In the

United States Court of Appeals
              For the Seventh Circuit

Nos. 06-3458 & 06-3502

U NITED S TATES OF A MERICA,
                                                  Plaintiff-Appellee,
                                 v.


P UN I. H ODGE and D AVID L. K UBLY,

                                            Defendants-Appellants.


            Appeals from the United States District Court
       for the Northern District of Illinois, Western Division.
            No. 05 CR 50009—Philip G. Reinhard, Judge.


    A RGUED N OVEMBER 2, 2007—D ECIDED M ARCH 11, 2009




   Before E ASTERBROOK, Chief Judge, and P OSNER and
R IPPLE, Circuit Judges.
  E ASTERBROOK, Chief Judge. From 2001 through the end
of February 2005, Pun I. Hodge and David L. Kubly
operated the Fuji Health Spa, later renamed the Royal
Health Spa, in Rockford, Illinois. The business’s structure
changed occasionally: for some of the time Hodge and
Kubly rented the premises to others, who actually ran
the business (though Hodge and Kubly often assisted); by
2                                     Nos. 06-3458 & 06-3502

fall 2004 the tenants had departed, leaving Hodge and
Kubly as owner-operators. But names and organizational
details don’t matter. What does matter is that “spa” was a
euphemism for brothel. Some customers paid by credit
card, processed by Hodge and Kubly through interstate
wires. Hodge pleaded guilty to one count of conspiring
to operate a racketeering enterprise through interstate
facilities, 18 U.S.C. §§ 371, 1952(a)(3), and a second count of
conspiracy to commit money laundering, §1956(a)(1)(A)
and (h). She was sentenced to 27 months’ imprisonment.
Kubly, her husband, pleaded not guilty of the same
charges and was convicted after a trial. He was sentenced
to 36 months. Both defendants were ordered to forfeit
about $270,000 in criminal receipts.
  Kubly contends that the district judge should not have
allowed the jury to learn that he patronized a similar
establishment before buying the Royal Health Spa. He
calls the evidence “prior bad acts” that should have
been excluded under Fed. R. Evid. 404(b). But at trial
Kubly denied knowing that prostitution occurred in the
closed rooms where “masseuses” met their customers.
His own experience, which showed knowledge (allowing
use under Rule 404(b)’s language), undercut that defense.
Both Kubly’s “spa” and the one he had visited earlier
charged customers a fee, nominally covering a shower
and massage. Once alone with the “masseuse,” the client
could contract for sexual services. These were paid for
in cash or on a second credit-card charge. Kubly processed
hundreds of these second charges but could not explain
what they were for, if not sexual services. The district
judge did not err.
Nos. 06-3458 & 06-3502                                         3

  No more need be said about Kubly’s conviction for
using interstate facilities to conduct a racketeering enter-
prise. Money laundering is a different matter. The evi-
dence did not show what Kubly did with the business’s
net revenues. The prosecutor’s theory is that Kubly vio-
lated §1956 simply by paying business expenses: rent,
advertising, utilities, and so on. The prosecutor recognizes
that in United States v. Scialabba, 

(7th Cir. 2002),
and Santos v. United States, 

(7th Cir. 2006),
affirmed, 

(2008), we held that the word
“proceeds” in §1956 means an illegal business’s net
income rather than its gross income—in other words,
that “proceeds” are profits, not receipts. But the United
States maintains that what remained after the prostitutes
received their cut was the business’s net profits, which
could not be spent on anything without violating §1956.
   That’s a preposterous understanding of net receipts.
To determine the net proceeds of a transaction, which is
to say the profits, one must subtract all costs of doing
business, not just an arbitrary subset of the costs. True,
the only costs at issue in Scialabba and Santos, which
concerned unlicensed gambling, were the gamblers’
winnings; we held that by paying the gamblers the defen-
dants did not engage in financial transactions with pro-
ceeds. That does not imply, however, that only an
illegal business’s largest (or first) expense is outside the
statutory scope of “proceeds.” Size matters not, Yoda
tells us. Nor does time. Whether Kubly paid the rent
before or after paying the prostitutes has nothing to do
with the distinction between gross and net. And the
prosecutor is wrong to suppose that the prostitutes got
4                                   Nos. 06-3458 & 06-3502

