Posts Tagged ‘white collar crime’

Who Are the Real Victims of Insider Trading?

Thursday, August 18th, 2011

 

Last week, the prosecution and the defense filed their sentencing memoranda in the Rajaratnam case.  Raj was convicted of 14 counts in all — 9 counts of securities fraud, and 5 conspiracy counts.  So what do the parties think that’s worth?  The feds asked Judge Holwell to sentence Raj in the range of 19.5 to 24.5 years.  The defense didn’t make a specific request, just said it ought to be “well below” what the feds want.

So 20 years, huh?  Wow, he must have been an awful bad guy.  Must have hurt a whole lot of people, right?

After all, a mugger in a dark alley only takes one person’s wallet.  A “white-collar criminal” can steal from thousands of people — and takes not just their wallet, but their life savings!  Right?

Well, hang on.  Did Raj actually steal from anyone?  How many investors did he really harm?  And did any of them really lose enough money to warrant locking someone up till we all have flying cars and jetpacks?

Judging from the feds’ sentencing memo, you bet.  Just look at this, from the introduction:

Raj Rajaratnam’s criminal conduct was brazen, arrogant, harmful, and pervasive.  He corrupted old friends.  He corrupted subordinates.  He corrupted entire markets.  Day after day, month after month, year after year, Rajaratnam operated as a billion-dollar force of deception and corruption on Wall Street.

Wow, that sounds awful.  So the victims are… who again?

But wait, there’s more:

Rajaratnam repeatedly leveraged the power of money and his position as the head of a 7-billion dollar hedge fund to induce friends, employees, and associates to participate in his criminal activities.  Although already rich, Rajaratnam did this to drive up his personal wealth through profitable trading in his hedge fund.  He did it to make sure that investors did not pull their money out of Galleon and to attract new money to his fund.  And he did it because of his egomaniacal drive to triumph over his competitors on Wall Street.

Again, wow.  (The feds sure like their adjectives, don’t they?  Comes off a tad over-the-top, if not insulting to the intelligence.)  So he was trying to increase his wealth, gotcha.  But at whose expense?  Guess we have to read more:

That was what he cared about: money and success.  What he did not care about, at all, was the extensive harm he left in his wake: harm to the capital markets; harm to the average, ordinary investors who played by the rules; harm to the companies whose secret information was misappropriated; and harm to the lives of those he corrupted.

Well, that sounds a little more like it… but again, who was harmed, and how?

Although particular investors on the other side of Rajaratnam’s illegal trades are not easily identifiable, there should be no question that ordinary investors paid the price for Rajaratnam’s crimes and that public companies were harmed by Rajaratnam’s repeated theft of corporate secrets.

Oh for crying out loud.  Are they joking?  Stripped of its demagogical rhetoric, this translates to “We have not identified any actual victims.  But we shouldn’t have to.  It’s obvious that lots of people must have been harmed, even if we don’t know who they were.”

If they don’t know who — or even whether — anyone was actually harmed here, how in blazes do the feds justify asking for 19.5 to 24.5 years of imprisonment?  Here’s how:

[The feds want that much time because they feel it is] proportionate to the historic nature of his crimes.  He is arguably the most egregious violator of the laws against insider trading ever to be caught.  He is the modern face of illegal insider trading.

That’s it.  That’s all.  “Because this is the first time we’ve ever caught someone so red-handed,” and “because this case got so much press.”  Those are the sole reasons why they are looking to put this guy away until he dies of old age.

Really?

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For the record, we’re predicting (more…)

Profiling Doesn’t Work? More Profiling!

Saturday, April 23rd, 2011

When we were just starting out in the law, we frankly had no problem with the concept of profiling.  Not racial profiling — that’s just a logical absurdity along the lines of “most people who commit crime X are of race Y, therefore it’s reasonable to suspect people of race Y of committing crime X.”  We’re talking about profiling as the concept that a significant number of people who commit crime X exhibit the combination of traits A, B and C, which is a combination rarely encountered otherwise, and therefore if one were to look for people exhibiting traits A, B and C, then one might have a better chance of catching someone guilty of crime X.

Intuitively, this sounds reasonable.  If we were to know, for example, that certain serial arsonists are motivated by a sexual mania, that these arsonists tend to remain near the scene to masturbate or so they can masturbate to the memory later, that they tend to have spotty work and relationship histories, and that they tend to have crappy cars — well then, there’s nothing wrong in letting the cops scan the crowd of spectators at a fire, question any who seem to be getting a kick out of it, and investigate those who are single, unemployed, and drive a beater.  (This is an actual profile, by the way.  We didn’t make this up.)

And emotionally, profiling sounds wonderful.  Catching a psychopath is often difficult, because they don’t play by the same rules as the rest of us.  Wouldn’t it be nice if there were some, er, rules that we could follow — a formula of some kind — that would make it easier to identify and catch them?

As we said, in our early years we thought this was a great concept.  Whenever we encountered some findings that certain traits had been identified with this type of serial killer, or that type of terrorist, we thought it was fantastic.  But we didn’t think too critically about it.  And for sure we never bothered to look for the underlying data, much less examine the methodology used to determine how strongly these traits correlated with perpetrators of that crime.

The problem is, nobody else was doing that, either.

Profiling only works if the profile is accurate.  That should go without saying.  But it has become plain over the years that the various profiles out there are not accurate.  They are not based on actual data, but instead only on anecdotes.  (And as we like to say, the plural of “anecdote” is not “data.”)  Nor are these profiles based on any significant sample size.  No profiling study ever did even a simple regression analysis to determine whether any particular trait happens to be a meaningful variable.

We figured this out soon enough, of course.  After our first couple of years with the DA’s office, we were already joking about the silliness of profiles.  It was almost a party game to figure out which psychopathic profile we and our friends happened to fit (secure in the knowledge that hardly any of us were really psychopaths).

