Thursday, June 30, 2005
A Wall Street Journal article (here) discusses recent efforts by the NASD and the New York Stock Exchange to come up with rules governing the amount and types of entertainment that brokerage firms can provide to executives at mutual funds. As discussed in an earlier post (here), the SEC is investigating Fidelity Investments, among other firms, for the receipt of lavish entertainment from brokerage firms seeking a slice of the approximately $1 billion the firm spends annually on commissions for its massive mutual and pension funds. The Journal article notes that the U.S. Attorney Office in Boston is conducting a grand jury investigation into whether fund executives received not only the usual perks -- free golf, tickets to sporting events, and elaborate dinners at fine restaurants -- but also drugs and trysts with prostitutes. That's a tough one to expense, and the brokerage firms may have a bit of books-and-records problem if it turns out company funds were used for the latter purposes.
Although the NASD has a $100 limit on gifts, there is no regulation in place on entertainment except that it can be "neither so frequent nor so extensive as to raise any question of propriety." That's about as helpful as writing an admonition "Don't do anything stupid." Many firms have their own internal policies, but those can often be avoided or waived. Among the possible limitations being kicked around at this point is to limit the value of any entertainment to $350 per person without prior approval, an amount sure to cause some New York restaurants to view as unworthy of their appetizer menu. Gift and entertainment policies are often like tax provisions, viewed as something to be gotten around rather than a guideline to proper conduct. We'll see if anything concrete comes from the current effort, although a criminal indictment would get everyone's attention in a hurry. (ph)
Robert Johnson, the former CEO of financial information and document management firm Bowne & Co., and also a former publisher of Newsday and member of the New York Board of Regents, was charged with two counts of possession of child pornography and one count of obstruction of justice (indictment here on Findlaw). In May 2004, Immigration and Customs Enforcement (ICE) agents tracked to a Bowne computer the downloading of child pornography from the internet and paid registration at websites that sell child pornography. ICE agents contacted the company to track the internet user to determine his identity. According to the indictment, the agents did not know Johnson was the user, and two company executives contacted about the investigation did the logical thing -- they told the CEO about the ICE investigation. At this point, according to the government, Johnson obtained a computer program called "Evidence Eliminator" and used it to remove child pornography from his work computers (desktop and laptop). (Child pornography is bad enough, but using your work computer to store the images is even more stupid) Once the user was identified, Bowne turned over Johnson's computers for a thorough analysis by government computer experts to recover some of the 12,000 destroyed files.
The obstruction charge against Johnson is under 18 U.S.C. Sec. 1519, a provision added by the Sarbanes-Oxley Act in 2002 when it appeared that the type of document destruction by Arthur Andersen might fall outside the general obstruction statute, Sec. 1512. Section 1519 provides:
Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.
The charge here involves impeding the ICE investigation by using the file removal program, which is a bit easier to prove than a Sec 1512(c)(1) charge ("Whoever corruptly— (1) alters, destroys, mutilates, or conceals a record, document, or other object, or attempts to do so, with the intent to impair the object’s integrity or availability for use in an official proceeding") because it avoids the "official proceeding" element.
It is also interesting to note Bowne's public disclosure about Johnson in May 2004, when this conduct occurred. A company press release (here) on May 17, 2004, a week after the seizure of Johnson's computers, states: "Bowne & Co., Inc. (NYSE: BNE), a global leader in delivering high-value document management solutions, announced today that Robert M. Johnson, chairman, president and chief executive officer, has retired from the company and the board of directors for personal reasons." We now know what those personal reasons were. An AP story (here) discusses the case. (ph)
The federal investigation of San Diego-area Congressman Randy (Duke) Cunningham's sale of his home in 2003 to Mitchell Wade, a friend, campaign contributor, and founder of MZM Inc., a Washington D.C. defense contractor, now includes a grand jury subpoena to Rep. Cunningham for his documents related to the sale. As discussed in an earlier post (here), Cunningham sold his home to Wade for approximately $1.7 million in November 2003, and a year later Wade sold the home for $700,000 less, even though it is in one of the hottest housing markets in the country. Rep. Cunningham described the transaction recently as showing "poor judgment" but that there was nothing criminal involved. Wade's company, MZM Inc., is a defense contractor that has seen its revenue grow by 285% over the past two years by providing intelligence services to the Pentagon, much of it related to the war on terrorism and the Iraq conflict. On the company's website (here) is the following statement: "Our values: Integrity, loyalty, reliability and the highest moral conduct in business."
