This Wall Street Journal ($) editorial addresses a litigation phenomenon that has been increasing in recent years — public employee pension funds serving as plaintiffs in class action lawsuits. And as the editorial notes, this new willingness to serve in such a role reflects even more troubling signs on the way in which at least several of those pension funds are operated:

It’s an article of faith these days that institutional investors are the white knights of the corporate governance crusade. And the most loyal acolytes of fiduciary duty, we are told, are the state-administered funds that provide retirement benefits for public-sector employees. But a couple of recent cases show that some public pension funds are not only failing their own beneficiaries, they are making mischief for well-run corporations.

The Journal notes that a few pension plans are collaborating with a few plaintiffs’ securities lawyers to shake down the companies in which the pension plans invest:

[T]wo funds representing Pennsylvania’s public school teachers and state employees have been busy this year suing corporate giants Time Warner and Royal Dutch/Shell Group. Alleging that the companies misled investors, the lawsuits seek hundreds of millions in damages. Since shareholders are essentially suing themselves, the main winners here will be the lawyers..

Meanwhile, the pension fund managers are not exactly providing overwhelming performance in their primary duty to the funds:

[T]he fund managers show more zeal for litigation than they do for stock picking. The two funds have lost $20 billion, or 25% of their value, over the last few years, despite paying $250 million a year in management fees. As a result, state and local governments will have to come up with extra tax revenue to make up the shortfall.

And though the performance of the managers of the Pennsylvania funds has been less than exemplary, it does not hold a candle to the corruption that takes place when one concocts the volatile mix of plaintiffs’ securities litigation with the traditional corruption of Louisiana politics:

[In Louisiana] the trustees of the state’s Teachers Retirement System were found to have violated state ethics rules by accepting golf outings, hunting trips, football games and $150 bottles of champagne from a Texas private equity firm, Hicks Muse Tate & Furst. The fund then committed more than $900 million to Hicks’s investments. The fund says that 23% of its $10 billion in assets were committed to similar “alternative” investments, earning it the rating of riskiest public pension fund in the country from Wilshire Associates. Because this strategy cost the fund somewhere between $500 million and $2 billion by different estimates, retirees are foregoing cost-of-living increases, and the state general fund and local school boards are struggling to make up billions in unfunded liabilities.
But instead of re-evaluating their investment practices, the trustees of the Louisiana fund have instead been racking up an impressive record of litigation. It has been involved in 60 class-action lawsuits in the last eight years, and a Tennessee judge last year rebuked it for seeking “lead plaintiff” status in 24 suits while already taking that role in eight others.

And what is the Louisiana fund managers’ response to such risky investment practices? They sue the company that represents one of their best investments:

To top it all off, last year the Louisiana fund tried to sue the majority shareholders of Regal Entertainment, the country’s largest operator of movie cinemas. Despite having only a $30,000 investment in the company, the fund launched an 11th hour lawsuit to stop the company from issuing an extraordinary dividend, accusing Regal’s controlling shareholders of “looting” the company.
This incendiary accusation was truly laughable. The dividend was paid equally to all shareholders, and no other investors found reason to object. After all, the company enjoys a strong cash flow, so distributing profits and increasing the company’s leverage was a legitimate management decision.
How can we say that with such certainty? Because the Louisiana teachers’ fund admitted as much when it dropped the case, in order to avoid a counterclaim by Regal. That climbdown only came after the judge refused to grant a preliminary injunction against the dividend because there was “not a shred of evidence” that minority shareholders would be hurt.
The biggest shock was just how little the Louisiana fund’s administrators knew, or cared to know, about the litigation they sponsored. Director Bonita Brown admitted in a deposition that, despite being one of only two officials responsible for deciding to initiate lawsuits, she not only had had no contact with the Regal management ahead of the lawsuit, but she also did not know whose idea it was to sue.

The Journal editorial concludes by summarizing the absurdity of it all:

So what we have here is a public fund whose risky practices have cost the taxpayer billions throwing mud at a profitable company’s management — throwing it, moreover, at a company (Regal) that was one of the fund’s better-returning investments. If the Louisiana and Pennsylvania pension funds were private entities, their trustees might well be the target of a lawsuit themselves for being so lackadaisical about their fiduciary duty. Given the ethics violations in Louisiana, state investigators might check to see whether law firms are illegally compensating trustees with junkets so they’ll ignore their duty to protect their funds from possible counterclaims arising from frivolous lawsuits.

