Category Archives: Legal – Criminalizing Business

The Price of Progress

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As noted here last fall, one of the key dynamics that is delaying the recovery of financial markets is the resistance of many societal forces to allow the markets to allocate the risk of loss among the various investors in failed businesses.

Inasmuch as private capital will not invest in even a potentially viable business until that company’s financial condition is likely to reward such an investment, the liquidation of unviable companies is an essential part of the process that has allowed market-based economies to generate the most wealth and jobs throughout modern history.

Despite the foregoing, the beneficial aspects of liquidating unprofitable businesses remains often unappreciated. A scene from the 1991 Norman Jewison film "Other’s People Money" illustrates this truth wonderfully, first as Gregory Peck’s character demonizes the forces of liquidation and then as Danny DeVito’s "Larry the Liquidator" shatters the myths upon which such demonizing rests. Enjoy.

The WSJ’s Myopia Regarding Prosecutorial Misconduct

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Bully for the Wall Street Journal for running this editorial last week decrying the prosecutorial misconduct of the Justice Department in obtaining the conviction of former Alaska Senator Ted Stevens on ethics charges (Mike over at the Crime and Federalism blog has posted a copy of the defense motion describing the prosecutorial misconduct here).

However, where was the nation’s leading business newspaper when even more egregious prosecutorial misconduct was involved in criminal cases that the DOJ brought in regard to Enron, particularly the prosecution of Jeff Skilling?

Could it be that the Journal was invested in the DOJ’s myth regarding Enron?

How ironic that the WSJ condemns prosecutorial misconduct with regard to the case against a politician, but largely ignores it in cases against businesspeople.

Stanford blows up

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stanford Well, that certainly didn’t take long, now did it?

As noted here this past Sunday, R. Allen Stanford’s Stanford Financial Group has been well-known around Houston as a smoke-and-mirrors investment outfit for quite awhile. Joe Weisenthal over at Clusterstock has the best overview of Stanford’s collapse, while Felix Salmon does a good job of summarizing the SEC complaint and asking the right questions about the principals of the firm. The Chron’s Kristen Hays and Tom Fowler provide the local angle here.

Meanwhile, the Chronicle’s business columnist Loren Steffy bemoans the fact that government regulators — who have been investigating Stanford for at least the past four years — were again behind the knowledge curve in protecting investors from Stanford’s apparent investment fraud.

However, Steffy’s expectations are simply misplaced. A government regulatory body will rarely be as effective or efficient as the information marketplace in preventing or mitigating investment fraud loss. Had the investors in Stanford relied on Houston’s information market in deciding on whether to invest in the company, they wouldn’t have needed the "protection" of government regulation.

Considering the whole man

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Chris Milton Over the years, I’ve written quite a bit (for example, here, here and here) on the questionable nature of the prosecutions of the executives who were involved in the AIG/General Re finite risk transaction that prompted Eliot Spitzer to demonize Hank Greenberg.

However, I’ve never written as eloquently about the injustice of those prosecutions as Anthony O’Donnell does in this I&T post about the sentencing of former AIG vice-president of reinsurance, Christian Milton.

As noted previously here, the human toll of the criminalization-of-business lottery is incalculable. Careers destroyed while lives and families are shattered.

A truly civil society would find a better way.

The potential consequences of being tricky

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Fuld It’s rarely pleasant for a businessman to have his personal affairs splashed across the front page of the New York Times business section.

But it has to be particularly unsettling for the businessman when he is already the target of numerous civil lawsuits and, quite possibly, a criminal prosecution.

Frankly, I’ve never understood the reasoning of lawyers who advise their clients at the center of such a litigation firestorm to transfer assets to their family members. Fuld and his wife are reportedly quite wealthy, so maybe they have legitimate estate planning reasons for Fuld to transfer his interest in a multi-million dollar home to his wife for nominal consideration.

But Fuld is also subject to numerous civil lawsuits in connection with the Lehman Brothers meltdown. Those lawsuits seek hundreds of millions in damages, and the company’s officers and directors’ insurance likely will not come close to covering those damages. Thus, the fact that Fuld is transferring a valuable interest in an asset to his wife for nominal consideration at this particular time will be of more than passing interest to the plaintiffs in those lawsuits.