And the rest of the world soon caught on.  The Onion did a piece entitled “Crime Reporter Finds Way of Linking Warehouse Fire to Depraved Sex Act.”  Malcolm Gladwell wrote an outstanding piece in 2007 called “Dangerous Minds: Criminal Profiling Made Easy,” in which he solidly debunked the whole profiling scam, showing how there’s no science or statistics behind it, and even the data it’s based on is mostly useless.

It’s now fairly common knowledge that criminal profiling is about as useful as a Tarot deck.  So of course the FBI has stopped using it, right?

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Wrong.

As a matter of fact, they’re expanding!  Just as the feds have (disastrously) tried to use street-crime investigative techniques like wiretaps to go after white-collar offenders, they are now (equally idiotically) starting to use criminal profiling to go after people for white-collar offenses.

Matthew Goldstein wrote an excellent piece on this for Reuters this week, called “From Hannibal Lecter to Bernie Madoff: FBI profilers famous for tracking serial killers are turning their attention to white collar felons.”  This (and the Gladwell piece linked to above) should be required reading for any white-collar defense lawyer now practicing.  When the Galleon case first came down, we were one of a handful of people doing white-collar defense who also had plenty of wiretap experience; now, of course, more of us are learning it the hard way.  Hopefully, with this new profiling issue, more of us will be prepared to deal with it ahead of time.  (And perhaps even nip it in the bud.  Like Barney Fife, we’re a big fan of bud-nipping.)

The agents in the FBI’s Behavioral Analysis Unit are the ones who profile serial killers and the like.  “The hope is,” reports Goldstein, that they “can get into the minds of fraudsters and see what makes them tick.”

“This originally started out as an attempt to find a way to prevent and detect Ponzi schemes,” said Peter Grupe, the FBI’s assistant special agent in New York in charge of white collar investigations.  “But it developed into (more…)

Insider Trading, Expert Networks, and a Big Honking Due Process Violation

Wednesday, March 2nd, 2011

 

 

First, a shameless plug: Tomorrow, we’ll be participating in a Dow Jones webinar for Private Equity and VC types, discussing how the current environment of insider-trading prosecutions affects them, and what they might do about it.  (Link here, if you’re interested.)  Of course, those guys aren’t so much the focus these days as, say, hedge funds and the expert networks that help them make investment decisions.  “In the spotlight” doesn’t begin to describe it.  Not a week goes by without some major news about insider trading allegations in the hedge fund world.

With all that reporting, and all the various cases that are going on, one might think the issues are pretty well understood by now.  But they’re not.  Not even by the very people who are doing the prosecuting and investigating, it seems.  It so unclear that a month ago the Managed Funds Association formally asked the SEC for guidance on what is and is not kosher when dealing with expert networks.  “Our industry would like to know where the sidelines are right now so that we can stay well within them,” MFA president Richard Baker said at the time.  “The trouble is the referees aren’t quite clear where those lines are.”

Amen.  Nobody knows where the line is between lawful and unlawful conduct.  The feds themselves admit it.  And yet they are prepared to prosecute people for crimes, when the public has no way of knowing that such conduct was criminal.  Even an investigation is enough to destroy a reputation, wipe out a career, erase a business.  A conviction will take away a real person’s liberty and rights.  Americans don’t allow their government to do that in a gray area.  But it is happening.  How that is not a serious violation of basic due process is beyond us.

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Expert networks are a fairly new thing.  It used to be that research was conducted by analysts who were more akin to investigative journalists than anything else.  They poked around, talked to people, and tried to piece together useful information about a company’s value or where an industry was headed.  The goal was to gain an insight that had value — something that wasn’t obvious to everyone else analyzing the public information.  Then along came Regulation FD, and all that changed.

Reg FD came about in 2000 as an attempt to (more…)

The Feds’ Insider-Trading Gamble

Tuesday, November 23rd, 2010

 

The feds are really ramping up their insider-trading enforcement.  But instead of going after real insiders, they’re going after consultants and investors who use them.  This is a big risk for the feds, and they could lose big.

It started a year ago, when the feds indicted a bunch of people in what we collectively refer to as the “Galleon” case.  For the first time ever, the feds had used wiretaps in a white-collar investigation.  It looked like the gloves were coming off, and the feds were going to start getting down and dirty, using street-crime law enforcement techniques to go after Wall Streeters.

Then in May, Lanny Breuer announced a “new era of heightened white-collar crime enforcement — an era marked by increased resources, increased information-sharing, increased cooperation and coordination, and tough penalties for corporations and individuals alike.”  In the wake of an economic bubble bursting, they were gunning for the suits who had profited.  And unlike the last time they tried, in the wake of the dot-com bubble, now there was no 9-11 to divert their resources.

To some extent, such a strategy is like shooting fish in a barrel.  Real frauds like Ponzi schemes and the like, which can hide amidst a rising market, come to light pretty easily when the market collapses.  And we saw a lot of those prosecutions in the past couple of years.

But to a larger extent, it’s a political strategy.  Going after those who make money by moving it around, instead of creating something of value, is always going to be a populist move.  It wins brownie points for the DOJ and the president.

And now comes the takedown.

On Saturday, the Wall Street Journal reported that the feds had been conducting a 3-year investigation into possible insider trading.  They had been approaching people out of the blue, telling them they were in trouble, and suggesting that they wear a wire (with at least a couple people refusing to do so, and then emailing all their clients to tell them what had just happened).  The feds had been subpoenaing records for a while.  The targets seemed to be Goldman Sachs and consultants who matched knowledgeable industry leaders with hedge fund managers looking for an edge.

That seems to have forced the feds’ hand, and on Monday they started executing search warrants at Diamondback Capital Management and Level Global Investors, which had been identified in the Saturday story.  Then they raided Loch Capital Management later in the day.  We hear that more raids are coming, and as we speak a lot of investment firms are doing some heavy internal reviews, to figure out if they might be on the list.

Because nobody knows what kind of behavior the feds are going after.  And if past performance is any indicator of present results, the feds may just well be going after perfectly innocent behavior.

