April 30, 2005
The Steady Stream of Disclosures Continues for AIG
The daily dose of accounting revelations at American International Group is like water torture* for the company, with each disclosure discussing a seemingly new way in which it appears to have manipulated its premiums, quarterly income (see previous post here), and reinsurance risk (think General Re transaction). Today's example comes via a New York Times article (here) in which former executives of the company are said to have disclosed that from the mid-1990s until 2001, the company booked premium payments before a final contract was reached with the party purchasing the insurance so that division executives could meet their monthly numbers at the American Home Assurance and National Union Fire Insurance units. The article asserts that this pre-booking of premiums did not affect AIG's financial statements because the amounts were not large (about $1.5 billion at American Home and $100 million at National Union), and that contracts which did not come through were reversed in subsequent months. Whether it hit the bottom line or not -- and I suspect that at least some of the revenue and earnings manipulation disclosed in AIG's internal investigation would also incorporate early revenue recognition -- this type of activity is further evidence of a corporate culture that viewed the rules as obstacles to profitability rather than guides for how to conduct a business properly (see earlier post here regarding AIG's reporting of workers compensation premiums). Indeed, the article notes that AIG's internal auditors put the early premium revenue in a category called "Games," a sure sign that things were not on the up-and-up. Drip . . . drip . . . drip. (ph)
* Although it is usually called "Chinese water torture," this item from "The Straight Dope" (here) notes that it is not really a Chinese practice but a derogatory term.
Former Homestore.Com CEO Charged with Securities Fraud
Former Homestore.Com CEO Stuart Wolff and executive vice president Peter Tafeen were charged with securities fraud for a scheme to inflate Homestore's on-line advertising revenues through "round-trip" transactions in which the company recognized income by lending funds to advertising purchasers, who used the money to purchase ads on the firm's website. The source of the funds was not disclosed, and according to the government the transactions allowed the company to meet Wall Street's revenue expectations. Nine other former executives of the company have entered guilty pleas and settled civil charges filed by the SEC related to the fraud. A press release from the U.S. Attorney's Office for the Central District of California (here) discusses the indictment and related prosecutions. (ph)
Longest Serving New Jersey Freeholder Charged with Accepting Bribes
Harry Larrison, Jr., whose 39 years as a Monmouth County Freeholder (the county's governing board) made him the longest serving Freeholder in New Jersey, was charged with accepting at least $8,500 from developers doing work in Monmouth County. Larrison began in public service in 1956, and was appointed a Freeholder in 1966. He retired last December, and an article in the Atlantic Highlands Herald (here) about his service described his accomplishments:
Over the years Freeholder Larrison has played a crucial role in the progressive development of county government in Monmouth County, including an award-winning county park system, the finest and largest library system in New Jersey, Brookdale Community College, and the Monmouth County Vocational School System; each facility recognized in its respective field as a preeminent county institution in our state.
Freeholder Larrison is considered a visionary. In the early 1970's he foresaw the coming crisis in the area of solid waste disposal and championed the development of a county-owned and operated landfill in Monmouth County. With the opening of the Reclamation Center in Tinton Falls, Monmouth County was assured of a safe, cost-effective method of handling its solid waste for years to come. The County’s state-of-the art facility has helped improve the environment and spawned the development of recycling programs that have become the model for other counties in New Jersey.
Larrison allegedly accepted $5,000 in cash in 2001 or 2002 from a Monmouth County official who received the money from a developer on Larrison's behalf. According to the criminal complaint, Larrison wanted to take a trip to Florida and sent the county official - identified in the complaint as someone holding an administrative position in Monmouth County government - to meet with the developer at an establishment in South Amboy. There, the developer removed the cash from a safe and gave it to the county official, who, in turn, delivered it to Larrison at Larrison's home, whereupon Larrison gave $1,500 of the cash to this county official. The $5,000 payment was in exchange for Larrison's official assistance in connection with the developer's various projects in Monmouth County, according to the complaint.
Recordings and statements of the Monmouth County official, one of the developers and Larrison himself provided the basis for the criminal complaint. Larrison received another cash payment of $3,500 from a second developer in 2002 or 2003, according to the complaint. The cash, which was supposed to be part of a $5,000 bribe payment, was delivered to his home by the same Monmouth County official who delivered the earlier $5,000 payment.
