SEC v. Koenig, 557 F.3d 736 (7th Cir. 2009):

Waste Management, Inc., grew at an average annual rate of 26% from 1979 through 1991. When growth fell off, James Koenig, its Chief Financial Officer, decided to improve appearances. He devised several accounting strategies that a jury found to be fraudulent. The district judge imposed a civil penalty of about $2.1 million and ordered Koenig to disgorge the bonuses he received in 1992, 1994, and 1995 ($ 831,500, plus more than $ 1.2 million in prejudgment interest). Bonuses depended on Waste Management's profits. If its profits had been stated correctly, the judge concluded, Koenig would not have received these bonuses. The court also enjoined Koenig from again serving as a director or top manager of a public company.***

2. Several of Koenig's arguments concern trial management. We discuss three of these.

a. After learning that Koenig planned to pitch his defense on the theory that Waste Management's new management had taken an "earnings bath" to make its own performance look good by comparison, the SEC filed a motion in limine asking the district court to exclude all evidence related to this theme. The right question, the SEC insisted, was whether Koenig intentionally made (or caused Waste Management to make) materially misleading statements from 1992 through 1996, not why other managers of Waste Management made other statements in 1997 or 1998. According to the SEC, the motive of anyone other than Koenig was irrelevant. Indeed, Koenig's motive also was irrelevant; securities fraud is wrongful even if committed in the belief that lies serve the issuer's, or investors', interests. See Basic Inc. v. Levinson, 485 U.S. 224, 234-36, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988). The plaintiff in a securities-fraud suit must show intentional deceit, see Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976); the motive for that deceit is beside the point.

The district court should have granted the SEC's motion. Instead the judge denied the motion, while warning Koenig that if motive became an issue he would allow the SEC to introduce its own evidence (much of which was sure to be hearsay) about why people acted as they did. Koenig then presented his defense, the SEC responded in kind, hearsay became rampant, and the trial dragged on and on, lasting a total of 12 weeks.

A good deal of research shows that 20 days is about the longest trial any jury can comprehend fully; the longer the trial goes, the more the jury forgets and the less accurate the decision becomes. See, e.g., Richard Lempert, Civil Juries and Complex Cases: Taking Stock After Twelve Years 20 (Center for Research on Social Organization Working Paper Series # 488, Nov. 1992); A Handbook of Jury Research §3.02(c) at 3-6 (Walter F. Abbott & John Batt eds. 1999); Joe S. Cecil et al., Jury Service in Lengthy Civil Trials 1, 9, 11-13, 28 (tab. 7), 33 (tab. 8) (Fed. Judicial Center 1987); Patrick E. Longan, The Shot Clock Comes to Trial: Time Limits for Federal Civil Trials, 35 Ariz. L. Rev. 663, 703-07 (1993). No wonder the ABA strongly recommends short trials. "Principle 12: Courts Should Limit the Length of Jury Trials Insofar As Justice Allows, and Jurors Should Be Fully Informed of the Trial Schedule Established," in American Bar Association, Principles of Juries and Jury Trials (Aug. 2005). Koenig does not complain about the trial's length; perhaps he was hoping that jurors would lose focus. (A 12-week trial about accounting! Sounds like material for Jay Leno.) But he does complain, and loudly, about the hearsay that the SEC adduced to meet his phantom "defense."

Like the district judge, we are inclined to say that error (if any) was invited. Koenig's theme was that the managers who issued the press release and restated the firm's financial position did so to serve their own interests rather than to provide investors with accurate information. That opened the door to questions about what these persons' motivation really was, and the district judge remarked that "the SEC [therefore] is entitled to allow [the] witnesses to explain why they did what they did." Koenig concedes that the judge's reasoning "is analytically sound as far as it goes." But he insists that it does not "justify permitting the restaters to testify about what some other person told them about past accounting practices". Why not? If the reason X issued a press release is that Y had told X that Koenig had misstated earnings and depreciation, then Y's statement to X is part of X's motive. Having put X's motive in issue, Koenig had to accept the consequence that X's account of his decision-making would be full of hearsay--for a top manager at a large corporation rarely examines the books on his own.

