This NY Times article reports that Berkshire Hathaway Inc. has disclosed that government authorities are probing at least one of the company’s insurance subsidiaries other than General Reinsurance Corp. over accounting of “finite risk” reinsurance transactions. Here are the previous posts on the wide-ranging probe into Berkshire, General Re, and others over such transactions.
Moreover, as noted in this London Telegraph article, Berkshire announced that it is also facing regulatory investigations in England, Ireland, Germany and Australia. In that regard, Berkshire also announced that it had terminated the employment of former reinsurance executive Milan Vukelic, who has been under investigation by those overseas authorities.

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This Wall Street Journal ($) article reports that federal investigators have turned up the pressure in its investigation of several prominent plaintiffs class action securities lawyers at the former Milberg, Weiss law firm, including granting immunity to a former Milberg Weiss lawyer who worked closely with William S. Lerach, who has already been fingered as a target of the investigation. Here are the prior posts on the investigation and related matters pertaining to the firms involved.

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Having tended to my day job at the end of last week, I wanted to pass along some further thoughts on the lively discussion that erupted between Vic Fleischer, Larry Ribstein, other commentators, and me last week in regard to my post on the four former Merrill Lynch executives who are appealing their convictions in the Enron-related Nigerian Barge case to the Fifth Circuit Court of Appeals.

Given the importance of the issues addressed in this blog thread to businesspeople, the American economy and the rule of law, I appreciate everyone’s interest in the thread and their contributions.

For those who want to read the prior posts in order:

Here is my original post on the former Merrill Lynch executives’ appeal;

Here is Larry’s first post noting my post;

Here is Vic’s first post responding to both Larry and my post;

Here is Larry’s response to Vic’s first post;

Here is my response to Vic’s first post;

Here is Larry’s post regarding my response to Vic’s first post; and

Here is Vic’s second post that replies to my response to his first post.

This post replies to Vic’s latest post and attempts to circle the thread toward a coherent close.

In his post regarding my response to Vic’s first post, Larry really asks the right questions and identifies the importance of the issues:

The question raised . . . is whether the criminal prosecution of this transaction, particularly in the way it has been done by the government, . . . was appropriate?

If the existence of a promise is essential to criminal liability, does the evidence . . . look even close to enough to hang a substantial prison sentence on?

[W]e academics . . . have an obligation to get this right. This is about how the power of government is and should be used against business, and so is immensely important to this country’s economic well-being. The newspapers and movies have slanted this issue, and the partisans either side will be discounted. We in the academy therefore have special influence.

So, really what we have is a narrower issue regarding whether Enron accounted properly for the Nigerian Barge transaction with Merrill Lynch — an issue that Vic focuses on more than Larry and me — and the broader issue of whether the government should be criminalizing such a transaction, which Larry and I tend to focus on more than Vic.

On the narrower issue, Vic is skeptical that the Nigerian Barge transaction constituted a true sale upon which Enron could book immediate earnings. He is suspicious of the deal’s structure, but more substantively, believes that Fastow probably made an oral promise (albeit unenforceable) that Enron would backstop Merrill’s investment either through an Enron repurchase of Merrill’s interest or by brokering a sale of that interest to a third party.

Vic reasons that the existence of this oral promise — although neither Fastow nor anyone who heard the alleged promise testified during the trial — means that no or inadequate risk was shifted from Enron to Merrill for the transaction to constitute a true sale.

On the larger issue, Vic concludes that Enron probably booked improper earnings intentionally. Apparently because each of the Merrill defendants was involved in the transaction in at least some small way, Vic reasons that the prosecution of the Merrill defendants was not particularly unreasonable, even though he concedes that it’s probably not a particularly strong criminal case.

On the other hand, my position on the narrower issue is that transaction was a true sale. The structure may have been for expediency, to facilitate a future transaction, or simply because Enron liked doing structured finance transactions, as noted in this earlier post.

Moreover, there was nothing inherently wrong with the structure of the deal. Moreover, Merrill undertook plenty enough risk for the transaction to constitute a true sale, probably best reflected by the fact that Fastow’s crime partner Kopper would not agree to have LJM2 buy the interest from Merrill until the risk of non-payment from the source of Merrill’s dividend stream was hedged through the pledge of security from a third party.

Consequently, my sense is that whatever unenforceable assurance that Fastow may have provided to Merrill — and the evidence is reasonably clear that Fastow never promised that Enron itself would buy back the interest — had a negligible effect on Merrill’s considerable risk in the deal.

However, putting aside for a moment the competing arguments on the narrower “true sale” issue that could make for lively debate in a corporate accounting class or civil lawsuit, the more important issue is the one that Larry raises:

Is there evidence of criminality here in regard to the four former Merrill Lynch executives that even comes close to fulfilling the government’s burden of establishing proof beyond a reasonable doubt?