But then everybody knows that the real blame lies with the politicians who appoint and protect these incompetent managers, and it’s up to voters to hold them accountable. Perhaps the better question is why Congress and federal judges still allow such funds to posture as guardians of good corporate governance while they dance to the trial lawyers’ tune.

Read the entire piece. The Journal editorial is correct in noting that the conduct of the pension fund trustees is certainly troubling in these particular cases. However, a related issue that the editorial does not address is whether the dubious cases are truly a significant problem or merely an anecdotal byproduct of an open civil justice system. For a detailed analysis of that issue in the context of class action settlements, see this article by Cal-Berkeley Law Professor Steven J. Choi and this Professor Bainbridge comment on Professor Choi’s article.

David Gerger, appellate counsel for former Dynegy finance employee Jamie Olis filed Mr. Olis’ appellant’s brief with the Fifth Circuit Court of Appeals this week in which Mr. Gerger contends that Mr. Olis’ conviction and 24-year prison sentence should be overturned because of insufficient evidence and U.S. District Judge Sim Lake‘s alleged misapplication of federal sentencing guidelines.
Interestingly, Mr. Gerger also represents former Enron CFO Andrew Fastow in connection with his plea bargain with the Enron Task Force, and Judge Lake is also overseeing the pending high profile criminal cases of former Enron executives Kenneth Lay, Jeffrey Skilling, and Richard Causey.
One of Mr. Gerger’s main arguments is that Mr. Olis’ sentence should be subject to the U.S. Supreme Court’s recent ruling in Blakely v. Washington that suggests that federal judges should be prohibited from increasing a sentence using factors not proved before a jury beyond a reasonable doubt. Previous posts are here on the Blakely decision.

This Wall Street Journal ($) article follows up on the status of the government’s investigation into KPMG‘s tax shelter practice and emphasizes the involvement of lawyers (from the Wall Street firm, Brown & Wood) in the promotion of that practice. Here are the previous posts on this investigation and KPMG.
Suffice it to say that this saga is not likely to end well for either KPMG or Brown & Wood (now merged with Sidley, Austin).

This NY Times article provides a fine report on the demise of Global Crossing, Ltd., the telecommunications company that went down under suspicious circumstances at the same time as Enron Corp. was cratering. However, unlike Enron, the Justice Department established no “Global Crossing Task Force.” Moreover, neither Global Crossing CEO and chairman Gary Winnick nor any other Global Crossing executive was ever charged with a crime:

Along with Kenneth L. Lay of Enron, L. Dennis Kozlowski of Tyco International and Bernard J. Ebbers of WorldCom, Mr. Winnick has emerged as a symbol of the financial shenanigans behind the 1990’s bull market. Unlike the others, however, Mr. Winnick, Global’s founder and chairman, has already been cleared of criminal charges. The Justice Department quietly dropped a criminal fraud investigation of him on Christmas Eve of 2002, relieving him of the prospect of prison time.

Nevertheless, the allegations in pending civil lawsuits sound the same as the core allegations in pending criminal indictments against various former Enron executives:

J. P. Morgan Chase and other leading banks are seeking $1.7 billion in damages from Mr. Winnick and other Global Crossing executives, contending that the group engaged in a “massive scam” to “artificially inflate” the company’s performance to secure desperately needed loans. . .
Among other things, the suit refocuses attention on exactly what Mr. Winnick knew about his company’s finances during times when it was borrowing heavily and he was selling hundreds of millions of dollars in stock.

Which led the U.S. District Judge Gerald E. Lynch to comment with regard to the banks’ case against Global Crossing:

“I am prepared to look at this case as, with all respect to the people involved, a bunch of crooks getting sued by a bunch of bankers who are too dumb to stop throwing money down the toilet.”

Indeed, Global Crossings’ growth was even more meteoric than Enron’s:

In a three-year whirlwind, Mr. Winnick tapped the stock and bond markets for $20 billion, all on the prospect that Global would keep growing and securing new customers. Global went public in August 1998, its shares leaping from $9.50 to $13.40 the first day of trading. Less than two years later, with the stock at a peak of about $64, the market valued Global at $47 billion – more than PepsiCo, more than CBS, more than McDonald’s.
None of Global’s financials justified this. It lost $20 million on sales of just $424 million in 1998, and it would never earn a penny in profits after that. In fact, losses would balloon. In 2000 alone, Global lost $1.4 billion, a staggering amount for any start-up, no matter how bright its future.
Nonetheless, Mr. Winnick’s $20 million initial stake in Global was, at its height, worth more than $6 billion. He had become a billionaire faster than anyone in American history – faster than Bill Gates, faster than John D. Rockefeller – and his picture landed on the cover of Forbes magazine, with a headline that read “Getting Rich at the Speed of Light.”