Cunningham is a member of the Defense Appropriations Subcommittee of the House Appropriations Committee, which approved the contracts for the company. The Defense Department's Inspector General suspended a five-year, $163 million contract with MZM because the agreement did not meet the competitiveness requirements for government contracts. An AP story (here) notes that another California Congressman, Jerry Lewis, who was chairman of the Defense Appropriations Subcommittee last year, said that all contracts approved by his subcommittee "passed the smell test." That sure is a high standard for contracting with the government. MZM also announced recently that James King, a retired Army general, has taken over for Wade as president of MZM. (ph)
Five defendants, including the chairman of the Democratic party in East St. Louis, IL, Charles Powell, Jr., were convicted of conspiracy and vote fraud for offering voters small amounts of cash, cigarettes, and liquor to vote in the 2004 Presidential election. The other defendants were a former director of regulatory affairs for the city, and three Democratic precinct committee members. In March, four other precinct committee members entered guilty pleas and cooperated in the prosecution (see U.S. Attorney's Office press release here). The prosecution relied on tape recordings that included Powell discussing paying $5 per vote. An AP story (here) discusses the guilty verdict. (ph)
Wednesday, June 29, 2005
On the TV lawyer shows, once the jury announces a not guilty verdict -- the outcome of both Matlock episodes I've watched -- everyone leave the courtroom and nothing further happens to the defendant. Not so, most likely, with Richard Scrushy. As discussed in our earlier posts (here and here) and in news stories (see AP story here), the government appealed the dismissal of three perjury charges and an obstruction of justice charge during trial because of misconduct by the prosecutors and the SEC in connection with taking Scrushy's deposition in the SEC investigation. Because the dismissal was not based on the sufficiency of the evidence, the government has the right to appeal and, if the Eleventh Circuit reverses U.S. District Judge Karon Bowdre's order, the government can retry Scrushy, as it has indicated it will. That may be a bad tactical decision, as Ellen has already noted, and the odds of winning a retrial are not very high, given that the case will be in Birmingham.
There's another issue in that Scrushy's lawyers will likely argue regarding the perjury/obstruction counts aside from the merit of Judge Bowdre's decision, and that is whether the jury's not guilty verdict on the 36 counts constitutes collateral estoppel on the perjury charges. Under the double jeopardy clause, the Supreme Court has recognized that the government may be collaterally estopped from prosecuting a different crime if the jury has already decided the underlying factual basis in favor of the defendant in a prior proceeding. The main case in this area is Ashe v. Swenson, which involved a second prosecution for robbing a participant in a poker game after the defendant was acquitted of robbing another participant in the same game. Scrushy will argue that the perjury counts (indictment here), which allege that he knew the company's financial statements were false when he testified as to their veracity, were effectively decided by the jury when it accepted his defense that he was misled by the company's CFOs and had no knowledge of improper accounting or revenue recognition. Collateral estoppel is a very difficult argument to win, but in this case, at least with regard to the perjury charges, Scrushy has a good claim that the not guilty verdict means that he did not know of the fraud, and therefore could not have intended to testify falsely.
Although most of the criminal case is over, and perhaps all of it, the SEC plans to pursue its civil enforcement action alleging securities fraud related to both the false financial statements and insider trading related to Scrushy's sales of HealthSouth stock. The judge in that case has scheduled a hearing in July to consider whether to dismiss the case, and the Commission will argue that the acquittal has no effect on the civil case because of the different burdens of proof. The standard understanding in this area is that the not guilty verdict does not mean the person is innocent, only that the government did not prove the case beyond a reasonable doubt, so the civil case with its lower "preponderance of the evidence" standard can go forward. This case, however, has been far from standard, beginning with the asset freeze hearing in 2004, so it is difficult to predict what will happen. If the SEC case does move forward, the Commission will be able to depose Scrushy, and call him to testify at trial, unlike in the criminal case. Fireworks are sure to ensue from that confrontation.