The correct answer is a resounding “no,” and my big difference with Vic is that I do not believe that this is even a close call. The question of whether Enron booked its earnings relating to the Nigerian Barge transaction correctly, improperly, or fraudulently is different from the issue of whether the Merrill defendants engaged in criminal conduct by carrying out their duties in connection with the transaction.

Inasmuch as Enron and Merrill always viewed Merrill as a “bridge” owner of the interest, there was nothing wrong — much less criminal — with Merrill obtaining assurances from Fastow that Enron would assist in finding a buyer who would take Merrill out of the investment after a short hold.

This is not much different than a banker seeking a business owner’s personal assurance that a non-recourse loan to the owner’s business will be repaid even if the company defaults and its security for the loan turns out to be inadequate. That’s just part of the process in which businesspeople gain trust in taking on risks.

Indeed, if Fastow’s assurance to Merrill in the Nigerian Barge transaction was — as Vic suggests — the basis of a crime, then dozens of Merrill executives, lawyers, and accountants who reviewed and approved the transaction were also involved in that criminality. They all knew and agreed that having Dan Bayly obtain Fastow’s assurance that Merrill would be taken out was a good idea.

Why have they not been prosecuted? Why are the four former Merrill executives being singled out? Why on earth is William Fuhs — who had nothing to do with structuring or approving the transaction, and handled only a few ministerial tasks in regard to the deal — going to jail for over three years away from his wife and two young children when the other Merrill executives, lawyers, and accountants who structured and approved the deal get off scott free?

Don’t get me wrong. I don’t believe that either Merrill or its four former executives came even close to crossing the line of criminality in regard to this transaction. But if you accept Vic’s analysis that they did, then you cannot logically stop with the four sacrificial lambs named Bayly, Furst, Brown and Fuhs. You must prosecute the company and everyone involved in the transaction, and then prepare to take shelter from the economic storms that would follow as implementation of such a dubious criminalization policy would inevitably lead to a raft of Arthur Andersen-type meltdowns. That is why corporate and individual responsibility in such matters — as Larry has repeatedly pointed out on his blog — is best sorted out in civil lawsuits.

Finally, Vic does not add much to the discussion by observing that the prosecution of the Merrill defendants has been fair because they have been afforded procedural due process. Although rather sad and humorous at the same time, it’s a reflection of the post-Enron era of anti-business sentiment that “fairness” in regard to Enron-related criminal proceedings is being measured by the fact that at least procedural due process has not yet been suspended in regard to those proceedings.

But even where procedural due process is provided, justice and the rule of law are undermined when the government uses its daunting power to criminalize individual behavior that, as Chief Justice Rehnquist put it in Anderson, “is by itself innocuous.” As the Chief Justice goes on to explain:

“We have traditionally exercised restraint in assessing the reach of a federal criminal statute, both out of deference to the prerogatives of Congress, Dowling v. United States, 473 U. S. 207 (1985) and out of concern that ‘a fair warning should be given to the world in language that the common world will understand, of what the law intends to do if a certain line is passed.’ McBoyle v. United States, 283 U. S. 25, 27 (1931).”

Thus, as with its Andersen prosecution, the Enron Task Force had to overreach badly — distorted application of criminal statutes, suppression of evidence, intimidation of key witnesses, primary reliance on the “shoddy merchandise” of hearsay testimony, etc. — to make a case against the Merrill defendants in the Nigerian Barge case.

Similarly, the list of Enron Task Force abuses in other Enron-related criminal cases is also getting quite lengthy. So, regardless of whether the prosecution of the Merrill defendants was a “witch hunt,” it’s clear that the government is exercising its formidable prosecutorial powers in the Enron-related cases in a highly troubling manner.

To a large degree, the overreaching nature of these prosecutions is a by-product of the vagaries of pursuing a policy of criminalizing corporate agency costs in the first place. In this excellent TCS Central op-ed, Stephen Bainbridge — who, along with Professor Ribstein — is one of most cogent scholars on corporate law issues (and one of Vic’s colleagues at U.C.L.A.) — criticizes the type of prosecution of corporate agency costs that Vic views as reasonable in the prosecution of the Merrill defendants:

Few serious persons would deny that fraud and theft are appropriate subjects of the criminal law. When corporate executives loot the corporation, . . . they should go to jail. Unfortunately, however, ambitious prosecutors have not limited themselves to cases of fraud or theft. . .

Business decisions rarely involve black-and-white issues; instead, they typically involve prudential judgments among a number of plausible alternatives. Given the vagaries of business, moreover, even carefully made choices among such alternatives may turn out badly.

At this point, the well-known hindsight bias comes into play. Decision makers tend to assign an erroneously high probability of occurrence to a probabilistic event simply because it ended up occurring. If a jury knows that the plaintiff was injured, the jury will be biased in favor of imposing negligence liability even if, viewed ex ante, there was a very low probability that such an injury would occur and that taking precautions against such an injury was not cost effective.