Inasmuch as Fuld is the only person in his family who has any civil liability in those lawsuits, why subject other family members to possible fraudulent transfer liability?

Similarly, in the unlikely — but certainly possible — event that Fuld’s litigation problems force him into a personal bankruptcy case, why take the risk that his legal right to a discharge of personal liability for claims against him would be denied because of the transfer to his wife?

However, beyond the civil liability concerns, the main reason that Fuld should not have engaged in this type of transfer under his particular circumstances is simply that it looks bad. Real bad. Not only to potential creditors, but more importantly, to prosecutors who will make the decision on whether to indict Fuld. And, most importantly, to jurors who will decide Fuld’s fate.

For example, remember the criminal case against former Enron chairman, Ken Lay? The prosecutors conceded (bragged?) afterward that it was a very weak case. So, rather than focus on the supposed criminal conduct, the prosecutors hammered away on Lay’s indiscrete use of his personal line of credit with the company. As noted in my concluding post on the seventeen-week trial:

[I]f there was a defining moment in the trial that sealed the defendants’ fate, then it likely came in Week Fourteen during Task Force prosecutor John Hueston’s cross-examination of Lay over the use of his company line of credit.

Although Lay’s line of credit was legal and the company disclosed his use of it in accordance with applicable law, Lay’s repayment of the large draws on the line with Enron stock at a time when he was encouraging employees and the market to buy company stock was an apparent contradiction that the jurors could easily grasp.

Similarly, Lay’s decision to draw down $1 million on the line five days before Enron’s bankruptcy [to help pay off the mortgage on Lay’s condominium] was a disastrous decision for the defense. Although done on advice of counsel, Lay’s last-minute draw as the company was sinking into insolvency looked so bad that reference to that testimony by leaders of the jury during deliberations was probably enough to seal any wavering non-leader juror’s view on whether to convict.

If Fuld is indicted, then you can rest assured that prosecutors will bring his recent transfer to his wife to the attention of the judge during proceedings over the amount of his bond pending trial. And although the transfer has nothing to do with the probable criminal charges against Fuld (i.e., violating the obligation to throw in the towel), prosecutors will try to use it anyway to make him look tricky in the eyes of jurors.

You see, such a transfer plays right into the real presumption these days in business crime prosecutions — Fuld is wealthy and his company collapsed, so he must be guilty of some crime in connection with his company’s demise.

Sadly, being proven greedy is often enough to be convicted of a crime.

 

Making Bad Policy

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It sure is getting hard to keep up with all the rules involved in determining whether an important person gets prosecuted for an alleged business crime.

First, there was the Apple Rule, which was quickly followed by the Dell Rule.

Next, there was the Buffett Rule.

And then we had the GM Rule.

Now, Larry Ribstein reports that we have the Geithner Rule.

None of which is likely to help Wachovia’s Bob Steel, who the SEC apparently believes violated the obligation to throw in the towel.

Does anyone really believe that all these rules and the criminalization-of-business lottery constitutes a coherent policy for regulating questionable business deals?

The Criminalization-of-Business Lottery

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The owners of Long Term Capital Management may have been the earliest winners in the most recent era of what Larry Ribstein has coined the criminalization-of-business lottery.

On the other hand, Jamie Olis may have been the biggest loser.

Martha Stewart lost, but at least never lost her business enterprise. Frank Quattrone also lost, but then he won, although I suspect that he believes that he lost overall.

Subsequently, Theodore Sihpol won while Bill Fuhs and his family lost a year of his life before he won, too. But he and his family will never get that year back.

Then, Ken Lay lost big even though he had a reasonable basis for believing that he should have won. Same with Jeff Skilling.

Meanwhile, mainstream media darlings Steve Jobs and Warren Buffett won, although several of Buffett’s associates did not fare as well. Neither did relative media unknown Greg Reyes.

But General Motors CEO Rick Wagoner appears to be a winner, even though those two Bear Stearns executives probably aren’t.

