Saturday, September 17, 2005

Will Deutsche Bank Get Sucked Into the Tax Shelter Investigation?

The fallout from the KPMG tax shelter business may now be reaching the firms that assisted in the execution of the transactions underlying the shelters.  The New York Times reports (here) that Deutsche Bank has been sued for its role in one of the shelters that involved currency trading, and the government's investigation of KPMG involved gathering evidence from the bank.  The various tax shelters the accounting firm peddled required the participation of banks and brokerage firms to execute the trades that generated the tax losses used to shelter income of individual taxpayers, and of course the lawyers were their to "bless" the transactions as valid -- at $50,000 a pop in some instances for a cookie-cutter letter, if the indictment of the individuals in the tax shelter case is correct.  To this point, none of the individuals have entered into a plea agreement, at least that has been publicly disclosed.  If one or more do agree to cooperate in the government's investigation, the prosecution could spread out beyond just KPMG and its former partners.  (ph)

September 17, 2005 in Tax | Permalink | TrackBack (0)

Interpublic Group Discloses Substantial Accounting Problems

Interpublic Group of Companies, Inc., the international advertising agency, disclosed that it will not be able to file its 10-K annual report, and that it will have to restate its financials due to internal control problems and other accounting issues.  More ominously, the company stated that some of its (now former) employees engaged in misconduct resulting in significant accounting fraud.  According to Interpublic's 8-K (here):

As a consequence of the expanded scope of our work on the restatement and our anti-fraud program, certain items came to our attention that required investigations into possible employee misconduct. These investigations, which relate primarily to agencies outside the United States, revealed accounting errors that were qualitatively material. These errors resulted from the misapplication and inadequate knowledge of GAAP as well as errors resulting from instances of falsified books and records, violations of laws, regulations and company policies, misappropriation of assets, and inappropriate customer charges and dealings with vendors. These investigations are nearing completion. The results of these investigations are being reviewed by the Audit Committee of the Board of Directors, with the advice of independent counsel and forensic accountants. As a result of these investigations, financial statement adjustments are being made and remediation plans have been, or are in the process of being, developed to address internal control and policy issues. In all cases, culpable employees have been terminated or are in the process of being terminated or are otherwise no longer with the Company.

Proper accounting, like image, is everything. (ph)

September 17, 2005 in Fraud | Permalink | TrackBack (0)

Larry Ellison's $100 Million "Charitable" Contribution to Resolve Insider Trading Claim

An earlier post (here) discussed the settlement by Oracle CEO Larry Ellison of a law suit in California alleging that he sold $900 million of Oracle stock while he was privy to information about declining earnings at the company that were announced only a month later, i.e. insider trading.  Ellison has agreed to make $100 million in charitable contributions spread over five years.  On our sister blog Business Law Prof, Dale Oesterle has an extensive discussion of the settlement, and the parallel Delaware Chancery Court case in which Vice-Chancellor Leo Strine dismissed the case on a summary judgment motion, and the post (here) wonders whether he was hoodwinked by Ellison.  Paul Caron, emperor of the LawProf Blog empire, has a post on sister blog TaxProf (here) that considers that all-important question whether the donations to charity are deductible, and for reasons that he explains far better than I can understand the answer appears to be "No" (thank goodness). (ph)

September 17, 2005 in Insider Trading | Permalink | TrackBack (0)

Attorney Sentenced to 18 Months for Contempt and Perjury

Providence, RI, attorney Joseph Bevilacqua received an 18-month prison term for leaking a government surveillance tape to a local television station, in violation of a court order sealing materials related to the case, during the prosecution of former Mayor Vincent (Buddy) Cianci and others.  Bevilacqua represented one of the defendants in the case, and the tape was made during the FBI's investigation of corruption in Providence government, called Operation Plunder Dome.  After the tape aired, the district judge in the case appointed a special prosecutor to investigate the leak, and a local reporter was convicted of criminal contempt and sentenced to home confinement for not revealing the source of the tape.  Bevilacqua admitted to perjuring himself in a deposition taken by the special prosecutor when he denied giving the tape to the reporter.  A press release issued by the U.S. Attorney's Office for the District of Rhode Island (here) discusses the sentencing.

