Category Archives: Legal – Criminalizing Business

Visiting a prison cell

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jail The troubling U.S. incarceration rate and the dubious governmental policy of overcriminalization have been frequent topics on this blog. The toll of the overcriminalization policy on citizens and their families is incalculable.

Part of the problem in modifying this destructive policy is that the constituency of current and former prisoners and their families is not powerful politically. But another aspect of the problem is that most well-meaning citizens who could make a difference on this issue politically have never experienced the hell that is most prisons in the United States. Itís human nature to avoid addressing even an important issue that one has never had to confront personally.

Thatís why this A Public Defender post is important ñ it provides penetrating insight into the destructive nature of our governmentís overcriminalization policy:

I sat in a prison cell yesterday.  .   .   .

There was a bed ñ a small bed ñ that was the length of the room. At the foot of the bed a metal toilet, with no cover. Just beyond that the heavy metal door, with a slit for a window. The door was maybe 3 feet wide, if that. At the head of the bed, if you were laying on your right side, youíd be about half a foot away from an ugly metal desk with holes that pretended to be drawers. This could not have been more than a foot long. The bed was flush with one wall. The desk with the opposite.

The bed looked hard, cold and dirty. And thatís it. This particular cell happened to have a window at the head of the bed. A window looking out onto nothing. Any future inhabitant of this particular cell would have it good. It was a single. Across the narrow passageway from this cell was another, identical in every respect except two: it was a double cell and there was no window. (Hereís a post I wrote a while ago about a different take on prisons in a foreign country.) [.  .  .]

I willed myself to stand there, though, for a minute. To look around at the bare walls, the bare desk, the dirty toilet and imagine someone ìlivingî there.

I even briefly closed my eyes and tried to picture myself there, day in and day out, for months, which turned into years, which turned into decades.

Would I survive? How does anyone? Would I give up and stop bathing, shaving, eating? Would I maintain my sanity or would I quickly decompensate? How long would it be before Iíd want to kill myself? [.  .  .]

People in cells are lucky, though. The next portion of the tour took me to the dorm-style housing. Which is nothing like any dorm youíve ever lived in. Imagine instead the makeshift MASH hospitals, or perhaps the busiest train station in your neighborhood at rush hour, except instead of standing, people are milling about a hundred bunk beds on that tiny platform.

There is no privacy, there is no solitude, there is no being left alone. You are part of a large crowd. You are in someoneís face and they are in yours. You are a collective. Day in and day out. You share your bedroom with 125 other people.

Leaving the prison, I asked my colleague: cell or dorm? Thereís no debate. Cell. Iíd rather lose my sanity by myself.

A truly civilized society would find a better way.

The Human Cost of Criminalizing Business

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In the news and public relations business, Friday afternoon is usually a good time to float news that someone involved doesn’t want many folks to notice. News tends to die over the weekend. Monday brings new news. Friday’s news is already old.

This past Friday’s news along those lines was that Joseph Cassano and other former American International Group executives involved in the AIG meltdown that almost brought the world’s financial system to its knees would not be subjected to criminal prosecution.

Inasmuch as the same thing that happened to Enron in late 2001 happened to AIG in late 2008 (as I predicted it could happen in 2005), it’s not particularly surprising that the federal government would like the news that it has elected not to pursue criminal charges against former AIG executives to die over the weekend news cycle.

I mean, really. Other than acknowledging the randomness of the criminalization of business lottery, how could anyone rationalize the government’s decision not to prosecute AIG executives, on one hand, with the government’s brutal treatment of business executives involved in Enron-related business, on the other?

Well, some would say at least the government finally got the decision right in regard to the AIG executives. Better late than never, right? Cassano and the other AIG executives are still subject to multiple civil class action lawsuits in which the responsibility for AIG’s meltdown will be allocated among all of the multiple parties involved. That’s the way this type of thing should be handled, right?

Well, yes, except that all of the mainstream media reports that I read about the government’s decision not to prosecute the AIG executives failed to mention that multiple business executives who did nothing other than be involved in transactions with AIG have already had their careers ruined and their lives uprooted by dubious criminal prosecutions.

