Over 15 months after opening a criminal investigation into Royal Dutch/Shell Group‘s overstatement of oil and gas reserves, federal prosecutors announced Wednesday that they will not charge the company in the continuing criminal probe. Here are previous posts over the past year and a half in regard to the reserve estimate mess and related problems that Shell and other energy companies have been confronting as a result of the government’s investigation.
Learning from the Department of Justice’s dubious decision to put Big Five accounting giant Arthur Andersen out of business through a misguided criminal prosecution, the Department of Justice observed as follows in its statement yesterday:

Because Shell has cooperated fully with the government’s investigation, has implemented substantial remedial efforts to enhance its reserves reporting and compliance, and has paid a $120 million civil penalty to the [Securities and Exchange Commission], the public interest has been sufficiently vindicated. Moreover, criminal prosecution would likely have a severe and unintended disproportionate economic impact upon thousands of innocent Shell employees.

However, just to make sure that no one should jump to the conclusion that the DOJ is backing off its questionable policy of prosecuting agency costs, David Kelley, the U.S. Attorney for the Southern District of New York, confirmed in an interview yesterday that the role of individuals in the energy reserve accounting scandal at Shell is still being investigated.
In 2004, Shell reported it has misstated for several prior years its oil and gas reserves, which are a key market gauge of the long-range health of an exploration and production company. Subsequently, Shell’s audit committee generated a report that blamed senior executives for ignoring warnings from Shell employees regarding the accounting of the reserves. As a result, Shell fired the chairman of its committee of managing directors and the chief executive of its exploration-and-production unit, and removed about 23% of the barrels of oil equivalent reserves from its books (about 4.5 billion barrels). Shell settled with the SEC and British regulators over the matter last year.

With the Scrushy trial out of the way, those interested in the criminalization of business are now focusing on the Enron Broadband trial, which is slogging through its eleventh week.

Houston Chronicle Enron reporter Mary Flood battles through the chloroforming pace of the trial to file this report on the fourth day of testimony of the third of the five defendants to tesify — former Enron Broadband CEO Joe Hirko.

Given the glacial examination and cross-examination of the defendants, my earlier prediction was wrong that the trial would pick up speed during the defense case. It now appears that the trial will not wind up until sometime in mid-July.

The trial has resembled a low-scoring, extra innings baseball game — long periods of tedious boredom spiked by brief spasms of chaotic excitement. Although it is impossible to predict how the jury is responding to the tedium, one thing appears to be reasonably clear — a case that looked like a layup for the prosecution at the beginning of the trial has turned into an old fashioned dogfight.

The trial began in a lively manner as former Enron CEO Jeff Skilling popped in to check out the proceedings first hand, resulting in the prosecution requesting that the judge exclude him from the courtroom for the rest of the case.

Then, the prosecution’s troubles began when the testimony of it’s key witness — former Enron Broadband co-CEO Ken Rice — was impeached as the defense showed on cross-examination that a portion of his testimony related to a video segment that was never shown to analysts as the prosecution and Mr. Rice had represented to the jury on direct. The prosecution compounded that error by attempting to shift the blame for its oversight to a female video contractor, a tactic that could well backfire among a jury of predominantly middle-aged Texas men.

However, after those interesting early stages of the trial, the remainder of the prosecution’s case-in-chief was mind-numbingly boring, which sparked a jury rebellion at one point. Understandably nervous about the effect of the slow proceedings on the jury, the prosecution quickened their presentation so that they completed their case-in-chief in five weeks, but, in so doing, may have undersold their case against two of the five defendants — former EBS executives Kevin Howard and Michael Krautz — whose criminal exposure relates to their participation in a structured finance transaction that is separate and apart from the insider trading and money laundering charges against the other three defendants.

Then, as the defense case opened, the prosecution’s case took another huge potential hit when a former Enron Broadband engineer testified that the prosecution had threatened him if he chose to testify during the trial, which brought into focus a dubious Enron prosecution tactic of chilling key defense witnesses in the Enron criminal trials.

Nevertheless, as with the early excitement in the trial, that opening dust-up in the presentation of the defense case has evaporated into tedious examination and cross-examination of the three defendants who have testified to date — Mr. Hirko, Scott Yeager, and Rex Shelby. Given the prosecution’s emphasis on its insider trading and money laundering charges against those three and the relative paucity of the prosecution case against Messrs. Howard and Krautz (who are not subject to those charges), it remains unclear whether the latter two defendants will testify, although my sense is that they will.

