Saturday, February 24, 2007
Guest Blogging - J. Kelly Strader - Professor of Law, Southwestern Law School
The KMPG Saga, Part 1
I recently gave a talk on the KPMG case at a symposium sponsored by Chapman University School of Law entitled "Miranda at 40: Implications in a Post-Enron, Post 9/11 World," and I thought I would share some of my observations. KPMG has been an extraordinary case, with fascinating legal and strategic issues for both sides. To avoid overloading the reader, I’ve divided my discussion into four parts. I discuss the latest developments in the case, and end with some views on the impact that the Thompson and McNulty Memos have had on complex white collar litigation.
Because the case has been pending for over a year and a half, with no trial in sight, it might be helpful to recap some key facts. KPMG is one of the world’s largest accounting firms. In 2002, the IRS issued summonses to KPMG in connection with its tax shelter practices. In 2003, the Senate held widely-publicized hearings on those practices. The IRS later referred the matter to the Department of Justice for criminal investigation. The grand jury handed down the original indictment in August 2005, and the superseding indictment later that year. (indictment here) ; press releases here & here.
The government has described the case as the largest tax fraud case in United States history, with an alleged two billion dollars of lost tax revenue due to fraudulent tax shelters. The 70-page, 46-count indictment named 19 defendants and included charges of conspiracy, tax evasion, and obstruction of justice. Among the defendants were 16 former partners or employees of KPMG, some of whom were at the highest levels of management.
Under a deferred prosecution agreement, the government also filed an information against firm, with a single tax fraud conspiracy count. (information here) The DPA required that KPMG pay nearly half a billion in fines, restitution, and penalties, and that the firm cooperate fully in the investigation. It is the DPA that has produced most of the notable issues in the case, including some fascinating Fifth and Sixth Amendment-related issues, including issues currently on appeal to the Second Circuit. (Next time: the attorneys’ fees imbroglio.)
The Department of Justice is looking at the options issuance practices of KB Home, joining a previously-disclosed SEC formal investigation. According to a company press release (here): "KB Home's past stock option grant practices are being investigated by the Securities and Exchange Commission. The Department of Justice is also looking into these practices but has informed KB Home that it is not a target of this investigation. KB Home has and intends to fully cooperate with any government agency looking into this matter." On November 12, 2006, the company announced (here) that long-time CEO Bruce Karatz was retiring, and he "voluntarily" agreed to repay the difference between the lower, backdated strike price and the proper price on options he had exercised. In addition, KB Home's human resources director was fired, and its general counsel resigned. While the disclosure of a criminal investigation does not necessarily mean charges will be filed, the fact that it comes on the heels of the SEC upgrading its investigation from an informal inquiry likely means the government will be looking at a wide range of transactions, and the company's former officers are the probable targets of the investigation. (ph)
South Korean businessman Tongsun Park first burst on the scene in the 1970s when he was indicted on influence-peddling charges in the Koreagate contributions scandal, although the charges were eventually dropped after he fled the United States. With the United Nations' Oil-for-Food program designed to get humanitarian aid into Iraq during the embargo after the first Gulf War, Park got involved in helping the Iraq government try to bribe UN officials, including then-Secretary General Boutros-Ghali, to set up the program in a way that favored the Iraqi government.. The government of Saddam Hussein gave Park $1 million in cash, much of which went into a company owned by a UN official. In July 2006, Park was convicted of conspiracy to act as an unregistered agent of the Government of Iraq. U.S. District Judge Denny Chin sentenced Park to the maximum five-year prison term authorized for his conviction (see USAO press release here), stating that "[y]ou either bribed a U.N. official or you were acting as if you were going to bribe a U.N. official." Park was immediately taken into custody at the end of the sentencing hearing. A Washington Post story (here) reviews the case and Park's history of involvement in various lobbying efforts. (ph)
Friday, February 23, 2007
Blog co-editor Ellen Podgor published an interesting article in the Yale Law Journal Pocket Part about the current nature of white collar crime sentences, "Throw Away the Key." She discusses the recent phenomenon of lengthy sentence for white collar defendants who are almost always first-time offenders posing no threat to society. She argues:
No doubt many of these white-collar offenders committed thefts within companies, and in some cases decimated employees’ and investors’ savings. But the sentencing Guidelines limit courts’ abilities to consider factors such as the motive of the perpetrator, the benefit he or she received, and the extenuating circumstances that caused the harm. Instead, the judge may only consider the sentencing Guidelines’ mathematical computation of loss when imposing a sentence. As a result, in some courts the person who steals to benefit the company without personal remuneration can receive a comparable sentence to the rogue employee who cashes in his or her company stock to obtain an immediate personal profit. The accused becomes irrelevant in a sentencing world ruled by the cold mathematical calculations found in the sentencing Guidelines. Not even the Supreme Court’s decision in United States v. Booker, which grants trial judges some flexibility after using the Guidelines, provides much relief. The statistics show that judges usually stick to the sentences provided in the Guideline grid.
