The Criminal Lawyer

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?

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…)

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!

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…)

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

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.

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.

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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.

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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.

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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.

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.

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.

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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.

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?

We’ve written about an upcoming wave of white-collar prosecutions, especially against Wall Street types. But wait, there’s more: the feds are now about to start prosecuting doctors.

The Department of Justice and the Inspector General of the Department of Health and Human Services are about to start prosecuting physicians who receive inappropriate incentives from manufacturers and sellers of pharmaceuticals and medical devices. Doctors who have accepted such incentives face criminal prosecution, as well as civil fines and being barred from participation in Medicare and Medicaid programs. Doctors who have received significant incentives from medical marketers might want to seriously consider consulting a good white-collar defense attorney.

Of course, incentives are a commonplace in medical marketing. And of course the purpose is to somehow influence which drug a doctor intends to prescribe, or what equipment a doctor uses. A wide range of incentives are offered, not just the free pens, prescription pads and trinkets routinely handed out. Expensive equipment can be provided for free or at a deep discount, in return for minimal obligations such as a product recommendation or letting one’s office be used (albeit rarely) as a training facility. In extreme cases, sellers actually pick up the tab for travel to seminars or other expenses, pay “advances on royalties” for helping develop products, or simply pay cash kickbacks.

In the past, it has usually been the manufacturers who got prosecuted for making kickbacks or bribes, often paying millions in fines and undertaking the supervision of monitors. What’s new now is the federal focus on the doctors themselves, on the receiving end.

Many doctors may not think they’re doing anything wrong by accepting incentives from sales folk. After all, it’s the norm. And so what if a doctor got a free trip to the conference, if he continues to make his prescription decisions independently and based on the actual needs of the individual patient?

The government sees this as criminal partly because such payments are opaque. A patient might not be so trusting of a prescription for FancyPharm if he knew his doctor was getting comped by that company. A patient might not have the same confidence in her eye surgeon if she knew that he didn’t actually select and purchase his laser equipment himself, but instead got it for nothing.

Another reason is the perception that medicines and procedures would be improperly prescribed, because the incentives had an undue influence on the doctor’s decisions. Unnecessary expense and harm could result.

The main tool that prosecutors have here is the federal Anti-Kickback Statute (formally known as “the Medicate and Medicaid Patient Protection Act of 1987,” 42 U.S.C § 1320a-7b). It basically provides up to 5 years imprisonment and $25,000 in fines.

The feds are most likely to go after those who allowed marketers to pay for their consulting fees, travel to seminars or other expenses, or who accepted advances or payments, or who accepted large rebates or extreme discounts without proportionate consideration, or otherwise received remuneration that could have influenced their decision making.

Lewis Morris, chief counsel for the Inspector General, told the New York Times last week that “what we need to do is make examples of a couple of doctors, so that their colleagues see that this isn’t worth it.”

When law enforcement says they are going to make examples of people, one might think that this means they will carefully pick and choose their cases, cherry-picking only the most obviously criminal acts with the strongest evidence. However, in real life, that’s not always the case.

Especially in cases like these, where the evidence tends to be more circumstantial (absent clearly incriminating admissions, recordings or emails), and where the conduct is very often in the gray area of culpability, prosecutors may not have many rock-crusher cases in the first place. And they certainly won’t have enough cases at first to do much cherry-picking in any event.

No, they have announced their desire to make examples of people, and we predict they will go after whatever crosses their desk.

Cases are going to come from marketers who got caught trying to bribe someone else, who are then flipped to inform (and wear a wire) against the other doctors they deal with. Those are the easiest cases for law enforcement to initiate. Other cases may come from third-party complaints or referrals, but those are rare in secret one-on-one deals such as those being investigated here.

If any doctors out there think they might have had dealings with a marketer that could get them in trouble, it might be wise to get counsel from a good white-collar defense attorney sooner rather than later.

A couple of weeks ago, we were at a luncheon with some white-collar defense attorneys, listening to a presentation by the acting U.S. Attorney, Lev Dassin. Mr. Dassin let us know that, although he couldn’t spill any particulars, there are a number of ongoing investigations at the Southern District of New York right now, which he expected to provide a lot of work for us later this year.