Although its problematic predicting how all of this plays with the jury, it’s clear from Ms. Flood and John Roper’s reports from the trial that the three defendants who have testified to date have acquitted themselves reasonably well on the stand. As Ms. Flood’s latest report on Mr. Hirko’s testimony reflects, Mr. Hirko is defending himself effectively during the prosecution’s cross-examination over the key question of whether he and Messrs. Shelby and Yeager overhyped the EBS technology in news releases and at a 2000 stock analysts’ conference in order to boost Enron’s stock price and cash-in by selling their stock.

Inasmuch as the defense probably wins the trial if they can establish reasonable doubt in the jurors’ minds on that issue, the fact that the prosecution has not scored a knockout blow on any of the three defendants who are being prosecuted on the insider trading charges bodes well for the defense. Moreover, even if the “elephant in the courtroom” — that is, the huge amount of money in Enron stock sales that those three defendants made — is too much for Messrs. Hirko, Yeager and Shelby to overcome, the prosecution appears to have real problems in its case against Messrs. Howard and Krautz, who have been largely ignored for most of the trial.

Consequently, in a case that looked like a tap-in for the prosecution at the beginning of the trial, the Enron Task Force has to be nervous. Despite the Task Force’s effective public relations campaign to equate the name “Enron” with “business corruption,” the Task Force still has not actually done much in court to prove that proposition.

Of the 33 indictments so far in connection with the Enron scandal, 15 defendants have pled guilty and only six (including just one former Enron executive) have been convicted — five defendants in the controversial Nigerian Barge case and Arthur Andersen, whose conviction was overturned by the U.S. Supreme Court.

If some or all of the Enron Broadband defendants are acquitted, then that result will confirm that the federal government’s questionable policy of criminalizing agency costs is not nearly as effective as its campaign to destroy reputations.

Former HealthSouth Corp. CEO Richard M. Scrushy was found not guilty today by the jury in the trial over over his alleged participation in a $2.7 billion accounting fraud at the huge health services company. Along with the sentencings in the Enron-related Nigerian Barge trial, the reversal in the Arthur Andersen case and the recent acquittal of Theodore H. Sihpol, the acquittal of Mr. Scrushy is the latest in a series of setbacks to governmental prosecutors’ attempts to criminalize business figures in the period after the meltdown of Enron at the end of 2001. Previous posts on the Scrushy case are here and here.
The Scrushy trial had turned into the legal equivalent of the Bataan Death March, as the jury was forced to endure four months of trial and 21 days of deliberations before arriving at a not guilty verdict on all 36 criminal counts against Mr. Scrushy, most of which related to conspiracy and securities fraud charges. The acquittal also marked the Department of Justice’s failure in its first attempt to convict a CEO for violating the 2002 Sarbanes-Oxley Act that requires CEO’s and CFO’s to confirm the accuracy of corporate regulatory filings personally.
But at the end of the day, the Scrushy case will stand for the dubious nature of the government’s policy of criminalizing merely questionable business practices. As much as the government protests that true business crimes are deterred by such vigorous prosecution of questionable business conduct, the fact of the matter is that any reasonable interpretation of justice is strained in squaring the result in the Scrushy case with the results in the Martha Stewart case, the sad case of Jamie Olis, the case of Dan Bayly, the case of William Fuhs, the DOJ’s handling of the Global Crossing case, the Tyco case, the Bernie Ebbers case and many others. As Professor Ribstein has noted:

So white collar prosecutions become a sort of lottery. If the prosecution can come up with something colorful, it wins, or maybe loses if it’s too colorful (Sardinia). These are not the elements of a rational criminal justice system.

Professor Ribstein comments further here.

The following is noted at the end of this NY Times article about American International Group Inc.‘s proxy statement that was recently published in anticipation of the company’s annual meeting on August 11:

A.I.G.’s proxy also noted that the cost of insuring directors and officers against lawsuits had increased significantly since the company disclosed a number of accounting irregularities earlier this year. The premium A.I.G. paid for such coverage last year was $9.4 million; the current premiums are about $32.8 million.

Ouch!

