35 Years of the FCPA

Hard to believe but the FCPA has been with us for 35 years.  For the history, we recommend Mike Koehler's piece, The Story of the Foreign Corrupt Practices Act.  We've included the abstract.

In the mid-1970s, Congress journeyed into uncharted territory. After more than two years of investigation, deliberation, and consideration, what emerged in 1977 was the Foreign Corrupt Practices Act (FCPA), a pioneering statute and the first law in the world governing domestic business conduct with foreign government officials in foreign markets. This Article weaves together information and events scattered in the FCPA’s voluminous legislative record to tell the FCPA’s story through original voices of actual participants who shaped the law. As the FCPA approaches thirty-five years old, and as enforcement enters a new era, the FCPA’s story remains important and relevant to government agencies charged with enforcing the law, those subject to the law, and policy makers contemplating reform.


BP Settlement of Criminal Charges

A post from John M. Holcomb in the Department of Business, Ethics and Legal Studies at the Daniels College of Business.  The post was also published on the site for the Institute for Enterprise Ethics at Daniels.   

BP has agreed to pay $4.5 billion in criminal fines and penalties, the largest in history, and to plead guilty to 14 criminal charges for the explosion of the Deepwater Horizon drilling rig in 2010. What is unique about the charges by the government is that it includes criminal charges against both a corporation and three executives. The Justice Department has brought a 23-count manslaughter indictment against two executives for disregarding high-pressure readings and ignoring red flags. Seaman’s manslaughter charges carry maximum sentences of 10 years per count, while involuntary manslaughter charges carry maximum sentences of 8 years per count. The other executive has been indicted for obstruction of Congress by withholding information on the spill rate. Since the 1980s and 1990s, the government has prosecuted corporations more often than executives, but is pursuing both in the BP case. As Attorney General Holder stated, “This is unprecedented, both with regard to the amounts of money, the fact that a company has been criminally charged and that individuals have been charged as well.”

The government can bring similar charges against the executives and the corporation, based on the concept of vicarious liability, when responsible managers or officers have endangered lives and the corporation. Executive liability can serve as a deterrent to other managers engaging in similar misconduct in the future. Corporate liability, meanwhile, can give shareholders and boards a greater incentive to build effective internal controls and maintain an ethical culture, which will prevent systemic breakdowns down the road. The mitigating factors under the U.S. Sentencing Commission guidelines, along with the charging guidelines of various regulatory agencies, reinforce the aims of corporate liability to provide incentives for creating effective internal controls and an ethical corporate culture.
To provide even further incentive, the settlement includes a provision that the government will monitor the safety practices and ethics of the company for the next four years. The ethics monitor will review BP’s ethics code and recommend changes in its enforcement. The government could also debar BP from competing for government contracts, but legal experts consider that step unlikely.

The penalties, to be paid out over five years, include $1.256 billion in criminal fines, $2.394 billion to be paid to the National Fish and Wildlife Foundation for remediation efforts, and $350 million to the National Academy of Sciences. The $4.5 billion also includes $525 million to settle charges by the Securities and Exchange Commission that BP misled investors about the flow rate of the oil spill, claiming it was only 5,000 barrels a day when it was actually 60,000 or more barrels a day.
BP will plead guilty to 11 felony counts of misconduct or neglect of a vessel’s officers, based on a law of the 1830s, known as Seaman’s manslaughter, which requires a lower burden of proof than normal manslaughter. It will also plead guilty to a felony count of obstruction of Congress and two misdemeanor counts under the Migratory Bird Treaty Act and the Clean Water Act.
The settlement made sense for the company and its board, as a necessary step to avoid a wider criminal indictment that would involve more employees and require even more company time and resources to mount a defense. By settling the criminal charges with the Department of Justice and the Securities and Exchange Commission, the company also stands a better chance of avoiding a finding of gross negligence in future civil lawsuits. Such a finding could expand the company’s liability under the Clean Water Act from $5 billion to over $21 billion, with one expert in environmental crimes even putting the liability at $30-40 billion.

The Justice Department could also levy fines of $31 billion under the Oil Pollution Act, with federal agencies controlling how the money would be spent, while states have discretion over 80 percent of fines collected under the Clean Water Act, due to the Restore Act recently passed by Congress. Corporations can also deduct fines paid under the Oil Pollution Act from corporate taxes.
Prior to the settlement announcement of $4.5 billion for criminal charges, BP had spent more than $14 billion on operational response and $1 billion on restoration costs, as well as paid out $9 billion to individuals, businesses, and governments for their losses. Plus, there will likely be an additional settlement of $7.8 billion for medical costs and economic loss from the trust established by the company and administered by Kenneth Feinberg. The total amount already to be paid is about $36.3 billion, while the potential liability under the Clean Water Act and Oil Pollution Act could exceed another $50 billion. Hence, any means the company could take to limit liability, e.g., through the settlement, are prudent.

In addition to the $38 billion in charges that BP has already taken, it will charge off another $3.85 billion due to the settlement, with more likely to come. BP’s stock is down 34 percent since the April 2010 disaster, but has recovered since its low. It has sold $35 billion in refinery assets to help finance its legal liabilities, while the company made $25.8 billion in profits last year.
Reactions to the settlement by environmental critics have varied. The chief executive of the National Audubon Society said it “matches the unprecedented offense BP committed.” Greenpeace blasted the settlement as “a rounding error for a corporation the size of BP,” while the director of Public Citizen’s energy program called the settlement “inadequate to address BP's repeated criminal conduct.” Leading legal experts consider the settlement to be fair.


A Change to Neither Admit nor Deny

The WSJ reported that the SEC has changed its policy of settling cases where defendants neither "admit nor deny" the alleged facts.  The Agency will not permit the practice where "the companies admit to or are convicted of criminal wrongdoing." 

Despite the timing, consideration of the policy change looks to have commenced before the current fracas over the Citigroup decision.  The Journal reported that the policy change came "after a review by senior enforcement staff last spring and separate discussions with commissioners 'over the last several months.'"

The change is a common sense one and will not affect a large number of cases.  Nonetheless, it does show that review of the practice resulted in a more nuanced application.  The Citigroup decision could have encouraged this type of analysis.  Unfortunately, by focusing on elimination of the practice rather than more nuance in application, this encouragement did not occur.   