The media reports also hint that Scrushy may seek to regain his job as CEO, and file a wrongful termination suit against the company. This will put him in a far different, and potentially weaker, position. As a defendant, he can rely on the burden of proof, while as the plaintiff he will have to establish that his termination was improper. Given that his defense in the criminal case was that he was misled for years by CFOs and others about the company's false accounting, that is hardly an endorsement of his conduct as CEO of the company. What worked as a criminal defense may undermine his claim that he was removed from office wrongfully when all these problems happened on his watch and, perhaps, with a measure of his participation. Once again, he will have to testify in a wrongful termination suit, and be subject to extensive cross-examination.
Finally, there can be plenty of litigation involving corporate issues if the board seeks to have the shareholders remove him, or if Scrushy mounts a hostile proxy to get himself and others on the board as a first step toward restoring himself to office. If the SEC were to win its securities fraud suit, he would be prohibited from serving as an officer and director for a period of at least five years, and HealthSouth's current management has been quite cooperative in the SEC's case. That could change if Scrushy retakes power, and he may be thinking that the best defense here is a good offense (hey, this is football country!).
Unlike a Matlock episode, this one will be in court for a while yet. (ph)
Update (6/29): Not to belabor the point, but Scrushy's employment agreement is available at Findlaw (here), and contains the following provisions for termination:
(c) Termination for Cause. The Company may terminate the Executive's employment hereunder for Cause. For purposes of this Agreement, the Executive shall be considered to be terminated for "Cause" only if (i) the Executive is found, by a non-appealable order of a court or competent jurisdiction, to be guilty of a felony under the laws of the United States or any state thereof or (ii) the Executive is found, by a non-appealable order of a court of competent jurisdiction, to have committed a fraud, which has a material adverse effect on the Company. However, in no event shall the Executive's employment be considered to have been terminated for "Cause" unless and until the Executive receives a copy of a resolution duly adopted by the affirmative vote of a majority of the Board at a meeting called and held for such purpose (after reasonable written notice is provided to the Executive setting forth in reasonable detail the facts and circumstances claimed to provide a basis of termination for Cause and the Executive is given an opportunity, together with counsel, to be heard before the Board) finding that the Executive is guilty of acts or omissions constituting Cause.
(d) Termination other than for Cause. The Board shall have the right to terminate the Executive's employment hereunder for any reason at any time, including for any reason that does not constitute Cause, subject to the consequences of such termination as set forth in this Agreement.
For a non-cause termination, Scrushy receives a number of benefits as set forth in the agreement. Yet one more cost to the company, most likely, along with the attorney's fees from the defense. (ph)
The Supreme Court granted cert. at the end of the term earlier this week in two civil RICO cases that are of interest. On Monday, the Court granted cert in Bank of China v. NBM LLC, on the following question: Did the Court of Appeals for the Second Circuit err when it held that civil RICO plaintiffs alleging mail and wire fraud as predicate acts must establish "reasonable reliance" under 18 U.S.C. §1964(c)? The plaintiff, Bank of China, won a $106 million RICO verdict in the district court based on claims of mail and wire fraud related to a scheme to defraud the bank. The defendants alleged that employees and officers of the bank were aware of the false statements, and therefore the reliance element for a common law fraud could not be met. The Second Circuit held (opinion below) that the proximate cause requirement to prove a RICO injury to business or property under § 1964(c), when based on mail or wire fraud, requires proof that the plaintiff reasonably relied on the misstatements or omissions, and the trial judge's instructions did not include that requirement, and therefore the verdict had to be vacated. Although the Supreme Court held in Holmes v. SIPC that RICO requires proof of proximate cause from the pattern of racketeering activity, it has not explained that position in any detail, and the circuits have taken different approaches to that requirement. Interestingly, the Solicitor General opposed the cert. grant, a position the Court chose to ignore after inviting the Government's view on the petition (SG Brief here).
On Tuesday, the Court announced the cert. grant in a familiar case, the third trip to the Supreme Court in the civil RICO abortion clinic access case, Scheidler v. NOW. Earlier opinions in 1994, on whether RICO requires an economic motive or purpose (it does not), and whether extortion under the Hobbs Act (as a predicate RICO racketeering act) requires that the defendants obtain or attempt to obtain property from the victim (it does). The question presented in the third iteration of the case is: Did the Seventh Circuit err when it held, on remand from the Supreme Court, that properly tailored injunctive relief may be available to redress Racketeer Influenced and Corrupt Organizations Act violations by abortion protesters based on jury findings that they committed predicate acts of violence and threats of violence in violation of the Hobbs Act? This round takes us to the remedy portion of RICO, outside of treble damages and attorney's fees that are provided in the statute, to the issue of the court's power to issue equitable relief even when it is not mentioned in the statute. An earlier post (here) discusses the cert. petition and contains a link to the petition filed by Scheidler.
