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United States v. Bloom

United States Court of Appeals, Seventh Circuit

January 19, 2017

United States of America, Plaintiff-Appellee,
Eric A. Bloom, Defendant-Appellant.

          Argued September 13, 2016

         Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 12 CR 409-1 - Ronald A. Guzman, Judge.

          Before Bauer, Kanne, and Hamilton, Circuit Judges.

          Hamilton, Circuit Judge.

         In August 2007 Sentinel Management Group collapsed. Sentinel managed short-term cash investments for futures commission merchants, individuals, hedge funds, and other entities. Its bankruptcy left customers and creditors in the lurch: over $600 million was lost. In the wake of the collapse, Sentinel president and CEO Eric Bloom was convicted of wire fraud and investment adviser fraud.

         The government's case rested on three theories. First, the government presented evidence that Bloom, despite assuring customers otherwise, put their funds at significant risk by using them as collateral for Sentinel's risky proprietary trading. Second, the government contended that Bloom fraudulently manipulated the rates of return paid to clients on their investments. Third, the government claimed that Bloom continued to accept new customer funds even after he knew that Sentinel was about to collapse. The jury found Bloom guilty on all counts, eighteen of wire fraud and one of investment adviser fraud.

         On appeal, Bloom offers five arguments, which we address in turn. First, Bloom challenges the sufficiency of the evidence supporting his convictions. Second, he argues that his convictions were tainted by prosecutorial misconduct. Third, Bloom argues that the court erred by refusing to instruct the jury properly on the meaning of a federal regulation governing futures commission merchants. Fourth, he challenges several of the district court's evidentiary rulings. Fifth, he argues that in sentencing the district court used too high a loss amount to calculate the sentencing guideline range. We find no reversible error.

         I. Factual Background

         We first provide an overview of Sentinel's business and its representations to customers regarding how it used their funds. Then we summarize Sentinel's collapse in 2007 and Bloom's later indictment, conviction, and sentencing.

         A. Sentinel's Business Model

         Sentinel was founded in 1979 by Philip Bloom, the father of defendant Eric Bloom. The company had a single office in Northbrook, Illinois, and had about twenty-one employees. Sentinel managed investments for various clients such as hedge funds, financial institutions, and individuals. Its primary business was handling short-term investments for futures commission merchants, also known as FCMs. FCMs represent investors who trade in the futures and options markets, and they are regulated by the Commodity Futures Trading Commission (CFTC).

         Defendant Eric Bloom joined the company in 1988. He worked in several different positions during his career at Sentinel, sometimes occupying multiple positions at once. Bloom served as head trader from 1988 until 2003 and chief compliance officer until 2006. He also served as president and CEO from 1991 until August 2007 when the company filed for bankruptcy.

         Sentinel's business model was unusual and perhaps unique. It was registered with the CFTC as an FCM, but it did not trade in futures or options. Instead, Sentinel invested funds for other FCMs and, like a mutual fund, paid a return based on profits and losses. Sentinel was the only company that the CFTC permitted to operate in this manner.

         There was a proviso, however. The CFTC required Sentinel to follow the CFTC regulations for FCMs. In particular, CFTC Rule 1.25 limited the types of securities Sentinel could purchase with customer funds. 17 C.F.R. § 1.25. To minimize risk of loss and to assure that cash was returnable on demand, Rule 1.25 permitted investment only in highly liquid, highly rated securities such as U.S. Treasury bills. It also required Sentinel to keep the funds of customers segregated from each other and segregated from Sentinel's own funds. Sentinel signed "seg letters" and Investment Management Agreements to this effect. These letters and agreements represented to the CFTC and clients that Sentinel segregated customer funds from its own "house" funds, that Sentinel would not have any interest in the customer funds, and that Sentinel would comply with CFTC rules.

         Sentinel was also registered with the Securities and Exchange Commission (SEC) as an investment adviser. As an adviser, Sentinel owed its clients a fiduciary duty of good faith. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963) (investment adviser has "an affirmative duty of utmost good faith, and full and fair disclosure of all material facts") (internal quotation marks and citation omitted). Defendant Eric Bloom was named on Sentinel's investment adviser registration as the person authorized to give investment advice on behalf of the company. The SEC Custody Rule also required segregation of customer funds. 17 C.F.R. § 275.206(4)-2.

