Second Circuit Concludes Later Lulling Statements Were Relevant To Prior Securities Fraud Scheme

False account statements that stock broker sent to his brokerage clients two to four years after their purchase of valueless securities were relevant as lulling statements to show the defendant’s efforts to avoid detection, in United States v. Kelley, 551 F.3d 171 (2d Cir. Jan. 5, 2009) (No. 06-5536-cr) (per curiam)

The Second Circuit considered a challenge to the admission of post-investment lulling statements in a securities fraud scheme trial. Lulling statements, which can take many forms, are used in a fraud scheme to persuade or discourage the investor from pursuing civil redress or from complaining to law enforcement. The defense argued that the false accounting statements “were sent after the purchases of the securities and were not made in connection with the purchase or sale of securities,” Kelley, 551 F.3d at 172.

In the case, defendant Kelley, a stock broker, sold valueless shares to his brokerage clients and failed to disclose the he controlled the company shares with other partners. Two to four years later some investors received account statements which overstated the value of the investments. The trial court rejected the defense claim that the evidence was irrelevant since “the false [account] statements were not made in connection with the sale or purchase of securities.” Instead, the trial court concluded the accounting “statements were relevant to Kelley's intent and his attempts to evade detection” in connection with the charged crimes of securities fraud. Kelley, 551 F.3d at 174. After the defendant was convicted, he challenged the admission of the accounting statements.

The Second Circuit agreed the accounting statements were relevant. Even though the statements themselves were not a securities law violation, they were relevant to prove defendant's intent to defraud. As the circuit explained:

“The section 10(b) violations that were charged stem not from the bogus account statements themselves, a sine qua non for Kelley’s argument to be persuasive, but instead stem from Kelley’s larger schemes to induce his clients to purchase the securities or to use his clients’ funds to purchase the securities without their authorization. References to the bogus statements were admitted as evidence because they tended to demonstrate Kelley’s intent to defraud his clients and the scope of the schemes he employed. They were never offered as proof of independent violations of section 10(b). The bogus account statements were relevant evidence with respect to the charged securities law violations. The statements provided the jury with evidence both that Kelley had intended to defraud his clients and that he continued efforts to avoid detection by deceiving his clients about the value of the investments, often up to two years after a particular investment ceased to have any value. The account statements also indicate that Kelley’s actions in defrauding his clients were not simple mistakes but were instead part of a larger, intentional scheme to defraud.”
Kelley, 551 F.3d at 176 (citations omitted).

The Kelley case presents an example of the use of lulling statements in a fraud scheme. Often the lulling statements will be made after the investment was made. The lulling statements may be essential to the fraud scheme to buy time and avoid reporting the scheme to others. As the Kelley, court noted, the lulling statement evidence is relevant to show intent and efforts taken to avoid detection.

Federal Rules of Evidence