January 29, 2005
Trading in Gillette Call Options Will Likely Trigger SEC Insider Trading Investigation
A report in the Wall Street Journal (Jan. 28) discusses heavy purchases of Gillette February call options right before the close of trading on Jan. 27, after which word began to leak out about the acquisition of Gillette by Procter & Gamble. Buying a call option, especially one set to expire in less than a month at a price well above the underlying stock's current market price, is a particularly bullish bet -- and often a signal of insider trading. According to the Journal report:
The heaviest trading was in Gillette's short-term February options, and 4,224 February 45 calls changed hands Thursday. Each of these calls gives the right, until mid-February, to buy 100 shares of stock at $45 apiece, and were valued at between $75 and $135 Thursday. By Friday, after the deal with P&G made headlines, Gillette shares gained $5.44 to $51.13. Each February 45 call is now worth between $610 and $630 Friday morning -- a nearly sixfold increase in less than 24 hours. Altogether, there were 6,525 Gillette February 45 calls currently outstanding.
My quick estimate, based on purchasing 4,000 calls at the highest price and selling at the lowest identified price, is that the transactions could yield a one-day profit of $1.9 million, and the actual profit is likely much higher, although the trades may have been conducted by more than one person or group. That kind of gain gets the attention of the SEC in a hurry, and we can expect to see the first cases filed in the next week or so, especially if any of the trading were conducted through an off-shore account that sought to liquidate its position. The Commission routinely files for a TRO to have the accounts frozen pending its investigation, and the courts (usually the Southern District of New York) just as routinely grant the temporary freeze orders. Moreover, when this type of brazen trading takes place, the U.S. Attorney's Office will not be far behind. (ph)
WorldCom Controller's Testimony Tries to Link Ebbers to Accounting Fraud
The testimony of David Myers, former WorldCom controller, continued on Friday (Jan. 28) in the government's effort to link Bernie Ebbers to the company's accounting fraud. An AP story recounts the following part of the testimony:
[Myers] remembers Ebbers saying that if the stock slid below the mid-teens, "My margin calls are called and everything I've worked for since I've joined WorldCom will basically be wiped out. "At the same meeting, without specifically referring to accounting tricks, he said Ebbers said "while the company was in extraordinary times, extraordinary things had to be done." In addition, Myers said Sullivan told him twice in 2001 that Ebbers understood, as Myers put it, "the magnitude of what we were doing on the revenue side and the line-cost side." The testimony appeared to be the most damaging yet against Ebbers, whose lawyers claim Ebbers left accounting matters to Sullivan and that Sullivan masterminded the fraud.
It is hard to draw much of a conclusion from the testimony because the cross-examination has not yet begun. (ph)
Tax Protester Convicted
Al Thompson, who refused to permit the 25 employees of his company file W-4s to withhold income tax because the tax system is illegal, was convicted on Jan. 28 in the U.S. District Court for the Eastern District of California (Sacramento) on 13 counts involving various tax violations. (Sacramento Bee article here) Thompson became nationally known when he boasted to the New York Times and on Sixty Minutes II about how the income tax is not enforceable and the government's failure to pursue him demonstrated that his position was correct. The company is now out out business, and Thompson was indicted along with former IRS Criminal Investigation Division Agent Joseph Banister, who worked with Thompson to advance the position that individuals do not have to pay income taxes. Banister's case was severed from Thompson's, and he is awaiting trial.
Thompson acted as his own attorney, and a New York Times article (here) notes that he avoided conviction on the conspiracy count by asserting to the jury that his public proclamation of his position meant that he could not have conspired. The article states: "Because he had publicly declared his actions, Mr. Thompson told the jurors that he did not see how they could convict him of conspiracy." Although I don't think the argument is technically correct as a matter of law -- a conspiracy does not require secrecy even if it is a common feature -- there is a certain logic to the position that only a fool (or tax protester) would announce a conspiracy. (ph)
January 28, 2005
Defense Opening in Trial of Former Tyco Execs
Discussed in the Wed. Jan.26th post is the prosecution opening in the case of Tyco executives Dennis Kozlowski and Mark Swartz. Yesterday, the defense responded and it sounds like mens rea, and whether the defendants had the appropriate intent, will be prominent in this case. This is not unusual in a white collar case. As reported in the New York Times, "Mr. Stillman [ ] told the jury that Mr. Swartz 'had no criminal intent because his intentions were honest. No criminal intent means no crime.'" On the law.com website, is included the following line from the opening of Stephen Kaufman, attorney for Dennis Kozlowsk, who stated, "You tell me how you steal when you sign a promissory note and repay it."
