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U.S. v. Scialabba: The Seventh Circuit holds "Proceeds" are net profits, not receipts

December 24, 2008

I fear I jumped ahead of myself when I last posted that my next post would analyze Justice Scalia’s majority opinion in U.S. v. Santos.  As alluded to towards the end of my last post, one should first understand the Seventh Circuit’s opinion in U.S. v. Scialabba to really appreciate Justice Scalia’s opinion in Santos.

At issue in Scialabba was whether section 1956(a)(1) “proceeds” involved net profits or receipts (the precise issue before the Court in Santos). Like Santos, it concerns a gambling sole proprietorship, except that this gambling operation involved the sale and maintenance of video poker machines. Cechini was the sole proprietor of OK Amusement and Scialabba acted as his “personal assistant/’treasurer.’ ” The factual basis for their money laundering convictions essentially consists of Cechini and Scialabba removing the coin boxes from the machines, compensating the machine’s host (i.e., bar owner) for his pay-outs to customers and his vig, keeping the remainder to cover expenses and, if all went well, make a profit. (By the way, these machines were even warrantied for replacement if seized in a raid, which underscores the centrality of customer service to profitability–even in illegal gambling operations. That concept needs to be relayed to Sprint/Nextel.)

One of the reasons I knew I had to post a more detailed review of Scialabba is its demonstration of the significance of the USSG points program (which is typically inversely related to my conclusions of fairness with regard to a given case). Cechini and Scialabba were actually convicted of a myriad of crimes, with each conviction plucking different pieces of the fact pattern to be reconstituted as elements of unique and separate criminal activities. Cechini and Scialabba’s attorneys likely conducted an astute cost-benefit analysis in determining that the 1956(a)(1) conviction was “the one” to appeal because it was the only conviction they appealed from a laundry list of convictions.

Here’s why: Scialabba’s base offense level, with the section 1956 conviction, yielded a sentencing range of 108-135 months; however, without the 1956(a)(1) conviction, he would have grossed a 37-46 month sentencing range. Cechini’s breakdown was 235-293 vs. 84-105. In other words, the meaning of section 1956(a)(1) “proceeds” either more than doubled or divided their sentences in half like Moses’s staff to the Red Sea. That is why I love statutory construction.

The prosecutor went out on a limb, arguing a plain meaning construction of the statute, which is to say that the words speak for themselves. It’s the first line of defense in statutory construction–if the plain meaning of the words in the statute is clear, then courts need not engage in the art of construction. The argument can be reduced to the following syllogism:

  • “Proceeds” clearly mean gross receipts because gambling clearly permeated every aspect of the operation, and gambling is clearly illegal, therefore everything they did was clearly illegal, hence everything reaped clearly constituted “proceeds” for the purpose of section 1956(a)(1). (My general observation is that “clearly” is to legal analysis what heat is to snow–the former simply dissolves the latter.)

While the plain meaning argument has a lovely minimalist appeal, an actual analysis of the statute reveals that things are not quite so “clear.” Section 1956 basically provides that if D conducts (or attempts to conduct) a financial transaction, knowing that the property used in the transaction represents the “proceeds” of unlawful activity, with the intent to, in this case, promote or continue that unlawful activity, he is guilty of money laundering. Thus, the prosecutor’s plain meaning construction translates into an assertion that every dollar constitutes the proceeds of the operation, therefore every financial transaction conducted with those dollars constitutes money laundering.  That is to say, for example, that the financial transactions wherein Cechini bought toilet paper with his gambling “proceeds” to use while conducting his gambling operation “in house,” would constitute money laundering.  I’ll let that one speak for itself.

Let’s consider a hypothetical regarding Cechini’s warranty program. A recent government study has found that video poker is responsible for the high crime rate because it arouses gambling addicts’ violent tendencies when they lose to a TV screen. Consequently, there is a crackdown on illegal video poker machines and Cechini is deluged by bar owners needing replacement machines. Cechini honors his warranty . . . repeatedly (highlighting his entrepreneurial hubris). He is not making a profit, however, because the machines are routinely being seized; he’s simply using the money that comes in while the machines are briefly installed to buy new machines with the hope that he can tread water during such perilous times. In other words, it’s more like a pyramid scheme because his liabilities exceed his assets–he can only continue his business so long as the machines that have not been seized make enough money to fund replacement machines and pay-outs to the bar owners.

Considering the statute, then, Cechini’s warranty program demonstrates that “proceeds” could mean gross receipts or net profits since he was continuing his operation, but operating at either a loss or, at best, simply breaking even. Consequently, since proceeds could mean either gross receipts or net profits, the Rule of Lenity requires that the term resulting in reduced criminal liability be applied.

The Rule of Lenity is a maxim of statutory construction that is only applicable to construction of criminal statutes. It is basically an extension of constitutional principles of fairness and notice, that one will not be taken by surprise because the words used in a statute were susceptible to two meanings. It properly puts the burden on Congress to write statutes comprehensibly (which is a challenge for them). Here, I think the decision is particularly well reasoned, not only because “proceeds” could truly implicate gross receipts or net profits, but also because while many Americans are not well versed in the money laundering laws, they are familiar with the general principles of the U.S. Tax Code. Based on that understanding, most people would consider the term “proceeds” stemming from some kind of business operation to mean net profits, not gross receipts.

I could go on about Scialabba–there’s excellent dicta about potential merger issues; however, I must keep moving towards reviewing the majority opinion in Santos.

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