I wonder what upside Bevilacqua saw in leaking the tape, and then lying about it?  It must have seemed like a good idea at the time, but it turned out disastrously, not only for Bevilacqua who will lose a year-and-a-half of his life, his law license, and still have to pay the court over $150,000 for the costs of the special prosecutor's investigation, but also the reporter who suffered the criminal contempt proceeding and disruption of home confinement. (ph)

September 17, 2005 in Perjury, Sentencing | Permalink | TrackBack (0)

Friday, September 16, 2005

Are White Collar Crime Sentences Too Severe?

The sentencing of former Tyco CEO Dennis Kozlowski and CFO Mark Swartz is scheduled for Monday, Sept. 19 in New York Supreme Court before Judge Michael Obus.  A New York Times article (here) raises the question whether sentences in white collar crime cases have become too severe, looking at the prison terms that Bernie Ebbers (25 years) and John Rigas (15 years) received in their fraud prosecutions. The article does not mention the substantial term (24+ years) received by Jaime Olis, a mid-level manager convicted of conspiracy and fraud for his work at Dynegy who is awaiting the outcome of his appeal (including the Booker remand issue).

This is quite a turnabout from the pre-Sentencing Guidelines days, when much of the disparity decried in the indeterminate system used by the federal courts arose in white collar cases.  The view that defendants in white collar crime cases were more likely to receive lower sentences, or probation, was prevalent, and the "poster boys" of corporate malfeasance in the 1980, Ivan Boesky and Michael Milken, received what are now viewed as fairly light sentences, serving less than three years.  Sentences received by the high-profile defendants are not the only ones that show the increase in punishment meted out in white collar cases.  A recent post (here) discussed a 30-year sentence to a lawyer who was a first-time offender in a large mortgage fraud scheme. 

One wrinkle Kozlowski and Swartz face in their sentencing is the possibility of having to serve at least a portion of the term in a maximum security prison.  In an earlier post, I discussed the potential sentence, and excerpt it below:

The most serious charge on which the jury convicted Kozlowski and Swartz was first degree grand larceny, which under New York law is a class B felony "when the value of the property exceeds one million dollars," which was certainly the case here (see N.Y. Penal Law Sec. 155.42 here).  Unlike the federal Sentencing Guidelines, which require a fairly intricate analysis of the circumstances surrounding the conviction and the relevant conduct of the defendant in the crime that leads to a "offense level" that gets plugged into a sentencing grid, New York provides for a range of sentences based on the type of offense and gives the sentencing judge discretion within that range to impose a term of imprisonment (i.e. an "indeterminate sentence").  Under N.Y. Penal Law Sec. 70.00(2)(b) & (3)(b) (here), the minimum sentence for a class B felony is from 1 to 8.3 years, and the maximum is 3 to 25 years (i.e. the minimum is 1/3 of the maximum).

What makes things dicey for Kozlowski and Swartz is that, under New York law, a sentence of more than six years means that they will be sent to a maximum security prison, such as Attica or the Downstate Correctional Facility in Fishkill, NY (doesn't that sound inviting).  While federal prisons are not necessarily pleasant, a minimum security camp is much less structured, and threatening, than a New York State Correctional Facility, especially a maximum security prison.  As discussed in a CNN.Com article (here), the usual practice in New York is to take the prisoner from the courtroom immediately after sentencing to begin serving the term of imprisonment, although the person will be processed for approximately six weeks until being sent to the assigned prison.  If Justice Obus does not grant Kozlowski and Swartz bail pending appeal, which is a distinct possibility, they could be in a New York prison by the end of the summer.