Hence, there is a substantial risk that juries will be unable to distinguish between competent and negligent management because bad outcomes often will be regarded, ex post, as having been foreseeable and, therefore, preventable ex ante. If liability results from bad outcomes, without regard to the ex ante quality of the decision and/or the decision making process, however, managers will be discouraged from taking risks. If it is true that lack of gumption is the single largest source of agency costs, as somebody once said, rational shareholders will disfavor liability rules discouraging risk-taking, as Judge Ralph Winter opined in Joy v. North:

[B]ecause potential profit often corresponds to the potential risk, it is very much in the interest of shareholders that the law not create incentives for overly cautious corporate decisions. . . . Shareholders can reduce the volatility of risk by diversifying their holdings. In the case of the diversified shareholder, the seemingly more risky alternatives may well be the best choice since great losses in some stocks will over time be offset by even greater gains in others. . . . A rule which penalizes the choice of seemingly riskier alternatives thus may not be in the interest of shareholders generally.

Hence, when juries review the merits of even bad corporate governance, they run the risk of effectively penalizing “the choice of seemingly riskier alternatives.”

In sum, shareholders deserve protection from theft, but not from risk taking, . . . Unfortunately, it’s not clear that prosecutors know the difference — or even care.

Yes, Vic, we can agree that this is not as bad as the Inquisition or the Holocaust. But it is still a gravely important issue when the state misuses its overwhelming power to prosecute and convict unpopular people for doing their job, which — in Mr. Bayly’s case — he had been doing in an exemplary manner for the past 30 years.

Even an appellate decision overturning the convictions of Mr. Bayly and the three other Merrill defendants cannot undo the emotional carnage that those men and their families have endured, just as the Supreme Court’s decision in Andersen could not breath life back into the 30,000 jobs that were lost as a result of the government’s overreach in that case.

However, as great as my compassion is for the Merrill defendants and their families, and as concerned as I am with the economic damage that is resulting from the government’s dubious criminalization policy, my greater concern remains for the principles of justice and respect for the rule of law upon which the success of American society is largely based. It is simply impossible to reconcile the convictions of the Merrill defendants with the results in such cases as the Enron Broadband trial, the Richard Scrushy case, the Arthur Andersen case, the William Sihpol case, the Martha Stewart case, the sad case of Jamie Olis, the DOJ’s handling of the Global Crossing case, the Frank Quattrone case, and many others.

Accordingly, the roulette wheel-nature of the results in these cases is precisely what casts the public’s respect for the rule of law into an ugly cauldron of cynicism, resentment, and tolerance for the abuse of the government’s daunting power to prosecute the unpopular people of the moment.

That’s why when a bright law professor rationalizes a travesty such as the conviction of the Merrill defendants as merely an unfortunate result of an otherwise legitimate use of the state’s prosecutorial power, I am concerned that we are well on our way to a time when, as Sir Thomas More warns us, we will not be able to “stand upright in the winds” of abusive state power that will blow then.

Ellen Podgor has the blog title of the day in this post on the extension of Martha Stewart’s home confinement over at the White Collar Crime Law Prof blog. Money quote:

“We should all feel safer knowing that Martha will be spending an extra three weeks on house arrest.”

As readers of this blog know, I believe that Martha was one of the victims of the government’s dubious criminalization of business during the post-Enron era.

Following on this earlier post that addressed the hard-nosed approach that Allied Capital Corporation has taken in attempting to avoid an Enronesque meltdown in the face of an ongoing criminal investigation, this Washington Post article notes that Allied Capital’s approach is a financial boon to one sector of the economy that is near and dear to this blogger’s heart:

Allied Capital Corp. executives yesterday said the company spent $25 million in legal expenses in the first half of the year on government investigations that have required it to produce “millions of pages” of company e-mails and documents. . .
The [company’s second quarter results] results would have been better were it not for $13.5 million in legal and other expenses associated with the investigations during the quarter, with much of the cost related to document production.

Nevertheless, the investment in legal fees appears to be paying off:

Allied Capital stock dropped 59 cents yesterday to close at $27.51. It is up more than $3 since the criminal investigation was disclosed Dec. 27.

This post from awhile back noted that former AIG chairman and Spitzer target Maurice “Hank” Greenberg and his legal team are preparing a “white paper” defending Mr. Spitzer’s charges of bad accounting at AIG. Here are the previous posts on the saga between AIG and Mr. Spitzer.
Well, the Wall Street Journal has obtained a copy of Mr. Greenberg’s white paper, and in this editorial ($), asserts that the paper “makes a compelling case that AIG’s new management took financial decisions detrimental to shareholders — and for no other purpose than to shift blame to past management and kowtow to Mr. Spitzer.” Here is the later NY Times article on the white paper. Moreover, Patrick over at Spitzer Watch is having some fun with this latest development, too.

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This post earlier in the week on the appeal of the Merrill Lynch defendants in the Enron-related Nigerian Barge case generated quite a bit of traffic and some interesting responses from around the blogosphere.

