Two news items at the end of this week reflect the festering cauldron of resentment toward business in American society that government is manipulating to advance its troubling regulation-through-criminalization policy.
First, there was the news that New York’s Attorney General Eliot Spitzer — after defaming former AIG chairman and CEO Hank Greenberg in the media (see also here) and strong-arming the company to show Greenberg the door — dropped virtually all the substantive charges of wrongdoing in his lawsuit against Greenberg. All that is left in the lawsuit is what amounts to an arcane accounting dispute over about $25 million in the context of a $150-200 billion company.
So, over this relative pittance, Spitzer blemished the reputation and career of a man who generated enormous wealth for millions of AIG shareholders, while extracting a $1.64 billion fine from AIG by threatening to cause the company to endure an Enronesque meltdown (see also here). For this and other anti-business crusades, Spitzer will soon be rewarded with the governorship of New York. Larry Ribstein adds additional perspective.
And lest you think that Spitzer’s manipulation of AIG and Greenberg is an isolated incident, just review what happened to the Merrill Lynch executives in the Enron-related Nigerian Barge case and the prosecutor who caused that outrage.
Meanwhile, a day after Spitzer dropped his lawsuit, New York authorities arrested Peter Dicks, the chairman of the English publicly-owned gambling company, Sportingbet. Dicks was detained under an outstanding warrant issued by Louisiana gaming authorities and the arrest comes just a couple of months after federal authorities arrested David Carruthers, the former CEO of BetOnSports, another British publicly-owned gaming company.
By the way, while Dicks sits in jail today, gamblers will place billions of dollars worth of bets in Louisiana casinos.
As Geoffrey Manne aptly asks, “Where’s the outrage?”

Yes, in an observation made yesterday during a Senate committee hearing that should send shivers up the spine of anyone concerned about the increasing criminalization of business in the United States, that’s how Senator Robert Menendez (N.J. Dem) characterized the widespread practice of backdating options as a means of compensating corporate executives (previous posts here).
That Senate hearing follows on a recent and far more reasoned discussion of the issues involved in backdating options that Matthew Bodie began here. Larry Ribstein returned Bodie’s serve here and Bodie volleyed back here. Geoffrey Manne and Josh Wright got into the game with this post, which Bodie responded to here. Finally, Professor Ribstein ripped this winner to close the discussion, at least for now.
Compare the depth of the foregoing discussion with the superficial platitudes described in the article about the Senate hearing yesterday. Then consider the damages to lives, communities and careers that occurred as a result of the criminalization of business that occurred as a result of the Enron meltdown. Is the allegedly wrongful conduct in regard to the practice of backdating options so clear that it should be handled with the blunt instrument of the criminal justice system? If you really think so, then consider this.

Let’s see here.

First, the Justice Department misleads U.S. District Judge Sim Lake in regard to the true amount of the market loss resulting from the transaction that forms the basis of former mid-level executive Jamie Olis’ conviction, which in turn resulted in the imposition of an over-the-top 24+ year sentence.

Then, after the Fifth Circuit reversed that abomination, the prosecution — while dragging its feet in regard to the re-sentencing of Olis — recommended to Judge Lake in December of last year that the Olis should be re-sentenced to “only” 15 years in the slammer.

Now, after U.S. District Judge Jed Rakoff provided a much-needed dose of sanity in regard to sentencing of business executives and Stanford University law professor Joseph Grundfest eviscerated the Olis prosecution’s market loss arguments, the Chronicle’s Tom Fowler reports that the Olis prosecution is now contending that Olis should be re-sentenced to “only” 12 1/2 years.

At this rate, I figure the prosecution will finally reduce their demands for the length of Olis’ sentence to an appropriate level by, say, 2009 or so.

The hearing on the market loss issue in the Olis case is scheduled for next Tuesday.

Inasmuch as it is going on 11 months since the Fifth Circuit reversed Olis’ original sentence, Judge Lake will likely re-sentence Olis shortly after Tuesday’s hearing.

Most mainstream media accounts of the Enron-related criminal prosecutions case have perpetuated the myth that the Enron Task Force has done a good job in handling the criminal cases, partly because the Task Force has obtained plea bargains from 16 former Enron executives.

Inasmuch as those former executives pled guilty, the media’s reasoning goes, that is proof that Enron really was just a den of thieves that needed to be eradicated.

However, the truth is far more nuanced.