Unfortunately for Larrison, his legacy is now tainted by his corruption with a charge of violating 18 U.S.C. Sec. 666. The criminal complaint is here.(ph)
Criminal and Civil Insider Trading Charges Against Six
The U.S. Attorney's Office for the Central District of California (Los Angeles) and the SEC announced the filing of criminal and civil insider trading charges against two former employees of the investment banking firms, Chanin & Co. LLC and Houlihan Lokey Howard & Zukin, Inc., and four tippees for trading on material nonpublic information about the following companies: NCS Healthcare, Inc., The DeWolfe Companies, Inc., Prime Retail, Inc., and Airborne, Inc. The two investment bankers, Doseph Shin and Robert Joo, were paid kickbacks by the tippees (Ernesto Sibal, Chae Hyon Chin, Benjamin Chiu, and Pejman Sabet), and the trading generated profits of over $970,000. Five defendants (all but Joo) settled the SEC civil complaint by agreeing to pay a total of approximately $1.1 million in disgorgement, penalties, and interest, and agreed to plead guilty to conspiracy to commit securities and wire fraud. Joo was indicted on eight count, including conspiracy, securities fraud, conspiracy to obstruct the SEC investigation, and making material false statements under oath to the SEC and FBI. The SEC Litigation Release is here, and a press release from the USAO is here. (ph)
April 29, 2005
Cross-Examination Begins - Dennis Kozlowski
The cross-examination of Dennis Kozlowski began yesterday. If this turns out to be the only defense witness, this trial may be over soon. The title of this morning's Wall Street Journal article here says it all - "Kozlowski Says He Didn't Notice $25 Million Missing From W-2." Now the question is whether his admission will be sufficient to the jury to demonstrate that the witness-defendant did not have the mens rea for the crimes charged. Will the jury believe the "honest but ignorant CEO" defense? It's difficult for the defense to convince people who may not think in terms of this amount of money, how someone could have overlooked 25 million.
And Kozlowski's cross examination may not have helped here. According to the Wall Street Journal, it says that "At times during yesterday's cross-examination, Mr. Kozlowski seemed to try to lighten the mood by giving jokey answers, which drew laughs from his friends and family in attendance." A witness-defendant who jokes on the witness stand can be problematic. In some cases you may want the witness to do this to lighten the tough tone exhibited by the person. But often this can make a jury think that the person doesn't take the charges and trial seriously. In some cases, the witness may be joking or laughing as a nervous reaction and there may be nothing the defense can do about it. It's unfortunate that the ability of the witness-defendant to present a certain imagine can sometimes have a strong influence in a trial. But sometimes, juries see through it all and do assess whether the person is telling the truth or not.
Tyson and SEC Settle
The SEC announced here that it settled with Tyson Foods and Don Tyson with an agreement of penalties to be paid by Tyson Foods in the amount of 1.5 million and Don Tyson to pay the amount of $700,000.