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The reason is that the feds don’t seem to understand the (more…)

How the Feds Enforce the FCPA

Monday, October 25th, 2010

 

The other day, we drew a contrast between the Manhattan DA’s new public integrity unit and the way the feds go after FCPA violations, and some folks asked just what exactly the feds do in these cases.  That’s a good question.  Especially now, as the FCPA has become a major star of the feds’ redoubled efforts to fight white-collar crime.

The Foreign Corrupt Practices Act, among other things, says it’s against the law for any U.S. citizen or business to pay a bribe to a foreign official.  The penalties can be staggering, with fines calculated as the amount of income the briber hoped to receive down the road as a result of paying the bribe.  “Any” U.S. citizen means just that: anybody, not just a corporate executive.  A “foreign official” means anyone with a government job — including people working in industries that are government-owned or government-controlled.

“Bribery” includes giving anything of value in the hopes of getting something in return.  It’s really a broad standard.  A bribe doesn’t have to be an explicit tit-for-tat, and it doesn’t have to be just for the purpose of landing a choice contract.  A bribe can be just a nice dinner at a fancy restaurant that might make get you looked on with more favor next time contracts are being awarded.  A bribe can be a “facilitation payment” to a petty bureaucrat, some grease to ensure that you are allowed to do what you are already entitled to do (this, by the way, is an example of where Wikipedia, at least as of today, get things wrong).  See here for a more thorough discussion.

As with many white-collar offenses, this one is enforced by both the SEC and the DOJ.  As of this year, the SEC now has a special unit dedicated to investigating and punishing suspected offenders.  As we mentioned the other day, the point is to keep as much expertise in the institutional memory, and also to better coordinate investigation and enforcement.  On the criminal side, the DOJ’s Frauds Section is the main enforcer as a matter of law, though some local U.S. Attorney’s offices like the SDNY will handle most of the work in-house.

Over the past few years, the number of FCPA cases has risen dramatically, in part because the (more…)

New Trend: Lawyers as White-Collar Defendants

Thursday, May 27th, 2010

businessman arrested

What’s with all the lawyers getting arrested these days, being charged with financial frauds, Ponzi schemes and the like?  Is this a new trend?  It sure seems like one.

The latest news is the announcement about an hour ago that the SDNY is charging one Kenneth Starr (no, not that one, this one), money manager for a bunch of celebrities, with yet another Ponzi scheme, funnelling $30 million of investors’ money into his own pockets.  He’s a lawyer in New York.  (You can read the complaint here.)

Then there’s the former law firm partner Michael Margulies, charged the other day with embezzling $2 million from his firm and clients in Minneapolis over the past 16 years.  Coincidentally-named lawyer James Margulies of Cleveland was charged the other day in a $60 million stock swindle.  A couple of weeks ago, two lawyers were charged with a mortgage-rescue fraud involving stripping $3 million in equity.   A lawyer went to prison a little before that for rigging tax-lien auctions.

That’s just a handful of headlines from this month alone.  But it’s been going on for several months now.  We’ve been noticing lawyers getting charged with increasing frequency ever since last July when Marc Dreier got sentenced to 20 years for hedge fund swindles totaling God knows how many hundreds of millions of dollars.  It really kicked into high gear, however, in December, after Scott Rothstein was arrested for a $1.2 billion Ponzi scheme.  And now there are several cases being announced every month.

What’s going on here?

Sure, these kinds of schemes tend to get noticed all at once, when the economy goes south, and the market’s gains no longer mask the fraud.  So we’re not wondering why all of a sudden there’s a bunch of financial-fraud arrests.  Our question is how come so many of these cases involve lawyers.

Has the profession changed?  Is it something new about how lawyers are getting more involved as investment managers and financial advisors?  Or is there a new focus by law enforcement?  We really don’t know.

But it sure looks like something’s going on out there.  What do you think?

Be Very Afraid: “New Era” of White-Collar Prosecution at the DOJ

Wednesday, May 26th, 2010

corporate crime

Lanny Breuer, the DOJ’s Assistant Attorney General for the Criminal Division, gave a speech today announcing a “new era of heightened white-collar crime enforcement — an era marked by increased resources, increased information-sharing, increased cooperation and coordination, and tough penalties for corporations and individuals alike.”

You can read his prepared remarks here.  We did, and we find them very troubling.

This is, of course, part of a larger trend back towards more white-collar enforcement. For much of the post-WWII era, through the early 1990s, white-collar cases didn’t get much attention. They were hard to spot in the first place, taking place behind closed doors in boardrooms and offices, not really part of any policeman’s beat. And allegations were challenging to investigate, and ever harder to prove to a jury. Agents and prosecutors lacked the knowhow and the tools to do the job.

And white-collar crime just wasn’t worth the effort — the law classified these crimes at the less-serious end of the spectrum. This wasn’t murder, it was just money. The crooks weren’t burglars or muggers, they were college-educated productive members of the community, involved in charities and otherwise living “normal” lives. Their crimes weren’t violent; they were almost administrative. Victims weren’t in your face, with visceral injuries and tangible losses; they were anonymous and diffuse. Devoting a lot of resources to prove minor offenses you didn’t really understand, with hard-to-identify-with victims, with easy-to-identify-with defendants, just wasn’t a big priority.

This all started to change in the mid-90s. By then, we’d gone through the junk-bond crisis and S&L meltdown of the (more…)

A Complete List of Goldman Sachs Crimes

Saturday, May 1st, 2010

Update: New York Investigating CDS Brokers

The SEC and DOJ’s investigations of Goldman Sachs have been big news for a couple of weeks now. We tend not to post right away on stories like that, because we don’t want to be yet another one of those blogs that just tries to jump on the bandwagon, simply repeating news without adding anything of value to the conversation. So we like to wait until we have some analysis to add.

In the Goldman Sachs case, as pretty much everyone reading this is aware by now, the SEC says Goldman created a mortgage-based investment, sold it to investors, and then bet against it by shorting it themselves. They also say Goldman messed up by letting hedge fund manager John Paulson pick some of the assets, despite the fact that his fund was betting heavily against the housing bubble (and ultimately made a killing when it burst). The SEC filed its suit about 2 weeks ago. Then during this past week, they referred it to the DOJ for criminal investigation. The fine folks at the Southern District are now looking into whether any criminal acts took place.

