The continuing quest to criminalize business judgment

handcuffs-fraud-300x200Yes, our Congress is back at it:

Since the Supreme Court limited the definition of ‚Äúhonest services‚Äù fraud in last year’s landmark Skilling v. U.S., the Obama Administration has been looking for a way to restore essentially unlimited prosecutorial discretion to bring white-collar cases.

Last fall Assistant Attorney General Lanny Breuer told a Senate committee that Congress should act to ‚Äúremedy‚Äù the Court’s decision. Three bills moving through the House and Senate would try to do so, expanding the reach of prosecutors to go after unpopular politicians or businesses whom they can’t pin with a real crime.

In Skilling, the Supreme Court ruled that the honest services statute was ‚Äúunconstitutionally vague‚Äù and restricted its application to clear cases of bribery or kickbacks. The new legal template of Senate bills sponsored by Judiciary Chairman Patrick Leahy, the liberal Democrat, and Illinois Republican Mark Kirk would end run that change, transforming many state or local ethics violations into federal felonies any time there is an allegation of undisclosed ‚Äúself-dealing.‚Äù .  .  .

Where to begin?

For starters, as Bill Anderson points out, why on earth do our political leaders think we need even more people in prison?

Moreover, as Larry Ribstein has been saying for years, granting the government this type of unfettered power to criminalize merely questionable business transactions has proven to lead to even worse prosecutorial abuse that is rarely sanctioned.

How is justice served by turning such prosecutions into a lottery? Is public confidence in the federal criminal justice system really promoted by unfavorable comparisons to Russia’s?

And let’s not forget the incalculable human toll of such prosecutions.

The truth is that this type of amorphous criminalization of business judgment is fundamentally bad regulatory policy. Such prosecutions obscure the true nature of business risk and fuel the myth that investment loss results primarily from criminal misconduct. Besides, allowing wide discretion to prosecute business judgment deters businesspeople from taking the business risks that lead to valuable innovation, wealth creation and – most importantly these days – desperately needed jobs for communities.

So, in the face of such compelling reasons to forego such criminalization, why do our political leaders and prosecutors insist on more?

Ayn Rand’s observation about socialists who use state power to further their supposedly altruistic goals seems particularly apt:

“[T]he truth about their souls is worse than the obscene excuse you have allowed them, the excuse that the end justifies the means and that the horrors they practice are means to nobler ends.”

“The truth is that those horrors are their ends.”

The Second Circuit corrects an injustice

GenReOver the years, I’ve written quite a bit (for example, here, here, here and here) on the questionable nature of the prosecutions and convictions of the Gen Re and AIG executives who were involved in the finite risk transaction that prompted Eliot Spitzer to demonize Hank Greenberg. As if Spitzer needed any prompting to grab some cheap headlines.

By now, the story regarding this transaction is well-known among those in the legal and business communities who have followed it. AIG booked the finite risk transaction as insurance, which increased its premium revenue by $500 million and added another $500 million to its property-casualty claims reserves. Generally accepted accounting principles at the time required insurance and reinsurance transactions to transfer significant risk from one party to another if either party accounted for the transaction as insurance. Absent risk transfer, such transactions had to be booked as financing, which defeats the purpose of the transaction. In the General Re-AIG deal, $600 million of potential losses were transferred from General Re to AIG in return for the $500 million premium paid by General Re.

The deal did not affect AIG’s net income and was the type of transaction that AIG — and many other companies in the insurance industry – had done for years without any adverse market reaction, much less a criminal investigation. Moreover, the transaction in question was disclosed to and approved by AIG and General Re’s independent auditors.

That made no difference to avaricious prosecutors, who proceeded to pursue a dubious prosecution because any executive even vaguely associated with AIG after the Wall Street meltdown of 2008 were easy marks. They were right – the four Gen Re executives and the AIG executive were all convicted of conspiracy, mail fraud, securities fraud, and making false statements to the Securities and Exchange Commission

Thankfully, some appellate court panels (unlike some others) are still willing to correct such injustices. In the decision below, the Second Circuit Court of Appeals reversed the convictions of the Gen Re and AIG executives and remanded the case for a new trial. The essence of the decision is that the prosecution used spurious stock price data to inflame the jury against the defendants and persuaded the trial court to use an incorrect jury instruction on a key intent issue in the case.

However, as this appropriately scalding Wall Street Journal editorial points out, this case is really about abuse of prosecutorial discretion: “The collapse of this case renders even more appalling the way that prosecutors used it to force both companies to fire their CEOs–Joseph Brandon at Gen Re and Hank Greenberg at AIG. In the latter case, the resulting loss of shareholder wealth–and creation of taxpayer risk–has been staggering” and in this “latest embarrassing episode, the abuses include prejudicial evidence, botched jury instructions and ‘compelling inconsistencies’ suggesting that the government’s star witness ‘may well have testified falsely.'”