First, Larry Ribstein complimented the post as an example of how blogs provide a valuable Hayekian information source, a subject on which Larry has written extensively. Subsequently, Vic Fleischer over at the Conglomerate blog excoriated Larry for “fawning” over my post, and then goes on to criticize the post.

That prompted Larry to post this response to Vic’s post, then Vic commented on Larry’s response, and others commented on both Vic and Larry’s posts. I encourage everyone interested in the government’s criminalization of business to read all of the above for a lively discussion of the issues relating to that policy. This type of give-and-take is one of the blessings of the blogosphere.

But what is particularly interesting to me is Vic’s approach to the subject. I do not know Vic, but I have read his posts on Conglemerate and he is an insightful fellow, and his professional pedigree appears to be developing in a quite solid manner. So, Vic is a reasonably sophisticated fellow in regard to the financial and legal issues that are involved in Nigerian Barge case.

Despite that sophistication, Vic harshly criticizes my post based on a combination of misinformation and misinterpretation. Although this is partially explained by the fact that I have had more access to the detailed information relating to the Nigerian Barge case than Vic, I have nevertheless found over the past several years that Vic’s reaction is not particularly unusual with regard to virtually anything having to do Enron.

As perhaps best reflected by the mildly entertaining but shallow Enron documentary, even intelligent lawyers have a difficult time analyzing Enron-related matters dispassionately. This is unfortunate because Enron represents precisely the type of difficult case for which the legal profession has a special responsibility not to allow public animus toward merely unpopular people to overwhelm justice and the rule of law.

Larry Ribstein notes in his response to Vic’s post the similar circumstances that surrounded the case of Michael Milken back in the late 1980’s, and Daniel Fischel examines how public perceptions overwhelmed the rule of law in his fine book about the prosecution of Milken, Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution (HarperCollins 1995). The same dynamic is at play nowadays in regard to Enron.

Vic relies on misinformation from the beginning of his post:

The basic facts are that Enron “sold” some barges to Merrill Lynch. That is, Enron recognized a “sale” for accounting purposes. Enron could not formally guarantee that they would buy back the barges, but promised to find a third party buyer within six months. From an economic standpoint, the so-called sale starts to look like a loan.

First, Enron did not sell barges to Merrill Lynch. Rather, in a sophisticated transaction (regardless of whether one characterizes it as structured finance), Merrill acquired from Enron common stock in a company that was the parent company of another company that owned the barges. In so doing, Merrill acquired the right to a dividend stream, the source of which was revenue generated by unsecured contracts for the use of the barges.

Moreover, contrary to Vic’s suggestion, the transaction was quite risky for Merrill. Heck, Fastow’s buddy in crime, Michael Kopper, declined to allow the LJM2 partnership to enter into the transaction at the time that Merrill did because of the unsecured nature of the source of the revenue stream (Kopper subsequently allowed LJM2 to buy Merrill’s interest when the deal was improved with security for those underlying contracts). The deal involved extensive documentation and common hedging characteristics, such as political risk and other types of insurance.

Now, Vic could not be expected to know all of that because he has not had an opportunity to review the documentation on the deal. But despite that lack of rather basic information, Vic has no problem in characterizing a complicated and risky transaction as a rather simple deal, and then making the remarkable leap that “the so-called sale starts to look like a loan.”

Vic goes on in his post to observe the following:

I agree that it’s not a slam dunk criminal case. The appeal has a real shot at success, and I’m not at all sure the government made its case. But that’s no reason to lionize the defendants.

Well, I’m not sure that characterizing the Merrill defendants as “decent men” is the same as lionizing them, but let’s not quibble about that detail. The fact of the matter is that each of the Merrill defendants — as reflected in the elaborate reports filed by both the government and the defendants in connection with their sentencings — had never been in any type of trouble whatsoever before the Nigerian Barge case, and each of them had outstanding personal and professional reputations.

Again, I don’t expect Vic to know that because he does not have access to that information. But what is it about Enron — resentment of wealth? Enron’s hard-nosed business reputation? investment loss? high profile business failure? — that would prompt an otherwise reasonable person to take offense at calling men decent who have never been in a lick of trouble?

Vic goes on:

The deal stinks. It reeks. In no way is this deal an “ordinary structured finance transaction,” as Kirkendall claims.

He follows that up with the following observation contained in a comment to Larry’s response to his post:

The transaction was not a typical or ordinary transaction, and calling it “bad finance” still understates the case. Fraud is fraud. Maybe they shouldn’t go to jail over it, but it’s not crazy to think maybe they should.

With nothing more than a flawed understanding of the deal, Vic now asserts that the Nigerian Barge transaction is a fraud. Was it a typical transaction that any number of public companies use to manage the timing of income? Absolutely, and Vic is much more naive than I think he is if he believes that such is not the case.