A response to Professor Podgor's article was written by Andrew Weissmann and Joshua Block from the Jenner & Block firm -- Weissmann was head of the Enron Task Force before leaving for private practice. Their article, "White-Collar Defendants and White-Collar Crimes," agrees with her point that long sentences for white collar defendants do not provide much deterrence, but disagree with the argument that such defendants should be viewed differently. They argue:
Most troubling are Podgor’s arguments with respect to white-collar criminals. It is one thing to say that certain criminal acts are not as bad as others. But it is quite another to argue that people who commit white-collar crimes as a generalized group should be punished differently from those who commit other crimes. Any such differences often correlate in fact to race and almost always to class. One of the laudatory goals in promulgating the Sentencing Guidelines was to remedy the potential for hidden—or unhidden—bias in favor of “white collar” defendants.
The discussion is especially pertinent because the pace of white collar crime prosecutions continues. Lord Conrad Black faces securities fraud, conspiracy and RICO charges in Chicago over transactions at Hollinger International when he was CEO, and former Qwest CEO Joseph Nacchio will go on trial in Denver on insider trading charges for selling over $100 million in shares shortly before the company's stock price collapsed due in part to accounting problems. Like CEOs before them, these men face substantial sentences, which could amount to a virtual life term, for conduct that involved rather mundane corporate transactions. (ph)
Just in time for the end of Carnival, two Brazilians settled an SEC insider trading civil suit arising from purchases in the target of an impending tender offer. The defendants are Luiz Gonzaga Murat was the chief financial officer and investor relations director at Sadia S.A., a Sao Paulo frozen food company, and Alexandre Ponzio De Azevedo, who formerly worked for ABN AMRO's Brazilian affiliate. Sadia planned a tender offer for Perdigão S.A., another Brazilian company, and ABN AMRO's investment banking unit advised on the deal. According to the SEC's Litigation Release (here):
[O]n April 7, 2006, representatives of an investment bank met with Murat and another Sadia executive to propose that Sadia make a tender offer for Perdigão. According to the complaint, Murat proceeded to purchase American Depositary Shares ("ADSs") of Perdigão both later the same day and subsequently on June 29, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to Sadia. The complaint alleges that Murat's holdings totaled 45,900 ADSs of Perdigão by the time Sadia announced the tender offer. On July 17, 2006, the price of Perdigão ADSs increased to $24.50, up $4.25 (21%) from the previous closing price. According to the complaint, Murat had imputed illicit profits of $180,404 from his unlawful trading.
The Commission's complaint against Azevedo alleges that he learned of the possible tender offer on April 11, 2006, in his capacity as an employee of ABN AMRO assigned to the tender offer financing team, and that ABN AMRO later placed Perdigão on a list of securities in which ABN AMRO employees could not trade. According to the complaint, Azevedo subsequently purchased 14,000 ADSs of Perdigão on June 20, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to ABN AMRO. Azevedo sold 10,500 ADSs on July 17, 2006, one day after Sadia had publicly announced its tender offer for Perdigão. According to the complaint, Azevedo realized illicit profits of $52,290 on the 10,500 ADSs he sold on July 17 and had imputed profits of $14,875 on his remaining 3,500 ADSs.
Murat agreed to pay $184,028 in disgorgement and a civil penalty of $180,404, while Azevedo will pay $68,215.45 and a civil penalty of $67,165.