And, of course, as with Enron, Global Crossing had its helpers among market promoters, including the ubiquitous politicians:

Mr. Winnick’s team also gave large donations to Republicans and Democrats, hired well-connected lobbyists in Washington and secured Wall Street’s loyalty, including that of Jack Grubman, a Salomon Smith Barney analyst who played carnival barker for the telecom joyride of the 1990’s. Mr. Grubman, whose firm reaped hefty fees for underwriting Global’s stock and for advising it on acquisitions, lavishly praised Global in his investor reports.

However, Global Crossing’s world came crashing down in 2001 as the telecommunications industry went through a severe shakeout. Although garnering only a fraction of the public attention of Enron’s meltdown, Mr. Winnick’s analysis of what caused Global Crossing’s demise sound the same as that of Enron’s Jeffrey Skilling or Kenneth Lay regarding Enron’s collapse:

In his Congressional testimony in 2002, Mr. Winnick offered his thoughts on his company’s fate. “Global Crossing’s bankruptcy, based on the facts known to me, is not a result of fraud but of a catastrophe that befell an entire industry sector,” he said. “I don’t offer this as an excuse because it’s certainly not an acceptable excuse. It’s an explanation.”

But, as with Enron, there are many who do not agree that Mr. Winnick and Global Crossing were just the victims of bad luck:

Susan Kalla, a telecom analyst at Friedman Billings Ramsey, said Mr. Winnick inflated the scope of every deal he struck and overstated what he was able to charge for access to Global’s network. “I believe this guy has set American business culture back greatly,” she said. “He wasted billions and billions of dollars that could have been spent on far more useful purposes. He’s set innovation in the industry back by a decade because he, and others like him, beat investors down so badly. “This was just about speculation,” she said.

Although Mr. Lay has been indicted for selling his Enron stock on margin calls while Enron spun downward in late 2001, Mr. Winnick skated free while selling his Global Crossing stock under the same circumstances:

According to the J. P. Morgan suit, [Mr. Winnick] sold $860 million worth of stock from 1999 to 2001, and the lawsuit contends that most was sold at a time when serious problems at the company were not being publicly disclosed. (Mr. Winnick’s representatives contest that figure, saying he sold $735 million worth of stock.)
[Mr. Winnick’s] lawyer, Mr. Christensen, said that all Mr. Winnick’s stock sales were preplanned or tied to the normal course of business – including a sale of $123 million of shares in May 2001 that has drawn S.E.C. scrutiny.
In the months before that sale, Global’s managers were on tenterhooks about the company’s precarious finances, according to documents introduced in various lawsuits. One internal Global e-mail message from a customer service representative to a company vice president in March 2000 said the company was “losing customers left and right” because of “network problems” and “poor service.” Three months later, Leo Hindery, the company’s chief executive at the time, sent a memo to Mr. Winnick saying that Global’s business “niche” was “going to die.”
The J. P. Morgan lawsuit raises questions about what Mr. Winnick knew about Global’s finances. It says that Mr. Winnick and other Global Crossing executives “personally oversaw and reviewed Global Crossing’s financial results” and “were aware of Global Crossing’s precarious financial position.”
At meetings in April 2001, senior Global executives discussed that revenues were going to fall $1 billion short of earnings estimates that had already been shared with the public, according to memos uncovered by Congressional investigators. Mr. Winnick did not attend those meetings, but he sold his shares a month later – with, he told Congress, the approval of Global’s chief executive.
In early June 2001, about two weeks after Mr. Winnick sold those shares, Global’s lawyers closed the window on all insider stock sales, citing the company’s deteriorating finances. Although Mr. Winnick orchestrated most of Global’s biggest deals, raised all of the company’s initial financing, answered analysts’ questions at road shows, kept in daily contact with a string of executives and even supervised landscaping at Global’s headquarters in Beverly Hills, he told Congressional investigators that it was not until that point that he learned Global would not hit its numbers. (His lawyer says others at the company did the numbers-crunching.)

And, as with Mr. Lay and Enron, Mr. Winnick was not the only Global Crossing executive to profit from stock sales while the company was spiraling downward:

Other Global executives also profited handsomely from a wave of stock sales. As a whole, the company’s culture was, one former senior Global executive said, “just a hot-deal shop.”
“There was this dichotomy between this small cabal in Beverly Hills and thousands of people in the rest of the country,” said the former executive, who requested anonymity. “It was put together by a bunch of flippers who saw an amazing gravy train and nothing else.”