And although the Second Circuit came to the right result relying on a version of the facts most favorable to the prosecution, it’s important to note that most of the decision overrules the defendants’ other grounds for reversal where the prosecutors at trial may well have suborned perjury from the key prosecution witness.

It’s never easy being an appellant, even after a trial that is chock full of prosecutorial misconduct.

That’s why there shouldn’t be criminal trials in this type of case in the first place. Let the civil justice system sort out responsibility for any provable damages caused by wrongdoing among all of the parties involved.

That’s a far more just — not to mention humane — approach than throwing a few sacrificial lambs in prison over conduct of dubious criminality.

Update: Larry Ribstein, who has also been following this case from the beginning, notes an ironic — and extraordinarily damaging — aspect of this sordid prosecution.

US v. Ferguson, Et Al 2nd Cir Decision

The cult of overcriminalization

scales-of-justice-150x150Last week, this Gary Fields/John Emshwiller article addressed an issue that this blog has hammered on for years – the absurd overcriminalization of life in the United States:

The U.S. Constitution mentions three federal crimes by citizens: treason, piracy and counterfeiting. By the turn of the 20th century, the number of criminal statutes numbered in the dozens. Today, there are an estimated 4,500 crimes in federal statutes, according to a 2008 study by retired Louisiana State University law professor John Baker.

There are also thousands of regulations that carry criminal penalties. Some laws are so complex, scholars debate whether they represent one offense, or scores of offenses.

Counting them is impossible. The Justice Department spent two years trying in the 1980s, but produced only an estimate: 3,000 federal criminal offenses.

The American Bar Association tried in the late 1990s, but concluded only that the number was likely much higher than 3,000. The ABA’s report said "the amount of individual citizen behavior now potentially subject to federal criminal control has increased in astonishing proportions in the last few decades."

A Justice spokeswoman said there was no quantifiable number. Criminal statutes are sprinkled throughout some 27,000 pages of the federal code. [.  .  .]

Great point, but it would have been more meaningful had the WSJ admitted its complicity in promoting the overcriminalization culture in the first place.

Oh well. This Heritage Foundry post does a good job of placing the overcriminalization issue in perspective.

My question is this: Is it reasonable to think that it is possible for Congress to curtail overcriminalization when Congress to date has been incapable of striking down something as clearly unreasonable as the abuses of security theater?

Why Jeff Skilling’s Case Remains Important

skilling 040711So, why is it that prosecutors won’t go after Wall Street executives for supposed criminal conduct in connection with financial crisis that began in 2008 and continues to bedevil the U.S. economy to this day?

That’s essentially the question that this recent NPR story asks. It’s not hard to find other mainstream media pundits asking the same question.

Or course, NPR – as with most of the mainstream media — utterly fails to recognize that the government’s pursuit of criminal convictions of businesspeople over the past decade has had much more to do with chance and politics than truly criminal conduct.

Could it be that the lack of criminal prosecutions stems from federal prosecutors finally coming to the realization that merely taking business risk in an effort to create wealth and jobs really is not a crime? Indeed, the rationalization for the lack of villains now as compared to earlier crises has never been particularly compelling.

The truth is that criminal prosecutions based on merely questionable business judgment has always been fundamentally bad regulatory policy.

Few people object to criminal prosecutions of true business crimes, such as embezzlement and kickbacks.

But prosecutions based on failed business judgment obscure the true nature of business risk and fuel the myth that investment loss results primarily from criminal misconduct. Policy that deters business risk is counterproductive because such risk is what leads to valuable innovation, wealth creation and – most importantly these days – desperately needed jobs for communities.

Which brings us back to the sad case of former Enron CEO Jeff Skilling, who continues to serve a brutal 24-year sentence in a Colorado prison.

As I’ve noted many times over the years on this blog, the Fifth Circuit Court of Appeals has not distinguished itself in regard to the appeals emanating from Enron criminal cases, including Skilling’s.

First, there was the appellate court’s affirmation of a local U.S. District Court’s absurd criminal conviction of Arthur Andersen, putting a nail in the coffin of that legendary firm and over 30,000 jobs in the process.

Although too little and too late to save Andersen, that gem of a decision was subsequently overturned by a unanimous U.S. Supreme Court.

Then, in 2009, another Fifth Circuit panel affirmed a local U.S. District Court’s 2006 conviction of Skilling. Subsequently, in 2010, a unanimous U.S. Supreme Court disassembled that pearl of judicial wisdom and, in so doing, struck down the prosecution’s “creative” (and unsupported) use of honest services wire fraud to prosecute defendants over merely questionable business transactions.