the first cut of customers’ money. Rent usually is paid in
advance of occupancy; advertising certainly precedes
the customers it generates. Only the utility bills can be
paid after the transactions to which they pertain.
  Scialabba holds that paying the ordinary and necessary
expenses of a business is not a federal crime, just
because that business violates state laws. That principle
covers this case (at least it covers the proof at trial, for
the prosecutor did not show what Kubly did with what-
ever remained after expenses).
  The prosecutor argues that advertising expenses must
be treated differently, because §1956(a)(1)(A)(i) forbids
using proceeds of crime to “promote” the carrying on
of unlawful activities, but this begs the question whether
Kubly used “proceeds” to pay for the advertising. If the
cost of advertising, like the rent (and the prostitutes’
wages) is subtracted from gross to produce net proceeds,
then the answer is no.
   Should advertising be treated differently? Not under
Scialabba’s net-revenue approach. Scialabba held that
expenses are subtracted to define net income. (This ap-
proach, which covers voluntary transactions such as
gambling, is equally applicable to prostitution.) Consider
the situation in those counties of Nevada that make
licensed prostitution lawful. A brothel incurs advertising
expenses, which are subtracted from gross income to
create net, taxable income. No accountant would define
the business’s net revenue to include money used for
advertising. What is paid to third parties for an input
into production is not part of net income.
Nos. 06-3458 & 06-3502                                   5

  Indeed, any income statement that failed to subtract
advertising expenses before reporting net income would
be treated as fraudulent under corporate and securities
law. Thus it is with lawful as well as unlawful businesses.
Ford Motor Company, Apple Inc., and every other enter-
prise treats advertising as an ordinary and necessary
business expense, which may (indeed must) be sub-
tracted to produce the “net income” figure reported to
investors, and on which taxes are paid. If Ford should
violate some federal statute—if, say, repeated violations
of the Clean Air Act were to end in a criminal conviction
of Ford Motor Co.—this would not make it less appro-
priate to deduct advertising expenses before calculating
net income.
  Economists (unlike accountants and tax lawyers) treat
advertising as an investment designed to produce future
income. From an economic perspective, advertising
should be capitalized and depreciated. Does this make
a difference under Scialabba? The answer depends on
how other capital outlays are classified. Accountants, tax
collectors, and economists alike would treat the video-
poker machines that the defendants in Scialabba used in
their gambling business as capital investments. But no
one would doubt that the cost of these tools of the trade
should be netted out of “proceeds” under Scialabba’s
approach. Likewise the cost of a business’s premises,
which can be obtained either by ownership (a capital
expenditure) or rental. If monthly rent is netted out to
produce “proceeds,” the capital expense of ownership (or,
equivalently, monthly depreciation on the building) also
must be netted out; capital and recurring expenses are
fundamentally the same for this purpose.
6                                  Nos. 06-3458 & 06-3502

  There is no warrant in Scialabba for treating capital
outlays differently from recurring expenses of the Royal
Health Spa. The real question is whether Scialabba
survived the Supreme Court’s decision in Santos.
   Four Justices in Santos concluded that “proceeds” in
§1956 always means net income. Four concluded that the
word always means gross income. Justice Stevens con-
cluded that the meaning depends on the nature of the
crime—that it means net income for unlicensed
gambling (the subject of Santos and Scialabba) but could
mean gross income for drug rings. We asked the parties to
file supplemental briefs addressing the question how
Santos applies to a brothel (operated in a place where
prostitution is unlawful) that lets the patrons pay by
credit card. The United States has conceded that the net-
income approach of Scialabba remains controlling.
  Whether the concession was appropriate is a difficult
question, which we need not answer since the prosecutor
has forfeited any benefit that Justice Stevens’s approach
may offer. Justice Stevens concluded not only that
normal business expenses are not proceeds but also that
the money-laundering statutes should be construed to
avoid raising the maximum punishment for a substantive
offense that necessarily entails the use of gross revenues
to carry on the business:
    [T]he penalties for money laundering are substan-
    tially more severe than those for the underlying
    offense of operating a gambling business. A money
    laundering conviction increases the statutory
    maximum from 5 to 20 years, and the Sentencing
Nos. 06-3458 & 06-3502                                     7