If Kozlowski and Swartz receive substantial prison terms, it will certainly draw the attention of corporate executives (and others) nationwide.  In that sense, the convictions may have a substantial deterrent effect, but how much is too much?  There's no answer to that one. (ph)

                                                                                                         

UPDATE: Tom Kirkendall on the Houston's Clear Thinkers blog asks (here) how the New York Times could have overlooked the Jaime Olis sentencing.  Sometimes memory only stretches back three months (or so), and Olis is "so yesterday."  How can the Fifth Circuit let him dangle, too?

September 16, 2005 in Sentencing | Permalink | TrackBack (0)

The Same Refrain: Insider Trading By Company Employees

This is one we've heard before, yet somehow it just keeps happening.  The SEC sued four employees of Cryolife, Inc., and two of their spouses, for selling shares in the company immediately before a product recall.  Cryolife sells implantable human tissue, and the FDA ordered a nationwide recall of the company's product.  Before the news became public, the defendants sold their shares, avoiding a loss of approximately $136,000 when the stock dropped from $9.46 to $2.03.  The SEC Litigation Release (here) discusses the case, which the defendant's settled by paying disgorgement and a one-time penalty.

Bruce Carton on the Securities Litigation Watch blog has an interesting post (here) imploring employees of company's whose shares are publicly traded to avoid the insider trading temptation -- one that the Cryolife employees could not resist -- if they think they will get away with it.  Bruce writes:

I saw it when I was at the SEC and I've seen it regularly ever since:  SEC enforcement actions against employees of publicly-traded companies who get advance notice of earnings news or other big news concerning their companies and buy/sell the company's stock prior to the announcement of that news.   Of course, that practice is called "insider trading" and it is against the law.  As I hope to persuade you below, it is also called "incredibly stupid."  Seriously, people, we're talking about Darwin Award-level stupidity here. 

I would add one more item to Bruce's list of reasons why it's difficult to get away with insider trading, at least on any significant scale.  One of the best ways to make a "big score" on inside information is to trade in options, particularly the out-of-the-money kind that are especially cheap.  Once the news hits, either positive or negative, the upside can be enormous.  The recent SEC case involving highly suspicious trading in Reebok stock options the day before the announcement of the Adidas takeover is a good example of how the leverage from options trading can produce large profits.  If you trade options, however, you will be noticed by the options market-makers.  Unlike stock trading, in which firms usually sell shares out of their inventory, stock options are written by firms that make a market in the securities by writing calls and puts.  Like a Las Vegas sports book (and no criticism is meant by the comparison), the market makers seek equilibrium, a match between those buying and selling the options, and they will hedge their position to limit the potential exposure.  When a sudden burst of buying (or selling) catches them in an exposed position, that money comes straight out of the firm's capital, and they will raise the roof if the transactions look suspicious.  Both the exchanges and the SEC pay attention to the complaints of options market makers because they have a very expensive ring-side seat for insider trading.  The big money may be in options, but that money comes from someone whose livelihood may be seriously affected by the transactions.  And, they know who you are. (ph)

September 16, 2005 in Insider Trading | Permalink | TrackBack (0)

Beware the Disgruntled IT Employee

William Shea was a program manager for a debt collection company who was having some problems at work.  Shortly after being placed on a "performance improvement plan" -- a sure sign of potential trouble -- Shea reacted by using his computer skills to wreak havoc on the company's financial records.  Shea was convicted for violating the federal computer crime statute, 18 U.S.C. Sec. 1030, as described in a press release (here) issued by the U.S. Attorney's Office for the Northern District of California:

Evidence presented at the six-day trial showed that Mr. Shea was hired around August 2001 as a programmer and manager of the company’s specialized financial software computer network. In this position, Mr. Shea had administrative level access to and familiarity with the company’s computer systems, including the database server. After Mr. Shea was advised of adverse employment issues near the end of 2002, he was placed on a performance improvement plan on January 6, 2003. The evidence showed that a “time bomb” was placed onto the company’s network around that time. When the defendant failed to show up at work without any prior notice on January 17, 2003, he was terminated. Company officials did not know at the time that he had placed malicious code on the computer network that was set to delete and modify data at the end of the month.