But not to be outdone, on remand from the Supreme Court, the Fifth Circuit panel produced yet another clunker, this time affirming Skilling’s convictions on the conspiracy and securities fraud counts that the Supreme Court did not address in reversing Skilling’s conviction on the honest services counts. This panel decision is so bad that it contradicts two previous decisions in Enron-related criminal cases that other Fifth Circuit panels actually got right — the Kevin Howard case and the Nigerian Barge case.

In the second Skilling opinion, the Fifth Circuit panel rationalized that it was somehow “harmless error” for the prosecution to present the false honest services theory of criminal conduct regarding Skilling to the jury so long as there was sufficient evidence to support a guilty verdict on any valid alternative theory of criminality. The panel ruled that way even though the Skilling jury returned a general verdict that did not distinguish on which theory of criminality they actually relied in convicting Skilling.

Unfortunately, the Fifth Circuit panel – as pointed out eloquently by Skilling’s petition for rehearing en banc below – applied precisely the wrong standard in determining whether the remaining counts against Skilling should be reversed.

When the trial court committed the error of allowing the Skilling prosecution to obtain a conviction by pursuing its false honest services theory, the question as to the remaining counts is whether there was any evidence in the record that could rationally lead to acquittal of Skilling on those counts, not simply whether there was evidence that a jury could have relied on in convicting him. As the Skilling petition notes:

A “reviewing court making this harmless error inquiry does not .   .  . become in effect a second jury to determine whether the defendant is guilty.” [cite deleted] Because determining guilt or innocence is solely the province of the jury, an error requires reversal if a rational jury could have found for the defendant on the valid theory because of the contested evidentiary record. [cites deleted]

There is no question that Skilling provided substantial evidence at trial contravening all charges against him, including the conspiracy and securities fraud counts. No reasonable review of the Skilling trial record could conclude that a jury might not have found in favor of Skilling on those counts. In fact, the jury found in Skilling’s favor on nine of the original 28 counts in the first place!

In short, the Fifth Circuit panel blew the application of the standard in adjudicating the remand from the Supreme Court of the remaining counts against Skilling. If the Fifth Circuit judges are honest with themselves and the law, then they will withdraw the panel decision and remand Skilling’s case to the U.S. District Court for a new trial.

The mess that is the prosecution against Jeff Skilling is a quintessential example of what happens when government is given the leeway to bastardize charges to criminalize merely questionable business transactions and then appeal to juror resentment against a wealthy businessperson to procure a politically popular outcome.

The damage to the defendant, his career and his family that such an abuse
of power causes is bad enough. But the carnage to justice and respect for the rule of law is even more ominous.

Do any of us really believe that we could stand upright in the winds of such abusive governmental power if that gale of prosecutorial power was turned toward us?

The remaining charges against Jeff Skilling should be reversed and his case remanded to the District Court for a new trial in a fair and non-contentious environment.

Not only for his protection, but for ours.

Petition for en Banc Review and Hrg2

We do love our myths, don’t we?


The Wall Street Journal’s Bret Stephens makes a good point about the way in which the mainstream media pounced on a morality play in the initial reporting on the rape case against former IMF chief, Dominique Strauss-Kahn:

.   .  .  the media (broadly speaking) has too often been guilty of looking only for the evidence that fits a pre-existing story line. It doesn’t help that in journalism you can usually find the story you’re looking for, whether it’s record-breaking heat in some corner of the world, or malicious Israeli settlers making life miserable for their Palestinian neighbors, or evidence of financial chicanery in Manhattan, or of economic prowess in Shanghai.

But anecdotes are not data–which happens to be the world’s most easily neglected truism. Also true is that sloppy moral categories like the powerful and the powerless, or the selfish and the altruistic, are often misleading and susceptible to manipulation. And the journalists who most deserve to earn their keep are those who understand that the line of any story is likely to be crooked.

Of course, insightful bloggers such as Larry Ribstein have been pointing out this dynamic in regard to the mainstream media’s coverage of business-related matters for years.

And Stephens’ own employer still has not owned up to the fact that it embraced in the case of Jeff Skilling precisely the same type of morality plays that Stephens decries in the DSK affair. The fact that Skilling remains imprisoned under an effective life sentence makes the WSJ’s touting of myths in his case even more egregious.

Life is complicated. Government is powerful. When the MSM embraces the latter’s suggestion that the former is simple, beware.

Obama’s criminalization of business?

Business crime cropped2David Henderson thinks the Republicans can make political headway against President Obama by campaigning against his administration’s criminalization of business.

That strategy might be viable if the Republicans hadn’t just gotten through criminalizing business for the better part of a decade.

The federal government’s criminalization of business policy obscures the true nature of business risk and fuels the myth that investment loss results predominantly from criminal misconduct. In turn, that myth is one of the underlying causes of the the criminalization of business lottery, which undermines the rule of law.