SEC v. Rajaratnam: Court Orders $92 Million Penalty for Insider Trading

In SEC v. Rajaratnam, No. 1:09-cv-8811-JSR (S.D.N.Y. Nov. 8, 2011), the court granted the Securities and Exchange Commission’s (“SEC”) motion for summary judgment against the defendant for insider trading in violation of Section 10(b) of the Securities and Exchange Act of 1934 and Section 17(a) of the Securities and Exchange Act of 1933. 

The SEC sought “disgorgement, prejudgment interest, injunctive relief, and civil penalties” as the result of the defendant’s alleged insider trading on shares of Intel Corp., Clearwire Corp., Akami Technologies, Inc., and PeopleSupport, Inc.  In the parallel criminal case, the judge sentenced the defendant to 11 years in prison, forfeiture of $53.8 million, and $10 million in criminal penalties.  The defendant conceded that based on the criminal conviction, “he was collaterally estopped from contesting liability for insider trading.”  In turn, the SEC conceded that its request for $31.6 million in disgorgement was rendered moot by the criminal sentence.  Based on the parties’ concessions, the only remaining issue for the court was whether civil penalties should be imposed and in what amount. 

District courts are authorized to assess civil penalties against inside traders under Section 21A of the Exchange Act.  To determine the amount of the penalty, the courts typically consider “‘(1) the egregiousness of the defendant’s conduct; (2) the degree of the defendant’s scienter; (3) whether the defendant’s conduct created substantial losses or the risk of substantial losses to other persons; (4) whether the defendant’s conduct was isolated or recurrent; and (5) whether the penalty should be reduced due to the defendant’s demonstrated current and future financial condition’.”  In this instance, the court also considered the penalty assessed in the criminal action.  Whereas criminal punishment focuses on compensating the victims and the defendant disgorging ill-gotten profits, civil penalties are imposed to make insider trading a “‘money-losing proposition . . . [and show that inside traders] are going to pay severely in monetary terms.”

The court determined that civil penalties were necessary based on the defendant’s high net worth and the “huge and brazen nature” of the insider trading scheme.  Although the court agreed that treble damages were appropriate in this instance, the court still had to determine what was the “‘profit gained and loss avoided’.”  The defendant argued that his profit gained or loss avoided should only be the amount directly connected to his use of insider information.  However, the court used Congress’ definition of “profit gained” or “loss avoided” which is the difference between the trading price “at a ‘reasonable period after public dissemination of the nonpublic information’” and the price paid by the defendant.

The SEC and the defendant agreed that within 24-hours of the announcement was a reasonable period of time, but arrived at a base figure for the penalty of $33,512,929 and $30,935,235 respectively.   The court held that despite the difference in the penalty calculated by the SEC and the defendant, trebling of the defendant’s calculation for a civil penalty of $92,805,705 would “still fulfill all the purposes of a civil penalty.”  In addition to the criminal penalties previously imposed, the court imposed a civil penalty of $92,805,705 and permanently enjoyed the defendant from violating the insider trading laws under the Exchange Act and Securities Act. 

The primary materials for this case may be found at the DU Corporate Governance website 



U.S. v. Ferguson: Second Circuit Reverses Convictions for Four Gen Re Executives and One AIG Executive 

In United States v. Ferguson, 2011 WL 3251464 (2d. Cir. Aug. 1, 2011), the court vacated the convictions of four executives of General Reinsurance Corporation (“Gen Re”) and one executive of American International Group, Inc. (“AIG”) (together, “defendants”).  The court remanded the case for a new trial.  

The case involved allegedly misreported reinsurance arrangements.  Loss reserves are liabilities that estimate expected claims on insurance contracts.  When new policies are written, analysts expect loss reserves at insurance companies to go up.  Loss reserves can be transferred between companies through reinsurance agreements.  In these agreements, an insurer purchases insurance from a reinsurer and cedes substantial risk to the reinsurer.  According to the Financial Accounting Standards (“FAS”) section113, a reinsurance transaction must have significant risk for the reinsurer.  An industry rule of thumb requires that a transaction with more than a 10% chance of incurring a loss greater than 10% is acceptable under FAS 113.  Any transition that does not meet these criteria cannot be booked as reinsurance.

In late October 2000, AIG and Gen Re began negotiations for a reinsurance deal in which AIG would be the reinsurer of Gen Re.  The government alleged that the defendants crafted a no-risk reinsurance transaction; AIG would “borrow” a range of Gen Re’s loss reserves without incurring any of the risk as a reinsurer normally would.  A jury convicted all defendants of all charges.

On appeal, the defendants alleged the district court abused its discretion in admitting bar charts showing AIG’s stock price into evidence and in issuing various jury instructions.  The defendants also alleged prosecutorial misconduct.  

The court agreed that the bar charts should not have been admitted.  The charts, the court reasoned,  suggested that the transaction at issue alone  caused AIG shares to decline 12% during the relevant period.  The  reinsurance transaction, however, was only one of many problems plaguing AIG at the time.  Thus, there were other possible causes for the decline in stock prices in addition to the challenged transaction.  

The court also held that the district court incorrectly instructed the jury.  The statute required proof that defendant “willfully cause[d]” the act that resulted in the offense.   In an attempt to accommodate phrasings offered by both parties, the court constructed a jury instruction that addressed the requisite act ("did the defendant act") and the requisite mental state but not causation.  As a result, the court held, the instruction allowed the jury to convict without a finding of causation.   

The court also addressed allegations of prosecutorial misconduct.  Defendants alleged, among other things, that the government knew a witness was testifying falsely involving what the court described as a claim for eliciting perjury.   Given the inconsistencies in a key witness’s testimony, the court agreed there was some indicating that the  the witness may not have testified truthfully.  Although expressing skepticism over the claim, the court declined to resolve the issue, having already  reversed on other grounds.  As the court noted:

Since we are vacating the judgments on the grounds discussed above, we need not reconcile these cases or decide whether the prosecution's actions amounted to misconduct. (Our decision would have been hindered by the defendants' gamesmanship; and their fact-intensive arguments are blunted by the underdeveloped record.) No doubt it is dangerous for prosecutors to ignore serious red flags that a witness is lying, and the government will doubtless approach Napier's revised recollections with a more skeptical eye on remand. At the same time, Napier's inconsistent statements concern facts that could not have been conclusively verified by the government, and the potential that Napier had lied in these respects was fully presented in cross-examination and summation to the jury, which resolved the credibility issue against the defendants.

The primary materials for this case may be found on the DU Corporate Governance website.