Was it a typical transaction for Merrill Lynch? No, and Merrill readily admitted that. But simply because a transaction is unusual for a firm does not make it questionable, much less criminal.

Was it a reasonable business decision for Merrill to invest and potentially lose $7 million in order to maintain and perhaps improve a relationship with the seventh largest public company in the United States, a relationship that was worth $40 million annually to Merrill?

Absolutely, and anyone who suggests that such a decision is even close to criminal conduct risks indicting major sectors of the American economy. Shoot, many large law firms commonly write-off fees, cover expenses and make investments with clients in order to maintain or enhance relationships.

Despite all that, Vic deems the question of whether the Merrill defendants are guilty of a crime a close call. If that is the case, then every businessperson involved in reasonably complicated business transactions in the U.S. better add a criminal defense attorney to their personal legal staff immediately.

In my over 25 years of specializing in defending complex business transactions, which includes advising dozens of criminal defense attorneys in regard to defending complex business transactions in white collar prosecutions, the Nigerian Barge case is the weakest white collar criminal prosecution that I have seen, and certainly the most egregious example of the government using “shoddy merchandise” and suppressing evidence to criminalize what, at worst, is a risky business deal.

If the Nigerian Barge transaction had involved Merrill Lynch and — rather than Enron — a debtor-company that was unknown to the general public, the Justice Department would have never pursued this prosecution.

Vic continues:

In an ordinary structured finance transaction, substantial economic risk is shifted away from the seller. I don’t think that happened here, and it’s the shifting of economic risk that justifies the accounting treatment.

Again, without fully understanding the transaction, Vic blithely concludes that there was no substantial shifting of economic risk in the Nigerian Barge transaction.

What would have happened if the barges would have sunk to the bottom of the Atlantic Ocean while Merrill owned them? Is that enough risk?

Frankly, that Merrill took on the substantial risk of ownership is clear from the answer to the following simple question: What would Merrill have been legally entitled to recover from Enron if Enron had not fulfilled Fastow’s alleged oral promise either to broker a sale of the interest to a third party or buy it back itself?

Answer: Zilch. Under the contract between the parties, both Merrill and Enron confirmed that any prior oral representations (i.e., Fastow’s promises) not contained in the deal documents were null and void, and that neither party relied on them in entering into the transaction. This is a standard contractual provision in such deals. But Vic still concludes that Merrill took on no substantial economic risk in the transaction because of Fastow’s unenforceable promise.

In a comment, Vic continues his disparagement of the deal:

The evidence suggests, to me, that Fastow promised to buy back the barges, that Merrill Lynch expected him to buy back the barges and did the deal based on that representation, and that Fastow (through LJM) in fact bought back the barges. The phone call is not the only piece of evidence.

Vic’s downplaying of the Fastow conference call belies the fact that the call was the crux of the government’s case during the trial and final arguments. Similarly, Vic’s assertion that Fastow “promised to buy back the barges” and that “Fastow (through LJM) in fact bought back the barges” falls into the same blurring of the transaction that the government engaged in at trial and to which the Merrill defendants now object on appeal.

Inasmuch as LJM2 was a third party, its purchase of Merrill’s interest did not render Enron’s accounting of the gain from the transaction improper, and the government conceded that during the case.

However, as the Merrill defendants point out on appeal, that did not stop the government from suggesting to the jury repeatedly during the trial that LJM2’s purchase of Merrill’s interest was somehow compelling evidence that a crime occurred and that a criminal conspiracy existed.

Vic goes on in his comment:

I noticed, for example, that one of Merrill’s memos noted “reputational risk” as a risk factor in the deal. You don’t do that with a plain vanilla financing.

Now, this may not add up to a criminal conviction. I have a lot of sympathy for the defendants here — drawing the line between planning and fraud is hard. If I were on the jury, I might vote to acquit, and the 5th Circuit has a tough case. But we should not pretend that the transaction was perfectly legal or run of the mill. It wasn’t, even in the pre-2001 era.

Although I’m glad Vic toned down his initial harsh comments toward the Merrill defendants in this comment, his off-hand reference to Merrill’s acknowledgement of “reputational risk” as an indication of wrongdoing is a painful stretch.

Reputational risk is an important consideration for any transaction that is done at year end, and management would be heavily criticized for not considering such a risk. Moreover, reputational risk was merely one of at least ten other risks that Merrill management identified and reviewed internally in considering whether to enter into the barge transaction. The existence of such risks — and Merrill’s consideration of them — underscores the mistaken nature of Vic’s contention that risk was not transferred from Enron to Merrill.

But Vic’s biggest doozy is the following:

Kirkendall really goes over the top at the end of the post, explaining:

For as Thomas More reminds us, if the courts do not stand up for justice and the rule of law in such cases, “do you really think you could stand upright in the winds [of abusive state power] that would blow then?”

The implicit comparison of the Merrill defendants to a Man For All Seasons makes me want to barf.