Why weren’t these men and their families spared the trauma of facing the brute force of a federal criminal prosecution and a prolonged prison sentence? Likewise, why were these men forced to endure the incalculable human cost of the government’s criminalization-of-business policy?

Meanwhile, the human cost or that dubious policy continues to mount.

This past week, Joe Hirko, the former Enron Broadband executive who copped a plea bargain in the face of a draconian trial penalty, was visited by his wife Kathleen in the California prison where he is serving his sentence.

During her visit, Mrs. Hirko was stricken by either a heart attack or stroke and died, leaving her husband, three children and four grandchildren to pick up the pieces of their lives.

Unlike the news about the government’s decision not to prosecute the AIG executives, Kathleen Hirko’s tragic death did not even register a blip on the mainstream media’s radar screen.

I wonder how much the past seven years of prosecutorial hell that the Hirko family endured contributed to Kathleen Hirko’s death? And what beneficial public purpose did the infliction of that emotional trauma achieve?

A truly civil society would find a better way.

So much for the presumption of innocence

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Allen Stanford This post from late last year noted this self-righteous NY Times Magazine piece  in which Andrew Meier decried the Russian government’s unjust prosecution and treatment of former Yukos chairman, Mikhail Khodorkovsky.

Meanwhile, the Times and most of the rest of the mainstream media have largely ignored the United States Government’s unconscionable treatment of R. Allen Stanford, who is still awaiting trial in downtown Houston’s Federal Detention Center. Stanford’s current legal team — which includes Harvard Law professor Alan Dershowitz — has filed another motion seeking Stanford’s release, this time on Constitutional grounds.

The deprivation of due process and other Constitutional arguments contained in Stanford’s latest motion are interesting, but what is even more compelling is the description of what the government has done to Stanford while he is presumed to be innocent of the charges asserted against him:

Mr. Stanford, a man who is presumed to be innocent, is being, and has been, subjected to substantial and undeniable punishment long before the trial of his case has even begun. He has been physically assaulted; he has suffered significant medical injury and psychological debilitation; he was held in solitary confinement two separate times for a total of 40 days; he has been subjected to 335 days of pretrial incarceration as of May 18, 2010; and before his scheduled trial concludes, he will predictably serve another nonspeculative 439 days.

Pivotally, he has, and will continue to have his constitutional rights compromised, including his fundamental right to assist counsel in the preparation of his defense, to personally review even a small fraction of the evidence that is material to his prosecution, to locate exculpatory evidence, and to have his core cognitive faculties undiminished by unnecessary conditions of confinement in a high-security prison which, in a myriad of ways .   .  . have prevented and will prevent him from preparing for trial.  .  .  . [T]he conditions of confinement to which Mr. Stanford has been subjected have been and continue to be manifestly punitive. [.  .  .]

On June 18, 2009, when Mr. Stanford surrendered to authorities, he was a healthy 59 year-old man, with no substantial physical or mental health issues. Now, nearly one year in detention later, Mr. Stanford’s pretrial incarceration has reduced him to a wreck of a man: he has suffered potentially life-impairing illnesses; he has been so savagely beaten that he has lost all feeling in the right side of his face and has lost near field vision in his right eye. The major injuries from his assault while in prison required reconstructive surgery under general anesthesia and was performed while he was under restraint.

Rather than placed in medical isolation or the general population to recover, immediately post-operation, Mr. Stanford was placed in the maximum security Special Housing Unit (“SHU”) area of the prison where he remained detained in solitary confinement for roughly 23 days, and denied all outside human contact with the exception of his attorneys; extreme measures which are generally reserved for only the most violent of convicted criminals.

Mr. Stanford has experienced, according to the Declarations attached hereto, a precipitate, severe, and ongoing deterioration of his mental and emotional health caused by the conditions of his confinement. Mr. Stanford has, moreover, been denied his Sixth Amendment right to counsel, to assist counsel in the preparation of his defense, and has been for the entire 335 days of his ongoing critical pretrial period deprived of the requisite confidentiality of his discussions with his attorneys by enforced institutional review of every document which his attorneys wished to discuss with him during their meetings.