We’re sure the SDNY is going to be a lot more careful than, say, the Eastern District was with the Bear Stearns case. [Full Disclosure: We represented one of the BSAM fund managers in that case, who was ultimately not indicted.] You know, maybe actually reading emails in context, actually figuring out how hedging is supposed to work, stuff like that?

Nevertheless, it’s a tough job. So as a good citizen, unaffiliated with the case in any way, we’d like to make their job easier. We’ve pored over the factual allegations that have been made, and delved into the facts that have been publicly disclosed so far. And after a great deal of legal analysis and number-crunching (yes, we do this for fun), here is a complete list of all criminal activity that we have been able to identify at Goldman Sachs here:

1).

You’re welcome, guys. Hope this helps!

Stop the Music – 3rd Circuit Slams DOJ’s “Musical Chairs” in Securities Fraud Prosecution

Wednesday, April 7th, 2010

musical chairs

SEC Rule 10b-5 is one of the main securities fraud laws. It says you can’t mislead people in connection with the purchase or sale of a security. You can’t make an untrue statement of a material fact. And you can’t fail to state a fact, when without that fact the statements you just made would be misleading.

That seems simple enough. But federal prosecutors in New Jersey seem to be having a hard time figuring out what that means.

In June 2005, the feds in New Jersey indicted Frederick Schiff, the CFO of Bristol-Myers Squibb, for failing to disclose material facts to investors. Allegedly, Bristol-Myers (a drug company) was paying wholesalers to order more drugs than they really needed, so Bristol-Myers could report higher sales numbers and inflate its stock value. Schiff allegedly didn’t tell investors about it during conference calls and in SEC filings. (See the indictment here and the DOJ’s press release here.) That indictment got thrown out for a grand jury leak, so they got a second one in May 2006, and finally a third one in April 2007 that dropped allegations of accounting violations.

With respect to the omissions, the government kept changing its tune. First, they said the company had a duty to correct misleading statements of others, based on a “general fiduciary duty.” The district court helpfully pointed out that there is no such duty in the law. So then the feds said there was a statutory duty under SEC regs S-K, which might actually have worked, but then they changed their mind and put on the record that they weren’t pursuing that theory. There was a “theory of duty based on falsity of reported sales and earnings,” which the District Court said wouldn’t fly. Then they tried to say the stuff left out of filings is a material omission that is misleading if you include the earlier analyst calls in the context (calling it “all of a piece”). The district court ruled that, no, there is no affirmative duty under either the “falsity” or the “all of a piece” theory. “It defies logic,” the court ruled, “to charge as a crime that an utterance in an analyst call must have other words written in a later SEC filing in order to make the utterance in the prior phone call ‘not misleading.’” Thanks for playing. The feds appealed.

In a unanimous decision today (opinion here), the Third Circuit slammed the DOJ for constantly changing its theory of the case, for playing “musical chairs” with its theory of how Schiff’s conduct counted as an unlawful omission under Rule 10b-5.

More importantly, the Circuit said the DOJ’s ultimate theory of liability here — that Schiff had a “general fiduciary” duty as a “high corporate executive” to disclose the inventory issue — was simply overbroad. “This argument reaches too far.”

This is a big setback for the feds, who now are left with a much narrower (more…)

Something to Tide You Over

Tuesday, November 17th, 2009

writer-boxed-flipped

We apologize to our loyal readers for the unusual delay between posts. We’ve been on trial, and you know how that goes. Trial is all-consuming. And then there’s all the work that piles up in the meantime. And the wife and kids need a token appearance from us once in a while. So the blog just isn’t happening while we’re on trial.

And that’s how it should be, of course.

So yeah, we’ve been on trial since November 2. We keep predicting that it will end soon, but it never does. With any luck, we’ll have closing arguments tomorrow. But we said the same thing yesterday, and on Friday, and on Thursday… And we’re going to have to take Thursday off if the jury’s still not back with a verdict then, because we’re giving our next “Hope for Hopeless Cases” lecture for West Legal Ed Center that day. So yeah, this case could easily last through Friday.

To tide you over until we finally get a chance to blog again, here’s a link to our latest article in Forbes magazine.

Link

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Excerpt:
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Expert View
BEAR STEARNS DEFENSE HOLDS LESSONS FOR EXECS

Going on offense is the best defense in white-collar cases.

It didn’t take long after the housing boom turned bust and trillions of dollars of wealth had gone poof that the public was out for blood. The government needed to “do something” about the mess.

An obvious point of focus were the securities firms Bear Stearns (now a part of JPMorgan Chase) and Lehman Brothers (now a part of Barclays) which blew up in quick succession. From there, it does not take a huge leap of logic to understand how federal prosecutors set their sights on Ralph Cioffi and Matt Tannin, two former managers of Bear hedge funds who were plucked out of obscurity, paraded through a perp walk and unceremoniously read their rights as criminal defendants.

As their Nov. 10 acquittals attest, they didn’t actually commit any crimes. But that didn’t spare them from two years of hell during which they were investigated, indicted, vilified, prosecuted and put on trial. If they’d lost, that would have all been a picnic compared with the 20 years of prison time they would have faced.

If the case teaches us anything, it’s that such ordeals can befall executives–innocent and otherwise. If enough things go wrong on their watch, it’s not all that rare for bosses to find gung-ho prosecutors eager to indict them before all the facts are in.

That leads to the question: What can you do to protect yourself if you fall under the eye of a suspicious prosecutor? Here, the Bear Stearns case is instructive.