And who knows about those Lehman Brothers executives — they may be winners, after all? I mean, everyone was doing it, right?

Finally, for awhile, it looked as if David Stockman was going to be a big loser. But in a startling turnaround, Stockman is now a winner.

Just as with a gambling lottery, there is no rhyme or reason as to who wins or loses in the criminalization-of-business lottery.

But in this lottery — which does little or nothing to deter the true business criminals of the world — the losers and their families give up much more than merely money.

A truly civil society would find a better way.

Another Angry Mob

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mob_ The Fifth Circuit’s decision yesterday reminded us of the angry mob that lynched Jeff Skilling.

Now, as this timely Roger Parloff/Fortune article notes, an even larger mob is gathering to lynch the businesspeople who were attempting to save their companies in the wake of last year’s financial meltdown on Wall Street:

The level of fury surrounding these inquiries is of a different order from what we saw with, say, the backdating scandals or the Enron and WorldCom failures. Today’s credit collapse has already vaporized about $9 trillion in investment capital, while ripping another trillion in assorted bailout money from the pockets of enraged taxpayers – also sometimes known as "jurors."

Based on the Fifth Circuit’s Skilling decision, those targeted businesspeople would be wise not to rely on the courts for protection from the mob.

The Fifth Circuit rules in the Skilling appeal

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Skilling. jpg In this current anti-business climate, not many folks were expecting that the Fifth Circuit Court of Appeals would set aside former Enron CEO Jeff Skilling’s conviction.

On the other hand, not many folks expected this decision, either.

In the curiously detached 104 page opinion, the Fifth Circuit affirmed Skilling’s conviction, but reversed his sentence and remanded that part of the case to U.S. District Judge Sim Lake for resentencing based on the appellate court’s rejection of Judge Lake’s four level enhancement under the sentencing guidelines for for "substantially jeopardizing a financial institution."

Based on my rough calculations, I think that means that the range for Skilling sentence would be reduced from 292-365 months to 188-235 months. If Judge Lake resentences Skilling at the bottom of new range, then Skilling’s 24 year sentence would be reduced by 104 months, which computes to an 8.5 year reduction.

That’s certainly better than nothing.

In reading the opinion, I gathered the impression that the Fifth Circuit panel really did not have its heart in it. Despite the 104 page length, the opinion mostly glosses over the hotly-disputed fact issues regarding the government’s charges against Skilling. And even in affirming Skilling’s conviction, parts of the decision provide hope to Skilling that his monstrously unjust 24 year sentence will be set aside completely or reduced even further.

Rather than parse the decision in a blog post, here is a copy of the decision in which I have used Adobe Acrobat to bookmark the sections of the decision, as well as highlight and annotate comments on my initial reading of the decision.

First and foremost, the decision muddles the adjudication of Skilling’s argument that his conviction was tainted by the government’s legally invalid "honest services" theory.

If you’ve been following the Enron-related criminal cases from the first one (Arthur Andersen), you know the drill — in an effort to facilitate prosecutions, the Enron Task Force developed a fallacious theory of criminal liability out of the honest services wire fraud statute that is normally used in corporate crime cases involving bribes or kickbacks. In short, the government’s new theory attempted to stick a square peg in a round hole.

As a result, none of the Enron-related prosecutions proceeded smoothly. The government would normally bludgeon former Enron executives into plea deals, have them testify about "secret side deals" that changed the nature of an otherwise valid business transaction and then accuse defendants such as Skilling of breaching their fiduciary duty to the company and committing the crime of honest services wire fraud by allowing the transactions to be accounted for pursuant to the terms of written agreements rather than the "secret side deal." The fact that all of the written agreements contained provisions that rendered any such oral agreements void has been regularly ignored by the government and most courts throughout the entire Enron ordeal.

After the Enron Task Force used this theory of honest services wire fraud to convict Skilling, the Fifth Circuit struck down the theory in the Nigerian Barge case by concluding that it does not apply where employees "breached a fiduciary duty in pursuit of what they understood to be a corporate goal."  Accordingly, the Skilling team based a major part of his appeal on the Fifth Circuit’s decision in the Nigerian Barge case.