At least several of those 16 plea bargains were the result of the Enron Task Force bludgeoning a former Enron executive who had not committed a crime into a plea deal to avoid the high risk of asserting innocence in a venue that is highly adverse to anyone that worked for the social pariah, Enron.

Indeed, any former Enron executive only needed to review the ordeals that Jamie Olis and the four former Merrill Lynch executives in the Nigerian Barge case — much less that of Ken Lay and Jeff Skilling — to be reminded that attempting to assert innocence in the face of weak criminal charges was a losing proposition.

Well, at least one former Enron executive who the Task Force bludgeoned into a plea deal is attempting to withdraw it.

Chris Calger, a former executive with Enron North America who pled guilty a year ago to a single criminal conspiracy count, has replaced the attorney who advised him in connection with that plea deal and hired Philip Hilder, Sherron Watkins‘ counsel (it’s a small world, isn’t it?) to file a motion requesting that he be allowed to withdraw his guilty plea.

As noted in this Tom Fowler/Houston Chronicle article on the motion, Calger argues that he should be allowed to withdraw his guilty plea because it was based on the Task Force’s malleable theory that any remotely questionable business judgment of a business executive is a criminal act of depriving the executive’s company (or, in the case of the Merrill Lynch executives in the Nigerian Barge case, of another company) of that executive’s duty to provide the company with the executive’s “honest services.”

Inasmuch as the Fifth Circuit eviscerated that theory in its recent decision in the Nigerian Barge case, Calger reasons that he should be allowed to withdraw his guilty plea.

The Calger plea deal was obtained under particularly egregious circumstances.

In an extraordinary exchange with an Enron Task Force prosecutor during the Calger plea bargain hearing, U.S. District Judge Lynn Hughes makes clear that the Task Force prosecutor neither understood the underlying transaction involved in the indictment nor could articulate precisely what crime Calger had committed. At the end of the hearing, Judge Hughes accepted Calger’s guilty plea, although it is clear from the transcript that he was troubled in doing so.

Calger’s guilty plea is only one of several that were obtained by the Enron Task Force under questionable circumstances. As with the Task Force’s equally dubious tactic of fingering dozens of former Enron executives as unindicted co-conspirators to induce them from testifying for Lay and Skilling (as well as for the Merrill Lynch executives and other Enron-related defendants), the Task Force’s bludgeoning of guilty pleas out of overwhelmed individuals is a serious affront to justice and the rule of law that the media has largely ignored.

Yale Law Professor John Langbien, who has written extensively on prosecutorial abuse in the American criminal justice system, puts the tactic of bludgeoning guilty pleas into perspective:

Plea bargaining concentrates effective control of criminal procedure in the hands of a single officer. Our formal law of trial envisages a division of responsibility. We expect the prosecutor to make the charging decision, the judge and especially the jury to adjudicate, and the judge to set the sentence. Plea bargaining merges these accusatory, determinative, and sanctional phases of procedure in the hands of the prosecutor.

Students of the history of the law of torture are reminded that the great psychological fallacy of the European inquisitorial procedure of that time was that it concentrated in the investigating magistrate the powers of accusation, investigation, torture and condemnation. The single inquisitor who wielded those powers needed to have what one recent historian has called ‘superhuman capabilities [in order to] . . . keep himself in his decisional function free from the predisposing influences of his own instigating and investigating activity.'”

I cannot emphasize too strongly how dangerous this concentration of prosecutorial power can be. The modern prosecutor commands the vast resources of the state for gathering and generating accusing evidence. We allowed him this power in large part because the criminal trial interpose the safeguard of adjudication against the danger that he might bring those resources to bear against an innocent citizen — whether on account of honest error, arbitrariness, or worse.

The pressure to cop a plea is overwhelming for individuals caught in the crossfire of a highly-publicized criminal investigation such as the one involving Enron. So, I ask again — who is the greater threat to justice and the rule of law?

The Chris Calgers of the world?

Or out-of-control prosecutors who place businesspeople in the untenable position of risking a long prison sentence for merely asserting their innocence?

Or a pliable media that largely ignores this injustice to fan the flames of the latest juicy story?

The NY Times business columnist Gretchen Morgenson — who regularly writes with a curious anti-business agenda — weighs in again in the Sunday Times with this frontpage article about trading in anticipation of merger announcements that begins with this proclamation:

“The boom in corporate mergers is creating concern that illicit trading ahead of deal announcements is becoming a systemic problem.”