According to law.com :
"Charles Stillman, the lawyer for Swartz, presented the same chart that Assistant Manhattan District Attorney Owen Heimer had used in his opening to detail the major payments in controversy. The prosecutor's chart had been labeled "thefts." Stillman's version had the word "alleged" added to it."
There is nothing better then being able to take another attorney's demonstrative piece of evidence and use it to your advantage. The ability to turn around opposing counsel's presentation by using their language or their exhibits can be dangerous (e.g., asking the witness to try out the glove to see if it fits in the OJ Simpson case). But the risk is somewhat minimized when you are not dealing with concrete factual evidence and merely the opposing sides "take" on what happened. We'll see if this was a good move here, when the prosecution responds come their closing argument.
There does, however, appear to be differences in the approach taken from the prior trial. The NYTImes reports:
"But lawyers for both defendants, who had appeared to soft-pedal the issue of directors' credibility in the first trial, said that accusations by board members that the two men stole more than $150 million - the basis of the prosecution's case - were part of a self-serving strategy to protect themselves from shareholder lawsuits."
The evidence begins on Monday.
January 28, 2005 | Permalink
Public Corruption Case in American Samoa is Pled
A DOJ Press release reports of the "fourth defendant to plead guilty in an ongoing investigation" coming out of a corruption prosecutions in American Samoa. According to this press release, the FBI states that " the Sataua, Seumanutafa, Solaita, and Mageo prosecutions are the first public corruption cases to be prosecuted by federal officials involving American Samoa in more than 15 years."
In this plea, the defendant, "the former director of the American Samoa Department of Education"[ASDOE]
"admitted that beginning in 1999 and continuing until July 2003, he agreed to fraudulently award ASDOE contracts paid for with USDOE [United States Department of Education] funds to his co-conspirators and their companies in exchange for his co-conspirators providing him with over $9,000 in cash and goods. The ASDOE receives in excess of $10 million per year from the USDOE and other federal agencies. Further, Sataua admitted that he stole and misappropriated food and goods from the ASDOE School Lunch Program that were supposed to have been used for feeding children in the American Samoa public school system. The A.S. School Lunch Program is wholly funded by the U.S. Department of Agriculture National School Lunch Program and the USDOE."
The defendant is this case pleaded "guilty to one count of conspiring to commit bribery and fraud concerning federal programs, in violation of 18 U.S.C. § 371."
January 27, 2005
Fundraiser for Former Governor McGreevey Sentenced
AP reports that David D'Amiano, "[a] Democratic fund-raiser and acquaintance of ex-Gov. James E. McGreevey was sentenced to two years in prison Thursday for soliciting $40,000 in cash and political contributions in return for his help in a land deal." D'Amiano had been charged with mail fraud, extortion and bribery, but plead guilty to two counts of bribery.
What was particularly bothersome to many in this case was the indirect references to the former governor in the indictment. The article reports that "McGreevey has acknowledged that he was 'state official 1' referred to in the indictment." The AP story notes that "[p]rosecutors charged that D'Amiano demanded campaign donations from Mark Halper, owner of a 74-acre farm in Piscataway, in exchange for helping Halper get a favorable offer from county officials for rights to preserve the farmland."
Scrushy & Ebbers - 1/27/05
Today in the Scrushy trial, an AP story relates how despite testifying against Scrushy, Aaron Beam told the jury that "HealthSouth CEO never told him to break the law at the start of a huge fraud, and that FBI agents were 'pressing' him for figures about the scam after he went to investigators." As previously noted in the post of 1-26-05, the credibility of witnesses, especially those with cooperation agreements, may prove important here.