Trial of this case is not scheduled to begin until January 24, 2011, and is expected to last six months, bringing the total, non-speculative, duration of pretrial detention to a minimum of 774 days; well over two full years without a determination that he is guilty of any crime.

And just to make sure that Stanford will never be of any meaningful assistance to his defense counsel, get a load of the routine that Stanford faces each day of his expected six-month trial if he continues to be incarcerated during the trial:

Mr. Stanford’s inability to assist counsel during trial will be magnified by the reality of the system for bringing detained defendants to court, which forces defendants to undergo procedures which result in elapsed time of 14-17 hours between wake-up in the morning and return to cell in the evening. The physically and mentally exhausting and degrading procedures which Mr. Stanford would be forced to endure day in and day out during the six month trial if he remains incarcerated — procedures which leave insufficient time for sleep and virtually no time for additional preparation — are roughly as follows:

The inmates are awakened at around 4:00 to 4:30 AM. A body search is done before leaving the cell.

They are then taken to a receiving area where they have to strip naked, go through another body search, and then given a set of green clothes.

The inmates are then placed in a concrete holding cell where they may sit for 2 to 3 hours. GEO guards come into the holding cell where they shackle the inmates’ hands to a chain around their waist and shackle the ankles.

After they are shackled, the inmates are taken down to the first floor and placed in a van. After about a 30 minute wait, they are driven to the U.S. Marshal’s office at the Federal Courthouse.

The inmates are then searched by the U.S. Marshals and placed in a steel cell where they wait until they are called and taken to their hearing. Mr. Stanford stated that he goes to the hearing with his shackles in place.

After the hearing, the inmates are taken back to the steel holding cell and they remain there until everyone is done with their hearing.

By the time all the hearings are done it can be anywhere from 5:00 to 7:00 PM. At that time, the inmates are taken to the van and driven back to the FDC.

At the FDC, the inmates strip naked, undergo a body search, and change back into their regular jail garb.

The inmates remain in the holding cell while a counselor spends 5 minutes with each inmate asking what happened at their hearing, whether they feel suicidal, etc. After everyone is interviewed, the inmates are taken back to their cells somewhere around 7:00 to 9:30 PM.

For years, we watched as an out-of-control federal task force – egged on by a vacuous media members – rode roughshod over local citizens’ Constitutional protections. Now, before our eyes, the presumption of innocence has been eviscerated in the Stanford case with nary a peep of protest other than from Stanford’
s attorneys and a few bloggers.

"When the last law was down, and the Devil turned ’round on you, where would you hide, the laws all being flat? .  .  .[D]o you really thing you could stand upright in the winds that would blow then?"

Robert Furst’s nightmare ends

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Furst_3.jpg

So, after seven years, the Department of Justice finally rolled over with nary a whimper and agreed to end the absurdly unjust prosecution of former Merrill Lynch banker Robert Furst. As usual, the deal to dismiss all charges against Furst will receive a small fraction of the publicity that the mainstream media trumpeted for his tainted conviction. The deferred prosecution agreement is below.

Although surely a relief, the agreement must be bittersweet for Furst. His business career is badly damaged and has been effectively put on hold for the better part of a decade. And for what purpose?

Thatís the question that we should be asking as we get ready for yet another round of the same type of senseless prosecutions than ensnared Furst.

UH Law Professor Geraldine Szott Moohr reminded us this week in the context of Jeff Skilling’s pending Supreme Court appeal of the foreboding nature of the government’s overwhelming prosecutorial power. As Sir Thomas More teaches us, “when the last law was down, and the Devil turned ’round on you, where would you hide, the laws all being flat? . . . do you really thing you could stand upright in the winds that would blow then?”

A truly civil society would find a better way.

Robert Furst Deferred Prosecution Deal

The Beneficial Nature of Derivatives

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I don’t watch much television news. But when I catch a glimpse these days, it always seems as if some politician is loudly declaring the need for more governmental financial regulation.

Mostly, the politicos contend that financial derivatives are dangerous instruments that are contrary to sound public policy. We have to protect those poor souls who bet against John Paulson, don’t you see?

But the proponents of this view simply do not want to understand the nature of derivatives, just as most of the same ones didn’t want to understand the valuable nature of the risk management of natural gas prices that Ken Lay and Jeff Skilling contributed to markets 20 years ago.