If you want to know what was in X's mind when he acted, you have to consider all the things X was told, as well as the effect the statements had for X's job tenure and the value of X's stock portfolio. The judge told the jury that these statements were being introduced to show what the managers knew (or thought they knew) before they acted, not to show whether what the managers had heard was true, so many of the statements were not hearsay. (They were not being offered for the truth of the matter stated, as distinct from the fact that they had been made at all.) But to the extent genuine hearsay came in, or the jury misunderstood the instructions: Well, Koenig asked for it. And although he insists that the judge should have excluded much of the evidence under Fed. R. Evid. 403 because its prejudicial effect substantially outweighed the probative force, that subject is committed to the district judge's discretion, which was not abused given that Koenig went into this irrelevant and unnecessary subject with his eyes open.

b. Principle 13(C) of the ABA's American Jury Project recommends that judges permit jurors to ask questions of witnesses. The Final Report of the Seventh Circuit's American Jury Project 15-24 (Sept. 2008) concurs, with the proviso that jurors should submit their questions to the judge, who will edit them and pose appropriate, non-argumentative queries. District judges throughout the Seventh Circuit participated in that project. The judges, the lawyers for the winning side, and, tellingly, the lawyers for the losing side, all concluded (by substantial margins) that when jurors were allowed to ask questions, their attention improved, with benefits for the overall quality of adjudication. Keeping the jurors' minds on their work is an especially vital objective during a long trial about a technical subject, such as accounting. The district judge in this case permitted jurors to submit questions to him. Some were asked; others were reformulated and asked; some were not asked, when the judge thought them inappropriate or repetitive.

Koenig contends that permitting the jurors to participate in this fashion is a reversible error. That can't be because any statute or rule of procedure bans the process. There is no such statute or rule. Nor has any court of appeals forbidden the judge to ask questions submitted by the jurors. See United States v. Richardson, 233 F.3d 1285, 1289 (11th Cir. 2003) (approving juror-initiated questions and collecting cases from other circuits to the same effect). The ABA and Seventh Circuit jury projects found benefits; so have scholars. See, e.g., Shari Seidman Diamond, Mary R. Rose, Beth Murphy & Sven Smith, Juror Questions During Trial: A Window into Juror Thinking, 59 Vand. L. Rev. 1927 (2006); Nicole L. Mott, The Current Debate on Juror Questions, 78 Chi.-Kent L. Rev. 1099 (2003).

In opposition to these studies, Koenig has only occasional judicial skepticism. For example, we said more than a decade ago that questions from jurors are "fraught with risks". United States v. Feinberg, 89 F.3d 333, 336 (7th Cir. 1996). Similar statements are easy to find. E.g., DeBenedetto v. Goodyear Tire & Rubber Co., 754 F.2d 512, 516 (4th Cir. 1985); United States v. Ajmal, 67 F.3d 12, 14 (2d Cir. 1995). These expressions reflect concern that allowing jurors to ask questions will lead them to take positions too early in the trial, emulating the advocates by choosing sides and becoming argumentative rather than reflective. The jury projects and other studies were designed to find out whether these risks are realized so frequently that they overcome the benefits, such as keeping jurors alert and focused. Now that several studies have concluded that the benefits exceed the costs, there is no reason to disfavor the practice. Like other issues of trial management-- may jurors take notes? should written jury instructions and copies of exhibits be sent to the jury room during deliberations?--whether to allow the jurors to pose questions is a topic committed to the sound discretion of the judge. That discretion was not abused in this case; to the contrary, the judge's decision, like his supervision of the questioning process, was well considered and sensible.

Koenig contends that the judge should have limited the jurors to "clarifying" questions, but jurors' perspectives are so different from those of lawyers that it is difficult to see how such a limit could be enforced (or why it would be appropriate). Testimony that seems clear to a specialist in accounting or securities law may be confusing to a juror encountering these subjects for the first time, so a juror may see as "clarifying" a question that the lawyer sees as unnecessary or obtuse. A judge should serve as a filter for questions and eliminate or rephrase those that are irrelevant or disguised argument (as the judge at this trial did); more than that a court of appeals cannot sensibly demand.

That some glitches occurred in the process--the judge forgot to ask some of the jurors' questions for some witnesses, and he failed to call back one witness when the jurors wanted to ask additional questions--is neither surprising nor a ground for concern. Trials are complex proceedings, and a judge must concentrate attention on what is most pressing. Jurors were told not to draw inferences from the judge's decision not to ask particular questions; there is little reason to think that jurors would have held against Koenig the judge's failure (even if inadvertent) to ask any particular question. Nor does it strike us as unusual or a source of concern that three jurors collectively asked about two-thirds of the 127 total questions submitted by the panel; some people are more voluble than others. That the panel had members of different interests and proclivities is a strength rather than a weakness of the system. (Note that 127 questions is roughly two per trial day; this litigation was not taken over by the jury.)