         Sentinel provided two investment options for its clients: the 125 Portfolio and the Prime Portfolio. The 125 Portfolio was for FCMs, and it allowed them to invest their customers' funds. This portfolio was intended to provide safe, short-term investments with same-day liquidity. It was subject to CFTC regulations, including Rule 1.25. At the time, Rule 1.25 permitted investment only in securities with a rating of AA or better. After 2007, however, the rule was revised to limit investment to securities that are fully guaranteed by the federal government. At Sentinel, the pooled accounts of customer funds from the 125 Portfolio were called "Seg 1."

         The second option for Sentinel customers-the Prime Portfolio-was for non-FCM clients such as hedge funds, financial institutions, and individuals. FCMs could also invest their own "house" funds (not customer funds) in the Prime Portfolio. The Prime Portfolio was slightly riskier. It was intended to provide a higher rate of return than the 125 Portfolio by investing in securities with longer maturity dates and slightly lower ratings. Nonetheless, Sentinel and Bloom promised that this portfolio would not stoop below high-quality "investment grade" securities. These funds were called "Seg 3."

         In addition to the two public portfolios, Sentinel had a "house account" for its own proprietary trading. This account was not constrained by the grade of securities. It could purchase securities of any rating or no rating. Defendant Bloom's father, Philip Bloom, owned the majority of the funds in the house account.

         B. Sentinel's Representations to Customers About Its Use of Their Funds

         Sentinel told its customers their funds would be safe, and it backed this assurance with specific claims about its business model and investment practices. The pitch was that customers could earn higher-than-average interest, receive same-day cash redemptions, and keep their funds effectively bankruptcy-proof. Sentinel claimed this was possible because it pooled cash from multiple clients, which afforded it greater investment flexibility. It made these claims through marketing materials, sales presentations, and its website.

         This was an attractive option to many Sentinel customers, particularly FCMs. Since FCMs were investing their customers' funds, preservation of principal was paramount for them. Liquidity was also vital because FCMs receive margin calls that require them to provide cash to exchanges on behalf of their clients on short notice.

         Sentinel told customers how it could assure the safety of their customers' principal. Its marketing materials said that it purchased "only the highest quality and most liquid securities" and that its "objective [was] to achieve the highest yield consistent with preservation of principal and daily liquidity, not simply 'the highest yield.'" Sentinel told customers of the 125 Portfolio that their supporting securities were highly rated and complied with Rule 1.25.

         Sentinel also promised that client funds would be segregated and thus thoroughly protected from bankruptcy. For both portfolios, Sentinel said that it would pool client assets by portfolio and place them in segregated, bankruptcy-proof custodial accounts in the client's name in the Bank of New York. The accounts would be bankruptcy-proof because, even if Sentinel went bankrupt, the securities remained in segregated accounts in the client's name and would thus not be considered Sentinel's assets. And if the Bank of New York failed, the assets would be transferred to another custodial institution.

         Customers were also told that they would know which securities generated their yields. Marketing materials stated: "Sentinel sends daily emails ... to each client reporting the total amount invested, the interest earned, and supporting securities." In other words, customers would know not only how much interest they were earning but also how they were earning it. In a letter to the CFTC, Sentinel said that customers' profits and losses were based on their ownership shares of an account's investments; there was no allocation of profits and losses across the different "Seg" accounts.

         Sentinel also told customers that it used two means to assure same-day liquidity: repurchase agreements and a loan from the Bank of New York. A repurchase agreement is a transaction where one party (the borrower) sells a security to a counterparty (the lender) with an agreement to repurchase the security later with interest. Sentinel was involved in both ends of these transactions: sometimes it used its customers' cash to purchase securities, earning interest when it resold the security (lending); other times Sentinel sold securities to obtain cash quickly, repurchasing the security and paying interest afterwards (borrowing). Sentinel's website said that it used "overnight" repurchase agreements to facilitate its liquidity needs.

         The second means to assure same-day liquidity was a loan with the Bank of New York. Sentinel and Bloom told clients that this loan was specifically for the cash redemptions of clients in the Prime Portfolio, not the 125 Portfolio. Bloom specified that it was a one-day transaction that was paid off the next day. It was purportedly only for liquidity purposes. Bloom did not tell clients that the loan ...

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