    Commission has prescribed different Guidelines
    ranges for the two crimes. When a defendant has
    a significant criminal history or Guidelines en-
    hancements apply, the statutory cap of five
    years . . . is an important limitation on a defen-
    dant’s sentence—a limitation that would be evis-
    cerated if [a gross-receipts] definition of “pro-
    ceeds” were applied in this case.
    ...
    The revenue generated by a gambling business that
    is used to pay the essential expenses of operating
    that business is not “proceeds” within the meaning
    of the money laundering statute. As the plurality
    notes, there is “no explanation for why Congress
    would have wanted a transaction that is a normal
    part of a crime it had duly considered and appro-
    priately punished elsewhere in the Criminal Code,
    to radically increase the sentence for that crime.”
    [128 S. Ct. at 2027.] This conclusion dovetails with
    what common sense and the rule of lenity would
    

(Stevens, J., concurring). All of this is
equally true of a brothel’s rent and utilities. It is not
necessarily true of a brothel’s advertising.
  Justice Stevens was worried about duplication of legal
prohibitions—about a situation in which it is impossible
to commit the substantive offense without committing
money laundering, unless the defendant eats or burns
the currency he takes in. But §1956(a)(1)(A)(i), which
forbids the “promotion” of certain unlawful enterprises,
8                                   Nos. 06-3458 & 06-3502

does not create the same problem of duplication. It is
possible to carry on organized crime without ad-
vertising it. Moreover, unless the costs of advertising are
included in the “proceeds” subject to §1956(a)(1)(A)(i), that
statute will never apply. Courts hesitate to read statutes
in ways that make them pointless, so Justice Stevens
may well conclude that at least for the purpose of
§1956(a)(1)(A)(i) advertising costs are not subtracted
when defining “proceeds.” Combined with the four
Justices who adopted the gross-revenue definition of
“proceeds” in Santos, that would produce a majority for
a conviction under §1956(a)(1)(A)(i) of someone in
Kubly’s position.
  But not, however, a conviction of Kubly himself. First,
the prosecutor has conceded that, for the purpose of this
appeal, Scialabba rather than Santos controls. Such a con-
cession cannot bind the court to one legal rule rather
than another, but it can forfeit the benefit of a particular
rule for one case. Second, the jury instructions at Kubly’s
trial did not distinguish between advertising and other
expenses. The jury was told that it could convict if it
concluded that Kubly spent money on advertising, or
rent, or utilities, or almost anything else, in order to
carry on the business. As a matter of law, a brothel’s
expenditures on rent and utilities do not come from net
proceeds and so do not violate §1956(a)(1), which means
that a general verdict cannot stand. Compare Yates v.
United States, 

(1957), with Griffin v. United
States, 

(1991).
  Kubly must be resentenced in light of this conclusion,
but Hodge’s convictions are based on her guilty plea, so
Nos. 06-3458 & 06-3502                                   9

we must address her arguments about the sentence. By
pleading guilty to money laundering as well as racketeer-
ing, Hodge bargained away the opportunity to make
the sort of argument on which Kubly has just prevailed.
She did this with eyes open, for her guilty plea came
more than three years after Scialabba. In exchange for
giving up the right to force the prosecutor to show that
the business laundered its profits, Hodge received a
reduction for acceptance of responsibility. (That’s why
her sentence is lower than Kubly’s.) For all we know the
prosecutor could have shown that Hodge and Kubly did
engage in prohibited financial transactions with the
profits of their illegal business. The prosecutor tried to
prove that offense against Kubly the easy way (every
business must cover its expenses) rather than by
showing how the business used its profits. One can’t rule
out the possibility that the prosecutor could have estab-
lished a prohibited use of the profits. Laundering the
proceeds of organized crime is indeed illegal. Because
the indictment against Hodge could not be dismissed
for failure to state an offense, she is bound by her plea.
  One of Hodge’s arguments is that the forfeiture is
excessive because it represents the intake of the business
(at least, the portion paid by credit card) without sub-
tracting revenues from the lawful shower-and-massage
service. When a business has both lawful and unlawful
aspects, only the income attributable to the unlawful
activities is forfeitable.
  That is because the forfeiture statute covers only income
and assets obtained from the unlawful deeds. 18 U.S.C.
10                                  Nos. 06-3458 & 06-3502