An interesting aspect of the case is that neither defendant ever set foot in the United States in connection with the transaction, and none of their trading involved an American company or even any communications that passed through the U.S. The jurisdictional hook is the securities of each company, which are traded on the New York Stock Exchange as ADS. Under Section 10(b) of the Securities Exchange Act, the general antifraud prohibition applies to any person who "directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . ." The fact that the securities of the target trade on the NYSE brings the case under the Act, although it is a fair question whether conduct wholly outside the United States with only a tangential connection to this country should be subject to a civil enforcement action by the SEC. The trades were placed in Brazil, and the companies were incorporated and operated there, but the transaction ultimately occurred in New York, bringing it into the SEC's cross-hairs. The case shows the long arm of the insider trading prohibition. (ph)
Thursday, February 22, 2007
U.S. District Judge Denny Chin reversed the securities fraud convictions of New York Stock Exchange floor broker David Finnerty, another in a series of setbacks in high-profile securities fraud prosecutions that began with a big splash and seems to be ending with a whimper. Fifteen brokers were indicted on charges alleging that they stepped in front of their customers to intercept trades at more favorable prices, leaving the clients putting in orders to pay a higher price or receive a lower one in the transaction. Called "interpositioning," it is basically front-running in which the floor broker, who is responsible for ensuring that the market trades smoothly, uses his superior position to recognize trends and trade for his firm's own account before executing customer orders -- in elementary school,, it was called "front-cuts." Judge Chin granted Finnerty's Rule 29 motion for a judgment of acquittal, finding that the government had not proven the defendant's conduct defrauded customers, the key to a securities fraud conviction (opinion below). Judge Chin held:
Finnerty is not arguing that evidence of customer expectations is an element of the crime that the Government must establish for a conviction under 10b-5. Rather, Finnerty is arguing that, under the facts of this case, the Government could not prove that interpositioning was deceptive without showing what the investing public expected. I agree . . . the Government was required to prove that customers expected one thing and got something different. Without evidence of what the customers expected, no rational juror could conclude that the interpositioning trades had a tendency to deceive or the power to mislead. A juror would only be able to reach that conclusion by speculating . . . .
Finding no evidence that the customers were misled, the conviction could not stand. The opinion also questions whether Finnerty even owed a fiduciary duty to customers who had no clue about the floor broker's role in a transaction, which is usually a linchpin in a fraud prosecution based on an omission rather than a misstatment.
The government earlier dismissed a number of cases against other floor brokers, and some were acquitted after trial. Two broker were convicted of securities fraud in July 2006 after trial before a different judge, and two others entered guilty pleas. Challenges to the two convictions likely will be bolstered by Judge Chin's decision. (ph)
West Palm Beach (Fla.) attorney John Garcia learned the hard way that lawyers have to keep their distance from clients, especially when a client is involved in a significant drug dealing operation. Garcia received an 18--month sentence after pleading guilty to three counts of failing to file CTRs for cash transactions over $10,000 and one count of making a false statement to a DEA agent. The case arose out of an investigation of Garcia's client, Joel McDermott, who was convicted on drug distribution charges. In looking at McDermott's assets after his conviction, the DEA noticed that payments were being made on a house being built in Wellington, Fla., in his name. Needless to say, McDermott was more than willing to roll over on his attorney, and it came to light that he gave Garcia cash to purchase cashier's checks to make the payments. As described in a press release (here) issued by the U.S. Attorney's Office for the Southern District of Florida:
Garcia admitted structuring cash transactions in his bank account to avoid the filing of currency transaction reports that would have disclosed the source of the monies and their amounts; he also admitted that he lied to Special Agents of the Drug Enforcement Administration when he said that: (1) he had no financial or equitable interest in the construction of a residence in the name of Joel McDermott located in a real estate development known as “Olympia;” and (2) he did not purchase cashier’s checks from Bank of America for the residence of Joel McDermott located in a real estate development known as “Olympia.” In fact, however, Garcia had a financial and equitable interest in the residence in “Olympia” and had purchased several cashier’s checks at Bank of America with cash given to him by Joel McDermott. Thereafter, Garcia caused those cashier’s checks to be tendered to Minto Homes for the benefit of Joel McDermott and a home McDermott was building in “Olympia.”