(ph)

September 16, 2005 in Computer Crime | Permalink | TrackBack (0)

Mortgage Fraud Doesn't End

In another sure sign that the housing bubble has skewed the real estate and mortgage market, here's another case of real estate brokers engaging in fraudulent activities to qualify borrowers for loans for which they are wild unqualified.  Indeed, some of the borrowers were illegal aliens.  According to a press release (here) issued by the U.S. Attorney's Office for the District of Colorado:

[B]etween July 2000, and November 2002, the defendants operated and/or worked at the Mendez Team real estate agency in Lakewood, Colorado. WILLIAM MENDEZ and CLAUDIA MENDEZ, and others who have been indicted previously, assisted home buyers, whom they knew to be illegal aliens or otherwise unqualified to obtain loans backed by FHA mortgage insurance, in preparing and completing loan applications containing false information.  In the process, BENEDICTA GOMEZ prepared false tax returns designed to allow the home buyers to obtain loans backed by FHA mortgage insurance.

Once the fraudulent applications and false documents were prepared, the defendants and others caused them to be submitted to the Department of Housing and Urban Development (HUD).  It was then part of the scheme for WILLIAM MENDEZ to compensate his employees acting as real estate agents by paying them approximately half of the commissions earned from the fraudulent transactions.  The indictment includes a criminal forfeiture count, where, if convicted, the defendants will be required to pay $80,654.45, which constitutes the traceable proceeds derived from the criminal activity.

An earlier post (here) discusses the outcropping of such mortgage fraud cases throughout the U.S.  Fraud goes where the cheap money resides. (ph)

Addendum - And private parties are also out there fighting mortgage fraud.  See here. (esp)

September 16, 2005 in Fraud | Permalink | TrackBack (0)

Thursday, September 15, 2005

Eight Marsh Inc. Executives Indicted

New York Attorney General Eliot Spitzer announced the indictment today of eight former executives of March Inc., one of the insurance subsidiaries of Marsh & McLennan Cos., on fraud, antitrust, and larceny charges related to bid-rigging for insurance quotes.  According to a press release (here) issued by the AG's Office:

[D]efendants and other Marsh employees told their excess casualty clients that they obtained bids for their business from insurance companies in an open and competitive bidding process. In fact, defendants had rigged the process in the following ways: First, before any bids were submitted, the defendants determined which insurance company would win the business. Second, they set a "target" for the winner to submit as its bid. Third, they obtained losing bids, which they called "B quotes," from other participating insurance companies. By misleading customers into believing that the customers' interests came first, the conspirators fraudulently obtained millions of dollars in commissions and fees for Marsh and millions of dollars in premiums for the insurance companies. The victim companies ranged from high technology firms to a fruit cannery to a cosmetics manufacturer.

Marsh Mac settled a civil complaint earlier this year that requires the company to set up an $850 million restitution fund. (ph)

September 15, 2005 in Fraud | Permalink | TrackBack (0)

Former Democratic National Committee Finance Chair Pleads Guilty to Attempted Extortion

It must the the time of year when prosecutions related to political officials come to fruition.  An AP story (here) discusses the guilty plea of Joseph Cari, who served as Finance Chair of the Democratic National Committee, for demanding that an investment company hire a sham consultant for $850,000 if it wanted to manage funds on behalf of the Illinois Teachers Retirement System.  Cari was indicted on August 3 along with Stuart Levine, a trustee of the System, and Steven Loren.  Both Cari and Levine are attorneys.  Just this week we have seen the indictment of a Massachusetts Republican party official (earlier post here) and the reindictment of individuals in connection with a political action committee founded by House Majority Leader Tom DeLay (earlier post here). (ph)

September 15, 2005 in Corruption | Permalink | TrackBack (0)