§981(a)(2)(A). The problem for Hodge is that most custom-
ers came to the Royal Health Spa (a shabby storefront
despite its lofty name) for sex. If every customer paid
for sex, then the initial charge was just an admission fee.
A brothel that collected $50 at the door, plus fees for
specific sexual acts, could not avoid forfeiture of the
$50 cover charge. The initial fee at the Royal Health Spa
may be just such a cover charge. To put this otherwise, if
the only reason why anyone paid for a massage at the
Royal Health Spa was to purchase sexual services, then
all of the business’s income derives from prostitution
and is forfeitable. United States v. Baker, 

(7th Cir. 2000). The statute says that derivation may be
direct or indirect. It is apt to treat an entrance fee as an
indirect part of the compensation for the illegal acts.
  According to evidence at Kubly’s trial, however, some-
where between 20% and 50% of the spa’s customers
never signed a second credit slip. This could mean that a
substantial fraction of the spa’s business was the pro-
vision of lawful massages. Or it could mean that these
customers paid the prostitutes in cash. The district judge
did not attempt to sort this out. As we see things, the
difference matters. If the spa did a substantial lawful
business, then the revenues of the lawful activity are not
forfeitable. If the lack of a second credit slip means
only that the clients paid in cash, however, and the busi-
ness as a whole was overwhelmingly devoted to prostitu-
tion, then everything is forfeitable. The subject requires
more attention on remand. If the business as a whole
would have closed its doors but for the prostitution
component, then it makes sense to say that all of its
Nos. 06-3458 & 06-3502                                        11

revenues derive (if indirectly) from prostitution; but if it
could have operated as a legitimate massage parlor, then
the revenues of the legal part of the business are not
forfeitable.
  Hodge contests her prison sentence as well as the
forfeiture. When calculating the guideline range, the
district court started with U.S.S.G. §2S1.1, which deals
with money laundering. Guideline 2S1.1(a)(1) says that
the base offense level comes from “[t]he offense level for
the underlying offense from which the laundered funds
were derived” when that level is ascertainable. That sent
the district court to U.S.S.G. §2G1.1, which deals with
commercial prostitution. That guideline provides a
base level of 14. The district judge then returned to
§2S1.1(b)(2)(B) and added two levels because Hodge
had been convicted under §1956. She contends that this
addition is inappropriate because U.S.S.G. §1B1.5(b)(1)
says:
    An instruction to use the offense level from
    another offense guideline refers to the offense
    level from the entire offense guideline (i.e., the base
    offense level, specific offense characteristics, cross
    references, and special instructions), except as
    provided in subdivision (2) below.
Subdivision (2) adds that an instruction “to use a
particular subsection or table from another offense guide-
line refers only to the particular subsection or table refer-
ences, and not to the entire offense guideline.” Guideline
§2S1.1(a)(1) sends the court to the base offense level of
the substantive offense, not to a particular table or sub-
12                                 Nos. 06-3458 & 06-3502

section. It follows, Hodge maintains, that §2G1.1 covers
additions as well as the base level, and as that section
does not provide an enhancement for convictions under
§1956 the offense level should have remained at 14.
  The prosecutor responds: “If the specific enhancement
in U.S.S.G. §2S1.1(b)(2)(B) were not to apply, then there
really would be no punishment under the Guidelines
for the money laundering conviction.” True enough, but
how does this meet the argument that §1B1.5(b)(1) pre-
vents the court from combining the features of two guide-
lines? What the prosecutor wants is the use of a base
level plus cumulative enhancements under two guide-
lines. That certainly would lead to higher sentences but
is not a sound understanding of the Sentencing Com-
mission’s approach.
  Section 2S1.1(a) was amended in 2001 to incorporate the
guidelines for the underlying substantive crimes. Amend-
ment 634, effective Nov. 1, 2001. In the prosecutor’s view,
this amendment is designed to use the guideline for
the substantive offense only when it is greater than the
guideline for money laundering; when the money-launder-
ing guideline is higher, it should continue to apply—and
ideally, as the prosecutor sees things, it should be
possible to combine a higher base offense from the sub-
stantive crime with the enhancements from the money-
laundering guideline, to yield the longest possible sen-
tence.
  This is not, however, what the amended language of
§2S1.1(a)(1) says. The Guidelines have plenty of “use X if
higher” clauses; §2S1.1(a)(1) is not among them. True
Nos. 06-3458 & 06-3502                                    13