Derivatives are simply a way for an investor to warn by trading – that is, by putting his money where his mouth is – that he has information about an upcoming shift in the markets. That facilitates a transparent and well-informed marketplace.

However, heavily regulating traders from taking advantage of that valuable source of information only makes it more difficult for valuable information about market shifts to reach the marketplace. How is that good for investors seeking as transparent and well-informed marketplace as possible?

An underappreciated cause of the Wall Street crisis was the underlying information failure. As opposed to restricting trading, we ought to be finding ways to bring more information to the market faster so that prices can be adjusted promptly.

Rather than demonizing folks who bet their money in bringing information to the marketplace, we ought to be encouraging them.

I won’t hold my breath waiting for that to happen.

Next Victim of the Criminalization-of-Business Lottery?

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Although it really shouldn’t have surprised anyone, the big business news at the end of last week was the the Department of Justice had opened up a criminal probe of Goldman Sachs well before the filing of the SEC’s lawsuit a couple of weeks ago.

Craig Pirrong provides his typically lucid perspective toward the news, while the Epicurean Dealmaker insightfully notes a dynamic involved in the growing cascade against Goldman Sachs that should concern us all. Interestingly, that dynamic is the same one that was involved in the prosecution to death of former Enron chairman, Ken Lay.

Frankly, after almost a decade of misdirected prosecutions of businesspeople, it’s confounding that many citizens believe that a prosecution of Goldman Sachs would serve any useful public interest.

It is indisputable that government cannot possibly discover or prosecute all business fraud. But government policies that purport to prevent fraud by prosecuting simply prompt private parties to be less careful in detecting or avoiding fraud in the first place.

Moreover, the utter randomness of the criminalization-of-business policy undermines the public’s respect for the rule of law. For example, who can possibly keep up with all the rules that government has invoked in determining whether an important businessperson gets prosecuted for a supposed business crime?

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

Then there was the Buffett Rule, closely followed by the GM Rule.

And who could forget the Geithner Rule?

Frankly, the rule of law has been replaced by what Larry Ribstein has coined the criminalization-of-business lottery where winning or losing becomes random.

For instance, the owners of Long Term Capital Management may have been the earliest winners in the most recent era. On the other hand, Jamie Olis may have been the earliest big loser.

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

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

And no one lost bigger than Jeff Skilling.

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

And who knows about those Lehman Brothers executives — they may be winners, after all? I mean, everyone was doing it, right? But you never know for sure.

Finally, who possibly can justify what Bill Furst has been through?

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

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

A truly civil society would find a better way.

Goldman in the crosshairs

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goldman-sachs-fbi-doj The inevitable SEC action against Goldman Sachs took the financial system by storm on Friday, so the weekend has been a feast of blogosphere analysis on the implications of the lawsuit. The best way to follow daily developments in the case is over at Clusterstock where Joe Weisenthal and Henry Blodget have their fingers on the blogosphereís pulse in regard to the SEC lawsuit.

The best analysis of the lawsuit that Iíve read in the blogosphere to date comes from Larry Ribstein, Erik Gerding and UHís Craig Pirrong. Read their posts and you will have a good understanding of the issues involved in the case.

Frankly, the SEC action against Goldman looks a lot more about public relations than effective regulation. As Blodget pointed out on Friday morning, the timing of the filing pushed the highly embarrassing SEC Inspectorís report on the SECís bungling of the investigation into Stanford Financial off the publicís radar screen. One would hope that the SECís due diligence in regard to its action against Goldman is better than its research into Stanford Financial, which was widely known in Houston financial and legal circles to be a sketchy outfit for over a decade before it blew up last year.

The key to the SEC’s case is that Goldman apparently did not disclose to ACA nor IKB and ABN knew that uber-mortgage short specialist John Paulson was placing bets against the underlying securities upon which the synthetic CDO was based at the same time as Paulson was helping Goldman and ACA choose the underlying securities.

Thus, the theory goes, Paulson presumably had an incentive to enhance the failure of the securities. Accordingly, the SEC contends that Goldman and Paulson structured the deal to lose, that Goldman knew the investors wouldn’t buy if they knew that, and that Goldman didn’t disclose those details because it was making fees all over the place.