In case anyone knows the answer to this trivia question, how many cases have gone to the Supreme Court three times? The winner gets my heartfelt congratulations on being a bigger geek than I am. (ph)
One of the issues raised in the debate of the Sarbanes-Oxley Act was the role of lawyers in corporate misconduct. One provision of the Act, Section 307, adopted the up-the-ladder reporting requirement for corporate counsel. Another aspect of the SEC's push to regulate securities lawyers is to bar them from appearing before the Commission because of their role in a client's securities fraud, similar to a disbarment by a state bar but limited to the practice of securities law before the Commission. Twice this week the SEC issued administrative orders, which were agreed to by the attorneys, imposing a bar from practicing before the Commission for their respondent's role in fraudulent transactions. One attorney, Warren Soloski, a California lawyer, was outside counsel to a company and advised its CEO in the dissemination of false information to manipulate its market price (order here). In the second action, David Klarman, another California lawyer, was general counsel to U.S. Wireless Corp. and was involved in the embezzlement of shares from the company. In addition to his practice bar, in a separate injunctive action Klarman was ordered to disgorge over $3 million in ill-gotten gains (order here). With all the allegations surrounding Milberg Weiss, the practice of securities law is coming under increased scrutiny for its ethical fiber. (ph)
Just to note that some judges continue to adhere to the Federal Sentencing Guidelines and impose significant sentences on defendants in white collar cases, U.S. District Judge Joseph Greenaway in New Jersey sentenced Rene Abreu to an 87-month term of imprisonment for his leading role in a large-scale bank and mail fraud scheme involving his company, The Mortgage Pros. The sentence was at the top of the advisory Guidelines sentencing range. According to a press release issued by the U.S. Attorney's Office (here): "Abreu was convicted on Aug. 4, 2004, on 21 counts of the 28-count Indictment naming him, three employees and a senior vice president of Hudson United Bank. The counts of conviction against Abreu included conspiracy to commit mail fraud, conspiracy to defraud Hudson United Bank by engaging in a fraudulent check-kiting scheme, conspiracy to structure currency transactions and specific counts of mail fraud, bank fraud and cash structuring." In a sure sign that bad things were to come, the judge said that Abreau moved from being an admired businessman to a "plain crook." A seven year term for a fraud that resulted in a restitution order of a little less than $500,000 is a substantial term of imprisonment, and the status of the defendant clearly got Judge Greenaway's attention. (ph)
Tuesday, June 28, 2005
The "not-guilty" verdict in the Scrushy trial is not surprising, although its timing is -
1. The judge replaced a juror after 16 days of deliberations, telling them to start "anew." But 4 days later there is a verdict. Did they really start anew? Or did this new juror help to reconcile the prior split that the jury had?
2. No one really won here. The government received a "not guilty" on a major case it had worked on for years - - a case that had to have cost taxpayers significant amounts of money. The company paid 100 million in a civil penalty. And Richard Scrushy, although walking out of court a free man, has had to have suffered enormously throughout this process. As he stated earlier, it is a shame that his father who passed away days ago did not get to hear the sound "not-guilty" after sitting through the entire trial.
3. Using the Sarbanes-Oxley Act will not mean an automatic guilty verdict for the government.
4. Jurors want to know that a defendant is responsible for the acts and that he or she really knew what was happening at a company - - that is before they will convict - and at least in Alabama.
5. One has to wonder what effect the prosecutor's conduct had on the jury-- the repeated references to Enron and WorldCom, even after being admonished by the judge not to do this. Also the government sending witnesses in who are wired up to "get" evidence is probably not something that plays well in the south. The fact that the government used so many charges - "the throwing of spaghetti against the wall and hoping something sticks" can make jurors wonder if the government really has a strong case.
6. And finally, the most important - Richard Scrushy is innocent. Maybe this verdict is because he did not know what others in the company, other who did plead guilty and tried to cut deals for themselves (although 2 sentences were vacated see here), were doing in the company. With jurors listening attentively to the trial, taking its time to deliberate, the reason for this result is because it represents what really happened here -- the man should not have been charged with a crime.
