U.S. District Judge Lewis Kaplan’s decision earlier this week was a major victory for the defendants in the KPMG tax shelter case because it at least gives the defendants the basis for obtaining the financial means for defending the case effectively. However, as this Lynnlee Browning/NY Times article points out, the deck is still stacked firmly in favor of the prosecution in such multiple-defendant, business fraud criminal cases. The conflicting interests of the multiple defendants are now rising to the surface of the case, as is the prosecution’s ability to cherry-pick certain defendants for attractive plea deals:

In pretrial hearings since their clients’ indictments last August and last October, defense lawyers have presented a unified front, filing joint motions and refraining from public squabbling. Lawyers for all of the defendants, countering prosecutors’ assertions of criminal intent, are expected to argue that their clients thought at the time that what they did was aggressive but legal.
But increasingly, defense lawyers speak of different camps forming over recent weeks, with lawyers for the junior defendants indicating that they will focus on proving that their clients took orders from the senior defendants, who were responsible for designing and approving the tax shelters.
“You’re beginning to already see the finger-pointing,” said a lawyer for one of the KPMG defendants, declining to be named or to name his client, saying he did not want to jeopardize the case. “It’s going to get antagonistic.”

Continue reading →

As noted earlier here, U.S. District Judge Lewis Kaplan earlier this week slapped the Department of Justice upside the head for threatening KPMG with indictment in the KPMG tax shelter case unless the firm threw its partners to the wolves by rescinding the firm’s policy of paying its partners’ defense costs in such cases. Although Judge Kaplan concluded that it was premature to dismiss the indictment against the KPMG partners as the remedy for the DOJ’s misconduct and fashioned a financial remedy for the partners instead, Larry Ribstein believes that Judge Kaplan’s opinion is a landmark decision that calls into question the DOJ’s dubious policy of criminalizing corporate agency costs in reaction to Enron and other recent corporate scandals:

My basic problem with criminalization of agency costs is precisely that it ignores internal corporate arrangements. The complex set of contracts and incentive devices that comprise a corporation simply doesn’t fit with the sort of moral condemnation that criminal penalties necessarily involve. The nuances of an agency contract are the proverbial square peg in the round hole of criminal law.
But Judge Kaplan emphasizes that indemnification serves an important function in an agency contract: If directors and other agents are over-exposed to liability, they simply wonít work for the firm. One might add that even if they do work for the firm, they wonít take the risks that are necessary to maximize shareholder value and to make capitalism work. Corporate criminal liability essentially seeks to reengineer the firm to change incentives so that agents are no longer maximizing profits, but attempting to root out fraud at all costs.
The fundamental importance of this case is that Judge Kaplan is telling the government that the contract matters, even if it gets in the way of prosecution. By doing this, Judge Kaplan is re-reengineering the firm to make it, once again, a profit-maximizing entity rather than a government agent. [. . .]
Of course this one case isnít going to solve all of the problems of corporate criminal liability. Corporate defendants will face the basic problem that it is hugely burdensome to defend these cases, which gives the government considerable leverage. The case’s precise implications for other uses of government leverage are unclear. But by saying that there is a limit to what the government may do in criminalizing agency costs, the judge has taken an important first step. I predict the opinion will be a landmark.

Read the entire post.

Richard Booth is the Marbury Research Professor of Law at the University of Maryland School of Law. In this fine Washington Post op-ed (hat tip Ted Frank), Professor Booth explains that the US securities fraud litigation framework is fundamentally flawed in that investors collectively end up worse off as a result of securities litigation and that a coherent system would protect reasonable investors (that is, ones who diversify their portfolios) rather than unreasonable ones (betting the farm on one company):

For diversified investors who do happen to trade during the fraud period, there are no benefits from class action suits over the long haul. A diversified investor is equally likely to be on the winning side of a given trade as on the losing side. Indeed, diversified investors are net losers from class action because of the costs of litigation. So it is no wonder that an investor would need a little inducement to sue.
Undiversified investors may suffer significantly more harm from securities fraud, possibly losing thier entire investment. But it does not follow that an undiversified investor should have a remedy if they voluntarily assume the unnecessary risk that goes with failure to diversify. Through diversification, an investor can eliminate the risk that goes with investing in a single stock without any sacrifice of expected return. The only risk that remains is market risk.
Moreover, . . . it is so cheap and easy for investors to diversify that it is simply unnecessary for investors to take company-specific risk. Given that the fundamental goal of investing is to generate the greatest possible return at the lowest possible risk, it is irrational for an investor, not to diversify.
The Supreme Court has clearly stated that securities law should be interpreted consistent with the needs of reasonable investors. Plaintiff class members should thus be presumed to be diversified and such actions should be dismissed for lack of harm . . .

Meanwhile, in the face of such lucid analysis, chief NY Times securities regulation advocate Gretchen Morgenson contributes to this article that breathlessly reports that the SEC may be firing employees who take up the good fight of attempting to protect unsuspecting investors from those shady hedge funds. The notion that anyone who invests in a hedge fund in the first place should not be unsuspecting (and, thus, not in need of government protection) is noticeably absent from Ms. Morgenson’s analysis.