According to the SEC Press release,
"The SEC charged that in proxy statements filed with the Commission from 1997 to 2003, Tyson Foods made misleading disclosures of perquisites and personal benefits provided to Don Tyson both prior to and after his retirement as senior chairman in October 2001. The SEC also charged the company with failing to maintain adequate internal controls over Don Tyson's personal use of company assets. Don Tyson was separately charged in the administrative proceeding with causing the company's violations and in the complaint with aiding and abetting the company's violations. "
The SEC Order appears to be very detailed, as the press release lists specific "perquisites [that] had not been raised with or authorized by the company's compensation committee." Some of the items listed on the press release are as follows:
- $84,000 in lawn maintenance at five different homes where he and his family and friends lived;
- $46,110 to maintain nine automobiles owned and used by Don Tyson and his family and friends;
- $36,554 in telephone services for him and his family and friends;
Internal Investigation of AIG Keeps Finding New Problems
The longer the internal investigation of American International Group goes on, the more problems seem to keep popping up. According to reports (N.Y. Times here, Wall Street Journal here), AIG's audit committee has decided to postpone for a third time the filing of the company's annual report, which was due in mid-March. One new area of concern, which will make it even harder to complete the audit and have management certify the financials as required by the Sarbanes-Oxley Act, are possible round-trip transactions with hedge funds that permitted AIG to recognize gains on the sale of securities repurchased in a later period. These types of transactions are window dressing for the quarterly numbers, and while the total amounts may be small, they raise substantial questions about whether false financial statements were filed with the SEC and relied upon by investors. Given Wall Street's addiction to consistently rising earnings and making the "numbers" each quarter, even a $.01 change in earnings could be material. (ph)
April 28, 2005
Scrushy Not the Only Case Happening in Alabama
A DOJ Press Release shows that there is a lot more happening than the Scrushy trial. It seems that " five Madison County individuals have been charged by a federal grand jury with conspiracy to commit fraud against the Department of Housing and Urban Development ("HUD") and with making false statements with regard to matters within HUD's jurisdiction." The press release states:
"In a lengthy description of how this conspiracy was carried out, the Indictment details how the defendants, after borrowing money for "commercial" purposes, certified to HUD officials that they were purchasing nine separate Madison County properties as their primary residence. The indictment further alleges that, when the properties were not purchased by the defendants, the parcels were purchased by other individuals who then immediately deeded or sold the properties back to the defendants or companies owned by the defendants."
Kozlowski - What is the Defense Strategy?
The WallStreet Journal describes here the opening day of Dennis Kozlowski's testimony, testimony that was not heard in the first trial. It is interesting that the defense has the defendant up in the early part of the defense case. Some thoughts here-
1. Normally you put the defendant on last so that he/she can refute prior witness testimony. Unlike other witnesses in a trial, the defendant is never subject to a sequestration order and can remain in the courtroom and listen to all the testimony.
2. Did the defense feel that they needed to present Kozlowski early so that the jury could humanize the prior testimony from the prosecution? Did they present him early to change the focus of the jury from the prior prosecution case?
3. Could this be an indication that the defense case may be extremely short and Kozlowski really is the last witness?
4. Or do they anticipate that Kozlowski will face a difficult cross-examination and they don't want to end the trial on that note? Trial attorneys often present their best at the beginning and at the end - the law of primacy and recency.
Scrushy- The Defense Continues
Scrushy - Although a defense witness was called to testify, according to an AP report here (al.com), it sounded more like evidence the prosecution would present. There were a few comments favorable to the defense. Strategy-wise this may prove more helpful to the defense than described in the press. A witness who tells it with both the good and bad for the side they are called by, may often offer the more credible evidence to a jury. But AP, also says the witness winked at Scrushy - HUM!
AP also reports here that a juror has been dismissed in the trial.
Another Twist in the Philadelphia Corruption Trial -- "Biased" Juror Removed, Deliberations Begin Anew
The prosecution of former Philadelphia Treasurer Corey Kemp and four other defendants went down a new path yesterday -- one sure to come up on appeal if there is a conviction -- that is likely to send the jury deliberations well into next week when U.S. District Judge Michael Baylson dismissed a juror because of what the judge described as bias against the FBI. The prosecution is the result of a long-term FBI investigation of corruption in Philadelphia city government that included planting a listening device in Mayor Street's office -- the Mayor is not a defendant in the case, although he is one of the lead characters in the story. Judge Baylson dismissed the juror, stating, ""I find that she is biased against the government. She is biased against FBI agents." A note from the juror appeared to favor the defense, but subsequent notes from other jurors revealed a possible bias against the government not based on the evidence. The court held additional closed door hearings before announcing the decision to remove the juror and substitute an alternate; the judge then instructed the jury to begin its deliberations all over again with the new juror.