In the Ebbers trial, the AP story relates the testimony of David Myers. The story on ajc.com says that, "Myers also made clear in his testimony that it was Sullivan, not Ebbers, who explicitly ordered him to find a way to hide expenses when they came in far higher than expected in the third quarter of 2000." But there appears to be damaging evidence as well for the defense, as the news story states that Myers "paraphrased Ebbers as saying: 'I'm sorry you were asked to do what you were asked to do. It's something that you should not have been put in that position to do.'" This evidence may go to whether the accused had the level of mens rea required for the crime. But the credibility of this witness, like others in this trial, will likely be questioned as Myers "former controller pleaded guilty to fraud and conspiracy in 2002, agreeing to cooperate with the government in hopes of winning a lighter penalty when he is eventually sentenced."
McKesson - The Hawkins Trial
Everyone is talking about the trials of Ebbers (Worldcom), Scrushy (HealthSouth) and Kozlowski (Tyco). The Atlanta Journal Constitution, in a website called "CEO Blotter: Corp Execs in Court" features the three trials. But overlooked is what is happening on the west coast. Yesterday the trial opened in the case of Richard Hawkins, a McKesson executive who is on trial for alleged conspiracy and securities fraud. According to law.com, "[f]ormer McKesson Corp. executive and convicted felon Albert Bergonzi took the witness stand Wednesday and described how he helped pull off a scam that led to a $9 billion investor loss -- one of the biggest in history."
According to Yahoo Finance's law com report,
In spring 1999, allegations of corporate wrongdoing soured the otherwise happy merger of San Francisco-based McKesson, touted as the world's largest health care management company, and Atlanta-based software maker HBO & Co.
The resulting scandal prompted a one-day stock drop that cost investors $9 billion and inspired a flurry of shareholder suits. Last week, McKesson agreed to pay $960 million to settle a federal class action, but numerous other suits remain. The government has also gone after several executives."
Like some of the other ongoing trials, the case involves individuals who plead guilty and are now testifying for the government. Credibility of these witnesses can be the essence of the case. As reported in law.com, "In an opening statement last week, one of Hawkins' lawyers, Orrick, Herrington & Sutcliffe partner Melinda Haag, characterized Bergonzi as a liar who is trying to help himself by dragging an innocent man down with him."
Riggs Bank Pleads
As anticipated in our post of January 26th, AP just reported that Riggs Bank pleaded guilty this morning "to a criminal charge of failing to report suspicious transactions in the accounts of foreigners, including two dictators, and agreed to a $16 million proposed fine." As noted in this report, "[a]ttorneys representing the bank entered a guilty plea at a hearing before federal judge Ricardo Urbina, who must approve the proposed fine. If he rejects the fine, Riggs and prosecutors may have to renegotiate or take the case to trial."
As noted in this story the DOJ had been "investigating the banks handling of" "former Chilean dictator Augusto Pinochet." This plea raises an interesting question as to what affect it will have on the DOJ investigation. Is part of the deal that the bank will cooperate in that investigation? Hopefully so, since many in the public desire to know the true story of Pinochet's money.
January 27, 2005 | Permalink
Testimony Begins in Ebbers Trial
According to the Wall Street Journal, the first two witnesses testified in the trial of Bernie Ebbers, former CEO of WorldCom Inc. These two witnesses provided background information, something that is necessary when dealing with a complicated case that has charges of "conspiracy, fraud and making false filings with the" SEC. The Wall Street Journal states:
"Douglas Webster, a group vice president at MCI, and Adam Quinton, chairman of Merrill Lynch & Co.'s research recommendations committee, served largely as expert witnesses. Mr. Webster, who joined MCI in 1986 and went to WorldCom in 1998 when it acquired MCI, explained the technology and history behind the company and the telecom industry overall."
But witness Adam Quinton also appears to be setting the groundwork for the upcoming testimony of former chief financial officer Scott Sullivan, a key witness in this case. The WSJ reports here:
"In court Wednesday, Assistant U.S. Attorney William Johnson quickly steered Mr. Webster to line costs, which the government alleges were manipulated to inflate WorldCom's earnings. Line costs, or payments to other carriers to initiate or terminate a call locally, were WorldCom's largest expense, followed by selling, general and administrative costs, said Mr. Webster."
One of the truly difficult tasks prosecutors have in presenting white collar cases to juries is simplifying the language and concepts to a level so that jurors who may have no connection with the financial world can understand the essence of the alleged fraud.
January 26, 2005
According to an AP news report, the prosecution called Arthur Beam to present testimony today in the trial against Richard Scrushy. Beam, a former HealthSouth exec, said that Scrushy told him "[i]t's not an option to miss our numbers. You guys need to fix the numbers." According to the news report, "Beam said he participated in the fraud for a year because Scrushy intimidated him."