A Palm Beach Post story (here) discusses the sentencing hearing for Garcia, attended by a number of defense attorneys and a retired circuit court judge, who attested to Garcia's integrity. Indeed, the Assistant U.S. Attorney prosecuting the case said that Garcia is "an honorable man of his word." While U.S. District Judge Daniel Hurley expressed some sympathy, noting the number of supporting letters he received, he also pointed out that Garcia's conduct was "180 degrees at odds with the person we thought we knew." While the judge mused about possibly giving a higher sentence than called for by the Federal Sentencing Guidelines, he ended up giving Garcia a term at the bottom of the sentencing range.
The old adage is that the client goes to jail and the lawyer goes to lunch (or dinner, or back to the office). When the attorney crosses the line and starts helping a client launder money, then the last person on earth that client will protect is the lawyer, who will join the client in jail. (ph)
Veritas Software Corp. settled an SEC securities fraud action alleging that the company engaged in accounting fraud, including round-trip transactions with AOL to increase revenues. The company, which was acquired by Symantec Corp. in 2005, was also accused of smoothing out its earning through "cookie jar" accounts to keep up the appearance that revenue and earnings were not fluctuating, which is anathema to Wall Street. The SEC Litigation Release (here) describes the accounting problems:
- In the fourth quarter of 2000, Veritas artificially inflated reported revenues in connection with a $20 million transaction with AOL and smaller transactions with two other Internet companies. In the three round-trip transactions, Veritas agreed to "buy" online advertising in exchange for the customer's agreement to purchase software from Veritas at inflated prices. To conceal the true nature of the AOL transaction, the company structured and documented the round-trip as if it was two separate, bona fide transactions, conducted at arm's length and reflecting each party's independent business purpose. In addition, the company lied to and withheld material information from its independent auditors about the AOL transaction and the other two transactions.
- AOL improperly recognized revenue on the round-trip transaction and reported materially misstated financial results to its own investors. Through its conduct, Veritas aided and abetted AOL's fraud.
- During 2000 through 2002, Veritas engaged in three improper accounting practices to manage its earnings and artificially smooth its financial results. Specifically, Veritas improperly (a) recorded and maintained excess accrued liabilities, employing "accrual wish lists" and "cushion schedules"; (b) stopped recognizing professional service revenue it had fully delivered and earned upon reaching internal targets; and (c) inflated its deferred revenue balance. As with the round-trips, the company took concerted steps to conceal these improper practices from its independent auditors.
In addition to the usual "sin-no-more" injunction, which will have little effect because Veritas has disappeared, the company will pay a $30 million civil penalty. (ph)
Wednesday, February 21, 2007
A dismissed complaint in a shareholder derivative suit against Mercury Interactive related to options backdating at the company shows once again the perils of writing things in e-mails that can come back to haunt you. Mercury Interactive is now a subsidiary of Hewlett-Packard, and the California superior court dismissed the case alleging breaches of various state law fiduciary duties because the shareholders no longer have standing to pursue the derivative claim. The complaint was sealed, but somehow the Wall Street Journal obtained a copy (available here), and it details e-mail discussions of setting the options strike prices on particularly favorable dates. Even worse, one e-mail states that to accomplish their goals an officer may need to "use her magic backdating ink." (see paragraph 45 of the complaint)
What on earth would possess someone to write something so stupid? The parties to the e-mail are lower-level employees, but other e-mails involving senior officers indicate an awareness of the effect of the rising stock price on the value of options, and the eventual backdating of them to secure greater benefits to the recipients. The notion that e-mails do not "exist" seems to perdure because people continue to write the darnedest things in them -- recall the "I shouldn't have asked" e-mail from Hewlett-Packard's chief ethics officer about pretexting. More importantly, e-mail traffic can be potent evidence of a person's intent at the time of a transaction because it is usually contemporaneous with the conduct being investigated.
H-P announced the buy-out of Mercury Interactive in July 2006, just as the options backdating investigations kicked into high gear, and it does not appear that there is an ongoing criminal investigation of the company or its officers, at least a publicly-disclosed one. The SEC has been investigating the backdating for a while now. There may be greater involvement from the criminal side in the near future because talk about "magic backdating ink" does not bode well for those involved in the options issuance, even if the company not long exists as an independent entity. (ph)
UPDATE: An article in The Recorder (here) notes the source of the complaint that had been under seal: "A fourth-year associate at Orrick, Herrington & Sutcliffe inadvertently disclosed a sensitive document about stock option backdating that the firm has spent the last five months fighting to keep under seal." It can't be a good day for that lawyer, although the complaint sat in a file at the courthouse for four months and only emerged on Friday, Feb. 16. (ph)
Tuesday, February 20, 2007
The trial of I. "Scooter" Libby will reach the jury today with instructions being given to them this morning. The final arguments, described in the Washington Post here, have the jury deciding if Libby deliberately told a "dumb lie" or whether he was just a hardworking employee. Perhaps a subsidiary issue that the jury may turn to will be whether this alleged lie warrants a criminal conviction. Check out Neil Lewis descriptive article in the N.Y.Times highlighting key points made by the parties in their closing arguments.