The atmosphere in Judge Baylson's courtroom appears to have moved from poisonous to malignant. An earlier post (here) discussed how defense lawyers responsed testily to the court's answer to a jury question that they believed was mistaken. When the judge announced the removal of the juror, defense lawyers are reported to have shouted in demanding a mistrial and accused the judge of becoming "the fifth prosecutor" -- no doubt a reference to Judge Baylson's former position as United States Attorney. While judges have wide discretion regarding the removal of jurors for cause, even during deliberations, the removal of a juror favorable to the defense is sure to trigger close judicial review if there is a conviction. It's not often that a federal courtroom reflects the side of Philadelphia empitomized by the Broad Street Bullies of the 1970s. An article in the Philadelphia Inquirer (here) discusses the court's ruling and provides excerpts from the jury notes. (ph)
MD and Employee Facing Charges
According to a DOJ press release, a federal grand jury in Camden, New Jersey, issued an indictment charging a doctor and an office manager "with conspiracy to defraud the United States, income tax evasion, and willful failure to account for and pay the IRS employment taxes withheld from their employees’ wages." The individuals indicted included the "owner and president of two Lyme disease treatment centers," and "the companies’ vice-president and office manager."
April 27, 2005
Arthur Andersen Argument Report
An AP story (here) reports on the oral argument this morning in Arthur Andersen v. United States. It appears that Michael Dreeben from the Solicitor General's office got the tougher questions from the Court, including -- and this will shock many -- questions expressing incredulity from Justice Scalia. A transcript of the oral argument should be available within the next two weeks, and I will post a link. (ph)
Ignoring Legal Advice at AIG
One item turned up in the internal investigation at American International Group is an accounting problem related to workers compensation policies sold by the company. According to a Wall Street Journal article (here), AIG may have treated shifted premiums from the workers comp policies, which would be subject to a 1% New York state tax to fund an insurance pool, to general liability policies to avoid paying the tax. The interesting aspect of this problem is not so much the accounting treatment or tax avoidance (except, of course, to accountants and tax lawyers), but the fact that in 1992 AIG's general counsel, E. Michael Joye, informed senior management, including former CEO Maurice Greenberg, that the company's accounting treatment for the premiums was illegal. Later that year, Joye resigned -- or perhaps was forced out -- from the company because of problems over the accounting issue.
Joye provided a copy of his memo about the workers comp issue to New York Attorney General Eliot Spitzer's office, and the Journal article reports that the company waived its attorney-client privilege regarding the matter to permit further investigation. Under the Department of Justice guidelines for charging corporations, one important indicia of cooperation to avoid criminal charges is a willingness to waive the attorney-client privilege and work product protection, and AIG will do its utmost to cooperate to save its various insurance licenses.
If senior management did force Joye out because he was unwilling to go along with questionable, and even illegal, accounting practices, then that is an important sign of a corporate culture that regarded legal (and ethical) requirements as something to be gotten around or avoided. One conclusion from the internal investigation of AIG is that its internal controls were easily evaded, and that is a further sign that management did not regard itself as being bound by the rules. Haven't we heard this story before? (ph)
The Defense Begins in the Tyco Trial
The prosecution of former Tyco CEO Dennis Kozlowski and former CFO Mark Schwartz begins today after the prosecution rested its case. This case has largely flown underneath the radar because it's a retrial and there were no new revelations. The prosecution honed its case this time through, not focusing so much on the salacious aspects, such as the Sardinian birthday party for Kozlowski's wife with the David sculpture -- this is a family-friendly site so I won't go on, but links to the party video are here. One criticism of the prosecution in the first trial was the lack of focus, and this time prosecutors completed their case in 13 weeks, certainly not a quick case but much less than the 18 weeks it took the first time. The only defense witness in the earlier trial was Schwartz, and there is some speculation that Kozlowski will testify at this trial to establish the "we got paid a lot but everyone knew it" defense. An AP story (here) discusses the start of the defense case. (ph)
UPDATE (4/27): The first witness for the defense is Dennis Kozlowski. In the last trial, Mark Schwartz testified for 9 days, and the cross-examination of Kozlowski will likely take a while. The Wall Street Journal article on the first phase of the testimony is here. (ph)
Does a Corporation's Former Lawyer Have a Conflict of Interest in Representing Former Executives in a Criminal Prosecution?