He also confirmed our impression that there is a lot of political pressure right now, causing prosecutors and law enforcement to focus more assets on white-collar crime. Many see the current economic downturn as the result of Wall Street skullduggery, so law enforcement is being tasked with doing something about it.

Our biggest fear is that people who did nothing illegal may get caught up in the frenzy to blame people for the recession. A federal criminal investigation is a serious matter, and even people who did nothing wrong can wind up in prison because of how they behaved during the investigation.

Still, a lot of white-collar crime is now coming to light these days, because of the hurting economy. Ponzi schemes and other fraudulent investments are being caught out left and right, as investors start trying to pay bills by cashing out their accounts, only to discover that their money isn’t there.

Furthermore, PricewaterhouseCoopers today published a white paper, “Boom Time for White Collar Crime,” predicting that the economy will cause greater numbers of people to commit white-collar crimes, such as embezzlement and fraud.

PwC partner Andrew Gordon told GAAP web that “sales targets seem ever more out of reach, bonuses are under threat, and people’s reputations and livelihoods are at stake. Together, these can be powerful motives for individuals to cross the line.”

The white paper predicts an increase in specific types of fraud: data theft by criminal organizations, “rogue traders” in corporate finance departments, and fraudulent mis-reporting of business numbers to make companies appear better to investors. The paper also sees more Ponzi schemes and fraudulent investment schemes collapsing as investors try to cash out.

So criminals caused a bad economy which is causing more criminals? That sounds a little simplistic.

Of course, the economy didn’t go south because a few Wall Streeters went around defrauding investors. The economy tanked for a lot of reasons, but mostly because lenders stopped believing they’d get paid back. Institutions with the most leverage — financial institutions particularly — got their margins called and couldn’t get new credit, a deadly combination. No amount of government stimulus would change that, without a condition that capital infusions to lenders must turn into loans. The government didn’t make such conditions, so lenders just hoarded their cash to sit out the storm. The credit market, already dying, was pretty much killed. The U.S. Congress and the new Administration have since then acted fairly consistently to prevent lenders from regaining sufficient confidence to start lubricating the economy again. In modern economics, perception is everything — if you are perceived to have liquidity, even if you are at risk, you will have liquidity (see JPMorgan Chase this time last year), but if you are perceived to be at risk even though you aren’t, your liquidity dries up (see Bear Stearns this time last year). Once lenders start perceiving that they will get their money back, things will start picking up. This crisis of confidence was caused, not by white-collar criminals, but by Clinton-era directives to make mortgages to people who can’t pay them, by borrowers and lending agents who cashed in on the resulting laxness, and by an ever growing house of cards that was destined to collapse.

So the economy didn’t go south because of criminals. Similarly, a worse economy doesn’t necessarily translate into more crimes being committed. People who would steal in bad times would have stolen in good times, too. White-collar types aren’t exactly Jean Valjean, stealing a crust of bread so their families don’t starve. No, white-collar crime requires a combination of opportunity and character traits, neither of which correlate with economic pressures.

What is true, however, is that more white-collar prosecutions are going to happen because an under-informed public and its politicians are screaming for blood. Unfortunately, we do not believe that all prosecutors out there understand the complexities and realities of the financial world well enough to accurately sift the guilty from the merely unlucky. Some innocent people are going to get caught in this ever-widening net.

18 U.S.C. § 1346 expands the definition of mail & wire fraud to include “a scheme or artifice to deprive another of the intangible right of honest services.” That’s short and sweet, but what does it mean?

The courts have been left to define the crime for themselves. Unfortunately, they differ wildly in what the theft of honest services means. The Fifth Circuit says it’s only a crime if the deprivation of services was also a crime under state law. The Seventh Circuit says the crime is when someone abuses their position for private gain. The Third Circuit says gain is irrelevant.

In general, they agree that employees and public officials have a duty to act only in the best interest of their employers and constituents. But there are lots of ways to act otherwise, and the courts seem to agree that not all of them ought to be criminalized. There is a spectrum of behavior, ranging from the socially acceptable to the abhorrent. Where the line ought to be drawn is undefined and uncertain.