Lesson One
You’re on your own. If you ever find yourself on the receiving end of an indictment related to your professional activities, don’t count on your…

Continue reading

Yet More Prosecutorial Misconduct by the Feds

Tuesday, August 18th, 2009

peroration

We’ve asked it before, but what the heck is going on with some of these federal prosecutors nowadays? There was the whole Ted Stevens fiasco over the winter, when the feds actively withheld exculpatory evidence and witnesses in their rush to convict the former Senator. Then the 7th Circuit directed an acquittal after the feds blatantly misrepresented the facts in a food labeling case. The W.R. Grace case was screwed by federal prosecutors who withheld exculpatory evidence and gave the judge reason to say he has “no faith in anything the Government says” any more.

And now we get yet another case of the feds blatantly misrepresenting the facts. This time, the 9th Circuit reversed and ordered a new trial, though it’s doubtful that there will be another one.

The case is U.S. v. Reyes, decided this morning. This was one of those options backdating cases that were all over the news for a while back in ’06 and ’07. (“Backdating” is when a company retroactively picks an effective date for stock options, so as to maximize the potential value of those options. It’s a crime when the extra value isn’t accounted for as an expense, because then the books give investors a false image of the company’s finances.)

Gregory Reyes was the CEO of Brocade Communication Systems. In August 2006, Reyes was charged with securities fraud and related crimes for backdating options without properly accounting for them. At trial, his defense was that he had no intent to deceive. He just signed off on the options in good-faith reliance on his company’s Finance Department.

High-ranking Finance Department employees had given statements to the FBI, describing how they knew all about the backdating scheme. But they didn’t testify at trial. Instead, the prosecution called a Finance Department employee who said she didn’t know about the backdating.

The prosecutor was well aware of the fact that others in the department knew all about it. But during closing arguments, he told the jury that the Finance Department employees “don’t have any idea” that backdating was going on.

After several days of jury deliberations, Reyes was convicted. He was sentenced to 21 months in prison with $15 million in fines. That was stayed pending appeal.

This morning, in an opinion byJudge Schroeder, the 9th Circuit held that this was prosecutorial misconduct, and reversed the conviction, ordering a new trial. Reyes argued that he didn’t know the Financial Department wasn’t accounting properly for the backdating, and the feds argued that the Financial Department didn’t know about the backdating. So that was a key question for the jury to decide. And the feds had lied to the jury.

And this wasn’t just a simple little throwaway line, either. The prosecutor did not even limit his argument to the testimony of the witness he’d cherry-picked to give the false impression that nobody in the Finance Department knew about it (which might actually have been permissible). No, the prosecutor:

asserted as fact a proposition that he knew was contradicted by evidence not presented to the jury. In direct contravention of the statements given to the FBI by Finance Department executives that they did know about the backdating, the prosecutor asserted to the jury in closing that the entire Finance Department did not know about the backdating, and further that the government’s theory of the case was that “finance did not know anything.”

“Our theory is that those people didn’t know anything. . . . [The cherry-picked witness] says finance didn’t know. Did you need everybody in the Finance Department to come and tell you that they didn’t know?”

The government even displayed for the jury a diagram explaining the prosecutor’s position that the Finance Department did not know of the backdating. The prosecutor asked the jury to assume other employees of the Finance Department would testify that they did not know about Reyes’ backdating procedure, when the prosecutor knew they did.

Federal prosecutors have “a special duty not to impede the truth.” As the 9th Circuit pointed out today, there is good reason to hold prosecutors to a higher standard: Their words carry the weight and imprimatur of the government itself, which can be very persuasive to a jury.

The 9th Circuit didn’t go so far as to direct an acquittal or dismiss the indictment, because the defense had also played it pretty aggressively. Instead, they ordered a new trial. It is anyone’s guess whether the feds will be up to the task of trying the case all over again, years after the fact. But we’ll go out on a limb and predict that this case will never see a jury again.

For crying out loud, feds! And for shame.

Hoist on Their Own Petard — How Forensic Accountants Catch Small-Time Scammers

Tuesday, August 11th, 2009

 

No law today. Let’s have a police procedural for a change. We’re in the mood for some white-collar stuff, so here goes.

Forget about the Madoff case. Most financial crimes are nowhere near as headline-worthy, nor do they involve such massive amounts of other people’s money. But smaller scams are just as likely to get prosecuted, and they’re just as much a felony as the big ones. And though the news may not report it, people get caught and convicted all the time.

And like Al Capone, the smaller scammers aren’t caught by the gun-toting detectives so much as by the green visor-wearing accountants.

It’s usually a case of self-incrimination. Defendants usually create the very evidence that puts them behind bars, in their financial books and records. Of course, most of them aren’t doing it on purpose. They’re not creating blatant records that flatly proclaim “here there be crimes.” Most take pains to avoid creating records of improper doings, and to conceal or camouflage the rest. But it is often those very attempts to hide their activities that wind up calling attention to them.

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Every law enforcement agent knows that, to catch the “bad guys,” you need to follow the money. Who wound up with the cash or the assets? How did the money get from person A to person B, and so on to Mr. X?

One easy way to start is to look at public documents. Lots of records get publicly filed, for anybody to look at, and they can be good leads. Does Mr. X own a house? Pull the deed from the county clerk’s office. There’s going to be information that leads to the mortgage itself, and then Mr. X’s bank records are just a subpoena away. Probate records lead to the estate, which leads to more bank records and real estate records. Does someone have a rap sheet already? Maybe they had to post bond in an earlier case. That’s going to show the source of the lien, and lead to more assets. Dun & Bradstreet and similar records can tell whether someone has a lien against Mr. X — such people are often more than willing to give more information to law enforcement. Heck, even newspapers can be a source of leads to get an investigation started.

Paper begets paper. Or computer data. It is nigh impossible to have dealings of any significance without some record being kept somewhere, in some form.

When following leads, the investigator ought to have an idea of what he’s looking at. What kind of business is this company in? Where are they located? What do they spend money on? The investigator can’t tell whether something is unusual unless he knows what the usual looks like.