My sense is that the case is far from a slam dunk (see also here and here) for the SEC, but it probably doesn’t make any difference. If Goldman defends itself and loses, then the trial penalty is that private civil lawsuits by other investors will use the judgment in favor of the SEC to establish liability against Goldman (interestingly, Goldman elected not to disclose its receipt of the Wells Notices related to the SEC lawsuit). Although Goldman could manage the payment of an SEC fine, damages in those civil lawsuits could seriously harm the firm.

Thus, my sense is that Goldman has to settle with the SEC, and probably for a good chunk of change to make the SEC look good. That will likely suit Goldman just fine because it would continue to distract the public from the far larger travesty, which was the way in which the federal government bailed Goldman out from its massive risk of loss in regard to AIG.

From a policy standpoint, the SEC action is a part of the Obama Administration’s public relations campaign to promote federal regulation of the derivatives markets, a point that Professor Ribstein makes in this post:

In other words, the SEC, under pressure to come up with something on the eve of Congress’s final push toward financial regulation comes with a case that the complaint makes clear is much more about the creation of systemic risk than about securities fraud.
This reflects, in part, the new Wall Street, more than three quarters of a century after the securities laws were enacted. Financial regulation is now much more about sophisticated market intermediaries than about individual investors who need somebody to ensure they have the truth about securities.
This is not to say that securities fraud is irrelevant. However, the SEC has struggled on that front ñ the Bank of America settlement, Madoff, Stanford.
And so now we are left with . . . Goldman.

Inasmuch as such regulation will allow federal regulators to exercise the same judgment in regard to derivatives regulation that it applied to regulating the likes of Stanford Financial and Bernie Madoff, count me as decidedly unconvinced that this development constitutes progress.

However, one positive aspect about the SECís complaint is that it provides a stark reminder to investors of the risk of doing business with the likes of Goldman. As Arnold Kling has been saying for years, perhaps it wouldnít be such a bad thing if investors didnít rely so much on the chauffered investment bankers of Wall Street and their friends in government.

Good bye and good riddance

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Ben CampbellDo New York Times reporters even bother to research the subject of their articles at all?

Take this A.G Sulzberger/NY Times puff piece on the departure of current U.S. Attorney for the Southern District of New York, Benton J. Campbell.

You may remember Campbell. He was the lead prosecutor on the Enron-related criminal trial known in these parts as the first Enron Broadband trial, which ended in an embarrassing loss for Enron Task Force after the prosecution was caught threatening defense witnesses (see also here) and propounding false testimony from one of its key witnesses. Sort of what you would expect from a trial in which the Task Force advocated an unwarranted expansion of a criminal law intended to punish kickbacks and bribes against business executives who didnít take any.

Then, as if that wasnít enough, Campbell proceeded to lead the prosecution (unsuccessfully, thank goodness) that attempted to make refusing to throw in the towel a crime. Given that he decided to become a prosecutor while watching Rudolph W. Guiliani, who could be surprised by such appalling lack of judgment?

Sort of makes one wonder just how much unwarranted destruction of lives one has to be involved in before the Times notices?

The criminalization-of-business lottery continues

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Greg Reyes So, after having been tried and convicted once in 2007, and having that conviction subsequently overturned because of prosecutorial misconduct, former Brocade Communications CEO executive Greg Reyes was convicted again last week on nine counts of securities fraud and making false statements in connection with his involvement in backdating stock options.

Alas, the criminalization-of-business lottery continues in regard to another business practice that simply should not be a crime. Frankly, Reyesí real crime appears to be that he is not Steve Jobs.

Unfortunately, the publicity surrounding this recent disclosure ñ which took place during Reyesí trial ñ probably didnít help Reyes much.

It probably wonít help Robert Furst, either, who is the next unlucky executive who will be put on the merry-go-round of an utterly baseless and random prosecution.

Meanwhile, the different trajectories of these two lives really makes one wonder about the purpose of all this?