Koenig sees in some of the proposed questions (principally those filtered out by the judge) signs that a few jurors had made up their minds or taken an adversarial position in mid-trial. It is dangerous to draw such inferences from questions; judges often ask pointed questions of both sides, and it would be a mistake to infer from these questions that the judge was leaning against both litigants. No matter. Koenig's position seems to be that ignorance is bliss: if some jurors have reached a tentative conclusion in mid-trial, it is best not to know it. Why? Jurors must be impartial, but like everyone else they respond to evidence and may think that they know enough even when lawyers want to feed them more. (We've already said that this trial lasted far too long; it is no surprise that some jurors thought they knew enough to decide even while the trial was ongoing.) Lawyers should want to know when some jurors are tending the other side's way, so that they can make adjustments to their presentations in an effort to supply whatever proof the jurors think vital, but missing. Just as questions from the bench can supply insight that helps lawyers make a stronger case, so questions from jurors can help lawyers tailor their presentations. Keeping jurors silent won't prevent them from reacting to the evidence; it will just make it harder for lawyers to know how things are going. It is a lot easier (and more reliable) to read jurors' questions than to read the expressions on their faces.

c. Koenig hired Frederick C. Dunbar, an economist on the staff of National Economic Research Associates, to serve as an expert witness on the question of materiality. He prepared a report and was subject to a deposition, but Koenig did not present his report or testimony at trial. Dunbar conducted an event study, using stock price changes (net of changes in the market as a whole) to isolate the effects of particular disclosures. After using statistical methods to remove the effects of what he deemed confounding events (such as the resignation of Waste Management's top managers), Dunbar concluded that disclosure of Koenig's netting, basketing, and other accounting devices caused Waste Management's stock to drop by $ 3.22 a share (a total loss of $ 1.45 billion, since the firm had about 450 million outstanding shares). The SEC found Dunbar's conclusions helpful, because it deems an effect of this magnitude to be material. (On the definition of materiality in securities law, see TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 96 S. Ct. 2126, 48 L. Ed. 2d 757 (1976), and Higginbotham v. Baxter International Inc., 495 F.3d 753, 759 (7th Cir. 2007).) So the SEC introduced Dunbar's testimony via the video of his deposition. Koenig maintains that the district court should not have let the SEC do this, because the agency did not include him on its list of potential witnesses.

Rule 26(a)(2)(A) requires litigants to alert the other side to their intended expert witnesses, and Rule 37(c)(1) provides that failure to identify a witness as Rule 26 requires means that "the party is not allowed to use that . . . witness to supply evidence . . . at a trial, unless the failure was substantially justified or is harmless." What Rule 26(a)(2)(A) says is that "a party must disclose to the other parties the identity of any witness it may use at trial to present" expert testimony. Disclosure of a potential witness's "identity" differs from disclosure of a plan to call that witness. Koenig did not need to know the identity of Frederick C. Dunbar; he was Koenig's own expert, after all, and appeared on the list of expert witnesses that Koenig sent to the SEC. Whether the adverse party wants to question an expert whose identity has already been revealed is not a subject within the scope of Rule 26(a)(2). A district judge may call for disclosure of each party's plans about who to put on the stand, but Koenig does not contend that the SEC violated its obligations under the pretrial order. (The SEC included Dunbar in its witness list for the pretrial order; Koenig's objection is not to a mid-trial surprise but to the fact that the notice did not come before discovery closed, a year or more before the witness lists of the pretrial order were exchanged.)

Rule 26(a)(2)(A) facilitates preparation for expert testimony. Disclosure of experts' identities, and their conclusions (reflected in their reports), is essential if lawyers (who are not themselves experts in accounting, economics, or other bodies of specialized knowledge) are to prepare intelligently for trial. Disclosure also permits lawyers to ask for other experts' views on the soundness of the conclusions reached by the testimonial experts. None of these considerations calls for notice from the SEC of a desire to call Dunbar. Koenig's legal team had his report, had been at the deposition, and for all we know had a platoon of non-testimonial experts analyze everything Dunbar wrote and said, which may be why Koenig did not present Dunbar's views at the liability portion of the trial. (The trial was bifurcated, and Koenig did use Dunbar in its remedial portion.)

Suppose this is wrong, however, and that the SEC should have identified Dunbar during discovery as its own witness. Rule 37(c)(1) says that a harmless lack of notice may be overlooked. See also 28 U.S.C. §2111; Fed. R. Civ. P. 61. Delay in alerting Koenig that Dunbar might testify was as harmless as they come, given Dunbar's status as Koenig's expert. The Committee Note accompanying the 1993 amendment to Rule 37 (when Rule 37(c)(1) took its current form) gives, as an example of a harmless violation, "the failure to list as a trial witness a person so listed by another party"; that fits this case. Koenig maintains that with more advance notice from the SEC he would have withdrawn Dunbar as an expert. But how could that have helped? A witness identified as a testimonial expert is available to either side; such a person can't be transformed after the report has been disclosed, and a deposition conducted, to the status of a trial-preparation expert whose identity and views may be concealed. See Fed. R. Civ. P. 26(b)(4)(B). Disclosure of the report ends the opportunity to invoke confidentiality. So if the SEC had identified Dunbar as an expert it might call, nothing Koenig could have done would have blocked the SEC from using Dunbar's conclusions. Any delay was harmless. ----------------------------------- -------------------------