My apologies for prompting that barfing reaction, Vic, but that barf was not the result of any “implicit comparison” that I made. Rather, it was the result of Vic’s misinterpretation of the point that I made by using Sir Thomas’ statement.

Rather than comparing the barge defendants to Sir Thomas, my point was to contrast Sir Thomas’ wisdom with the government’s dubious decision to use its enormous power to bring a flimsy prosecution against four innocent men based on suppression of evidence and appealing to the jury’s resentment of Enron.

The context of Sir Thomas’ statement was a debate with several family members. Sir Thomas’ wife, daughter, and future son-in-law (Will Roper) were urging Sir Thomas — as England’s Lord Chancellor — to arrest and prosecute Sir Thomas’ student, Richard Rich, who had decided to leave Sir Thomas’ tutelage in a huff over Thomas’ refusal to grant him a political appointment.

Although Rich had not committed a crime, it was clear to everyone that the conniving Rich would betray Sir Thomas in the future. So, Sir Thomas’ family beseeches him and Sir Thomas engages Roper in the following passage to make his point:

Wife: “Arrest him!”

Sir Thomas: “For what?”

Wife: “He’s dangerous!”

Roper: “For all we know he’s a spy!”

Daughter: “Father, that man is bad!”

Sir Thomas: “There’s no law against that!”

Roper: “But there is, God’s law!”

Sir Thomas: “Then let God arrest him!”

Wife: “While you talk he’s gone!”

Sir Thomas: “And go he should, if he were the Devil himself, until he broke the law!”

Roper: “So, now you give the Devil the benefit of law!”

Sir Thomas: “Yes! What would you do? Cut a great road through the law to get after the Devil?”

Roper: “Why, yes! I’d cut down every law in England to do that!”

Sir Thomas: “Oh? And when the last law was down, and the Devil turned ’round on you, where would you hide, Roper, the laws all being flat? This country is planted thick with laws, from coast to coast, Man’s laws, not God’s! And if you cut them down — and you’re just the man to do it, Roper! — do you really think you could stand upright in the winds that would blow then?”

“Yes,” Sir Thomas concludes. “I’d give the Devil the benefit of law, for my own safety’s sake!”

In short, even relatively wealthy business executives who had the misfortune of being involved in a business transaction with a societal pariah are entitled to the protection of the rule of law in the face of the overwhelming power of government. Not only for their protection, but for ours.

Update: As usual, Larry Ribstein has additional perceptive observations on these issues.

Update II: And Vic responds with a more thorough analysis here.

I want to digest Vic’s post before deciding whether to extend this debate because the issues have already been well-defined and we all have day jobs.

But I do want to make one point regarding Vic’s speculation that LJM2 was not a really a third party purchaser of Merrill’s interest.

As you would expect, the prosecution examined that issue thoroughly before trial because it would have made the prosecution’s case easier in many respects against the Merrill defendants if it could have simply contended that LJM2’s purchase of Merrill’s interest was the same as an Enron buy back.

Despite that incentive, the government concluded that LJM2 was a seperate entity with different ownership from Enron, and the government conceded that fact well before trial.

Thus, the government did not contend during the trial that Fastow’s involvement with LJM2 made it one and the same as Enron or that LJM2’s purchase of Merrill’s interest was equivalent to an Enron buy back. However, that pre-trial concession did not stop the prosecution from blurring that very issue during the heat of trial, which is why the Merrill defendants are raising that as an issue on appeal.

This Washington Post article reports that at least 20 former partners KPMG LLP — including some who were members of its senior management team — have been informed by the Justice Department that they are targets of the criminal investigation into their role in selling tax shelters over the past decade. Here are the previous posts on the ongoing sagas involving KPMG and other auditors.
As noted in this prior post, the DOJ has been turning up the heat for some time on KPMG, and it is still unclear in my mind whether the firm can survive or will fall into the same trap that enveloped Arthur Andersen. Although it would seem unlikely that the DOJ would pursue an indictment of KPMG after its Arthur Andersen fiasco, experience tells me that this bunch does not always make rational decisions in such matters. As Professor Ribstein noted awhile back, it would be ironic if a truly good criminal case against KPMG (still not established yet) would be undermined by the Justice Department’s dubious handling of the prior case against Andersen.

Canadian Imperial Bank of Commerce announced today that it has agreed to pay $2.4 billion to settle the class action securities litigation against the bank arising out of the demise of Enron Corp. in late 2001. The CIBC settlement is the largest settlement to date in connection with the Enron securities class action (previous settlements are here, here, here, here and here), and pushes the aggregate amount of such settlements a billion over the $6 billion benchmark established earlier this year in connection with the settlements in the WorldCom class action litigation. Here is the Chronicle article on the settlement.
William Lerach — the lead plaintiffs’ lawyer in the Enron class action — publicly stated in connection with the CIBC settlement that his goal is to have each settling financial institution pay more than previous settlements. That piece of information could not have brought warm and fuzzy feelings to the remaining financial institution defendants in the Enron securities fraud class action, which include Credit Suisse First Boston, Merrill Lynch & Co., Barclays PLC, Toronto Dominion Bank, Royal Bank of Canada, Royal Bank of Scotland, and Deutsche Bank AG.