Rajaratnam Sentenced

Raj Rajaratnam received an 11 year sentence, something that the WSJ describes as the longest ever in an insider trading case.  It was much shorter than what the government had been seeking.  He was also required to pay a $10 million fine and to forfeit $53.8 million.

Sentences in insider trading cases are getting longer.  Rajaratnam's sentence may have been at least in part designed to send a message to those who opt to go to trial rather than accept a plea.  At the same time, however, one has to wonder whether the government would have offered a plea that would have entailed a sentence of much less than the eleven years.  In other words, the risk taken by Rajaratnam in going to trial, although ultimately unsuccessful, may have been a good one.

For the sentencing memos in the case, go to the DU Corporate Governance web site. 


Rajaratnam, Rule 10b-5 and the Common Law

Raj Rajaratnam was originally scheduled to be sentenced this week.  The government was asking for an extraordinary sentence of between 19 and 24 years.  We have posted the sentencing memos submitted by both the government and Rajaratnam.  Resolution will have to wait until mid-October.  The trial judge postponed the sentencing until Oct. 13.

There has been commentary already about the fact that sentences in white collar cases cases have grown in length.  Peter Lattman's article at the Deal Book does a nice job on this.  As he notes:

  • Today, prison terms measured in decades are common for white-collar criminals. In 2005, Bernard J. Ebbers, the former chief executive of WorldCom, was sentenced to 25 years in prison for a huge accounting fraud. Earlier this year, Lee B. Farkas, a former mortgage company executive, received a 30-year term for his role in a fraud that the government says caused $2.9 billion in losses. On Monday, a federal judge in Miami sentenced Marianella Valera, a former mental health company executive, to 35 years in prison for her role in a $205 million fraud at American Therapeutic; a 50-year sentence was earlier imposed on her co-defendant, Lawrence Duran.

From a broader perspective, Rajaratnam's sentencing illustrates something most American lawyers rarely think about. 

The US uses the common law rather than the civil law system of justice.  The common law system is built around judge made law, whether law created ab initio or judicial interpretation of statutes.  While all systems use judges and all judges must interpret, they have far less breadth in civil law countries.  Thus, in many civil law countries, judges do not come from private practice but are selected based upon tests taken after law school.  It reflects the role of judges where technical knowledge is more important than private experience. 

Insider trading is an example of the common law approach that ought to startle even common law lawyers.  While its true that insider trading is loosely based on a rule (rule 10b-5) which is in turn loosely based on a statute (Section 10(b)), the reality is that almost every important element of the requirement has been devised by a court.  This includes a private right of action which the administrative father of the rule indicated he never contemplated.  With respect to insider trading, courts have added a complicated gloss that looks at such things as duty, benefit, and temporary insider status.  Try to find any of that language in the statute or the rule.

But beyond the judicial nature of the requirement are the consequences.  Courts make up the law but defendants, such as Rajaratnam, can go to jail for this judge made law.  Moreover, as the government is proposing, they can go to jail for decades.  There is an element of flexibility in the common law system but also unpredictability.  As Raj Rajaratnam will see, it is a system with judge made law and judge made sentences.   


The Rajaratnam Trial and Counsel

Raj Rajaratnam was represented by John Dowd from Akin Gump. Take a look at the email he sent to Chad Bray, a reporter for the WSJ when he was unhappy about an article that came out. Its on p. 9 and 10 of the online version of Dirty Business, an article on the trial in the New Yorker.  One suspects that Mr. Dowd did not expect to see the email in the New Yorker but it is a risk that comes with sending it to a third party.


The Rajaratnam Trial and the Integral Role of the SEC

The New Yorker this week includes an article about Galleon, Raj Rajaratnam and Preet Bharara, the US Attorney bringing the case.  The most interesting thing about the case is the role played by the SEC in detecting the fraud and causing the US Attorneys Office to initiate the investigation.  As the article described:  "In March, 2007, the S.E.C. briefed the F.B.I. and the United States Attorney’s Office for the Southern District of New York, which opened a criminal case."  

Most interestingly, the SEC staff identified a party that potentially had information about possible insider trading at Galleon, Roomy Khan.  The witness was turned over to the FBI who promptly questioned her.  The testimony of the witness and her actions afterwards provided the basis for the all important wiretaps. 

  • As part of her coöperation, Khan began recording her calls with Rajaratnam. She caught him on enough “dirty” calls that, in March, 2008, Judge Gerard E. Lynch, of the Southern District, approved the government’s application for a thirty-day wiretap on Rajaratnam’s cell phone. The order was renewed through the rest of the year. The Rajaratnam recordings led to taps on other phones, including Chiesi’s, and identified other conspirators, harvesting a huge crop of direct evidence. By the time of the October, 2009, arrests, the government had taped thousands of calls.

And when the case went to trial, there was Johanthan Streeter and Reed Brodsky from the US Attorneys Office.  In addition, though, there was Andrew Michaelson from the SEC.  Why?  According to the New Yorker, "he knew more about the Gallenon case than anyone else."

In other words, this case emerged from hard and skilled work by the SEC.  This does not diminish what the US Attorneys Office did.  The lawyers there had to take the handoff and make it work, which they did.  But had the SEC not done its job, this case would never have been brought.

In the post-Madoff period when the SEC has to live with the criticism that came from missing some frauds (and has that used against it by some in Congress in the funding battles), it deserves credit when its hard work and skill result in critically important cases.  The SEC's role in the Rajaratnam case is one such example. 


The Rajaratnam Verdict: The Power of Wiretaps

Its probably safe to say that for most people a conviction wasn't a huge surprise.  Its probably also safe to say that a conviction on all 14 counts was a surprise.  Without any question, some of the counts were much strong than others.  Moreover, some of witnesses had serious credibility issues.  Finally, not every count had incriminating tapes.  It was reasonable to expect some of them to result in an acquittal or at least a hung jury.

But the jury didn't and this demonstrates the power of the wiretaps in an unequivocal way.  A handful of the wiretaps were hard to get around (involving very specific types of non-public information) and probably allowed the jury to easily convict on some of the counts.  Once the jury determined that Rajaratnam engaged in insider trading on a few counts, they most likely didn't believe the denials on all of the others.  In other words, weak counts become stronger when there is solid wiretap evidence on even one of them.