7. So government- my advice is to take this decision and move on to other cases. To proceed against Richard Scrushy on dismissed charges of perjury and obstruction of justice, as now stated by Alice Martin here is not the answer. And would this statement have been made if the verdict was guilty?
esp (from across the pond -in Edinburgh, Scotland - at the International Society for the Reform for Criminal Law -ISRCL).
P.S. I am still bothered by that other southern jury case (here), where the jurors had to work through Memorial Day weekend and Memorial Day.
The jury returned not guilty verdicts on all counts in the prosecution of Richard Scrushy, dealing the government a significant blow, at least for now. Among the charges was the first prosecution under the CEO/CFO certification provision adopted in the Sarbanes-Oxley Act (18 U.S.C. Sec. 1350), and the acquittal means that legal issues related to the provision, such as the requisite intent level for a violation, will have to await another case.
We will not doubt hear from the jurors later, and I expect their comments on the verdict to focus on the government's failure to meet its burden of proof and the credibility (or lack thereof) of the government's many witnesses who participated in the fraud at HealthSouth. One question for the government will be its decision to pursue the case in Birmingham, Alabama, which certainly gave Scrushy a "home court" advantage in a city in which he is well-known and was widely admired, at least by a segment of the population -- think about the prosecution of Bernie Ebbers in New York City, a venue that he challenged but did not win. While U.S. Attorney Alice Martin and some members of the prosecution team are equally local, it is almost impossible for the federal government to play the home town card.
The question now is what's next for Scrushy and HealthSouth. Just last week the company entered into a final settlement with the SEC on its civil securities fraud suit, agreeing to pay a $100 million penalty and to adopt corporate governance changes (Litigation Release here). The SEC's civil fraud suit against Scrushy is pending (complaint here), and his first victory against the government came last year when he defeated the SEC's attempt to freeze his assets. While Scrushy was dismissed as CEO in March 2003, when the fraud at HealthSouth first came to light, he remains a member of the board of directors, largely because the company has not been able to hold an annual meeting because of its inability to put out an audited financial statement until just last week. Scrushy owns over 3 million shares of HealthSouth stock, and still has stock options for 700,000 shares (see HealthSouth 10-K here). Given the "vindication" the verdict has delivered for his defense that he was misled by, among others, the Five Guilty CFOs, I think it is likely that Scrushy will seek to reclaim his position at the company he founded, or go down fighting any effort to remove him from the board.
The acquittal delivers even more bad news to the company because, under Delaware law (the jurisdiction in which HealthSouth is incorporated), Scrushy has been "successful on the merits or otherwise" in the criminal trial for conduct related to his actions on behalf of the corporation. Therefore, under Delaware General Corporation Act Sec. 145(c), the company is legally required to pay all of his attorney's fees related to the criminal case. There is litigation pending in the Delaware Chancery Court about the company's obligation to advance expenses in the criminal case (disclosed in the 10-K), but the acquittal means the decision is out of the hands of the board and the expenses must be paid. Scrushy had a large, and no doubt expensive, legal team, a bill the company will have to foot -- and disclose at some point, which will give us an idea of just how much this defense cost.
Each week seems to bring a new view of the success and failure of the government in prosecuting cases of corporate fraud. The convictions of Dennis Kozlowski and Mark Swartz for their conduct related to Tyco meant the government could not be stopped, while this verdict means the government has suffered a significant blow to its effort. I suspect the lesson the government will learn is to try to stay away from smaller venues, but we'll see if there's more.
These are just some first thoughts, and I'm sure Ellen will want to weigh in from across the pond in Scotland where she is at the moment, although it may take her a bit longer to supply a reaction. (ph)
The U.S. Attorney's Office for the Southern District of New York filed a memorandum on the government position on the sentencing of former WorldCom CEO Bernie Ebbers, which is currently set for July 13. The government's memorandum, which runs 83 pages (available below), adopts the position taken by the Probation Office that the loss from the criminal conduct was $2.223 billion (heaven knows how they came up with that total). Other enhancements recommended to the court (and supported by the prosecutors) are that the crime had more than 50 victims, Ebbers derived more than $1 million from the misconduct, and he had a leadership role in the offense. The PSR does not recommend an enhancement for obstruction of justice, but the government argues that Ebbers committed perjury, which can result in an additional two level enhancement. All told, the government calculates the offense level (under the advisory Federal Sentencing Guidelines) at 44 (the Sentencing Table only goes up to 43, so this is as high as a sentence can get), which would result in a life term of imprisonment. The government, not surprisingly, opposes Ebbers' arguments for a downward departure, and his argument that the loss was zero -- the latter will be a very tough sell to the judge, no doubt.