An interesting article in The Business Journal of Kansas City (here) discusses the U.S Attorney's attempt to disqualify an attorney in the prosecution of former Westar CEO David Wittig and executive vice president Douglas Lake. The charges involve alleged misconduct by the defendants in misusing corporate assets and structuring transactions to benefit themselves. The first trial of Wittig and Lake ended in a mistrial last December, and approximately a month ago Lake hired Nick Badgerow to join his defense team. Westar's general counsel wrote a letter to Badgerow raising questions about whether privileged or confidential information might be used by him in the defense of his new client. Badgerow had representing the company in litigation against another attorney on an issue that came up during the first trial, and the charges involve the executives' conduct while they employees of the company, Badgerow's former client. Just to make things more complicated, Westar is paying the attorneys fees for Wittig and Lake, although there is a pending arbitration about the company's duty to pay those expenses.
District judges are usually quite wary of conflicts that might taint a conviction, but do not always accede to the government's requests to remove counsel. Lake has agreed to waive an ineffective assistance of counsel claim he might have against Badgerow if he is convicted (see Business Journal of Kansas City story here), but courts are generally unwilling to accept a blanket waiver in advance, which can always be attacked later on the ground that the defendant was not adequately informed of the scope of the waiver. The standard for removal of defense counsel for a potential conflict of interest under Wheat is quite deferential to the district court, and a decision to disqualify counsel cannot be appealed until after a conviction, and even then the claim rarely is successful. The relationship between the defendant's and the district judge has become quite contentious, with a writ of mandamus being filed with the Tenth Circuit seeking to force the judge to recuse herself. The second trial is scheduled to start in May. Thanks to the Legal Ethics Forum (here) for highlighting the case.
Possible Expansion of Criminal Investigation of L-3 Communications
A previously disclosed criminal investigation of Interstate Electronics, a subsidiary of L-3 Communications Holdings Inc., the large defense contractor, may be expanding into new areas. A Wall Street Journal story (here) discusses an investigation by the U.S. Attorney's Office for the Central District of California (Los Angeles) involving defective parts for military radios that may now involve other military supplies, including artillery shells, for which L-3 Communications was a subcontractor. The company has not provided any information about the types of equipment on which Interstate Electronics works, and its 10-K filing in March 2005 makes vague reference to criminal investigations involving the company: "We are currently cooperating with the U.S. Government on several investigations, none of which we anticipate will have a material adverse effect on our consolidated financial position, results of operations or cash flows." An Interstate Electronics spokesman denied any knowledge of an expanded criminal investigation of the subsidiary's products. A criminal indictment can have a very serious effect on military contractors, including possible debarment as a result of a criminal conviction. With expanded spending on the military since 9/11, the investigation and prosecution of procurement fraud and defective parts has received renewed emphasis from the Department of Justice. (ph)
April 26, 2005
Pasquantino - For the Government - 5-4
In a 5-4 decision, the United States Supreme Court issued an extremely narrow decision favorable to the government in the case of Pasquantino v. United States. Justice Thomas, delivering the opinion of the Court, held that there was no violation of the common law revenue rule when the government prosecutes a wire fraud (18 U.S.C. s1343) and the scheme to defraud involves the deprivation of tax revenue to another country. In this case petitioners were "convicted for federal wire fraud for carrying out a scheme to smuggle large quantities of liquor into Canada from the United States." The circuits were split on whether wire fraud could be used when the loss involved foreign tax revenue. The Court permits this prosecution and additionally finds that the tax revenue is "property" for purposes of the wire fraud statute.
What is more interesting about this case, is what is not decided:
1. In footnote one of the decision, the Court specifically states that it is expressing "no view on the related question whether a foreign government, based on wire and mail fraud predicates, may bring a civil action under" the RICO statute for defrauding of taxes.
2. The Court does not rule on the issue of extraterritoriality as it does not see this case as allowing the wire fraud statute to have "extraterritorial effect." (the Court in a footnote says this issue was not raised until the Reply brief).
The dissent, authored by Ginsburg, and joined by Breyer, Scalia, and Souter, focused on the extraterritorial application. The dissent states:
"Construing s1343 to encompass violations of foreign revenue laws, the Court ignores the absence of anything signaling Congress' intent to give the statute such an extraordinary extraterritorial effect."
The dissent also supports its position through use of the Rule of Lenity.