Lack of Judgment does not Constitute Insider Trading: SEC v. Obus

In Securities and Exchange Commission v. Obus, 2010 WL 3703846 (S.D.N.Y. Sept. 20, 2010), the Securities and Exchange Commission (“SEC”) alleged that defendant Nelson J. Obus (“Obus”) along with codefendants Peter F. Black and Thomas Bradley Strickland were guilty of insider trading – a violation of the prohibition of deceptive conduct under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  

The SEC claimed that Strickland, while an employee at GE Capital Corp. (“GE”), tipped off Black who at the time worked as an analyst at Wynnefield Capital, Inc. about the potential acquisition of SunSource, Inc. (“Sunsource”).  Black allegedly alerted his superior, Obus, who in turn executed a purchase order of SunSource stock. The SEC asserted two theories of insider trading: the “classical” theory and the “misappropriation” theory.

Under either theory, the parties agreed that the tipper must have possessed material, non-public information about the publicly traded corporation, that the tipper divulged this information to the tippee, that the tippee in question traded in the particular corporation’s stock while privy to this information, that the tippee violated the trust of the corporation in question by sharing the information, and that the tippee benefited from the disclosure.  The issue in the case concerned the fourth element, the need for a breach of a duty. 

The “classical” theory of insider trading applies not only to officers, directors, and other permanent insiders of a corporation, but also to "temporary insiders" such as third party consultants, accountants, or attorneys. Under this theory, the SEC would have to prove that Strickland became a temporary fiduciary and subsequently violated that duty. The court acknowledged that "[f]inancial consultants, including underwriters such as GE Capital, working for a corporation may become "temporary insiders" of a corporation." 

For temporary insider status to arise, however, it was not enough to allege possession of nonpublic information.  "Instead, "a fiduciary relationship, or its functional equivalent, exists only where there is explicit acceptance of a duty of confidentiality or where such acceptance may be implied from a similar relationship of trust and confidence between the parties." Id. To establish acceptance, the plaintiff must show defendant was on notice of his duty not to use or disclose the material non-public information."

Because, however, GE Capital had not admitted having accepted a fiduciary duty, the court had to resolve whether "a duty can be implied, and acceptance inferred, from the parties' relationship absent a transaction-specific, written, confidentiality agreement?"  The court concluded that under the facts of the case, no duty had arisen.

  • In the instant case, there is a lack of a specific confidentiality agreement or a retainer payment, and the dearth of facts sufficient to imply communication of an expectation by SunSource or acceptance of a fiduciary duty by GE Capital  vis-a-vis the borrower/lender relationship. Additionally, the fact that SunSource was negotiating  with other lenders as of the May 24, 2001, date of the alleged tip, establish that no reasonable fact-finder could find the existence of the required fiduciary relationship or its functional equivalent. Even if, as alleged, GE Capital  received confidential information, and SunSource unilaterally expected it to remain as such, the absence of any ascension on the part of GE Capital  to accept such a duty precludes a finding of liability under Section 10b and Rule 10b-5.  The "absence of any expectation of confidentiality or breach of a duty of confidentiality is fatal to the SEC's claim." . . . Even after independently searching the record and resolving any and all inferences in favor of the SEC, the Court cannot identify the critical facts required to establish the existence of an enforceable duty. The SEC cannot prove from the facts on record that GE Capital  or Strickland owed a duty of confidentiality to SunSource as of May 24, 2001. Accordingly, judgment must be entered in favor of the Moving Defendants and Strickland with regards to the SEC's claims under the "classical" theory of insider trading.

As for the “misappropriation” claim, the SEC had to show that the defendant breached a duty of trust and confidence.  The court conceded that the defendant had a fiduciary relationship with GE Capital.  Nonetheless, the defendant did not act with scienter when he violated the duty by disclosing the nonpublic information.  In effect, the court held that no deliberate breach of the duty of trust and confidence occurred. 

In reaching the determination, the court looked to the actions of the employer, GE Capital.  The company, according to the court, "did not find that Strickland breached this duty, stating, following an investigation, 'that Brad Strickland made a mistake by. . . inquiring about the borrower that GE Capital  Click for Enhanced Coverage Linking Searcheswas looking to provide the financing for, and that he did not do it with any sort of malice or intent.'"  The SEC, according to the court, could show no deception "beyond the trade itself." 

As a result of these findings, the court granted the defendant's motion for summary judgment.

The primary materials for this case may be found on the DU Corporate Governance website. 


Broker Duties and FINRA's Regulatory Notice 10-22

Brokers, in selling securities to customers, have certain duties and obligations.  These were the subject of Regulatory Notice issued by FINRA earlier in the Summer. 

Regulatory Notice 10-22 creates no new law but reminds broker-dealers of two things when recommending an investment sold without registration under Regulation D.  These are the duty to conduct reasonable investigations and to perform investor suitability requirements.  Both require, among other things, the acquisition of basic information about the issuer selling the securities. 

Broker-dealers have a duty to perform reasonable investigations "concerning that security and the issuer’s representations about it" when recommending Regulation D offerings to investors.  The nature of the investigation "depends, among other factors, upon the nature of the recommendation, the role of the broker in the transaction, its knowledge of and relationship to the issuer, and the size and
stability of the issuer."  The duty is not a discretionary duty; conducting a reasonable investigation is obligatory.  Moreover, to the extent lacking "essential information about an issuer or its securities when it makes a recommendation," the broker must "disclose this fact as well as the risks that arise from its lack of information."

Finally, while the broker often relies on information obtained by the issuer of the securities, the Regulatory Notice calls for caution in doing so.  As FINRA describes:

  • In general, however, a BD “may not rely blindly upon the issuer for information concerning a company,”14 nor may it rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation.  While BDs are not expected to have the same knowledge as an issuer or its management, firms are required to exercise a “high degree of care” in investigating and independently verifying an issuer’s representations and claims.16 Indeed, when an issuer seeks to finance a new speculative venture, BDs “must be particularly careful in verifying the issuer’s obviously self-serving statements.”

The Regulatory Notice also reminded brokers of their obligation to conduct a suitability inquiry. The security must be suitable for the specific customer.  As FINRA points out, this requires more than an assessment that the investor meets the standards for accredited investor in Regulation D.

  • The fact that an investor meets the net worth or income test for being an accredited investor is only one factor to be considered in the course of a complete suitability analysis. The BD must make reasonable efforts to gather and analyze information about the customer’s other holdings, financial situation and needs, tax status, investment objectives and such other information that would enable the firm to make its suitability determination. A BD also must be satisfied that the customer “fully understands the risks involved and is…able…to take those risks.”