So, why are dozens of former Enron executives currently subject to criminal proceedings while no former Global Crossing executives are experiencing similar troubles? Frankly, there is no good explanation. The answer lies primarily in politics — a Republican administration could not afford politically to look as if it was going easy on Enron, which was a highly visible financial supporter of the President Bush’s campaign. Although Global Crossing and Mr. Winnick also contributed to both political parties, Mr. Winnick’s primary support was to former President Clinton, who was gone by the time that Global Crossing was going into the tank.
The discrepany in treatment between the Justice Department’s handling of Enron and Global Crossing highlights the high risk of arbitrary and capricious results that occur when government seeks to criminalize business behavior. As Professor Ribstein has pointed out on several occasions, criminalization of ordinary business behavior risks diluting the moral force of the law, not to speak of discouraging beneficial risk-taking that generates economic development and job creation.
And the counterproductive political activity does not end with criminalization. Sarbones-Oxley Act (“SOX”) was a political regulatory reaction to Enron and other business scandals of the early part of this decade, and Professor Ribstein’s post today points to yet another article that hints of the negative effects of such increased regulation:

In a nutshell, after SOX executive pay becomes less risky and therefore provides lower-powered incentives, and firms are managed more conservatively. The authors concede that they establish only a temporal and not a causal relationship, but the inference is there.
Hopefully politicians and voters will remember that, just as a speculative market bubble can have a regulatory hangover, so a “regulatory bubble” like SOX can put a long-term damper on the market. But I doubt it.

Given the current popularity of criminalizing ordinary business behavior among politicians, I share the Professor’s pessimism.

About a dozen former El Paso Corp. traders and their supervisors have been notified they are targets of a grand jury investigation into natural gas price manipulation. The former employees received target letters from the United States Attorney’s office in Houston office advising them that they may face charges of commodity price manipulation, conspiracy and wire fraud.
The charges referred to in the target letters are virtually the same as those previously filed against Todd Geiger, a former El Paso trader who was accused of providing false information to Inside FERC’s Gas Market Report. In December, 2003, Mr. Geiger pleaded guilty to one count or wire fraud and of reporting inaccurate information under the Commodity Exchange Act.
The government’s investigation relates to natural gas price indexes, which various publications produced through surveys of energy traders and others. The indexes offer pricing snapshots for hubs across the country that buyers and sellers of natural gas use to help set prices in contracts. The Commodity Futures Trading Commission has filed civil charges against several companies over the past couple of years in which the CFTC claims that traders knowingly provided false data to publications with the intention of influencing natural gas prices. The CFTC has collected about $250 million in penalties from companies, including $30 million from the Royal Dutch/Shell trading subsidiary, Coral Energy Resources, and $20 million previously from El Paso.

Following on previous posts here and here regarding the rather wild business of exploring for oil and gas in the African nation of Equatorial Guinea, Devon Energy Corp. announced that it had received a letter Friday from the Securities and Exchange Commission asking for cooperation in an inquiry into whether U.S. oil companies violated federal law by bribing officials in Equatorial Guinea.
Other U.S. companies that have been contacted include Exxon Mobil Corp., Marathon Oil Corp., ChevronTexaco Corp. and Amerada Hess Corp. The inquiry follows a U.S. Senate subcommittee report last month into Washington-based bank Riggs National Corp.
The Senate report concluded that several companies had made millions of dollars in dubious payments to top officials in the West African nation through the bank. Devon and the other companies have also denied violating the law and said they would cooperate with the commission inquiry.
According to the Senate report, Devon made payments totaling $350,000 to Equatorial Guinea officials, reportedly to meet “educational training obligations” required under production sharing contracts. Devon also announced that it had begun an internal investigation into the matter.

Gil Weinrich has a piece at TCS Central that proposes a different approach to punishment of corporate wrongdoers:

Our society does a poor job of penalizing [corporate] crime. . . In the white-collar arena, the unrequited losses endured by victims of financial crime similarly underscore the fecklessness of the system.
Besides the injustice to victims there is an inherent lack of mercy to criminals who are not given an opportunity to make amends. For the sake of the victims of Enron and other white-collar crimes, we need to shift away from a system based on punishment to one based on restitution.