SEC Sues Biopure for False Statements About Pending Drug Approval

The SEC filed a securities fraud action against Biopure Corp., a biotech company, its former CEO, Thomas More, former senior VP Howard Richman, and current General Counsel, Jane Kober, related to misleading statements made about FDA approval of the company's synthetic blood product.  According to the Commission's Litigation Release (here):

[B]eginning in April 2003, Biopure received negative information from the FDA regarding its efforts to obtain FDA approval of its synthetic blood product Hemopure but failed to disclose the information, or falsely described it as positive developments. Specifically, the Complaint alleges that in April 2003, the FDA placed a clinical hold barring Biopure from conducting clinical trials of Hemopure in trauma settings such as emergency rooms, because of safety concerns about Hemopure. As alleged, during the next eight months, the company concealed the imposition of the clinical hold while making public statements about its plans to obtain approval for trauma uses of Hemopure. In addition, according to the Complaint, in July 2003 the FDA informed Biopure that it had not approved Biopure's application for use of Hemopure in orthopedic surgery, and instead conveyed serious concerns about whether the materials Biopure had submitted in support of its application were reliable and questioning the safety of Hemopure. Biopure, however, issued public statements beginning on August 1, 2003 describing the FDA's communication as good news, causing its stock price to increase by over 20%. The Complaint alleges that Biopure continued to make misleading statements until December 2003. During this period, Biopure raised over $35 million from investors. The Complaint further alleges that as the true status of Biopure's efforts to obtain FDA approval gradually became public, through a series of incomplete and misleading disclosures between late October and the end of December 2003, the company's stock price plummeted almost 66% from its August 1 price.

Unlike most SEC cases in which the company enters into a settlement, Biopure issued a press release disputing the claims in the suit, arguing that it did not need to make certain disclosures related to the FDA approval process.  The release (here) quotes corporate counsel:

"The company intends to seek dismissal of the SEC's claims or judgment in its favor and expects to prevail," said Robert A. Buhlman of Bingham McCutchen LLP, counsel to the company. "Biopure intends to establish that its disclosures were accurate based on governing law, testimony provided by the FDA to the SEC, the FDA's review procedures and practices, and what was communicated by FDA at the relevant times."

There's nothing like a good fight over disclosure issues. (ph)

September 15, 2005 in Civil Enforcement, Fraud, Securities | Permalink | TrackBack (0)

Ratzlaf Redux: Intent for Structuring

In Ratzlaf v. U.S., 510 U.S. 65 (1994), the Supreme Court interpreted the "willfully" element for a currency structuring violation under 31 U.S.C. Sec. 5324 to require proof that the defendant knew the structuring was illegal.  Congress responded rather promptly to the Court's holding by dropping willfulness from the statute, so that now all the government needs to prove is that the defendant knows that the financial institution is required to file a Currency Transaction Report (CTR) for transactions over $10,000 in cash, and that the defendant intended to avoid having the report filed by structuring the transactions to keep them under $10,000.  A Second Circuit decision in U.S. v. MacPherson deals with the issue of what evidence suffices to establish this intent, particularly when the funds are not the proceeds of any unlawful activity.

MacPherson was a New York City policeman and real estate investor who held a real estate license.  To shield his assets from a tort lawsuit filed by a tenant of one of his buildings, MacPherson began to liquidate various accounts and held the funds in cash.  Once the tort case settled, MacPherson shifted his assets back into bank accounts.  For an unknown reason, he did so by engaging in a series of 32 cash deposits into various banks of amounts below $10,000, including 23 in the $9,000 range; some days, MacPherson went to three separate banks to make his deposits.  He deposited approximately $250,000 in cash over a four-month period  Charged with violating the anti-structuring statute, MacPherson argued that there was insufficient evidence of his intent to evade the bank's currency reporting requirement.  He noted that the funds were not the proceeds of any illegal activity, and the tort case had been settled so he had no motive to hide the amount of money he had.  The trial judge granted a Rule 29 judgment of acquittal after the jury returned a guilty verdict, and the Second Circuit reversed (opinion available here).