Maybe this is a kickback scheme. If I am demanding kickbacks from you, or bribes, or extortion payments so I allow you to keep doing business with me, then maybe I don’t want that money coming directly to me. And maybe you don’t want it coming directly from you. So perhaps I set up a “consulting” company to receive payments from you. Or maybe you set up a “customer” company to make payments to me. Or perhaps we do both. Maybe we have lots of shell companies, or only one. If the investigator figures it out, though, our cautions might turn around to condemn us.

Maybe you pay me with a no-show job. If so, you’d better be careful about who is holding back my payroll checks or delivering them to me. And is my pay typical of my job? A steady, constant paycheck is more typical of an office worker than a blue-collar worker, after all. These are possible tipoffs to an investigator. And paper begets paper.

-=-=-=-

So how else do they get the paper, apart from going to public records?

Subpoenas are the main stock-in-trade of the white-collar investigation team. Smart teams won’t subpoena the world, of course, because that just makes for far more work than necessary, while increasing the odds of tipping off Mr. X to the existence of the investigation. Instead, they’ll just limit their subpoenas to what they really need. Narrow requests also make more subpoenas necessary down the road, which keeps open a line of communication.

A shotgun subpoena followed by a narrower one just tips off defense attorneys like us. We see something like that, we have a chat with the client, and figure out what the investigators are probably looking for. We get all that extra time to prepare our defense.

When in doubt, utility bills are a common lead-generator, to figure out how someone is paying for their phone, cable, electricity, etc.

One thing they’ll probably want to see are old tax returns, especially for a business. Tax returns can be a mine of useful information, such as who formed the business, who the officers are, how much they get paid, who their accountant is (always a good person to interrog… ah, interview). And if the tax returns don’t match reality, well that’s another charge for the grand jury to hear, isn’t it?

The company’s accountant often did the tax returns for the owners and officers, too. Investigators can request the accountant’s retained copies of those returns, and find out all kinds of information about assets, mortgages, sources of income, etc.

Canceled checks are a high-want item. They’re one way of seeing who’s paying money to whom.

Bright investigators don’t settle for photocopies, but insist on originals. Critical information could have been whited out before copying. Photocopies are often illegible, and may not include the all-important information on the back of checks showing who deposited it and to what account.

In general, subpoenas are going to be issued to non-targets. There’s little point in asking the suspect to provide the evidence that will hang him. All it does is raise him up. And a savvy defense attorney is going to bring that client in to present the documents to the grand jury — because here in New York, for example, it is far too easy for the prosecutor to slip up and confer total transactional immunity on the client right there in the grand jury. (That’s a topic for a whole nother post.)

No, suspects aren’t usually the ones who get subpoenaed. They get searched.

-=-=-=-

Search warrants are a unique chance for the investigators to get all that stuff they never would have gotten from a subpoena. The “second set of books,” rather than the official set they keep for the IRS and other outside eyes. The secret records. (Although these can sometimes be viewed by an undercover posing as a legitimate potential buyer of the business.)

That’s what the investigators are hoping for: a “smoking gun” document of some kind. Original documents with all the info that got whited out in the subpoena response. Records of illicit payments made, cash skimmed, investors gypped. Evidence that customers were told one thing, but reality was something else entirely. It may be buried somewhere in all those boxes of docs and all those hard drives, but they can’t wait to find it.

These records may be as simple as a notebook or a wad of scratch paper. They could be as detailed as anything. Maybe there’s evidence of a cash payroll — which leads to questions of where that cash came from (the bank? really?) on top of issues of tax and benefits evasion. Maybe there’s a little black book recording paid bribes, or extortion payments received.

Search warrants are often a fine way to gain evidence of embezzlement. Maybe those personal expenses were paid for with the business’s money, or with investors’ deposits. A good search warrant team will have agents who know what they’re looking for, others speaking to the subject. Others will be busy talking to witnesses, family members, employees and others at the location, letting them think the cops know exactly what’s going on, so they’d better come clean.

In a suspect’s home, the search team might see pictures of that really nice boat, or expensive collections, or the like. Investigators love to see things like that, especially when the checkbook doesn’t show those expenses. A lifestyle and possessions beyond one’s official means is going to make them poke around for illegitimate sources of cash.

Obviously, the execution of a search warrant means the investigation ain’t a secret any more. So these usually come at the end of an investigation.

-=-=-=-=-

So how about some examples. Let’s say I have ABC company. Law enforcement subpoenaed or seized a bunch of payroll checks. Every week, my company is cutting a few dozen checks to employees. They all look totally legit, until one of the forensic accountants notices that Joe Blow tends to deposit four or five checks at a time, all on the same day. That means he’s probably not getting them each week like a normal employee, but is receiving a bunch of them once a month. That is typical of a no-show job. Joe Blow and I are now just that much closer to getting caught. Thanks, Joe.

Meanwhile, my manufacturing company DEF sends out invoices every month or so to Jack Nimble, charging tens or hundreds of thousands of dollars for all kinds of different products being delivered. Payment is due on receipt, send the check to my headquarters at 1405 Blank Lane, Suite 120. Unfortunately, the forensic accountant noticed that each month’s invoice number is one more than the previous month’s. Do I only have one customer, for all these things I’m selling? And Suite 120 turns out to be a mail drop box number. Suspicious. They’re going to watch that box and I.D. who uses it, and maybe figure out who’s paying for it. And due on receipt? Someone’s standing on the loading dock with a check for a couple hundred grand? No way. And anyway, how come there are no bills of lading, shipping records, or anything else indicating this really happened? This looks like Jack Nimble is paying me some kickbacks through a shell company.

Original checks are a treasure trove. I’m cutting tons of them to small suppliers, nothing more than $9500 or so. Oddly enough, however, they all tend to get cashed at the same check-cashing joint. They’re not deposited to anyone’s accounts. Looks like I’m laundering some money. Investigators are going to check up on these companies to see if they’re legit, maybe subpoena invoices, bills of lading and purchase order forms to see what’s going on.

