Saturday, August 13, 2005

Is There a Bright Line Between Civil and Criminal Fraud?

Bruce Carton on the Securities Litigation Watch blog (here) and Prof. Larry Ribstein on the Ideoblog (here) raise questions about when a securities fraud case, perhaps more specifically a case involving accounting issues, moves from being a civil to a criminal case, and whether the direction of a case is anything more than the "corporate crime lottery."  Prof. Ribstein's post asks: "So will somebody explain where this magic bright line is between criminal and non-criminal fraud?"  I assume the question is somewhat rhetorical, because I'm not sure there ever was a "magic bright line" between the frauds, and given their roots in the common law crime of larceny I'm not sure there's any significant difference between them -- except, of course, the penalty.  It is not much of an answer to say that anything civil could be criminal, although as Mr. Carton points out every violation of the federal securities laws (and regulations) could be prosecute criminally, although a specific intent to commit securities fraud must be proven and not just recklessness.  Anyone who has tried (and no doubt failed) to explain to a criminal law class the difference between knowledge (including willful blindness) and recklessness knows how thin that magical line can be too.

The question is whether it is indeed a lottery, in the sense that the decision to pursue a criminal case is random, based on unaccountable variables.  I think (and hope) the answer is no, that there are certain signposts that prosecutors look for in deciding whether to pursue a criminal case based on accounting decisions.  WorldCom involved a number of false entries in the company's books, and not just "shading" of the numbers, at least as admitted by the five cooperating defendants who were sentenced over the past week or so.  There have been quite a few criminal accounting cases over the past few years involving false receivables, inflated inventory, and round-trip transactions to give the appearance of actual revenue.  One indicia that prosecutors look for is some type of clearly false document or transaction to build a case around, and not just a questionable accounting judgment.  But then, there is a tough line to draw between what is false and what is a judgment (check FASB 5 for the ultimate in judgment calls).  There is not a simple checklist that prosecutors use in deciding whether to pursue a case or leave the remedy to the civil side.  Cases tend to start with the regulatory agencies agencies (SEC, CFTC), and often the first-cut is made there regarding the strength of the case and whether to refer it to the criminal authorities.  Like anyone else, the regulators want to be heard, and so they will reserve the more egregious cases for a criminal referral.  That's not to say that headlines don't generate grand jury investigations, although if a case makes the front page of the Wall Street Journal it probably would have gone criminal at some point.

Does the size of the company matter?  It certainly does to the SEC because of its investor-protection mission, and likely matters to the U.S. Attorney's Offices because they are concerned about resource allocation, and a large public company will generate more interest.  Although most offices don't acknowledge a monetary cut-off point for taking a case, they will not pursue small dollar cases with few victims or only a minimal impact.  Another thing that gets the attention of both the civil and criminal players is the nature and extent of cooperation, or on the flip side any indication of perjury or obstruction of justice will shift a case over to the criminal side in a hurry.  It is sometimes hard to figure out why a criminal investigation has started (see the post today on a criminal investigation of Collins & Aikman) because the government does not disclose the rationale for its decision and companies provide as little information as possible.  Any number of cases don't pan out on the criminal side, and may not even result in a civil enforcement action.

Finally, for all the discussion of corporate crime prosecutions, the vast majority of cases in this field are brought against individuals and not companies.  A number of recent high-profile cases against senior executives did not involve any criminal charges against the companies: Enron, WorldCom, Adelphia Communications, and HealthSouth.  The recent trend to use deferred prosecution agreements for companies (e.g. Bristol-Myers Squibb, Time, and perhaps KPMG in the next few weeks) may result in an increase in the number of cases against corporations.  If a company complies with the agreement, though, the criminal charges are dismissed.  The main focus will continue to be on individuals, particularly senior officers of companies, including CEOs.  The current investigation of the reinsurance industry has already resulted in plea agreements by senior General Re officers, and may extend all the way to its former CEO.  Is that the result of a lottery?  Are there cases involving similar or greater misconduct that are not prosecuted criminally, or even ignored by the civil regulators? I have rambled long enough, especially for a Saturday. (ph)

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Civil Enforcement, Fraud, Prosecutions | Permalink

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