So the Supreme Court finally had a chance to clear it all up, define what “honest services” means, and give straightforward guidance to the courts and to all the employees and officeholders out there. Sorich v. United States, No. 08-410 came to the Supremes on a cert petition, asking them to define the crime and settle the issue at last. That’s what the Supreme Court likes to do, after all — if the circuits can’t agree, it the Court’s job to define the correct approach.

Instead, the Supremes punted, and denied cert.

Scalia wrote an intense dissent, pointing out that this is precisely the kind of issue that the Court ought to resolve, that the split among the circuits is causing confusion in the law, and that real injustice is resulting. “It seems to me,” he wrote, “quite irresponsible to let the current chaos prevail.” We can’t help but agree.

“If the honest services theory… is taken seriously and carried to its logical conclusion,” Scalia pointed out that all kinds of actions would be criminal. Not all ought to be. “A state legislator’s decision to vote for a bill because he expects it will curry favor with a small minority essential to his reelection,” a perfectly normal and expected aspect of electoral politics, would be a federal crime. “A mayor’s attempt to use the prestige of his office to obtain a restaurant table without a reservation,” a perhaps obnoxious act, but one hardly worthy of punishment, would also be included. “Indeed, it would seemingly cover a salaried employee’s phoning in sick to go to a ball game.”

“What principle it is that separates the criminal breaches, conflicts and misstatements from the obnoxious but lawful ones, remains entirely unspecified.” Failing to define what the crime actually means invites unjust prosecutions by “headline-grabbing prosecutors.” Furthermore, nobody knows if their actions would be considered criminal or not, and “it is simply not fair to prosecute someone for a crime” that won’t be defined until the judge’s ruling that sends him to jail. “How can the public be expected to know what the statute means when the judges and prosecutors themselves do not know, or must make it up as they go along?”

Scalia closed with an excellent dictum, quoting from another useful dissent — that of Hugo Black in Green v. United States, 365 U.S. 301, 309 (1961) — “Bad men, like good men, are entitled to be tried and sentenced in accordance with law.” It is truly unfortunate that the Supreme Court has passed on an excellent opportunity to ensure just that.

Gang crime is on the rise, the FBI reports. The politicians and prosecutors, however, are focusing on white-collar crime these days. Here’s a look at why this is happening.

Gang crime seems to have increased, ironically, as a result of improved anti-gang law enforcement in the big cities.

According to the 2009 National Gang Threat Assessment, street gangs have started expanding more rapidly from urban centers into suburban and rural areas. This has spurred new membership, as fresh populations are opened to gang recruitment. By the end of last year, about a million people were estimated to belong to gangs within the U.S.

One might think that the burbs lack the same social pressures that drive gang membership. Gangs are products of the inner cities, after all, where kids lack fathers to lead them, involved communities to belong to, competent schools to teach them, and opportunities for money and glory. We expect gangs to arise in the inner cities of single moms, apathetic neighbors, dysfunctional schools, government welfare and hopelessness. Suburbia’s not like that, right?

Well, according to the NGTA, drugs drove the expansion. During the 1980s, the suburbs began to become a profitable new market for drug dealers who had previously focused on the urban market. During the 1990s, the huge profits from suburban drug sales caused the street gangs to physically expand their territory, often resulting in violence as urban gangs clashed with local toughs and with each other in the race to occupy the burbs.

Meanwhile, law enforcement started cracking down on gang and drug crime in the cities. It was getting dangerous to operate in NYC, LA and Chicago. Suburban cops, however, just weren’t as much of a concern. The burbs were also seen as safe places to hide from unsuspecting law enforcement, unused to dealing with a gang element.

The combination of weaker opposition from law enforcement, and higher profits from suburban drug users paying “white boy prices,” was a clarion call for gang expansion. It was an irony that improved law enforcement actually resulted in the spread of gang-related crime.