Back in 2006, Larry Ribstein was the first blogger to challenge the backdating prosecutions. The utter vacuity of those prosecutions proved that his skepticism was correct. I cannot improve upon Professor Ribsteinís characterization of the true scandal relating to the backdating of stock options:

ìThe real backdating scandal is not the one that has been generally reported. It is, instead, the woeful inadequacy of mainstream business reporting compounded by prosecutorial misconduct.î

A truly civil society would find a better way.

My Lehman Bullshit

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Mike over at the Crime and Federalism blog (a good blog, by the way) thinks my explanation yesterday of Lehman Brothers’ controversial repo 105 transactions is bullshit.

Well, I’m as full of bullshit as anyone, but my sense is that Mike’s analysis is flawed. That’s not to say that the folks involved in reporting Lehman’s earnings to the marketplace after those repo 105 transactions didn’t commit fraud. I don’t know enough about the facts to know one way or the other.

The main point of my post is that a whole bunch of of executives, accountants, auditors, counterparties and governmental officials were swirling around Lehman at the time of these repo 105 transactions. As a result, the responsibility for any fraud is better allocated among the responsible parties in the civil justice system than in the criminal justice system, where guilt is adjudicated with a sledgehammer when a scalpel is more appropriate.

But one of the interesting aspects about Mike’s post is that he is very sure that he understands that Lehman committed fraud. So, let’s take a look at his example of what he thinks happened with regard to Lehman and the repo 105 transactions (my observations are in italics below each of his statements):

I ask you to invest $100,000 in my new business. You ask me how much money I have in my business account. I only have $5,000, but do not tell you this.

Okay, as my prior post noted, I concede that Lehman may have misrepresented its true liquidity position through the repo 105 deals.

I can sell everything the business owns (including all of our inventory) to a pawn shop for $100,000.

If Mike can sell all the assets of the business to a pawn shop for $100,000, then the business owns much more than $100,000 in assets. Pawn shops – much like the financial institutions with whom Lehman was dealing – do not engage in repo 105 transactions unless they are darn sure that they can liquidate the assets that they purchase for more than they paid if the seller breaches his obligation to repurchase the assets.

The pawn shop will sell me everything back for $105,000 if I come up with the money within 48 hours.  They won’t even take possession of the property if I pay them within 48 hours.

I do not know of any pawn shop – or financial institution for that matter – that would be willing to leave property that they purchased in the hands of a financially-troubled seller, even for just 48 hours. Moreover, my understanding of the repo 105 transactions is that Lehman was not obligated to repurchase the asset for the sale price plus 5%. My understanding is that the “105” in repo 105 relates to the fact that financial institutions require property at least worth 105% of the purchase price that the financial institution pays the seller for the asset. I’m sure that Lehman’s counterparties required a steep fee for engaging in the repo 105 sales, but not 5% of the purchase price.

I make the “sale” to the pawn shop. I show you a copy of my bank statement. You can see that I have $105,000 cash in my bank account. I’m, in other words, liquid 100 grand. You loan me $100,000.

Here is where Mike is confused. Prior to taking the $100,000 loan, his company’s balance sheet actually looks a bit worse because of his sale to the pawn shop. The company has sold assets worth more than $100,000 in order to increase its liquidity to $105,000. No rational investor would make a $100,000 unsecured loan to a company with assets of only $105,000 cash that the investor would not have been willing to make when the company had $5,000 cash and over a $100,000 in non-liquid assets. But let’s play along with Mike to get to his main point. After the loan, his company now has $205,000 in cash with a $100,000 liability.

I buy my stuff back for $105,000. I now have, thanks to you and some quick accounting fraud, $95,000.

No, that’s only part of it. The company now has repurchased its assets that are worth over $100,000, it has cash of $100,000 and a $100,000 liability. So, the company’s balance sheet is pretty much the same had the investor made his loan when the company only had $5,000 cash and over $100,000 of non-liquid assets. The only difference is that the investor feels deceived because he would not have made the loan under those circumstances.

So, maybe Mike’s investor in the example above has a good fraud case against the company (I’m not sure that’s the best way for the investor to recover his loan, but that’s another issue). But maybe not, too. And the situation that Lehman faced was far more complex than Mike’s hypothetical and involved a large number of well-intentioned people who were attempting to find any loophole available to save Lehman.

And that’s no bullshit.