The suitability investigation also requires some knowledge about the company issuing the securities. This includes the company's business prospects, assets, and intended use of the proceeds, as well as a reasonable investigation into any claims being made by the company. 

The Regulatory Notice also sets out circumstances that can raise additional responsibilities for a broker in the context of recommending securities.  These include affiliations with the issuer, participation in the drafting of the private placement memorandum, and the consequences of uncovering red flags.  The Notice also sets out reasonable investigatory practices. 


SEC v. Benger: Charging the Escrow Agent 

In Securities Exchange Commission v. Benger, et al., No. 09 CV 676, 2010 WL 918065 (N.D. Ill. Mar. 10, 2010), the SEC brought an action against defendants for assorted violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, as well as equitable relief, in connection with an allegedly fraudulent securities offerings under Regulation S.  The SEC’s complaint grouped defendants into two categories:  (1)  Distribution Agents who allegedly masterminded the fraud, and (2)  Escrow Agents who allegedly assisted the Distribution Agents.  This case involves a motion to dismiss by Philip T. Powers ("Powers"), one of the alleged Escrow Agents. 

The SEC asserted that defendants collectively ran a “boiler room” scheme.  The Distribution Agents allegedly entered into agreements with issuers selling shares purportedly exempt from registration under Regulation S.  Under the agreements, 60% of the investors’s proceeds for sales of securities went to Distribution Agents as commission – characterized by the SEC as “penny stocks.” 

According to the allegations, Distribution Agents employed what the SEC referred to as “boiler room agents” – sales agents located outside the US who use aggressive sales methods to persuade citizens to invest.  These agents made cold calls to elderly British and European citizens, pressuring them to invest.  The binding Share Purchase Agreements failed to disclose that the commission charged exceeded 60% of the total consideration paid by the investors.  Instead, it falsely notified investors of a nominal fee of $50 or 1% of cost of shares. 

Escrow Agents collected investors’s payments and then distributed the sales proceeds. Specifically, Powers was alleged to have acted as the Escrow Agent for many of the penny stock transactions in question.  According to the SEC, Powers, as an agent for Handler, Thayer & Duggan, maintained control of the investors’ bank and brokerage accounts.  Additionally, he purportedly received the foreign investors’ money and distributed the monies according to agreement.  At no time during his participation in the scheme did he register with the SEC as a broker or a dealer. 

Count IV of the SEC’s complaint accused Powers of aiding and abetting, alleging that he provided “substantial assistance with either knowledge of the material misrepresentation and omissions concerning commissions, or with a reckless disregard of the fraud.”  To determine if the SEC sufficiently stated a claim for aiding and abetting a securities violation, the court looked to whether the SEC sufficiently alleged that Powers acted with the requisite scienter and substantially assisted the Distribution Agents.

First, the court held that the SEC sufficiently pled facts that Powers had knowledge of the Distribution Agents’ assumed fraud. The SEC asserted that Powers knew that the scheme distributed more than 60% of the investors’s funds to Distribution Agents as commission because he personally allocated the monies among the agents.  He was also alleged to have dealt directly with the Share Purchase Agreements and knew of the misleading statement regarding the nominal fee charged to investors.  The court also found that because of Powers’s own expertise in securities law, it could be inferred that he knew that a commission exceeding 60% was not normal practice.  See Id.  ("Furthermore, considering Powers' own expertise in compliance with securities laws, it may also be inferred that Powers himself would have known that charging commissions in excess of sixty percent in connection with the sales of securities was not customary.").  Therefore, the court found that the Commission had alleged facts sufficient to show that Powers acted with the requisite scienter. 

Second, the court found that the SEC alleged facts sufficient to establish that Powers substantially assisted the Distribution Agents in the fraud.  To establish this element, the SEC had to show that “the aider and abettor proximately caused the harm to [the victim] on which the primary liability is predicated.”  As the court concluded:   

  • Powers is alleged to have played an integral part in the completion of the sale to the investor by, inter alia, taking custody of and distributing the investors' funds according to the terms of the escrow agreements, which were corollaries to the distribution agreements; receiving and processing the signed SPAs [Share Purchase Agreements], which failed to disclose the exorbitant commissions; communicating the receipt of those SPAs to the issuers; and sending the investors their share certificates, which, as far as the investors' knew, meant that their total consideration have been transmitted to the issuer.

Count V of the SEC’s complaint alleged that Powers failed to register as a broker or dealer as required by Section 15(a)(1) of the Securities Exchange Act of 1934 (“the Act”).  The court stated that whether Powers acted as a broker within the meaning of the Act depended on whether he was engaged in the business of “effecting transactions in securities for the account of others.”  The court held that the SEC sufficiently alleged that Powers was “effecting transactions in securities for the account of others.”  He received compensation based on the gross proceeds of the sale, collected investors’s funds, distributed the monies among agents, and received and processed documents relating to the securities sales.  Accordingly, the court held that the SEC sufficiently stated a claim under Section 15(a) and therefore denied Powers’ motion to dismiss Count V of the SEC’s complaint.  As a result, the court found the SEC’s motion to strike portions of Powers’s reply brief relating to Count V as moot. 

The primary materials for this case may be found on the DU Corporate Governance website.  


Former KB Home CEO Found Guilty

On April 21, 2010, a federal jury in the Second Circuit found Bruce Karatz, the former CEO of KB Home, guilty of four felonies in a stock backdating scam.  Karatz was found guilty of two counts of mail fraud, one count of lying to company accountants, and one count of making false statements in reports to the Securities and Exchange Commission. 

The case involved allegations of backdating. Karatz was said to have set his stock option price at dates in the past when the share price was low.  In doing so, this allegedly allowed Karatz to sell the shares at a much higher profit at a later date.  The prosecution contended that Karatz backdated options from 1998 to 2005 and made over $6.62 million in profits as a result.

Backdating itself is not illegal.  The violation arises out of the failure to properly disclose or account for the options.  Karatz failed to disclose to investors that his own stock options were retroactively granted on dates when the price was low.

The prosecution argued that Karatz changed a company policy regarding stock option awards, then took advantage of his own new policy, concealing it from investors.  The defense attorneys responded that Karatz did not knowingly break any laws.

Although guilty on four counts, Karatz was acquitted on sixteen others, including securities fraud, wire fraud, and filing false proxy statements.  Defense attorney John Keker said that the defense plans to appeal the four felony convictions.

