting their theories of
loss.5
V
We vacate Martin’s tax convictions and her entire
sentence, and remand for further action consistent with this
opinion.
VACATED and REMANDED.
5
Martin concedes that if we affirm her fraud convictions, as we do in the
concurrently filed memorandum disposition, then the district court’s
forfeiture order should remain in place.