The jury may have gotten to see if Beam can be intimidated, as one news report states that "Beam came under sharp questioning" from the defense. The news report says that Beam could not recall some information when questioned by defense attorneys Jim Parkman and Art Leach.
Beam is one of several former HealthSouth execs who are scheduled to appear as witnesses in this trial. As noted by the Wall Street Journal, "Mr. Beam has pleaded guilty to one count of bank fraud and one count of criminal forfeiture tied to the $2.7 billion accounting fraud at HealthSouth, but hasn't been sentenced yet." It is common for the prosecution to have sentencing delayed pending the witnesses testimony and cooperation. In these situations, the question sometimes becomes the credibility of the testimony received through this form of cooperation agreement. Can we trust the testimony?
The Prosecution Opens - Tyco Execs
The prosecution gave its opening statement in the retrial of Dennis Kozlowski, Tyco's former chief executive officer, and Mark Swartz, the company's former finance chief. According to an AP report on the trial, the prosecution has made some changes in the way they are proceeding. This news story reports that, "[a]bsent from [the prosecutor's] opening was the assertion made by prosecutors in the first trial that Kozlowski and Swartz had stolen $600 million by outright theft and by deceiving the government and the public and defrauding Tyco shareholders." Additionally, there was no mention of the shower curtain, something we discussed in a prior post.
It sounds like the prosecution is not going to be trying to overwhelm the jury with testimony of extravagant spending by Kozlowski. This may also mean that the trial may not be lasting the six months seen in the last trial.
Retrials present all kinds of strategic issues. It will interesting to see if the defense pursues the same, when they open tomorrow.
Will Scrushy or Ebbers Testify?
With the opening statements in the trials of Bernie Ebbers and Richard Scrushy out of the way -- on the same day no less -- the question arises whether either one will testify in his defense. Reports on the opening arguments gave no indication one way or the other, which is not surprising because defense counsel need to keep their options open and do not want to overpromise in the opening statement. There is no "rule" regarding whether a white collar defendant should (or should not) testify at trial because so much depends on the type of evidence the government will introduce, the defendant's prior statements, and how well the person will come across to a jury. On the last point, a deep-pocket defendant can afford to have a mock jury observe a test-run of a cross-examination of the defendant to see how the person responds to tough questioning, although that is not fool-proof. Frank Quattrone came across poorly at his first trial, and was convicted in his retrial, having testified both times. Neither Martha Stewart nor co-defendant Peter Bacanovic testified in their trial, to no avail there.
The opening statement in the Ebbers trial included the assertion by defense counsel Reid Weingarten that "[t]here are zillions of documents in this case and their ain't one smoking gun." The clear focus of the defense is on the credibility of the government's main witness, former WorldCom CFO Scott Sullivan, including hints that Sullivan's marital infidelity will be used against him (earlier post here), and Ebbers' lack of involvement in accounting issues. According to a New York Times article (Jan. 26), Weingarten asserted that Sullivan was the mastermind of the fraud and "is more than a liar, but a poseur." [NB: I think I missed that one, and the definition of "poseur" is "One who affects a particular attribute, attitude, or identity to impress or influence others." Did the jury pick up on it?] The "honest-but-ignorant CEO" defense that will be offered, coupled with the lack of documentation linking Ebbers to the fraudulent accounting, leads me to think that Ebbers will not be called to testify unless Sullivan comes across especially well in his testimony. There does not seem to be as much for Ebbers to refute or explain, and of course a defendant asserting that he was ignorant of the happenings at his company risks coming across to the jury as less-than-honest, effectively scuttling the defense.
I think Scrushy's case presents a different calculus. The government intends to call a number of former HealthSouth executives who are cooperating in exchange for reduced sentences, including all five CFOs the company had since its creation. The sheer weight of that evidence may compel Scrushy to testify to establish his defense that they are all liars and kept him in the dark. The plea agreements alone are unlikely to undermine the credibility of that many witnesses. When everyone around you is claimed to be a liar, the jury may well expect that Scrushy will explain how it was possible he never knew about the fraudulent accounting, or at least how he was kept in the dark.