The last section of the government's memorandum is interesting because the prosecutors argue that the sentence Judge Barbara Jones imposes should be consistent with those given to other senior executives who engaged in significant fraud that caused their companies to collapse, triggering substantial losses for investors. The three examples of sentences that should guide the court as offered by the U.S. Attorney are John Rigas, former CEO of Adelphia Communications who received a 15 year sentence, Patrick Bennett, the former CFO of Bennett Funding who received a 22 year sentence (after resentencing), and Steven Hoffenberg, the former CEO of Towers Financial Corp. who received a 20 year sentence. While the Guidelines call for a life sentence, the government seems to be taking a more reasonable approach by asking for a sentence in the range of 15-20 years, which for a 63-year old man is virtually a life sentence. While I still stand by my earlier prediction of an 8-10 year sentence for Ebbers (a foolish consistency and all that), I suspect that the John Rigas sentence will likely be the floor for Ebbers, and the 20 years given to his son, Timothy, could well be the target. (ph)
The Johnson family, which controls Fidelity Investments, the mutual fund giant, has become part of the SEC investigation into gifts given by brokers seeking to obtain the business of large investment firms. An earlier post (here) discussed the investigation of Scott DeSano, a senior Fidelity executive in charge of stock trading, related to gifts he took that included a coveted slot to play in the Pebble Beach golf tournament that was paid for by Bank of America. According to a Wall Street Journal article (here), the Commission staff has questioned Edward C. Johnson, III, Fidelity's CEO, about tickets he received in 2002 to the women's figure skating final at the Salt Lake City Olympics, and his daughter, Abigail Johnson, also a senior executive at Fidelity, about her requests to other employees to obtain tickets from brokers doing business with the firm. The amounts involved are trivial compared to the wealth of the Johnson family members, but the issue is one of corporate culture rather than bribery. The expectation of perks, and the desire to furnish them, detracts from offering the best service at the lowest cost to customers of Fidelity (full disclosure: I have retirement money at Fidelity, too. I can't seem to miss with these firms!). No perk is cost free, even if you don't have to open up your wallet. To make matters a bit more interesting, in May, the U.S. Attorney's Office in Boston began conducting a criminal investigation of gifts to Fidelity executives (see N.Y. Times story here). (ph)
A Wall Street Journal article (here) indicates that one Paul Tullman, who entered into a guilty plea last year to tax charges, may be cooperating in the grand jury investigation of alleged payments made by Milberg Weiss to representative plaintiffs in securities class action and shareholder derivative suits (see earlier posts here and here). The law firm was an unnamed coconspirator in an indictment hand up last week against Seymour Lazar, who was a representative plaintiff in a number of cases in which Milberg Weiss was lead counsel. Tullman, like Lazar, is an attorney (and also a stockbroker), but the Journal article indicates that payments he received related to referring clients to the law firm, not for serving as a representative or named plaintiff. A quick Westlaw check did not disclose any cases in which Tullman was among the named plaintiffs in a case in which Milberg Weiss was counsel.
A referral fee is permissible under the legal ethics rules, so long as the fee-sharing arrangement is disclosed to the client and, in some states, the referring attorney must do some work on behalf of the client. There must be an attorney-client relationship between the referring attorney and the client for the payment of a referral fee, otherwise the payment would be improper, just like a payment to a person working in an emergency room who refers patients to a lawyer is unethical. While payments to a representative plaintiff would be unethical for the attorney, and improper for the plaintiff acting as a fiduciary for the class, a referral fee is a legal fee that, if properly disclosed to the client and the court, would not be problematic. If Tullman is cooperating, it will be interesting to see what information he can provide about possible payments to representative clients, the focus of the investigation to this point. (ph)
General Motors changed its policy in April when it stopped giving earnings guidance, no doubt because all the bad news of the past year meant its financial executives had to conduct conference calls while wearing flak jackets. When a company does not try to guide estimates of its quarterly and annual earnings, there is a greater likelihood that disclosure of financial information will move the market one way or the other (mostly down recently for GM, but that could change). In an apparent effort to avert any temptation for its executives to trade on financial information before its disclosure, the company issued a prohibition to all executives with access to sensitive financial information from all trading in GM stock, at least for the time being. It is unlikely the company will adopt a permanent ban on trading by its executives because stock awards are an important component of compensation at most publicly traded companies. GM may direct its executives toward a program of pre-planned sales through a written plan for securities transactions, which is permissible to avoid liability for insider trading under SEC Rule 10b-5-1(c) (here).