Morgenson then goes on to report on a recent study that confirms the particularly unsurprising news that trading frequently increases in the stock of companies immediately before public announcements concerning deals involving the companies.
Morgenson’s article is so disingenuous I struggled to know where to start. She doesn’t explain cogently why insider trading is illegal — just that honest investors are victims of the practice — but even her argument in that regard makes little sense. She contends that sellers of stock are injured by insider trading because they could have held their stock until after the merger announcement and received more value, but that argument assumes that the seller would only sell at the higher price generated by the insider trading and not at the lower price that existed before the insider sales. This is strained, to say the least, as sellers generally sell at the market price (whatever it is at the time of the sale) and take the risk that they are selling the bird in the hand instead of the potentially more valuable one in the bush if they were to wait and sell later.
With such basic flaws in Morgenson’s analysis of insider trading, I was shuddering at the thought of how long it would take me to critique Morgenson entire piece. Thus, I was heartened to discover that Larry Ribstein had already done so, in which he concludes with the following observation:

In sum, this page 1 story on one of America’s leading papers is a particularly egregious example of shoddy and slanted reporting by, perhaps, America’s leading practitioner of shoddy and slanted reporting. No doubt Morgenson’s influence will lead to misguided regulatory and legislative activity, which will impose additional costs on American business. Shame on Morgenson, and even more importantly, shame on her editors for failing to see the dangers of mixing news and commentary, for propogating these phony scandals to sell newspapers.

Former CSFB investment banker Frank Quattrone’s ordeal came to a close yesterday as the Court in the criminal case against him approved a deferred-prosecution agreement under which the charges will be dropped in a year and Mr. Quattrone was not required to pay a fine or admit any wrongdoing.

Thus, apart from the enormous cost of the prior litigation and having this talented businessman out of work for the past five years, at least Quattrone can now get back to his career and, as Peter Lattman notes, recover $120 million that he has coming to him.

But the same cannot be said for Arthur Andersen, which was prosecuted out of business under similar circumstances as Quattrone.

Just as Mr. Quattrone was never charged any criminal offense related to investment banking, Andersen was not prosecuted for providing fraudulent accounting services to its client, Enron.

Rather, appealing to the dynamics of resentment of wealthy and powerful business interests in the aftermath of Enron’s demise, Quattrone and Andersen were both indicted for obstruction of justice and witness-tampering related almost entirely to a single email that Quattrone and Andersen in-house counsel Nancy Temple sent reminding employees of each organization to clean up there files in accordance with each company’s document retention policy.

Instead of undertaking the difficult task of proving that either Quattrone or Andersen were really involved in any fraudulent acts, prosecutors in both cases portrayed the emails as a criminal cover-up. Then, without basis, the prosecutors liberally “suggested” in inflammatory public statements and during trial that Quattrone and Andersen were involved in fraud.

The prosecution of Quattrone was costly, but that cost pales in comparison to the economic damage that the Justice Department caused in prosecuting an American accounting institution and its 30,000 employees out of business. Despite that, similar misguided prosecutions continue.

This is simply not a rational deployment of the prosecutorial resources of our criminal justice system.

A heavyweight has entered the ring on behalf of Jamie Olis.

The WSJ’s Peter Lattman reports that Joseph A. Grundfest, W.A. Franke Professor of Law at Stanford University and one of the leading securities law experts in the US, is donating his services to Olis on a pro bono basis in regard to the key issue of market loss in Olis’ upcoming September 12th resentencing hearing.

Olis’ case is arguably the most egregious product of the government’s increasing criminalization of business interests in this particular post-bubble era.

In Olis’ most recent sentencing memorandum, Grundfest and Olis appellate attorney David Gerger expand on many of the points that have been raised over the past two and a half years on this blog regarding the flimsy basis of the government’s position that Olis should be imprisoned for at least the next two decades, particularly the government’s disingenuous market loss theory.

As noted in this previous post relating to the Enron-related Nigerian Barge trial, the prosecution misled U.S. District Judge Sim Lake regarding the proper method for calculating the market loss in connection with the original sentencing of Olis, and then has ignored subsequent decisions that have undermined the spurious market loss theory that it has employed in the Olis case.

The prosecution in the Olis case won’t be able to dodge facing the misleading nature of its market loss theory any longer.