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The Enron-related Nigerian Barge case has been a frequent topic on this blog as a prime example of the Justice Department’s dubious criminalization of common business practices in the post-Enron era.

As a result of that questionable policy, four former Merrill Lynch executives — Daniel Bayly, William Fuhs, James A. Brown, and Robert Furst — are unjustly facing prison sentences of between 2.5 and almost four years.

Although the former Merrill executives are appealing their convictions, both the U.S. District Court and the Fifth Circuit Court of Appeals have rejected their motions to remain free on bond pending disposition of their appeals.

Inasmuch as those motions had substantial merit, and the Nigerian Barge trial was only the second Enron-related case (the Arthur Andersen case was the first) to be tried in the anti-business environment of Houston in the post-Enron era, the denial of those motions without so much as an explanation is highly troubling.

Nevertheless, the Fifth Circuit did at least put the former Merrill executives’ appeal of their convictions on an accelerated track for a ruling on the merits. Consequently, the Merrill executives filed their initial briefs in the appeal late last week. To say that they make interesting reading is an understatement.

Inasmuch as the mainstream media has rendered Enron to social pariah status and condemned most anyone who did business with the former seventh-largest company in the United States, the conventional wisdom has blithely concluded that the Merrill Lynch executives must have been guilty of some crime in connection with the Nigerian Barge deal.

However, the briefs of the Merrill Lynch executives in the Nigerian Barge appeal reveal a stunningly different picture. Rather than even a questionable transaction, the briefs compellingly portray a typical structured finance transaction that the Enron Task Force decided to criminalize through a brazen web of distortion, inadmissible hearsay, suppression of key testimony, opposition to a defense jury instruction on the key issue in the case, and prosecutorial misconduct.

After reading the briefs, one is left with the unmistakable impression that the Justice Department’s prosecution of the Merrill Lynch defendants had nothing to do with truth or justice, and everything to do with demonizing four decent men for their misfortune of having been involved in a rather ordinary structured finance transaction with Enron.

The Nigerian Barge case arose out of a now familiar deal in which Enron sold to Merrill Lynch a financial interest in power-generating barges moored off the coast of Nigeria. The sale took place in late in December 1999 so that Enron could book in 1999 the relatively small amount of $12 million of income generated by the sale.

According to the government’s theory of prosecution, Enron should not have recognized income because the sale of the barge interest was not a “true” sale because Enron — through it’s former CFO Andrew Fastow — had orally guaranteed to the Merrill executives that, if Enron could not find a third party to “take Merrill Lynch out” of its investment, Enron would itself buy back Merrill Lynch’s interest in the barges within six months. Due to this alleged guaranteed Enron “buyback,” the prosecutors contended that Enron did not truly part with any interest in the barges and, thus, should not have recognized any income on the sale. Inasmuch as the former Merrill Lynch executives enabled Enron to book the income on the sale, the prosecution’s theory is that the former Merrill Lynch executives were guilty of conspiracy and wire fraud.

In response to these draconian allegations, the Merrill Lynch executives had a simple reply — they freely acknowledged that Merrill Lynch had not wanted to be a long-term holder of an interest in the barges, and admitted that Enron had therefore assured Merrill Lynch that it would be “taken out” of its investment. But the Merrill Lynch executives insisted that Enron had simply assured them that the “takeout” was to be through a sale to a third party and not through any guaranteed Enron buyback. Even the government acknowledged during the trial that Enron was entitled to recognize a sale — and no crime was committed — if Enron had simply assurred Merrill Lynch that it would arrange a third party to purchase Merrill Lynch’s interest in the barges.

Thus, the entire case turned on the nature of the oral representations that Mr. Fastow made during a late December 1999 conference telephone call that had about a half dozen other participants from Enron and Merrill, including Messrs. Bayly and Furst. In a transparent effort to hide the weakness of its case, the government chose obfuscation over clarity in presenting its evidence on that key call. Incredibly — and despite the fact that Mr. Fastow is a cooperating witness for the government — the Enron Task Force prosecuted its entire case against the Merrill defendants without calling a witness who had any first-hand knowledge of what Mr. Fastow said during that key telephone conference. Rather, the prosecution relied on hearsay testimony and hearsay within hearsay regarding the call, and on witness accounts who testified as to their “understanding” of what Mr. Fastow had said, but who could not remember where that understanding had come from. In so doing, the government intentionally confused the critical distinction between a lawful promise to find a third-party purchaser, on one hand, and an unlawful promise of a buyback, on the other. As Mr. Bayly’s brief notes on page 30 regarding the testimony of key prosecution witness Michael Kopper:

So which was it, according to Kopper, an Enron buyback or a third-party purchaser? Not even Kopper could keep the two accounts straight, at one point offering both versions in the same breath. Enron, he stated, had to “follow through” on its “promises” — the promise to repay, to get them repaid[.]” But those are two very different “promises.” A “promise to repay” suggests an Enron buyback. But a promise to “get them repaid” suggests a third-party purchase. It should give this Court pause, we respectfully submit, that a theory of prosecution might hang on a nuance in second-hand information so delicate that the witness himself cannot keep the “promises” straight.