Given the gyrations in the company's stock, the threat posed by investor Kirk Kerkorian, who is now the largest individual shareholder in the company, and the need to renegotiate its retiree health care costs, the last thing GM needs to see is an allegation of insider trading by one of its executives. While the prohibition against insider trading is well-known, there is always a temptation to pick up a little "free money" that GM may be acknowledging as management tries to turn the company around. Of course, a cynic might argue that the restriction is really meant to keep executives from dumping shares after the recent run-up in the stock price, but I'm hardly a cynic. A Detroit News article (here) discusses the restrictions on trading imposed by the company. (ph)
The Enron Broadband Services prosecution of five former executives at the unit grinds into its third month, with three former high-ranking officers taking the witness stand to dispute the government's claim that they misled analysts and investors about the unit's technology and engaged in accounting fraud. Former executives Scott Yeager, a senior vice president for business development, and Rex Shelby, senior vice president of engineering and operations, have already testified, and former co-CEO Joe Hirko is on the witness stand. The other two defendants, Kevin Howard and Michael Krautz, who ranked more as mid-level officers on the finance side of the Broadband Services unit, appear to be left behind in the trial. A Houston Chronicle article on June 11 (here) notes that most of the testimony focuses on the statements and conduct of Hirko, Yeager, and Shelby, and that the judge sometimes does not even ask the other two defendants' attorneys whether they want to ask questions because there has been no mention of either. Moreover, unlike the other three defendants, Howard and Krautz are not charged with securities fraud related to sales of Enron stock, so there may be an even greater distance between them and the three more prominent defendants, who must defend sales of Enron shares that provided them with millions of dollars in profits before the company collapsed.
While the high-level executives have all taken the stand, I would not be surprised if Howard and Krautz do not testify to avoid bringing attention to themselves, relying instead on a "Hey, we're the little guys" defense, which is accentuated by their being almost ignored each day at trial, sitting at the back table in the defense area. An "Out of sight, out of mind" approach is not a bad strategy in a multi-defendant case that rises and falls on intent and whether statements were misleading. If the two mid-level executives don't testify, then the case may be able to go to the jury in fairly short order. The Houston Chronicle has excellent coverage of the trial in a number of stories available here, along with Tom Kirkendall's Houston's Clear Thinkers blog (which also includes a valuable update on the struggling Astros, who proved last year that the first half of the season does not determine the second half). (ph)
Monday, June 27, 2005
The potential that Milberg Weiss, one of the leading plaintiff class action firms, will be indicted triggered an interesting reaction from the firm, which argued that the government should not indict the partnership for wrongdoing by individual lawyers because of the effect on innocent employees. Earlier posts here and here discuss the indictment of Seymour Lazar for accepting payments from an unnamed New York law firm with California offices -- Milberg Weiss acknowledges that it is the law firm named as an unindicted coconspirator -- for serving as the named or representative plaintiff in over 50 class actions involving consumer complaints, securities fraud, and shareholder derivative claims. An article in the Wall Street Journal (here) discusses the law firm's response to the government investigation in which it cites the prosecution of Arthur Andersen as showing the harm that can befall innocent employees from an indictment of an organization.
Is Andersen an apt precedent? One important difference between the two situations is that Andersen's conduct was not directly related to its primary business as an accounting and consulting firm, and there was never an issue that its accounting at Enron, even if questionable, constituted criminal conduct. If Milberg Weiss attorneys made payments to individuals to serve as representative plaintiffs, and that conduct can be tied to the firm, then this goes to the core of the law firm, which is to represent clients before the courts in an honest and ethical manner. The payments would not only be improper, but more importantly would involve deceiving the court, opposing counsel, and the class members about the firm's involvement in the case. That strikes me as categorically different conduct than Andersen's document shredding, and calls into question the entire culture of the firm.