The court rejected MacPherson's argument that an inference of the defendant's intent to structure should be limited to cases in which the proceeds are known to be derived from illegal activity.  The court stated: "If a defendant structures cash transactions knowing that the financial institution involved is obligated to report transactions exceeding $10,000 and intending to evade that requirement, he is guilty of structuring without regard to whether the cash at issue represents criminal or lawful proceeds. More to the point, whether or not a § 5324 prosecution relates to criminal proceeds, a jury may properly consider the pattern of structuring activities and draw reasonable inferences therefrom as to whether the defendant possessed the requisite mens rea."

The court also rejected MacPherson's argument that he was unaware that banks have to file CTRs for cash transactions over $10,000.  When he first started to shield his assets, he withdrew cash from his bank accounts and the banks obtained the necessary information from him for the CTRs on that side of the transaction.  When it came to depositing the money back into banks, the court stated: "More to the point, a reasonable jury could certainly infer that it was improbable in the extreme that MacPherson, a New York City police officer, would have repeatedly gone through these identification procedures (three times on one day) without knowing their purpose. Indeed, the possibility of naive ignorance is rendered all the more unlikely by the fact that MacPherson, as a licensed real estate salesperson, would himself have been required to file CTRs in connection with cash business transactions." 

In other words, the Second Circuit has a very hard time believing that anyone involved in either real estate or law enforcement could plausibly claim not to have heard about the currency transaction reporting requirements.  The interesting aspect of the case is that, while Justice Ginsburg stated in Ratzlaf that structuring cash transactions is "not inevitably nefarious," it is a crime regardless of the reason for the structuring.  As always, be very careful with cash. (ph)

September 15, 2005 in Money Laundering | Permalink | TrackBack (0)

Wednesday, September 14, 2005

Key Massachusetts Republican Charged With Money Laundering

The Boston Globe reports here that "[t]he vice chair[ ] and former treasurer of the Massachusetts Republican Party was arrested yesterday on federal money-laundering." The case arises from his representation of a criminal client who has agreed to cooperate.  And to make matters worse, he does not appear to be getting much support from his party. What is particularly unusual about these charges is that the accused is also running for political office and his campaign slogan is ''the tough, smart, strong leader we need to fight crime."  See also here.

(esp)

September 14, 2005 in Money Laundering | Permalink | TrackBack (0)

Mortgage Fraud Remains A Top Issue

A year ago, CNN wrote here that the FBI was issuing warnings of "rampant fraud in the mortgage  industry."  The Washington Post reported here that "FBI Director Robert S. Mueller III testified . . . at a Senate Intelligence hearing that 550 investigations of mortgage fraud were conducted in fiscal 2004, compared with 102 in 2001." A year later it would appear that mortgage fraud still remains a concern.

For example, this week the US Attorneys' Office for the Southern District of Texas issued a press release here telling of the indictment of an individual "for his role in a multi-million dollar mortgage fraud scheme allegedly executed in the Houston area since 2002."  The criminal statutes being used to prosecute the alleged crimes in this case are wire fraud, mail fraud, bank fraud, and making a monetary transaction with criminally derived property.

The Atlanta Business Chronicle reported here that in June of this year the U.S. Attorneys Office "indicted 11 Atlantans and eight other people in an alleged mortgage fraud scheme." In the Norther District of Georgia, a thirty year sentence was recently issued on a case related to mortgage fraud. here.

In other parts of the country, U.S. Attorneys are also pursuing mortgage fraud cases.  See here (Colorado); here (Ohio); here (Illinois).

(esp)

September 14, 2005 in Fraud | Permalink | TrackBack (0)

How Many Times Can You Re-Indict A Person?