20 Years Sounds About Right for Dreier

Monday, July 13th, 2009

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So Marc Dreier was sentenced today to 20 years in prison, plus forfeiture of $746 million and restitution of nearly $388 million (that’s more than a billion dollars, with a “b”). That’s his punishment for his guilty plea to conspiracy, securities fraud, money laundering and wire fraud. The feds had asked for 145 years in prison, and Dreier’s counsel Gerald Shargel had asked for a sentence in the 10-12.5 year range.

We have to say, we’re not offended by this sentence. It’s high enough to be meaningful, but not so high that it will scare away future plea bargains in white collar cases.

It’s important to have a meaningful sentence, if the justice system is to function properly. If justice is not perceived to be done, then law and order lose their authority. For many years, white collar crimes were seen to be treated unjustly, with sentences too low for the harm done. A massive financial fraud could have many more victims than a violent street crime, and can do far more damage to each victim by taking not just their wallet, but the savings representing a lifetime of labor. But until recently, such frauds were punished far more lightly.

In recent years, however, the pendulum began to swing the other way. From Tyco to Enron to MCI to Madoff, we saw white-collar sentences lurch upward and upward. Madoff’s 150-year sentence earlier this summer was just amazing, and not at all proportionate to the harm done. The pendulum had swung too far.

If that was to be the new par for the course, white collar sentencing would be just as unjust as it was in the days of the old slap-on-the-wrist. In addition to the very real problems of perception, in a world where perception equals reality, there is the separate problem of efficiency.

If people think they’re going to get slammed at sentencing whether they plead guilty or not, as Madoff did, then there is no point to pleading guilty. One might as well take one’s chances with a jury and shoot for the off chance of an acquittal. It happens.

(As an aside, there’s an old story of a band of soldiers in medieval China, who had become lost in a swamp en route to a muster. The penalty for being late was death. The penalty for rebellion was death. So they rebelled. And eventually toppled the government. Extreme punishments have had extreme public reactions throughout history. *Cough*drug laws*cough*)

Here, the government wanted 145 years for Dreier, to punish him for putting one over… not on mom and pop investors, but on sophisticated hedge funds who really ought to have done their homework. That would be just five years less than what Madoff got, for essentially doing the same thing. But it would have been a horrible outcome for our criminal justice system if they actually got their way.

Fortunately, Dreier drew Judge Jed Rakoff, who has been vocal in opposing the recent trend towards ever-higher sentences in white collar cases (in addition to his criticism of the severity of the U.S. Sentencing Guidelines). Rakoff is making him give back the money he filched, and forfeit his ill-gotten gains, and serve a prison sentence equal in severity to his crimes.

Nobody can reasonably say Dreier got off light, and nobody should complain that his sentence was unjustly harsh. We think Judge Rakoff nailed this one.

Are White Collar Sentences Too Harsh Now?

Tuesday, June 30th, 2009

dilbert-wcc.pngPrison Farm

When we started law school back in ’93, we felt that white-collar criminals just weren’t punished that harshly in this country. The Dilbert strip above, from about the same time, shows that we were not alone in thinking this. It seems that this was a common perception going at least as far back as our early childhood — click on the audio button above to listen to an early ’70s National Lampoon skit called “Prison Farm.”

Like many, we felt that there was some serious injustice going on here. Socioeconomic elites were getting off lightly, even though they may have victimized far more people, far more seriously, than street-level crooks who were doing hard time. A mugger takes one person’s money, and gets a long sentence in a high-security prison. Meanwhile, a Wall Street scammer wipes out thousands of families’ savings, erases their years of labor and planning, and gets a slap on the wrist. It seemed absurd, like something from Alice in Wonderland.

And we weren’t wrong. As late as the early ’90s, we had guys like Mike Milken serving less than two years, even after the sentencing judge (Kimba Wood) had said such things as “You were willing to commit only crimes that were unlikely to be detected…. When a man of your power in the financial world… repeatedly conspires to violate, and violates, securities and tax business in order to achieve more power and wealth for himself… a significant prison term is required.”

The lesser sentences were of course due in no small part to the difficulty of spotting white-collar crime in the first place, and then proving it to a jury. Also, the law itself classified these crimes at the less-serious end of the spectrum. So you had to expect significant plea bargaining in difficult-to-prove cases, and the plea sentences were being discounted from relatively short terms in the first place.

Another important factor was the socioeconomic status of the white-collar defendants. These were not street thugs, they weren’t skeevy bottom-feeders. They were college-educated, productive members of the community, involved in charities and otherwise living “normal” lives. Their crimes weren’t violent, they were almost administrative. Victims weren’t in your face, with visceral injuries and tangible losses; they were anonymous and diffuse, with paper losses of mere money. These middle- and upper-class defendants weren’t people who belonged in prison — their loss of status, their shame, did more to rehabilitate and deter than any time behind bars. Judges felt this, and acted accordingly.

But by the time we graduated law school, this had all started to change. By then, the federal Sentencing Guidelines had gone into effect. The Guidelines had three major effects on federal cases. First, they increased the penalties for white-collar crimes, especially where the dollar amounts were high and there were many victims. Second, judges lost most of their discretion to sentence lightly based on the defendant’s socioeconomic status, and were not all that willing to put such reasoning on the record. Third, the Guidelines took away much of the plea-bargaining leeway, only permitting two or three levels of departure for taking a plea.

The biggest change happened when the tech bubble burst in 2000. In the late ’90s, Americans became investors like never before, with even cops and construction workers becoming day traders at home. Tons of our money went into IRAs, brokerage accounts and 401(k)s. And then the bubble burst, the markets dipped, and the average Joe saw his investments tank. As always happens, this revealed financial frauds that had escaped unnoticed in the up market. The middle class was outraged, and began to demand severe penalties for the fraudsters.

Prosecutors and judges got the message, and the exposed fraudsters got slammed. WorldCom’s Bernie Ebbers got 25 years. Enron’s Jeff Skilling got 24 years and 4 months (Andy Fastow, reported to be the primary Enron fraudster, cooperated and got six years). Adelphia’s John Rigas got 15 years. In state court, Tyco’s Dennis Kozlowski got 8-1/3 to 25 years.