The impact of an indictment on Milberg Weiss will also have a different effect on the "innocent" employees and partners of the firm than the Andersen conviction. Accounting firms are licensed by the states, and the criminal conviction would have resulted in Andersen losing its license in almost every jurisdiction in which it practiced in the U.S., preventing the firm from providing services to publicly-traded companies. While lawyers are licensed by the states, law firms are not, so lawyers with no involvement in the misconduct will still be able to pursue their trade and can try to switch to a different firm or start their own firm. The support staff will suffer significant disruptions, but the number of law firms is much greater than the number of public accounting firms, so the job market is probably much better for them. While accounting went from the "Big Five" to the "Big Four" with Andersen's demise, there is no such effect on the plaintiff class action bar which has a number of firms that operate, and they may be in the market for experiences lawyers and support staff. The effect of the Andersen indictment went well beyond just that firm because of the oligopoly that exists in public accounting, a problem that will not affect the Department of Justice's analysis of Milberg Weiss as it has on whether to pursue criminal charges against KPMG for its tax shelter business (see earlier post here).
That's not to say that the indictment of a law firm should be pursued without considering the impact of a criminal conviction on its employees and partners. But if a law firm acts unethically in its representation of clients by paying kickbacks to representative plaintiffs, the harm to other clients of the firm will be substantial. While Andersen's other clients were affected by the criminal conviction, Milberg Weiss' clients may be represented by lawyers who do not put the client's interests first. (ph)
Eight term California Congressman Randy (Duke) Cunningham's sale of his home for $1.675 million in 2003 is the focus of an FBI investigation, according to an article in the North County (Calif.) Times (here). The purchaser was Mitchell Wade, a contributor to Rep. Cunningham's campaigns and the owner of MZM Inc., a defense contractor whose revenues have tripled over the past two years to approximately $65 million. The company provides intelligence services to the military, including translators in Iraq. Records show that Wade sold the house for $700,000 less than he purchased it from Rep. Cunningham approximately one year later -- this in one of the hottest housing markets in the country, which is saying a lot given the current real estate bubble. Rep. Cunningham is on the Defense Appropriations Subcommittee of the House Appropriations Committee, so the connection (if any) between his work on that subcommittee and the house sale is the likely subject of the investigation, i.e. whether the transaction, which appears to be at an above-market price, was a bribe or unlawful gratuity under 18 U.S.C. Sec. 201. An AP story (here) notes that Rep. Cunningham said in a written statement that the transaction with Wade showed "poor judgment." The article also notes that Rep. Cunningham lives on Wade's yacht in Washington DC, and he pays dock fees and other expenses. (ph)
The spate of high profile white collar crime trials over the past 18 months (or so) -- kicking off with Martha Stewart and Frank Quattrone through the jury deliberations about the fate of Richard Scrushy and leading up to the anticipated blockbuster Enron conspiracy trial of former CEOs Ken Lay and Jeffrey Skilling -- is triggering a reassessment of some of the so-called conventional wisdom in criminal prosecutions. An article in Business Week (here) highlights the strategies of prosecutors and defense counsel in white collar crime cases, touching on topics from indictments and plea bargains to pre-trial publicity and the decision whether to have the client testify. The author is even kind enough to mention this blog (I plead guilty to shameless self-promotion). (ph)
Sunday, June 26, 2005
A judge in Milan, Italy, ordered Parmalat CEO and founder Calisto Tanzi to stand trial beginning Sept. 28 on charges related to the accounting fraud that led to the company's bankruptcy. In addition, Italian officers of Bank of America, accounting firm Grant Thornton, and Parmalat's accountant Deloitte & Touche, are among others who will also be tried in the case. The Milan charges are the result of one branch of the investigation of Parmalat's collapse, which included falsified documents on Bank of America stationary indicating large accounts at off-shore banks that never existed, except of course on the company's balance sheet that was widely circulated to investors in its bonds. An investigation in Parma, Italy, site of the company's headquarters, is continuing. On the civil side of the Parmalat case, Morgan Stanley agreed to pay €155 million to settle claims by Parmalat related to underwriting of the company's bonds (8-K here). An AP story (here) discusses the charges against Tanzi and others. (ph)