According to the Dallas Morning News here, another indictment has been issued, with new charges, against "associates of U.S. House Majority Leader Tom DeLay."   The new charges relate to campaign contributions. And as one might suspect, defense counsel is complaining about the defendants being indicted "three times for the same alleged acts." (See also post here)   

(esp)

September 14, 2005 in Media | Permalink | TrackBack (0)

Tuesday, September 13, 2005

Enron Broadband Case to Be Retried With New Configuration

Looks like the Enron Broadband trial may go into round two.

As previously noted here, despite a lengthy first trial, no one was found guilty.  Three former Enron executives were found not guilty on some counts, while the jury failed to reach a verdict on other counts against these three individuals.  Additionally two other individuals, also on trial, had a hung jury.  Questioned here was whether there would in fact be a retrial.  The unscientific poll of the Houston Chronicle poll on August 5th had 91% of people voting, saying "no" retrial. Interestingly the number opposed to a retrial is now up to 93%. (see here). 

But according to the Houston Chronicle here this number may not deter the government. The government seems to be rethinking its strategy, going for a shorter more streamlined trial.  And as one might suspect, they are being met with defense legal motions to their recent moves.

Texas, bearing the weight of assisting many from New Orleans and the surrounding areas, has a lot on its mind right now. This could be both detrimental and/or a benefit to the prosecution.  Extravagances by the accused individuals may be frowned upon by these jurors, many who may have recently experienced difficult times.  On the other hand, will the jurors approve of valuable dollars being spent on this trial. Would some rather see their dollars used to assist the new arrivals to the state.

(esp) 

September 13, 2005 in Enron | Permalink | TrackBack (0)

Westar Execs Convicted

While Westar Energy was working, in the aftermath of Hurricane Katrina, to restore power in places like Florida and Louisiana, a jury was convicting a couple of former executives of the company. 

The Kansas City Star, here, reports that David Wittig, former chair of the board at Westar, along with the "executive vice president and chief strategic officer" were convicted of the vast majority of counts they faced.  The charges included conspiracy, wire fraud and money laundering, the latter charge being a common add-on charge in recent fraud prosecutions. Still to come in this matter are the forfeiture counts. See more here (Bloomberg) and here (AP).

(esp)

September 13, 2005 in Prosecutions | Permalink | TrackBack (0)

Monday, September 12, 2005

Civil Insider Trading Case May Be Resolved With A Charity Benefitting

A civil action alleging insider trading may be resolved by a payment of $100 million dollars to a charity.  The New York Times reports here that the CEO of Oracle has agreed to pay this sum "to resolve a lawsuit charging that he engaged in insider trading in 2001."  The agreement is subject to approval by the board. This type of resolution is certainly different and one has to wonder if this could have happened if DOJ were doing the negotiating, as opposed to this being a derivative shareholder suit. So, which charity will receive the funds - -it seems the CEO may get to choose.

(esp)

September 12, 2005 in Insider Trading | Permalink | TrackBack (0)

Enron and Job Growth?

A New York Times column by Daniel Gross (here) discusses  a National Bureau of Economic Research working paper by two finance professors (at NYU and Rutgers) that seeks to draw a link between companies that have had to restate their earnings (from Jan. 1997 through June 2002) and the loss of jobs. The poster-child for accounting fraud, one of the triggers of a restatement, is Enron, and the authors see a connection between aggressive accounting, which permits increased hiring, and subsequent job losses due to the inevitable restatements that a company must issue and, consequently, the loss of jobs as the company cuts back to deal with the downturn in its business.  The authors cite Enron as a "typical -- if somewhat extreme -- example" of the effect of accounting losses, and the abstract states:

We argue that earnings management and fraudulent accounting have important economic consequences. In a model where the costs of earnings management are endogenous, we show that in equilibrium, bad managers hire and invest too much in order to pool with the good managers. This behavior distorts the allocation of economic resources among firms. We test the predictions of the model using new historical and firm-level data. First, we show that periods of high stock market valuations are systematically followed by large increases in reported frauds. We then show that during periods of suspicious accounting, firms hire and invest excessively, while insiders exercise options and sell stocks. When the misreporting is detected, firms shed labor and capital and productivity improves. In the aggregate, our model seems able to account for periods of jobless and investment-less growth.