Thus, Henderson is right that the criminalization of business policy is terribly counterproductive. He is simply wrong about it’s political basis.

The criminalization of business policy is perfectly bi-partisan. 

The real LinkedIn morality play

linkedin-logoSo, the NY Times Joe Nocera (as well as Henry Blodget) think that the investment bankers scammed LinkedIn’s owners in favor of the investment bankers other customers.

Grand conspiracy theories – as well as criminal prosecutions – certainly have been hatched with less.

But as the Epicurean Dealmaker lucidly explains (also here), morality plays and conspiracy theories are hard to piece together given the wide variety of forces that are in play when owners of a company tap the public markets with a piece of their company. Heck, LinkedIn’s shares are trading at a massive multiple to what they traded for recently in private in secondary markets.

The instinct of most politicians and much of the mainstream media is to embrace simple “villain and victim” morality plays when attempting to explain a particular outcome in which someone gained at the expense of someone else.

Take, for example, investment loss. The more nuanced story about the financial decisions that underlie a failed investment strategy doesn’t garner sufficient votes or sell enough newspapers to generate much interest from the demagogues or muckrakers. That’s why we periodically endure witch hunts — such as demonizing speculators – when it’s unquestionable that speculation in markets has a beneficial purpose.

Morality plays are comforting because they make it easy to identify and demonize the villains who are supposedly responsible for trouble. The truth is usually far more nuanced and complicated, but ultimately more rewarding to embrace.


Geithner as matinee idol

TimGeithnerAs regular readers know, I have long thought that Timothy Geithner is in over his head as Treasury Secretary.

So, it stands to reason that many people continue to listen carefully to what he says, this time at the opening of the new HBO film based on Andrew Ross Sorkin’s book about the most recent financial crisis, Too Big to Fail.

“You can’t prevent people from making mistakes,” observed Geithner philosophically. “Taking too much risk and making stupid mistakes may not be a crime.”

Yeah, right. Try to persuade Jeff Skilling of that.

The reality is that there isn’t much difference between the way in which Geithner and Skilling reacted to their respective crisis. Yet one remains in one of the most powerful positions in government, while the other wastes away in a prison cell.

There is simply no rational basis for the disparate treatment of these two men.

Warren Buffett, self-preservationist

warren_buffett2Professor Bainbridge surmises that Berkshire Hathaway’s Warren Buffett threw David Sokol under the bus in connection with the Berkshire audit committee report on Sokol’s front-running stock purchases, which may be the subject of criminal investigations at this point. Frankly, the Professor makes a good case.

However, no one should be surprised if that was Buffett’s purpose. As noted here, here and here, there is certainly precedent for Buffett offering up sacrificial lambs to protect himself and Berkshire. That precedent certainly had consequences for the ones who were fingered, too.

Meanwhile, Jeff Skilling remains living in a Colorado prison under the cloud of a 25-year prison sentence, partly because he was unwilling to emulate Buffett’s behavior.

Neither Warren Buffett nor David Sokol is a criminal. But neither is Jeff Skilling. What is criminal is a system that offers perverse incentives for risk-takers who generate jobs and wealth to finger others to protect themselves from the government’s arbitrary exercise of its prosecutorial power.

So, Why No Pound of Flesh?

That’s essentially the question that this Gretchen Morgenson/Louise Story/NY Times article asks.

Why have there been so few criminal prosecutions in regard to the 2008 meltdown on Wall Street that prompted a huge federal government bailout that citizens will be subsidizing for decades?

Yet, the intrepid NY Times reporters can’t quite bring themselves to recognize that whether the government pursued and obtained a criminal conviction of a businessperson over the past decade has had much more to do with chance and politics than prosecution of truly criminal conduct.

Could it be that federal prosecutors are finally realizing that old-fashioned greediness really is not be a crime?

Of course, the rationalization for the lack of villains now as compared to earlier crises has never been particularly compelling.

What the NY Times reporters refuse to confront is that business prosecutions over merely questionable business judgment is fundamentally bad regulatory policy.

Such prosecutions obscure the true nature of business risk and fuel the myth that investment loss results primarily from criminal misconduct.

Taking business risk is what leads to valuable innovation, wealth creation and – most importantly these days – desperately needed jobs for communities. Throwing creative and productive business executives such as Michael Milken and Jeff Skilling in prison may placate NY Times reporters, but it does nothing to educate investors about the true nature of risk and the importance of diversification.

Ignorance about business risk is one of the underlying causes of the the criminalization of business lottery. Basing criminal prosecutions on the luck of the draw breeds cynicism and disrespect for the rule of law.

Isn’t it about time that dubious policy be put to permanent rest?

Update: Larry Ribstein — who maintains an entertaining archive of blog posts that he wrote over the years on Morgenson’s misfires — comments on Morgenson’s latest posse-gathering effort here.