I don't hold myself out as much of a prognosticator, and this is all armchair lawyering before any of the evidence has come in. I think it is more likely that Scrushy will testify than Ebbers, but it would not surprise me if both did not testify. Any thoughts? (ph)
Riggs Bank To Accept Plea Agreement
Riggs National Corporation, the parent of Washington D.C.'s Riggs National Bank, is on the verge of accepting a plea agreement with the Department of Justice for violating the Bank Secrecy Act for failing to report suspicious activity in accounts involving possible money laundering, according to an article in the Wall Street Journal (Jan. 26). The article states: "The Riggs board has been presented with a plea agreement by prosecutors in which the bank would admit to one count of violating the Bank Secrecy Act by failing to file reports to regulators on suspicious transfers and withdrawals by clients, people close to the case said. Directors are expected to accept the plea and the bank would pay a fine of between $16 million and $18 million. The deal could be announced as soon as tomorrow, these people said." As discussed in earlier posts here and here, Riggs came under federal scrutiny for possible money laundering by foreign government executives, including former Chilean dictator Augusto Pinochet, through accounts maintained that involved large-scale transfers of funds. The article notes that the plea agreement, if it goes through, may affect the deal Riggs has to be acquired by PNC Financial, including the possibility that the transaction will be canceled. (ph)
Goldman Sachs and Morgan Stanley Settle SEC Complaints About IPO Allocations
The SEC announced that it filed and settled complaints against Goldman Sachs and Morgan Stanley relating to the allocation of shares in Initial Public Offerings (IPO) to clients of the firms by requiring those receiving shares to place orders to purchase additional shares, thereby raising the price of the stock. Each firm agreed to pay a civil penalty of $40 million. The Litigation Release regarding Morgan Stanley states:
In its complaint, the Commission alleges that Morgan Stanley violated Rule 101 of Regulation M under the Securities Exchange Act of 1934 by attempting to induce certain customers who received allocations of IPOs to place purchase orders for additional shares in the aftermarket. The complaint further alleges that Morgan Stanley did induce certain customers to place such orders during the new issues' first few trading days.
The allegations against Goldman Sachs are substantially similar (Litigation Release here). The Commission action does not involve a fraud allegation, and with the cooling of the IPO market there is much less demand for the shares of newly-public companies. (ph)
Mail/Wire Fraud Charges Involving Federal Rural Telephone Subsidies
The U.S Attorney's Office for the Western District of Missouri (Kansas City) announced the indictment of Richard and Daniel Martino, the controlling shareholders Cass Country Telephone Co., a rural communications provider that is eligible to receive subsidies from the federal government for providing service (it's the Universal Service Fee on your telephone bill). The eleven-count indictment (here) charges conspiracy, mail and wire fraud related to inflated billings. A press release by the USAO states:
Count One of the federal indictment alleges that the Martinos participated in a conspiracy from January 1998 to July 2004 to defraud the Universal Service Administrative Company (USAC), which disperses federal subsidies to rural telephone companies, and the National Exchange Carriers Association (NECA), which handles tariff filings and revenue distribution among carriers. The Martinos, along with Kenneth M. Matzdorff, 48, of Belton, Mo., allegedly inflated expenses of the Cass County Telephone Comany, LP (known as CassTel) in order to qualify for $8.9 million in unwarranted subsidies and disbursements.
January 25, 2005
Opening Day for Ebbers
According to an AP story, opening statements in the trial of Bernie Ebbers had the prosecution and defense presenting very different sides to events. The government presented a scenario that "Bernard Ebbers told 'lie after lie after lie' about the crumbling state of WorldCom Inc. in an obsessive drive to meet Wall Street expectations and keep its stock price high." The defense, however, according to the AP story presented Ebbers "as a self-made corporate hero who never had an inkling of the massive fraud carried out by others on his watch." Reid Weingarten, Ebbers' lead trial counsel, made the point that "[t]here are zillions of documents in this case and there ain't one smoking gun." The article notes that the case may come down to "the testimony of Sullivan, who pleaded guilty to fraud in 2002 and agreed to testify against his former boss."
Cooperating witnesses are common in federal criminal trials and are not exclusive to white collar crime cases. For example, one finds cooperating witnesses at the heart of many drug prosecutions. Whether the accused had the intent to commit the crime is very often the focal point in a white collar crime case. This case will have the jury determining the knowledge of the accused and the evaluation may perhaps hinge on the credibility of a witness.