Following on this post from over the weekend regarding the developments in the ongoing criminal investigation of lawyers in two firms who used to practice together in the well-known plaintiffs class action law firm formerly known as Milberg Weiss Bershad Hynes & Lerach, this Wall Street Journal ($) article reports that Paul L. Tullman, a former stockbroker and lawyer who referred clients for class action cases to the firm, is cooperating with federal investigators in their criminal investigation of the way in which the firm recruited class representatives in the class action cases that the firm handled. Mr. Tullman was charged with in May 2004 with fraud and false statements on tax returns, and the WSJ reports that he copped a plea late last year. The plea agreement remains under seal.
As Professor Ribstein has pointed out, there is already a witch hunt aura to the government’s recent public disclosures regarding its investigation into Milberg Weiss’ practices. Referral fees in all types of lawsuits have been common and legal for decades, and there is not even an allegation yet — much less proof — that Milberg Weiss failed to disclose any such fees in either its tax filings or disclosures to the various federal courts in the various class action cases. Nevertheless, the government is using leaks of information to play to the general public’s resentment toward wealthy lawyers in turning up the pressure in its investigation of Milberg Weiss. Business interests may consider Milbert Weiss’ current plight sweet irony, but that does not make what the government is doing right.
As noted in this earlier post regarding Eliot Spitzer’s similar tactic toward former AIG chairman and CEO, Maurice “Hank” Greenberg, after over five years of investigating Milberg Weiss, if the government has a case against the firm, then it should get on with it.

This post from last week made the following comment about the “finite risk” insurance transaction that is at the center of Eliot Spitzer‘s investigation of AIG and Berkshire Hathaway unit General Re, and AIG’s former chairman and CEO, Maurice “Hank” Greenberg:

Despite the government’s bludgeoning of various AIG and General Re executives into plea deals and the AIG’s board acquiescence to Mr. Spitzer and other governmental investigators, it still has not been proven that the transaction in question in AIG’s case was even accounted for improperly, much less illegal. Should not the government wait to address possible criminality (and its corresponding negative effect on value) until at least the underlying transaction has been proven to be violative of applicable accounting rules?

In this letter to the editor in today’s Wall Street Journal ($), Mr. Greenberg observes as follows about the same transaction:

That transaction is the subject of litigation so I am not free to respond fully. I can assure you that an appropriate response will be made at a proper time in a proper forum. (I do note that rules for finite reinsurance are opaque and only now have the NAIC and FASB undertaken to clarify these rules.)

The dozens of securities fraud lawsuits against Enron and various other parties are consolidated under the federal multi-district litigation rules in Houston federal court. The legal community involved in those cases is abuzz today with the news that a federal indictment last week of two Southern California lawyers is a sign that the lead plaintiff’s lawyer in the Enron securities fraud litigation — William Lerach — and his former firm (Milberg Weiss Bershad Hynes & Lerach) may also be targets of the investigation. Mr. Lerach and Milberg Weiss split last year, and Mr. Lerach started a new firm based in San Diego.
The indictment of almost 70 pages (press release here) accuses a former Milberg Weiss client — Palm Springs lawyer Seymour Lazar — of taking $2.4 million in kickbacks from a “New York law firm,” presumably Milberg Weiss. Although Mr. Lazar’s personal attorney — Paul Selzer — was also named in the indictment, the indictment contains no formal charges against “the New York firm.” The indictment alleges that the New York firm reaped $44 million in attorney fees from over 50 cases in which Mr. Lazar was the lead plaintiff. As an inducement for Mr. Lazar and his family members to serve as lead plaintiff, the indictment alleges that the New York firm and others secretly paid Mr. Lazar kickbacks out of a portion of the firm’s attorneys fees.
The indictment is the result of an investigation that began in 2002 that resulted in subpoenas being issued to dozens of law firms that have been co-counsel with Milberg Weiss in securities fraud class action cases over the years. Speculation is rampant throughout the plaintiffs’ securities class action bar that the purpose of the indictment of Messrs. Lazar and Selzer is to pressure them to turn on the former Milberg Weiss lawyers.
In addition to observing that it is “saddened” by the indictment, a Milberg Weiss press release stated the following:

“We are also surprised and disappointed that, in the face of recent criticism of the government following the reversal of the Arthur Andersen conviction, the U.S. attorney’s office would risk harming the Milberg Weiss firm and its many fine lawyers and staff by making this accusation in circumstances where the firm cannot defend itself.”

As usual, Professor Ribstein provides insight and caution regarding this latest use of governmental power against an unpopular target (i.e., plaintiffs’ class action securities fraud lawyers) of the day. Moreover, check out Professor Hennings’ thoughts on the differences between the government’s potential case against Milberg, Weiss and the prosecution of Arthur Andersen, and Professor Bainbridge’s comments regarding the implications of the possible indictments on the prosecution of class actions.