To make matters worse, while presenting this “shoddy merchandise,” as Mr. Furst’s appellate counsel calls it, the prosecutors suppressed Mr. Fastow’s pre-trial statements to the government in which he admitted that he indeed had not promised an Enron buyback, but had instead told the Merrill executives that they could have a high level of confidence that Enron could arrange a third party to buy the barges from Merrill. When the Merrill defendants attempted to introduce Mr. Fastow’s inconsistent and exculpatory statements under Fed. R. Evid. 806 during the trial, the prosecution again vigorously opposed introduction of that evidence, and the trial court sustained the government’s objection. Finally, when the Merrill defendants requested a theory-of-the-defense jury instruction stating that a promise to find a third-party purchaser would not be illegal, the government also opposed the proposed instruction on this crucial issue in the case, and the trial court again sustained that dubious objection.

Thus, despite the almost 400 pages of briefs, the former Merrill Lynch executives’ argument is simple. The convictions were based almost entirely on inadmissible hearsay, and even that hearsay evidence was hopelessly confused.

Similarly, the District Court’s decision to sustain the prosecution’s objections to the exculpatory Fastow out-of-court statement and the theory-of-defense jury instruction on the key issue in the case denied the jury from considering important information that was favorable to the Merrill defendants.

Finally, the Task Force distorted — similar to the Task Force’s distortion of the obstruction of justice statute in the Arthur Andersen case — the honest services, money or property, and books and records charges in criminalizing an ordinary structured finance business transaction. In regard to that latter point, Mr. Bayly’s brief refers to Judge Easterbrook‘s classic passage on criminalization of ordinary behavior from his opinion in United States v. Walters, 997 F.2d 1219 (7th Cir. 1993):

According to the United States, neither an actual nor a potential transfer of property from the victim to the defendant is essential. It is enough that the victim lose; what (if anything) the schemer hopes to gain plays no role in the definition of the offense. We asked the prosecutor at oral argument whether on this rationale practical jokes violate 1341. A mails B an invitation to a surprise party for their mutual friend C. B drives his car to the place named in the invitation. But there is no party; the address is a vacant lot; B is the butt of a joke. The invitation came by post; the cost of gasoline means that B is out of pocket. The prosecutor said that this indeed violates 1341, but that his office pledges to use prosecutorial discretion wisely. Many people will find this position unnerving * * * . * * * [T]he idea that practical jokes are federal felonies would make a joke of the Supreme Court’s assurance that 1341 does not cover the waterfront of deceit.

As the Enron Task Force’s growing legacy of misconduct continues, it has become abundantly clear that its purpose is something other than to uncover the truth regarding Enron.

This was brought home again this past Friday afternoon in a seemingly innocuous exchange during a status conference in the Task Force’s legacy case against former Enron chaiman Ken Lay, former Enron CEO Jeff Skilling and former chief accountant, Richard Causey. U.S. District Judge Sim Lake asked the lawyers on each side of the case whether they would prefer to sit during the upcoming trial at the table in the courtroom that is closer to the jury box.

Mike Ramsey, Mr. Lay’s counsel, piped up and stated that the defendants preferred the table closer to the jury box because — due to the way in which the tables in the courtroom are situated — the other table would not require witnesses to look at the defendants (and vice versa) while they were testifying.

Although giving no reason for wanting to deny the defendants this basic part of their right to confront witnesses against them at trial, the Task Force prosecutors opposed the defense’s request for the table closer to the jury. Judge Lake has not yet decided which side will get the table, but the Task Force’s knee-jerk response reflects that their true purpose is something other than to assure that the defendants receive a fair trial.

Accordingly, after fumbling the Arthur Andersen appeal, the Fifth Circuit now has two high profile opportunities — the Nigerian Barge appeal and the Jamie Olis appeal — to redeem itself and send the Justice Department a clear message that the federal judiciary will not countenance distortion of criminal statutes and evidence even when the defendant is an unpopular business executive.

For as Thomas More reminds us, if the courts do not stand up for justice and the rule of law in such cases, “do you really think you could stand upright in the winds [of abusive state power] that would blow then?”

In the Nigerian Barge case and the Enron Broadband case, the Enron Task Force is showing us precisely what happens when such winds blow, and the emotional carnage being experienced by the individuals involved and their families is not something that can easily be overlooked as a trade-off of an imperfect system.