Monday, February 19, 2007
An opinion piece in the Washington Post by Victoria Toensing, a former deputy assistant attorney general in the Reagan administration and now a Washington lawyer, provides a long list of "possible" indictments resulting from the circumstances surrounding the Libby trial. It includes everyone from the prosecutor J. Patrick Fitzgerald, the CIA, to the DOJ. It is the kind of article that makes one wonder whether we really do need to reexamine the wide breadth of prosecutorial power given individuals who have the ability to ruin people's lives, put people in jail, and also decide who will walk free.
In yet another example of the wide disparity between those who went to trial and those who cooperated and plead guilty in Enron related cases, CNN Money reports that "two former energy traders" received sentences of two years probation and a fine.
Is it too risky for an accused to go to trial in white collar cases, especially fraud related cases that include a possible significant "fraud loss" if a conviction results? Are defendants being deprived of their constitutional right to a jury trial when there is an enormous disparity between going to trial and being convicted and pleading and cooperating?
A press release of the DOJ reports that "a former Department of Defense (DOD) employee, pleaded guilty to accepting illegal gratuities while serving as an operational support planner in the Future Operations Division of the U.S. Army Headquarters, Special Operations Command–Europe (HQSOCEUR)." This case comes out of the recent National Procurement Fraud Initiative. The case appears to involve $24,000 and a job offer by an individual who "served in the U.S. Air Force until January 2005, when he left active duty and began work as a DOD civilian employee." One question is whether this plea and others will be used to secure indictments of individuals who are in higher roles. Another question is whether there were adequate compliance programs in effect to avoid the cases being examined by the National Procurement Fraud Initiative.
Sunday, February 18, 2007
According to CCN Money, the government has decided not to appeal the decision in U.S. v. Brown. This Enron-related case involved executives at Merrill Lynch. The Fifth Circuit Court of Appeals reversal of the conspiracy and wire fraud counts against the defendants was based on the use of the "honest services theory." (see here).
Although the government does not maintain a conviction here, it does leave for future use, the honest-services theory of prosecution. Honest services cases have been a source of concern since the adoption of the statute, 18 U.S.C. Sec. 1346. In the Rybicki case, the dissenters called for Congress to "repair this statute."
Arkansas Online (subscription required) is reporting that Interim USA Griffin has decided not have his name go forward for the permanent position if he has to go through the confirmation process. Attorney General Alberto Gonzalez had appointed Tim Griffin in one of the recent surprise changes in U.S. Attorneys. Attorney John Wesley Hall questioned this appointment in legal documents (see here) Griffin appears to be concerned about the process, if he has to go through a confirmation hearing. Is this not the same legislative process that creates the laws he will be enforcing?
(esp) (w/ a hat tip to Jack King)
The case of I. "Scooter" Libby is likely to head to the jury this coming week with closing arguments set for Tuesday. The Washington Post has an interesting piece titled, "Almost Everyone Lies, Often Seeing it as a Kindness." The article speaks with Robert Feldman, "a social psychologist at the University of Massachusetts, who studies lying in everyday life." I guess I keep wondering what Martha Stewart would say about all of this.
Talkleft here has Libby's Revised Proposed Theory of the Defense Instruction. And the government has filed an objection to this Instruction and proposed its own final jury instructions. (see here from TalkLeft).
Instructions can be important in a case. Most juries try to follow the law and the instructions provide them with the applicable law to follow. Many instructions are difficult for a jury to follow, as the legal language can be problematic, especially for those without a legal background. Instructions can also be crucial if there is a conviction, as this is an avenue that can be used to present issues for review in the appellate court. For example, the Arthur Andersen case was reversed premised on an instruction given in the trial court.