Other recent backdating government convictions include Gregory Reyes, the former chief executive of Brocade Communications, Kobi Alexander, the former chief executive of Comverse Technology, and  James Treacy, the former president and chief operating officer at Monster Worldwide.

Additional posts regarding backdating in the criminal context can be found here, here, and here.

The primary materials for this case may be found on the DU Corporate Website.



The Foreign Corrupt Practices Act and Control Person Liability: SEC v. Nature's Sunshine Products 

In SEC v. Nature's Sunshine Products, Inc. (“NSP”), and SEC v. Douglas Faggioli and Craig Huff (collectively “Nature’s Sunshine”), the SEC brought a suit in the Federal District Court of Utah under control person liability based on an unprecedented extension of the Federal Corrupt Practices Act (“FCPA”).    The SEC claimed that when NSP allegedly made cash payments to bypass government regulations, control person liability applied because NSP’s business records and internal accounting controls failed to accurately record the alleged bribes.  However, without admitting guilt, the defendants consented to a final judgment, thereby closing the case.

NSP is a Utah based corporation which manufacturers nutritional and personal care products.  It has subsidiaries in 21 foreign countries, including Brazil (“NSP Brazil”).  By the late 1990’s, Brazil was NSP’s largest foreign market responsible for $22 million in sales in 2000.  At the height of NSP’s Brazilian profits, Brazil reclassified certain vitamins, herbal products, and nutritional supplements as medicines, which required NSP Brazil to register previously sold products as medicines.  NSP Brazil attempted, unsuccessfully, to reclassify numerous products, resulting in a massive decline in sales revenue, down to $2.6 million in 2003. 

The SEC alleged that in an effort to sell NSP’s products without the required re-classification, NSP engaged in bribery.  Specifically, NSP made undocumented cash payments totaling over $1 million, which it booked as importation advances to customs brokers and customs officials.  In November, 2001, a new controller discovered that NSP Brazil had made eighty undocumented cash payments. 

The SEC brought five causes of action against NSP and its former CEO and CFO, alleging illegal payments to foreign officials, securities fraud, false filings, and books and records violations.  The SEC brought an action against the officers relying on control person liability. 

Along with the SEC’s traditional securities violation claims, the SEC broke into uncharted territory by using the FCPA to charge the officers with control person liability based on the violation of books and records and internal controls provisions of the securities laws.  As stated in a client publication by the law firm Shearman & Sterling, the SEC rarely uses control person liability in FCPA cases.  The SEC relied upon Section 20(a) of the Exchange Act to expand control person liability.  Section 20(a) states:

  • Every person who, directly or indirectly, controls any person liable under the provision of this chapter or any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.” 

Although the SEC never claimed the former officers had any personal knowledge, activity, or awareness of the cash payments, the indirect supervisory oversight of fraudulent records from NSP Brazil was enough to establish control person liability for both officers.  Both were charged despite the language in Section 20 that excepted those who did not “directly or indirectly induce the act.” 

Because the Nature’s Sunshine defendants consented to a Final Judgment without admitting or denying the allegations, this case was not actually litigated and no fact finder resolved the underlying issues.  The company agreed to a permanent injunction, stipulated to implement a more vigorous accounting system, and pay $600,000.  Each former officer agreed to pay $25,000. 

Although the case holds no precedential value, it does show an aggressive enforcement policy by the SEC and its willingness to use control person liability to bring actions against individuals who played no actual role in the illegal payments but had some type of supervisory responsibility.  It may portend more actions against supervisory personnel in the future. 

The primary materials for this post are available on the DU Corporate Governance website.


SEC v. Tambone: Specificity, Scienter, and 10b-5 violations; Part 2 

In a previous post this blog covered the First Circuit’s decision in SEC v. Tambone, the case against James R. Tambone and Robert Hussey, executives of Columbia Funds Distributor, Inc., for violations of federal securities laws.  Neither defendant made false statements, but the SEC alleged that they distributed prospectuses that they knew were misleading.  The court held that the SEC's allegations met the elements § 10(b), Rule 10(b)-5, § 206 of the Investment Advisors Act, and § 15(c) of the Exchange Act, reversed and remanded the case for further proceedings.

This blog also covered the en blanc rehearing pending in front of the full First Circuit.  Tambone’s supplemental brief, focused on the SEC's "implied representation" theory.  The “implied representation” theory is that underwriters make an implied representation as to the truthfulness and completeness of disclosure documents.

In the SEC’s supplemental brief, the Commission noted that the Supreme Court has repeatedly and expressly made clear that § 10(b) should be construed flexibly to effectuate its remedial purpose, and that a strict or technical reading would unduly hamper the Commission and run contrary to Congress’ goals.  The Court has limited only private actions, and when doing so, explicitly stated that such limitations were inapplicable to Government enforcement actions.

The SEC asserted that, within the properly construed meaning of Rule 10b-5(b), defendant’s use of misleading statements was unlawful.  The Supreme Court has noted that the language of 10b-5(b) is broad and “obviously meant to be inclusive.”  Affiliated Ute Citizens of Utah v. United States, 406 U.S. at 151.  The SEC contrasted this to Tambone’s assertion that the scope of “making statements” is limited to those who draft the statement, and not to those who direct the drafter, or those who endorse or distribute the drafting in a prospectus.  The SEC also noted that , the Supreme Court and the Fourth Circuit have included dissemination as a critical part of “making” statements.

The SEC also argued that the implied representation theory is central to the SEC’s mandate to regulate securities professionals, noting that courts have historically endorsed this theory in numerous cases and contexts.  Furthermore, the Commission’s interpretation is entitled to “substantial deference” unless it is plainly erroneous or inconsistent with the regulation.

While Tambone asserted that the earlier aiding and abetting decision depends on the implied representation theory, the SEC argued that this argument is without merit.  The SEC referred to the First Circuit judicial panel’s finding that did not rely on the implied representation theory, and that it did find that Tambone had a duty to correct misleading statements.  

The primary materials for the post are available on the DU Corporate Governance website.


Reyes' Conviction Reversed: Pocedural Misconduct Warrants New Trial

In January, this blog reported the $15 million fine and sentencing of Gregory Reyes (“Reyes”), former CEO of Brockade Communication Systems, Inc., for backdating options.  On August 18, the Ninth Circuit Court of Appeals reversed Reyes’ conviction due to prosecutorial misconduct and remanded for a new trial.