So, what does Weinrich propose?: A financial debtor’s prison:

When Andrew Fastow pleaded guilty early this year, he agreed to surrender $23.8 million in cash and property, including vacation homes in Vermont and Galveston, Texas. That’s a start. He and those who shared in his crime should be apportioned the part of the losses for which a court deems them responsible, including an extra 10 percent to compensate for the unearned return on the victims’ money, and an additional fine to compensate the government if the perpetrator did not cooperate in the investigation of the crime.
The perpetrators should then spend as long as it takes, up to the rest of their lives if necessary, to repay that debt. Andrew Fastow may be a criminal but he is also a financially savvy corporate executive. Surely his vast talents can be put to some good use for some company somewhere. A court could give him an allowance (based on a percentage of his income so that he would always have an incentive to increase his earnings), with the lion’s share (say, 90 percent) devoted to a restitution fund.

Weinrich then proposes a rather elaborate system of ceremonies involving victims and the perpetrators in which they would either discuss the crimes or welcome the perpetrator back from the financial debtor’s prison once the debt is paid off.
I’m an advocate against the criminalization of business in America that has culminated in absurdly long prison sentences such as the one involved in the sad case of Jamie Olis. However, Weinrich’s proposal strikes me as silly. The civil justice system already provides a financial disincentive for corporate wrongdoing. Moreover, the fact that politicians have arranged for absurdly long prison sentences in business cases to appeal to the public passion to punish wealthy people excessively does not mean that there should be no penal system disincentive whatsoever for engaging in corporate crime. One imagines Bialystock & Bloom in “The Producers” blithely continuing to create Ponzi schemes in perpetuity under Weinrich’s proposed system (and so long as Zero Mostel could continue to play Bialystock, that might not be such a bad thing).
Professor Bainbridge agrees with me.

You know that a local scandal has hit the big-time when the New York Times finally notices it.
This NY Times article reports on the embarrassing scandal involving Houston’s Crime Laboratory, which was already relling from the requirement that it retest evidence that it provided in 360 cases, now faces a much larger crisis that could involve many thousands of cases over 25 years. In a report to be filed in a Houston state court on Thursday, six independent forensic scientists said that a crime laboratory officials — because they either lacked basic knowledge of blood typing or gave false testimony — may have offered “false and scientifically unsound” reports and testimony in thousands of criminal cases. The panel called for a comprehensive audit spanning decades to re-examine the results of a broad array of rudimentary tests on blood, semen and other bodily fluids.
Elizabeth A. Johnson, a former director of the DNA laboratory at the Harris County medical examiner’s office in Houston, estimated for the Times article that a conservative number of re-examinations required by the report would probably be 5,000 to 10,000 cases, but if cases involving examination of hair are added, the number of required re-examinations would be “off the board.”
A state audit of the crime laboratory dated December 2002 found that DNA technicians there misinterpreted data, were poorly trained, and kept shoddy records. In many cases, the technicians used up all available evidence, making it impossible for defense experts to refute or verify their results. Even the laboratory’s building was a mess, with a leaky roof contaminating evidence. The DNA unit was shut down soon afterward, and it remains closed.
What a mess. Stay tuned for more.

PricewaterhouseCoopers publishes an annual survey of securities litigation, and it has just released its 2003 Securities Litigation Study. As usual, the review contains a number of interesting findings, including the following:

107 of the 175 securities class action filed in 2003 were accounting-related. In more than half of those cases, the primary allegation related to revenue recognition issues;
The percentage of cases with pension funds as lead plaintiffs has grown steadily from less than 3% in 1996 to over 28% of the cases in 2003;
Average settlements for all cases was up 20% from 2002, and there were more large settlements, including six greater than than $100 million;
After 2002 saw over 40 “triple jeopardy” cases in which companies were subject to securities class actions along with parallel SEC and Justice Department investigations, the number of those cases dropped to eight in 2003, which is above average.

Hat tip to Lyle Roberts over at the 10B-5 Daily for the link to the PwC report.

Robert Shapiro, the L.A.-based criminal defense attorney who put together O.J. Simpson‘s criminal defense team, writes this Wall Street Journal ($) op-ed today in which he takes issue with a number of tactics that Martha Stewart and her defense team took in defending Martha. Mr. Shapiro is particularly critical of Martha’s belief that she could personally persuade prosecutors that she had not lied about the stock sale and, in so doing, makes this salient point about litigating with the government:

While everyone entertains the fantasy of being publicly and dramatically vindicated by a “not guilty” verdict, the fact is that as a defendant the odds are stacked against you at trial. In white-collar cases, particularly federal ones, prosecutors tend to be very experienced, highly skilled, and extremely able. What’s more, they are backed up by almost unlimited investigative resources, as well as by laws that give them ready access to financial records. In short, the playing field is hardly level.