There were other reasons for the spread of gangs into suburban and rural communities, not detailed by the NGTA report. From the author’s own interviews with drug traffickers in the New York area, gangs sometimes followed inner-city populations that had moved out there first. People on government assistance began moving out to places such as Lancaster, Pennsylvania and various towns Upstate along the Hudson River, because a person on welfare could have a nicer quality of life there. Many of them brought with them the quality of life that they were trying to avoid, unfortunately. And those who were drug users brought their demand with them. And so the dealers followed, the gangs followed, and the forces that spurred gang recruitment never went away.

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Despite the spread of violent crime and drug trafficking, however, the FBI is focusing more on white collar crime. White collar crimes certainly are on the rise lately, especially fraud cases.

“We may not be doing as many drug enterprise operations,” Special Agent in Charge Richard Lambert recently said, “so we can focus more on mortgage fraud and corporate fraud problems.”

In just the past month or so, 3000 new FBI positions have been created to combat white collar crime. On top of those new hires, the Senate Banking Committee is preparing a $110 million fund that would hire 500 new FBI agents, 50 new AUSAs, and 100 new SEC agents.

Bill co-sponsor Chuck Schumer (D-NY) stated in the accompanying press release that “our white collar crime divisions are under-staffed, under-funded, and overwhelmed. When a wave of violent crime sweeps through a city, the immediate response is to beef up the police forces, putting more cops on the beat, extending overtime, and making sure the city returns to safety. Our reaction to the financial crisis and the massive and complex financial fraud investigations that loom should be no different.”

Why the rise in white collar cases? It’s not just the economy, stupid.

Sure, people may be tempted to commit crimes in an economic downturn. But this usually applies to people who are on the bottom rungs of the economy. Wall Street types and CEOs don’t start robbing banks just because their net worth slipped a bit.

Instead, white collar crime goes on all the time. What’s changing now is not the number of crimes being committed, as the number of cases being prosecuted. There’s a difference. As Anne van Heerden, head of forensics at KPMG Switzerland told Swissinfo, “I do not believe that the number of cases is growing, but rather the detection rate is increasing.”

Sophisticated financial crimes have always been sexy for law enforcement. What prosecutor didn’t want to convict the next Ivan Boesky, Andy Fastow or Michael Milken? The problem is, they’re hard to catch. The crimes take place on paper, in back rooms, and on golf courses. Not places frequented by cops or detectives. Evidence is often hard to find, and even harder to comprehend if found.

But the new economic downturn — which many see as the direct result of white collar crime — has led to new political pressure to “do something about it.” (At a function last week, we joked with a prominent judge that our white-collar defense practice was recession-proof, to which the judge responded “yes, but your clients caused the recession.”) Elected officials feel that pressure to “do something,” and they start rewarding successful prosecutions, and funding more of them.

So the word has come down from above that white-collar prosecutions are what the chiefs want. And that’s what they’re getting.

Expect to see more.

Yesterday, we observed that there have been a lot of Ponzi schemes coming down lately, and asked what gives? Today, the Wall Street Journal made the same observation, and asked the same question.

Here are some points from the article:

* In 2007, the SEC had brought civil actions from 15 alleged Ponzi schemes. In 2008, they brought 23 such cases. So far this month, they’ve already brought 9. And that doesn’t include all the state-level fraud cases that have come down.

* On the criminal side, there have already been 6 multimillion-dollar fraud cases brought this month.

* Experts say these schemes are being discovered now because of the economic downturn. Investors try to cash out their investments, only to learn that the money’s gone. There’s also less money out there being invested, so the source of cash for these schemes dries up, and the house of cards comes crashing down.

The New York Times also had some similar observations:

* “What is causing them to surface now appears to be a combination of a deteriorating economy and heightened skepticism about outsize returns after the revelations about [Bernie Madoff]. That can scare off new clients and cause longtime investors to demand their money back, which brings the charade tumbling down.”

* The Commodities Futures Trading Association has also experienced a doubling of reported Ponzi schemes in the last year.

* On Thursday last week, Senators Chuck Schumer and Richard Shelby introduced a bill to hire 500 new FBI agents, 50 new AUSAs, and 100 new SEC officials to crack down on these crimes.