During the trial, Reyes argued that he lacked the necessary criminal intent to knowingly deceive because he disclosed the backdating to the Finance Department and the corporation disclosed the backdated options as expenses on the financials.  However, during closing arguments, the prosecutor in the trial told the jury that the Finance Department did not know that the backdating was occurring.  Reyes moved for a new trial on the grounds of prosecutorial misconduct, arguing that the prosecutor prejudiced the jury by offering this statement without supporting evidence.  The trial court denied the motion, reasoning that the prosecutor’s verbal slip was harmless error. 

The Court of Appeals disagreed, and found that Reyes’ defense relied upon convincing the jury that the Finance Department was aware of the backdating and that Reyes was merely deferring to its judgment.  In coming to its conclusion, the Court pointed to the seven days it took the jury to deliberate, the prejudicial effect of making false statements during closing arguments, and the influence prosecutors have over the public.  The Court found the prosecutor’s error particularly blatant because one of the Finance Department’s employees was a witness for the prosecution who testified that she knew of the backdating scheme.  This testimony was further corroborated by other Finance Department employee statements gained through an FBI investigation.

Reyes also argued that the misconduct was sufficient grounds to dismiss the indictment.  The Court disagreed on this point, only stating that the prosecutor’s conduct was not so egregious as to rise to the level of dismissing the indictment.  However, the procedural error was sufficient to remand to the district court for a new trial.

The primary materials for this post are available on the DU Corporate Governance Website.



Nacchio Gains a 10th Circuit Court Victory on his Sentence and Forfeiture

Yesterday, the 10th Circuit panel reversed Nottingham’s “gain” and forfeiture determinations and remanded the case back to the district court to follow the 10th Circuit’s instructions on the proper calculations. These instructions could have the effect of reducing the “gain” for federal sentencing purposes to reduce Nacchio’s six year sentence to 3 to 4 years and of reducing his forfeiture of approximately $52,000,000 to $44,600,000 representing the gross proceeds of $52,000,000 less the brokerage expenses and perhaps the cost of exercising the options. Unless the 10th Circuit en banc reverses this same panel of judges (2 to 1 prior decision to grant Nacchio a new trial), today’s unanimous panel decision will create a conflict with the Mooney en banc decision in the 8th Circuit triggering automatic review by the U.S. Supreme Court.  Currently, the Supreme Court is considering whether to hear Nacchio’s appeal for a new trial from the first 10th Circuit en banc decision upholding his original conviction.  The decision yesterday is at the 10th Circuit’s website. I will analyze the “gain” for purposes of the federal sentencing guidelines first.

Determination of the “Gain” for Purposes of the Federal Sentencing Guidelines

A factor in sentencing Nacchio was the gain or total increase in value realized through insider trading. Before siding with Nacchio’s argument, the 10th Circuit’s decision explained how Nottingham adopted the majority decision in Mooney, (United States v. Mooney, 425 F.3d 10903 (8th Cir. 2005) (en banc, 9 judges for the majority, 3 dissented--cert. denied 2006). Nottingham determined this “gain” was approximately $28,000,000. This was based upon the government’s calculation of approximately $44,000,000 ($52,000,000 sales from insider trading less the cost of the options for the stock and brokerage fees). However, Judge Nottingham reduced the gain further by the $16,000,000 in income taxes that was withheld which I blogged at the time was inconsistent with Mooney. For background on how I viewed the error by Nottingham as a harmless one since his error still resulted in a sentence within the range of the government’s and my perspective, see my July 30th, 2007 post entitled: Judge Nottingham's Sentencing Error a Harmless One.

Nottingham’s determination of the gain from the insider trades resulted in a sentencing range under the Federal Sentencing Guidelines of 63 to 78 months and Nottingham sentenced Nacchio to 72 months (6 years or in the middle of range). As did majority in Mooney, Nottingham specifically pointed to the commentary to Section 2F1.2 of the sentencing guidelines that “because the victims and their losses are difficult if not impossible to identify” in insider trading cases, “the gain, i.e., the total increase in value realized through trading in securities by the defendant ... is employed instead of the victims’ losses.” The 10th Circuit counters that this comment must be interpreted to mean the gain related to the insider trading deception to be consistent with the intent of the underlying federal sentencing guideline.

Nacchio appealed on the basis that the amount of gain is too high since it incorporates the permissible increase in value of Qwest stock before the illegal insider trades. Nacchio pointed to his expert’s calculation that the maximum amount of gain attributable to inside information was approximately $1.8 million which results in a sentencing range of 41 to 51 months (over three years to a little over 4 years).

The 10th Circuit adopted the rationale of the dissent in Mooney on how “gain” was to be computed under the Federal Sentencing Guidelines and then stated the following under “Our Approach” heading:

We further determine that it was incumbent upon the district court to adopt a realistic, economic approach (1) that would take into account that Mr. Nacchio’s offense did not inhere in his sale of the shares itself, but in the deception intertwined with the sales due to his possession of insider knowledge, and (2) that consequently would endeavor to compute his gain for sentencing purposes based upon the gain resulting from that deception. (page 19 of the opinion). 

The 10th Circuit then concluded that the civil disgorgement remedy provides an appropriate guidepost for computing how much of the gain is attributable to the “deception” of insider trading. Lastly, the court noted that its decision was consistent with the key objectives of federal sentencing policy—namely:

Federal sentencing is individualized sentencing: the sentencing court seeks to craft a sentence that fully reflects a particular defendant’s criminally culpable conduct, including the harm caused by it, and the defendant’s personal circumstances....However, if the impact of unrelated twists and turns of the market is ignored in the sentencing calculus then an insider trading defendant is likely to suffer a sentence that is detached from his or her individual criminal conduct and circumstances. And this detachment can have a profound, detrimental impact on another objective of federal sentencing—the elimination of unwarranted disparities between similarly situated defendants. (citing Booker) See pages 38-40 of the decision.

Certainly, the 10th Circuit's fundamental fairness sentiments are laudable.  However, while the 10th Circuit’s professed concern for the market vagaries facing insider trading defendants and the consequential “unwarranted disparities between similarly situation defendants,” the government pointed out that Nacchio, by withholding the material nonpublic information, artificially kept the Qwest stock price higher and longer than it should have. Moreover, I could add that Nacchio, as is the case with any insider, was able to lock in his profits at the time of the insider sales when legally he was required to abstain. Granted the gain has some element of non-deception gain, but Nacchio’s insider trades effectively insulated him from the vagaries of the market place. Who knows how much the stock could have declined (due to industry and national economic trends, for example) while he abstained until the nonpublic information was announced by Qwest? Under this analysis, all the economic gain relates to the insider trading deception and is another rationale for the commentary to Section 2F1.2 under Federal Sentencing Guidelines that the total amount of the gain from the insider trades should be used.