I don't purport to know enough of the "dismal science" to argue with their conclusions, but it does not look like they have accounted for the lawyer and accountant full employment effects of the Sarbanes-Oxley Act.  Somewhat less facetiously, accounting fraud is often a reaction to a failed (or failing) business model, or a response to a changing marketplace that corporate management had not anticipated.  For example, Enron and WorldCom resorted to accounting tricks, and ultimately fraud, to hide the losses in their core businesses, which were not nearly as successful as they had sold to Wall Street.  Bristol-Myers Squibb's channel-stuffing is an example of how changes in the business environment can catch companies unaware, and they respond by trying to paper over the problem, figuring that sales and revenue will recover in a future period to help make up for the tricks used to meet current expectations.  In other words, accounting fraud is usually a symptom of a much deeper business problem, and is a means to postpone the effects of the marketplace until a new plan can be implemented.  Enron and WorldCom shed workers because they plunged into bankruptcy when their businesses could not survive, and it no longer made sense to continue to follow an obviously failed business model. 

Many accounting frauds start small, and grow out of control over time (see HealthSouth) as the pressure to meet ever-higher earnings expectations makes it impossible to go disengage, at least not without it being noticed.  I doubt that hiring is a product of accounting fraud, although pumped-up earnings and revenues lead everyone to believe that the company needs to expand, and once that bubble is popped it will lead to job losses.  Check out Tom Kirkendall's post on the Houston's Clear Thinkers blog (here) for his analysis of the effect of Enron's collapse on the Houston economy. (ph)

September 12, 2005 in Enron | Permalink | TrackBack (0)

Judge Lake's Modest Solution to the Recalcitrant Witness Problem

The defendants in the Enron conspiracy trial, Ken Lay, Jeffrey Skilling,and Richard Causey, received less than the dismissal they sought from U.S. District Judge Sim Lake at a hearing on Sept. 8 for alleged witness intimidation by the Enron Task Force.  Instead, Judge Lake accepted the Task Force's recommendation and will write a letter to the lawyers for 38 witnesses who have not responded to defense requests for interviews, informing them that the government will not retaliate against them if they choose to meet with the defense lawyers.  Judge Lake will not, however, order the government to produce any of its cooperating witnesses for interviews, and said that he has not made any finding that the prosecutors engaged in any illegal activity in this area. A Houston Chronicle article (here) discusses the hearing and the Judge's decision to write the letter.

The interesting question is whether the lawyers for the 38 "lucky" recipients of Judge Lake's letter should have their clients agree to an interview with the defense team.  If the witness has nothing of any importance to say, then there is little risk, but that's tough to determine at this point.  If the witness believes he or she has information that might implicate him/herself in illegal conduct, then speaking with the defense lawyers without a grant of immunity would be a serious mistake, and it's unlikely the government will grant immunity to facilitate the defense gathering evidence. 

If the witness has inculpatory evidence about one or more of the defendants, and may be called by the government, allowing that person to speak with the defense lawyers only creates more cross-examination material, and so the lawyer is unlikely to allow the client to speak.  If the witness has exculpatory information, and there is no risk that the witness will also be implicated in any criminal activity, then the lawyer can recommend speaking with the defense lawyers.  The problem with that scenario, however, is the same as the no-information situation: how does a lawyer assess whether the client may have any criminal exposure at this point, particularly in light of the government stating that up to 114 Enron employees are unindicted coconspirators?  The careful lawyer may see little upside to meeting with the defense lawyers -- I assume the attorney's fees for this meeting will be borne by the witness -- and plenty of possible downsides to any interview.  It's a little bit like the old Woody Hayes view of passing: only three things can happen if you meet with the defense lawyers, and two of them can be bad, so why take the risk.  I will be surprised if many of the 38 letter recipients agree to meet with the defense team. (ph)

September 12, 2005 in Enron | Permalink | TrackBack (1)