Without expressly saying so, the Fifth Circuit in Skilling creates a "policymaker exception" to the rule that a breach of fiduciary duty that is aligned with corporate interests cannot be an honest services wire fraud. The Court reasons that, since Skilling was the person who authorized the fraudulent means to achieve the corporate goal, he could be held criminally liable under the honest services wire fraud statute even if his employees could not (pp. 21-23).

Not particularly persuasive reasoning, but there you go.

Some other observations:

At several points in the prosecutorial misconduct section, the Court invites Skilling to file a motion for a new trial with Judge Lake, particularly in regard to the Fastow interview notes that the prosecution failed to turn over to Judge Lake during the trial. The Court specifically finds that "the omission of this statement [that Fastow did not think he discussed Global Galactic with Skilling] from the [FBI Form] 302’s is troubling."

The Court clearly is not impressed by the objectivity of the Houston Chronicle, citing the newspaper’s highly inflammatory coverage of Skilling’s case in finding presumed community prejudice against Skilling. Of course, the Chronicle’s most vitriolic critic of Skilling doesn’t even notice (see also here and here) the Court’s criticism.

On one hand, the Fifth Circuit finds that Judge Lake committed error by failing to presume jury prejudice for purposes of Skilling’s change of venue and jury prejudice argument. Then, on the other, the Court rules that Skilling waived his jury prejudice argument on appeal by failing to register objections for cause on 11 of the 12 jurors.

The Court concludes that Judge Lake’s "exemplary voir dire" helped the government fulfill its burden of establishing that an impartial jury had been impaneled despite the presumed prejudice against Skilling. I have my doubts.

The Court chides Judge Lake for his remarks during a pre-trial hearing that there was a "reasonable likelihood" that the witnesses did not cooperate with Skilling because the witnesses were guilty of related crimes and wished to assert their Fifth Amendment privilege to avoid incriminating themselves. However, the Court concludes that Judge Lake’s improper remarks were harmless error.

The Fifth Circuit lets former Enron Task Force Andrew Weissmann off the hook with regard to Skilling’s allegation of witness intimidation, but notes that "Weissmann would have done well to have brought the issue [of alleged conflict of interest] to the court’s attention instead of emailing [former Enron executive Ken] Rice’s lawyer."

The opinion starts out by observing that "[A]n initial investigation uncovered an elaborate conspiracy to deceive investors abo
ut eh state of Enron’s fiscal health." The Court does not identify who conducted this "initial investigation" or who the participants were in the "elaborate conspiracy." Not particularly convincing.

Although the Fifth Circuit opinion provides Skilling with some running room to continue challenging his conviction and sentence, it is foreboding to the dozens of business executives who are currently subjects of various pending grand juries investigating the meltdown on Wall Street. Given the paper-thin nature of the government’s allegations of criminal conduct against Skilling and the substantial evidence of prosecutorial misconduct, the Fifth Circuit’s decision sweeping most of that under the rug is a strong indicator that obtaining convictions in future prosecutions of business executives will be akin to shooting fish in a barrel.

Playing fair

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Ted Stevens So, now Alaska Senator Ted Stevens is finding out that some federal prosecutors do not play fair (H/T Doug Berman). Of course, we’ve known that for quite some time down here in Houston.

Oh well, at least the mainstream media has strong incentives to expose such abuses in the case of a major political figure.

But do the same media incentives exist in the prosecution of a wealthy and unpopular businessperson?

What if the reporter most responsible for such a prosecution is, might we say, not particularly motivated to expose prosecutorial abuses? Or what if the reporter for the nation’s most prominent business newspaper is so conflicted that he ignores the abuses even when they are playing out in front of him?

And the foregoing doesn’t even consider what we should think when one of those reporters in another case actively attempts to help investors score on their positions at the expense of a company and its chief executives.

It’s hard enough to maintain innocence against the overwhelming resources of the federal government when the prosecution plays fair. It’s next to impossible to do so when it doesn’t. What chance is there if the people responsible for exposing prosecutorial abuse have incentives that override that responsibility?

Ask Jeff Skilling.