Relentlessly avoiding addressing the real issue, this NY Times article speculates that the problem with Eliot Spitzer’s recent unsuccessful prosecution of Theodore C. Sihpol, III was not that he charged Mr. Sihpol in the first place, but that he should have charged all of Mr. Sihpol’s superiors, too.

In so speculating, the Times confirms that it still does not understand that the governmental policy of regulating business through criminalization of merely questionable business transactions is a slippery slope toward injustice that ultimately undermines the rule of law.

Take the case of William Fuhs. He is the former mid-level Merrill Lynch executive who was recently convicted and sentenced to over three years in prison as a result of his participation in the Enron-related Nigerian Barge case.

As has already been noted in regard to the conviction of Daniel Bayly — the former head of global investment banking at Merrill Lynch and one of Mr. Fuhs’ bosses — the government’s prosecution of the Merrill Lynch executives in regard to the Nigerian Barge transaction was dubious, at best. The resulting convictions are a plain miscarriage of justice.

As with its prosecution of Mr. Bayly, the government’s case against Mr. Fuhs strains credulity.

Of the four Merrill Lynch defendants in the Nigerian Barge case, Mr. Fuhs was the only one who was not a managing director of Merrill Lynch. Mr. Fuhs did not participate in the one telephone conference with former Enron CFO Andrew Fastow in which Mr. Fastow allegedly assured Mr. Bayly and other Merrill Lynch executives that Enron would find a buyer within six months of the interest that Merrill was buying in the barges.

In fact, Mr. Fuhs’ only role in regard to the transaction was the ministerial processing of the transaction after Merrill Lynch had agreed to buy the interest in the barges from Enron.

Incredibly, during the government’s case-in-chief in the Nigerian Barge trial, none of the government’s fact witnesses knew or interacted with Mr. Fuhs — indeed, the only government witness who had ever worked at Merrill had neither met, spoken to, nor even heard of Mr. Fuhs!

Mr. Fuhs never conferred with anyone at Arthur Andersen (Enron’s auditors) regarding the transaction and the deal was the only Enron transaction that Mr. Fuhs ever worked on.

In short, the government presented no witnesses or evidence during its case-in-chief that Mr. Fuhs — who is not an accountant — had any idea that Enron’s booking of a $12 million gain on the Nigerian Barge transaction was arguably improper, much less that he intended to promote Enron’s accounting of the transaction.

Nevertheless, while Mr. Sihpol walks away from the New York courthouse a free man, Mr. Fuhs — a young man with a wife and two young children — faces a shattered professional and family life and 37 months in federal prison.

As Professor Bainbridge noted in this TCS op-ed and Professor Ribstein has repeatedly observed, the contrasting results in the cases of Mr. Sihpol and Mr. Fuhs — not to speak of the sad case of Jamie Olis — confirms that the pursuit of justice in such cases has become a sort of lottery.

If the prosecution pursues a bit player such as Mr. Fuhs but can come up with something particularly distasteful to the jury — such as Merrill Lynch’s involvement with the corporate pariah, Enron — then it wins.

On the other hand, if the government slams a little guy such as Mr. Sihpol while not pursuing his dastardly superiors, then the government loses.

This is a radical abuse of our criminal justice system, and the carnage to the families of Martha Stewart, Mr. Bayly, Mr. Fuhs, Mr. Olis and others who are caught in this troubling spiral simply cannot be responsibly dismissed as a “trade-off” of an imperfect system.

But as great as my compassion is for members of those families, my even greater concern is for the principles of justice and respect for the rule of law upon which the success of our society is largely based.

If we lose those, then, as Sir Thomas More asked Will Roper in A Man for All Seasons, “do you really think you could stand upright in the winds [of abusive state power] that would blow then?”

U.C.L.A. law professor Stephen Bainbridge is one of America’s leading experts in the area of corporate and securities law, and he has long been generous in sharing his expertise on those subjects and others on his popular ProfessorBainbride.com weblog. Professor Bainbridge is also a formidable writer who is particularly gifted in breaking down complex legal issues in a simple and straightforward manner.
In this TCS Central op-ed (his blog post on the article is here), Professor Bainbridge takes dead aim at the dubious governmental policy of criminalizing business interests through the prosecution of agency costs, which are essentially the costs of poor corporate governance. The entire op-ed is a must read, and here is the money quote:

[S]hareholders deserve protection from theft, but not from risk taking, even when the risk in question is how much to pay an executive. Unfortunately, it’s not clear that prosecutors know the difference — or even care.