This pattern repeated itself in the recent economic downturn. After several boom years, a credit crunch and market dip exposed many white-collar offenses (most of which we are told are still in the pre-indictment phase). Voters had lost a lot, and their voices were heard.

So now we get yesterday’s 150-year sentence of Bernie Madoff. As we’ve explained before, we’ve avoided writing about the Madoff case, because everyone else is already talking about it, and we don’t feel like we have anything new to add.

But this 150-year sentence… we’re going to go against the grain here and wonder out loud if perhaps it’s too harsh.

* * * * *

Whoa. How can we say that, when we just got done saying how unjust it seemed when white-collar types were getting off lightly? Isn’t this exactly what we wanted?

No, it isn’t. We wanted the punishment to fit the crime, and to fit the policies underlying criminal punishment. This sentence doesn’t do that.

For one thing, Madoff took a plea to avoid trial. And yet he still got the worst sentence that he could have gotten had a jury convicted him. What was the point of taking a plea? This sends a strong message to white-collar defendants now: you might as well just go to trial, because you’re going to get the same sentence if you lose — and juries being what they are, you might just win. The system could see a lot fewer pleas — pleas it relies on to keep working.

For another thing, Madoff got a bunch of consecutive sentences. Normally, even after trial, they’d mostly run concurrently. He’d have gotten about 30 years — still a life sentence for a 71-year-old guy. Judge Chin said he did so for “symbolic” reasons, to make the victims feel better. But is that a valid purpose of sentencing?

Of course it isn’t. The purpose of sentencing is not to make victims feel better, or give them closure, or anything like that. The criminal justice system does not serve the function of making victims whole. That’s the job of the civil courts. A criminal court can order restitution as a condition of sentencing, but that’s about it. The purpose of sentencing is not reparation, but punishment. Punishment is supposed to deter future crimes, retaliate against the offender, rehabilitate the offender so he doesn’t do it again, or remove a threat to society.

But maybe Judge Chin is on to something here. Perception is important. Few of the purposes of punishment work unless there is some perception. Deterrence doesn’t work, unless people get the impression that crimes are probably going to be punished, and that they will probably be punished harshly enough to make them not worth your while. (This raises an interesting thought experiment — would the criminal justice system work just as well if we could give the public the impression that crimes are punished, without actually incurring the expense and hassle of, you know, punishing them? Discuss.)

Another problem we have with this sentence is that his scam wasn’t directed at Joe Retail out there. It was a secretive investment fund that did not disclose what it was doing, as it would have had to if it had been sold to the average person. It could be secretive because it was sold to sophisticated investors. These sophisticated investors saw an unusually high and steady rate of return, and instead of investigating to see what was going on, simply told Madoff to cut them in.

Sophisticated investors have a duty to check these things out. Are we blaming the victims here? Yeah, a little. They had the size or experience to know that something that sounds too good to be true probably isn’t. And yet they shoved their money into the fund anyway. And for those who shoved all of their money into the fund, ignoring basic investment principles of diversification, they were victimizing themselves just as much as if they’d invested in Pets.com. And for those who invested beyond their discretionary income, but actually sent Madoff the money they needed to live on, that’s the epitome of dumb. These weren’t blue-collar workers, these were investors with enough dough to get in the game, and enough savvy to have known better. The law just doesn’t need to afford them the same protections as ordinary folks.

So the law doesn’t need to impose punishments harsher than those imposed on victimizers of ordinary folks.

What is needed is parity. Yes, white-collar sentences should reflect the seriousness of the harm done, just as sentences for violent crimes and street crimes need to be proportionate to the offense. A white-collar offense that causes as much harm as a back-alley mugging probably deserves a similar punishment, all else being equal. Maybe a little less, actually, as there is more likelihood of deterrence or rehabilitation. White-collar crimes are usually calculated, they aren’t crimes of the moment, and offenders usually have the smarts to take punishment into account. And white-collar offenders aren’t as likely to re-offend once they’ve gone through the system. So sure, maybe they don’t need quite as much punishment. But it ought to be about the same.

Giving 150 years here, though, is not at all proportionate. Murderers don’t get that much. Kidnappers don’t get that much. And taking someone’s life or liberty is just not the same as taking someone’s property. White-collar victims only lose money. It’s only money. It’s a big deal, but it should not be punished more severely than crimes that are obviously more severe.

The pendulum has swung too far.

Antitrust Division Indicts Japanese National in Yet Another LCD Monitor Case

Thursday, April 2nd, 2009

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The DOJ got an indictment this week against a Hitachi executive, in the government’s ongoing prosecution of alleged price-fixing in the LCD monitor industry.

We first blogged on this back on November 13th, when Sharp, LG Display and Chunghwa all pled guilty to price fixing, agreeing to pay $585 million in fines. Since then, Chungwha executives also pled guilty during February.

After the Chungwha executive pleas, Hitachi itself agreed in March to plead guilty and pay $31 million in fines.

Breaking from the pattern, however, rather than a Hitachi executive subsequently pleading guilty, the feds went ahead and indicted him.

According to a DOJ press release, Tuesday’s indictment charges a Japanese national, Sakae Someya, who was an executive at Hitachi Displays Ltd. Mr. Someya is accused of taking part in a larger global conspiracy to fix the prices of LCD panels sold to Dell.

Mr. Someya is accused of agreeing to charge set prices for the screens, sharing sales information to ensure everyone was complying with the agreed prices, and trying to keep the arrangement secret. These are Sherman Act charges, with a max of 10 years in prison plus a max fine of the greater of $1 million, double the gain, or double the loss to victims.

We wonder how much of the allegedly criminal conduct is simply normal business practice in Japanese culture. After all, the keiretsu distribution system used by Japanese industry looks very much like price fixing to Western eyes.

It certainly looks to us as though the DOJ’s Antitrust Division is busting through decades of resistance to offshore enforcement of U.S. antitrust rules. Whether it is proper to impose U.S. laws on a very foreign culture… that’s another question entirely. What do you think?