The bottom line is that this case does not resolve the extraterritorial application of white collar laws, although it does permit wire fraud to be premised on a tax loss othat occurs outside the United States. The question of extraterritoriality is made more interesting by the Court's accompanying decision in Small v. United States, where it held that "convicted in any court" as used in section 922(g)(1) is limited to domestic as opposed to foreign convictions.
Addendum - Scotus Blog notes that:
"Justice Thomas said that this prosecution "creates little risk of causing international friction through judicial evaluation of the policies of foreign sovereigns" -- the problem on which the revenue rule was based. The Executive Branch brought this case, according to the opinion, and it thus could be assumed that "the Executive has assessed this prosecution's impact on this nation's relationship with Canada, and concluded that it poses little danger of causing international friction."
WCC Blog notes - If this sounds familiar, see the reasoning the Court used in Alvarez-Macahin. (esp)
No Booker "Sea Change" Exception to Broad Waivers of Right to Appeal Sentence
One of the ways in which the government seeks to ensure that a plea bargain is the end of a case is to demand a broad waiver of the right to appeal the sentence so long as it meets certain criteria, one of which is that the sentence be within the Guidelines range or below the statutory maximum. The statutory maximum cap was the sole sentencing limitation in a plea agreement at issue in the Seventh Circuit's decision in United States v. Bownes (here), a case in which the defendant entered a guilty plea to mail fraud for engaging in "land flips" involving low income property. and the defendant argued that he did not knowingly waive the right to appeal because Booker effected a "sea change" in sentencing law and therefore he should be permitted to seek a resentencing under the now-advisory Guidelines. The court, per Judge Posner, rejected that argument:
Bownes argues that Booker is special because it brought about a “sea change” in the law. The identical argument was rejected, rightly in our view, in the Bradley and Killgo cases that we cited in the preceding paragraph. It is true that Booker has had a tremendous impact because it has affected many thousands of sentences, but it is no more, and indeed less, of a “sea change” than numerous other legal innovations scattered across the volumes of the United States Reports and the Federal Reporter. And anyway a “sea change” exception to the rule that an unqualified appeal waiver is to be enforced as written would be hopelessly vague.
Deloitte & Touche Settle Two SEC Cases Involving Improper Audits
Deloitte & Touche settled two SEC investigations by agreeing to settlements related to the firm's audits of Adelphia Communications and Just for Feet, Inc. The Adelphia case is the far larger one in which Deloitte agreed to pay $50 million into a settlement fund for Adelphia investors related to its audits of the company before its collapse into bankruptcy in 2002. The SEC Litigation Release (here) describes the problems in the audit:
The Commission's complaint against Deloitte alleges that, during Deloitte's audit of Adelphia's financial statements for the year ended December 31, 2000, Deloitte failed to implement audit procedures designed to detect the illegal acts at Adelphia and failed to implement audit procedures designed to identify material related party transactions or related party transactions otherwise requiring disclosure. Among other things, Adelphia understated its subsidiary debt by $1.6 billion, overstated equity by at least $368 million, improperly netted related party receivables and payables between Adelphia and related parties, and failed to disclose the extent of related party transactions.
The Just for Feet proceeding involved Deloitte's failures related to its 1998 audit of the company, as described in the SEC's administrative complaint here:
Just for Feet’s 1998 financial statements included in its annual report for fiscal 1998 on Form 10-K, filed with the Commission on April 30, 1999, were materially false and misleading, overstated net income and net assets, and failed to comply with generally accepted accounting principles ("GAAP"). Just for Feet falsified its financial statements by (1) improperly recognizing unearned and fictitious receivables and revenue from its vendors, (2) failing to properly account for and to disclose problems with obsolete inventory, and (3) improperly recording as income the value of display booths provided by its vendors.
Deloitte agreed to pay a $375,000 civil penalty related to the audit, and two audit partners were barred from practicing before the Commission, with the right to reapply in one and two years.
This is the second administrative action against a Big Four firm in the past week, with KPMG settling with the SEC regarding its audit work for Xerox that involved disgorgement and a civil penalty totaling over $22 million (earlier post here). (ph)