In a devastating analysis of the government’s market loss theory, Professor Grundfest’s declaration attached to the Olis’ sentencing memo disassembles the work of the prosecution’s market loss expert, Frank Graves. Professor Grundfest summarizes his critique in the following manner:

The Graves Declaration fails to establish that Project Alpha inflated Dynegy’s stock price on any date by any amount. It also fails to establish that any portion of Dynegy’s stock price decline on April 25, 26, or May 8, 2002 is attributable to Project Alpha. the Graves Declaration’s methodology for measuring price declines caused by Project Alpha is also internally inconsistent with Graves’ prior report in another matter.

It also fails to recognize that Dynegy’s stock price rebounded significantly on April 30 (the second trading day following April 26) when the market was informed that concerns regarding Project Alpha had been exaggerated. It further fails to adjust for the presence of confounding information that entered the market on May 8, 2002.

The Graves Declaration also relies on methodologies that are broadly criticized in the scholarly literature, and repeatedly commits logical errors. The Government has therefore failed to demonstrate through the Graves Declaration that Project Alpha has caused any loss whatsoever to any investor at any time. . . .

The methodologies relied upon by the Graves Declaration to calculate the number of damaged shares have been broadly criticized in the academic literature and have been rejected by several courts. The damage measure relied upon by the Graves Declaration has also been broadly criticized in the academic literature because, even if perfectly applied, it fails to measure the economic loss caused by aftermarket frauds such as Project Alpha. This well-established literature helps explain the Second Circuit’s observation that the methodology applied by the Graves Declaration can lead to “Draconian, exorbitant damages, out of all proportion to the wrong committed . . .” [citation deleted]

Finally, . . . the magnitude of a settlement paid to resolve a private class action lawsuit is not a reliable measure of the loss caused by a fraud.

Other than that, Professor Grundfest would presumably conclude that the Graves analysis is just fine.

Professor Grundfest’s declaration is one of the most thorough and well-reasoned analyses that I have read regarding the vagaries of attempting to attribute huge market losses in a company’s stock to one of a plethora of events and variables that affect that company’s stock price. I recommend reading the entire declaration.

Although the focus of the Olis sentencing memo is market loss, one other part of the memo jumped out at me.

On pp. 5-6, the memo outlines over a dozen company executives, Arthur Andersen accountants, and outside lawyers — almost all of whom were senior in status to Olis — who participated in devising and analyzing the transaction for which Olis was prosecuted.

Nevertheless, only Olis and his two immediate supervisors (who copped pleas and testified against Olis) were prosecuted.

As Larry Ribstein has eloquently contended over the past two years on his blog and most recently in his paper The Perils of Criminalizing Corporate Agency Costs, are we really prepared to throw all corporate actors in prison for participating in the type of risk-taking involved in Project Alpha?:

Disciplining agents also requires pinning responsibility for corporate failure on particular people in the organization.

If someone should be criminally responsible for obscuring Enron’s financial condition, who should it be?:

the midlevel executives who designed the misleading structures,

the executive officers who signed off on them,

the independent directors who failed to object,

the lawyers, accountants, banks and other executives who enabled them,

anybody who knew about them and didn’t speak up,

the whistleblower who told only those within the organization,

Or all of the above?

Unfortunately, in Olis’ case, it turned out to be the junior executive taking directions from superiors who had the audacity to assert his innocence at trial. Chalk it up to the increasingly high price of asserting innocence in business-related prosecutions.

Although Professor Grundfest’s salutary effort on behalf of Olis is heartening and one that should buttress his already exemplary reputation, Olis still faces daunting hurdles to having a just sentence assessed in his case.

Professor Grundfest’s analysis of Graves’ market loss opinion reveals its essential lack of objectivity, so Graves will literally be fighting for his expert witness life in this case. Thus, it should be expected that he will respond to the Grundfest declaration by attempting to bolster his earlier opinion.

Similarly, Judge Lake, who levied the original 24 year sentence against Olis, will be resentencing Olis. Inasmuch as no judge — particularly one as competent as Judge Lake — enjoys being reversed by an appellate court, Olis faces the risk that Judge Lake will attempt to justify his original harsh sentence during the resentencing.

However, similar to his colleague Ewing Werlein, Judge Lake is a man of unusual depth, so my bet is that he will recognize that the prosecution misled him regarding the market loss issue during Olis’ original sentencing and will correct the stark injustice of that sentence.

As Professor Ribstein points out in his post on the Grundfest declaration, “Olis’ sentence has become an important symbol of the excesses of criminal prosecutions in the wake of Enron. Freeing Olis would be a start toward correcting these injustices.”