Opening Salvos in Scrushy Trial
The government and defense made their opening arguments in the trial of former HealthSouth CEO Richard Scrushy. A report from the Atlanta Journal-Constitution (Jan. 25) provides the following summary of the arguments by U.S. Attorney Alice Martin and Jim Parkman:
"They pumped up the profits, and he hid it from the public," said Martin. She described Scrushy as "a very hands-on leader" who personally selected top aides and tried to sway their statements to federal agents once an investigation began."The evidence will show that Richard Scrushy as chief executive officer gave phony numbers to the public," Martin said.
The defense conceded that a fraud occurred, but Scrushy lawyer Jim Parkman blamed it on a group of overly ambitious, tightly knit executives who called themselves "the family" — a group, he said, that hid the misstatements from Scrushy."This was no ordinary family. This was a family that operated as a unit on their own," said Parkman.
In a deep, folksy drawl that contrasted with Martin's more businesslike approach, Parkman portrayed the Alabama-born Scrushy as an everyman CEO from humble beginnings who did his best yet failed to detect fraud that also eluded graduates of top Ivy League schools."How could it get by Richard Scrushy? You know how? This group controlled the numbers," Parkman said. In an early attack on a key government witness, Parkman described former chief financial officer Williams Owens as "the godfather" of the conspirators, casting doubt on the man who prosecutors say helped cement their case by secretly recording discussions with Scrushy.
An earlier post (here) discussed Parkman's "country lawyer" approach to the trial -- no doubt against the array of city-slickers. This is the rare prosecution in which the United States Attorney will try the government's case, and Martin is putting the reputation of her office on the line in the prosecution. (ph)
International Insider Trading Settlement
The SEC issued a Litigation Release (Jan. 25) discussing the settlement of a civil injunctive action for insider trading by Jun Singo Liang, a Chinese citizen who does not reside in the United States. Liang is a senior vice president and general manager of the Wireless Business Department for NetEase.Com, a Beijing-based company with an office in California whose shares are traded as American Depository Receipts on NASDAQ. The complaint alleges that prior to a public announcement that Liang's division, NetEase's largest, had suffered a significant revenue shortfall, he "sold more than 47,000 shares of NetEase stock * * *, realizing over $3 million in sales proceeds. After NetEase announced the revenue shortfall, the stock price plummeted by 23%. By trading ahead of this news, Liang avoided more than $700,000 in losses." Liang agreed to pay disgorgement and prejudgment interest totaling $731,169, a civil penalty of $355,129, and a five-year director-and-officer bar.
The Commission's Release notes that Liang's penalty is lower than the usual one-times trading profit sought from defendants because he voluntarily disclosed his trading to the company and the SEC. The civil action shows once again the scope of the SEC's jurisdiction to reach trading by those outside the United States when the securities are traded on an American market. (ph)
Let the Trials Begin!
The jury has been picked in the trial of Richard Scrushy in Birmingham, Ala., and opening statements will begin today. An article in the Birmingham News (Jan. 25) describes the jury: "A jury made up mostly of blacks and men was selected Monday to decide the case of HealthSouth Corp. founder Richard Scrushy, who faces charges in the company's accounting scandal. Though the identities of the jurors are not public, at least 10 of the 18 chosen are black and at least 10 are male. On Monday, both sides seemed pleased with the jury selection process that began Jan. 5 and said they are prepared to move forward with the trial that could last up to four months." The jury selection process is nearly complete in the Bernie Ebbers trial in New York City, according to a Wall Street Journal story (Jan. 25), and seven more jurors have been selected in the retrial of former Tyco CEO Dennis Kozlowski, bringing the total to eleven.
It will be a surprise is any of the trials are done by mid-April -- barring a mistrial or grant of an acquittal -- and one (or more) could stretch into the summer. The Ebbers trial seems to be the least-complicated, to the extent that the paper-trail appears to be less extensive than in the other two cases. The testimony of Scott Sullivan, WorldCom's former CFO and the person with the closest business relationship with Ebbers, likely will take quite a while, possibly two to three weeks. Given how long these trials will take, make sure to curb your enthusiasm and don't get too worked up over the exciting accounting issues that will be aired to the juries. (ph)