enough, one reason for the amendment was a belief that,
if the substantive offense is very serious, the sentence
should be higher than one based on money laundering
alone. The Sentencing Commission said as much in
its explanation for Amendment 634. But the Commission
also explained that its goal was to reduce the effect of
charging decisions and make the sentence reflect real-
offense behavior.
    This amendment is designed to promote propor-
    tionality by providing increased penalties for
    defendants who launder funds derived from
    more serious underlying criminal conduct, such as
    drug trafficking, crimes of violence, and fraud
    offenses that generate relatively high loss
    amounts, and decreased penalties for defendants who
    launder funds derived from less serious underlying
    criminal conduct, such as basic fraud offenses that
    generate relatively low loss amounts.
Sentencing Guidelines Manual App. C (Vol. II) 222 (empha-
sis added). The prosecutor’s suggestion that the 2001
amendment propels sentences higher, but never lower, is
at odds with this explanation.
  Two courts of appeals have held that the reference in
§2S1.1(a)(1) means that judges should use the offense
level calculated under the substantive guideline as the
base level for money laundering, and then make any
other adjustments that the money-laundering guideline
provides. See United States v. Anderson, 

, 327–28
(6th Cir. 2008); United States v. Cruzado-Laureano, 

, 48 (1st Cir. 2006). Using the guideline (including its
14                                     Nos. 06-3458 & 06-3502

adjustments) for one offense as the “base” level for
another is an unusual approach, but it has the support
of the Commission’s own explanation:
     For direct money launderers (offenders who com-
     mit or would be accountable under §1B1.3(a)(1)(A)
     (Relevant Conduct) for the underlying offense
     which generated the criminal proceeds), subsection
     (a)(1) sets the base offense level at the offense
     level in Chapter Two (Offense Conduct) for the
     underlying offense (i.e., the base offense level,
     specific offense characteristics, cross references,
     and special instructions for the underlying of-
     fense).
Sentencing Guidelines Manual App. C (Vol. II) 222. This
implies that §2S1.1(a)(1) sends district courts to the com-
plete substantive guideline, not just its base offense
level, and that the result is then plugged back into the
base for money laundering. Another comment by the
Commission says that things work this way:
     As a result of the enhancements provided by
     subsections (b)(2)(A), (b)(2)(B), and (b)(3), all direct
     money launderers will receive an offense level
     that is one to four levels greater than the Chapter
     Two offense level for the underlying offense,
     depending on the statute of conviction and sophis-
     tication of the money laundering offense conduct.
Sentencing Guidelines Manual App. C (Vol. II) 223 (empha-
sis added). Adding levels for “all” direct launderers is
possible only if, as Anderson and Cruzado-Laureano hold,
§2S1.1(a)(1) plugs the full offense level for the substan-
Nos. 06-3458 & 06-3502                                 15

tive guideline into the “base” level for money laundering.
If this is hard to reconcile with §1B1.5(b), so be it;
the Commission is entitled to modify its own handiwork,
and Amendment 634 was adopted long after §1B1.5(b),
which was part of the original Guidelines of 1987.
  The Commission’s statement that “all direct launderers”
receive extra levels under §2S1.1(b) speaks to Hodge’s
situation. That, plus our reluctance to create a conflict
among the circuits, leads us to join Anderson and Cruzado-
Laureano in concluding that §2S1.1(a)(1) treats sub-
stantive guidelines as providing base offense levels for
the purpose of §2S1.1.
  Defendants’ other arguments do not require discussion;
they have been considered and are rejected. Kubly’s
conviction under §371 and §1952(a)(3) is affirmed, but
his conviction under §1956 is reversed and his case re-
manded for resentencing. Hodge’s sentence of imprison-
ment is affirmed, but the forfeiture is vacated and re-
manded for proceedings consistent with this opinion.




                          3-11-09