Moreover, the 10th Circuit makes the point that Nacchio should not have his prison term lengthened by the gain prior to the insider trades in 2001 (1997 to 2001). However, it is ironic that the SEC’s civil suit alleges that Nacchio committed Rule 10b-5 financial statement misrepresentation during those pre-insider trading years, but that lawsuit has been postponed during the criminal proceedings.

Finally, it is interesting to note that my prior blog post two years ago made the following observation:

[Nacchio’s position] is not completely without legal merit. In Mooney, there was well reasoned vigorous dissent based on the lack of uniformity that could result in applying the total gain, some of which might not be attributable to the material nonpublic information. Moreover, in the law journal article entitled “Reexamining 'loss' and 'gain' in the wake of Dura Pharmaceuticals v. Broudo -- New Ammunition for Securities Fraud Defendants” (30 Champion 10), the authors provide the following recommendation to legal counsel in Nacchio’s position:

The goal of uniformity in sentencing is clearly undermined by applying the Guidelines in a way that leads to such disparate sentences for defendants who engaged in identical conduct. "Such an application would create a through-the-looking-glass inversion of the Guidelines -- advising unequal sentences for identical crimes -- defeating the chief purpose of the Guidelines." While the "realistic economic approach" adopted in Olis advances the guidelines' goals of uniformity and fairness, the "brightline" rule applied in Mooney sacrifices those goals in favor of expediency.

For all of these reasons, it is difficult to reconcile Mooney with the Fifth Circuit's subsequent holding in Olis, or with the pragmatic approach adopted by the Supreme Court in Dura. Consequently, Mooney should not deter counsel from encouraging sentencing courts, when calculating the gain attributable to insider trading, to apply "thorough analyses grounded in economic reality," aimed at determining the economic impact that the "'defendant truly caused or intended to cause,'" "exclusive of other sources" of impact on the price of the security. (Emphasis added). To see the entire post, see my July 11, 2007 post entitled: The Extreme Importance of the Gain on Nacchio’s InsiderTrades.


Truly, the 10th Circuit has squarely placed this issue front and center for consideration by the U.S. Supreme Court unless reversed by the entire 10th Circuit.  This post is my initial analysis of the 50 pages the 10th Circuit devoted to this issue.  I plan to post a series on each of the critical arguments on both sides of this important legal issue.


Determination of the Amount of Forfeiture

On balance, the 10th Circuit’s decision regarding a reduction of the amount of the forfeiture will probably be upheld, but winning this issue will likely save Nacchio only $60,081.09 out of the $52,007,545.47 forfeiture determined by Nottingham.

Nottingham determined that Nacchio’s insider trading sales should be classified under 18 U.S.C. § 981(a)(2)(A) as an unlawful activity involving “illegal goods, illegal services, unlawful activities, and telemarketing and health care fraud schemes” requiring forfeiture of the gross receipts from the unlawful activity or in Nacchio’s case: $52,007,5745.47. In contrast, the 10th Circuit decided that 18 U.S.C. § 981(a)(2)(B) is the appropriate classification for the illegal insider trading sales since this provision provides:

In cases involving lawful goods or lawful services that are sold or provided in an illegal manner, the term “proceeds” means the amount of money acquired through the illegal transactions resulting in the forfeiture, less the direct costs incurred in providing the goods or services. . . The direct costs shall not include any part of the overhead expenses of the entity providing the goods or services, or any part of the income taxes paid by the entity. (Emphasis added.)

The 10th Circuit reasoned that since selling stock is a lawful activity, but sold in an illegal manner (insider trading), subparagraph (B) applies by its terms and is not covered under subparagraph (A) that “was meant to cover inherently unlawful activities such as robbery that are not captured by the words ‘illegal goods’ and ‘illegal services.’” Otherwise, the court reasoned that under Nottingham’s decision, the proceeds of every section 981(a)(1) offense would fall under the broad definition of subparagraph (A), and subparagraph (B) “becomes a null set.” Citing a more recent case from another judge from the same court that criticized All Funds (the case Nottingham relied upon), the 10th Circuit found the latter case more persuasive. (United States v. Kalish, No. 06 Cr. 656(RPP), 2009 WL 130215, at * (S.D.N.Y. Jan. 18, 2009).

In footnote 27 of the opinion below, the 10th Circuit declined to determine whether the $5 per share option price could also be used to lower the amount of Nacchio’s forfeiture, leaving that decision to the district court:

The government argues that even under § 981(a)(2)(B), it would be erroneous to deduct the exercise costs of the options Mr. Nacchio received as this amount was not “incurred” in the subsequent illegal sales. We express no opinion on whether the costs to exercise the options should be deducted alongside brokerage fees as the district court can revisit that issue in recalculating the forfeiture amount under the proper provision.

It will indeed be interesting to see whether the District Court includes in “direct costs” the $5.50 per share option price paid by Nacchio, but that outcome is far from certain. The calculation below shows the likely net amount Nacchio will save by winning this issue:

Nottingham’s Determination     $52,007,545.47
Less Brokerage Fees                     (60,081.09)
Net Forfeiture                       $51,947,464.38
Less Option Costs                   (7,315,000.00)    Unlikely
Less Income Taxes               (16,078,147.81)    Not allowed under 18 U.S.C. § 981(a)(2)(B)

The issues “Option Costs” and “Income Taxes” will be analyzed in depth in a subsequent post since Nacchio will most assuredly press for both reductions in his forfeiture calculation in district court. For example, at the trial, he asserted that the income taxes of approximately $16,078,147.81 should be allowed since he never received the total proceeds, only the net after the income taxes were withheld.

However, if you are anxious to get up to speed on these issues immediately, you can access my blog posts on these issues after the conviction, but before Nottingham’s sentence. For an extensive analysis of the calculation of Nacchio’s sentence that was later mirrored by the government’s calculation of the sentence for Nottingham to consider, see my April 23, 2007 post entitled: What Prison Term Range will Nottingham Consider? For an extensive analysis of the calculation of the sentence under the federal sentencing guidelines before Nacchio was sentenced, see my July 9th, 2007 post entitled: Government's and Nacchio's Different Perspectives on His Sentence. For extensive background on the issues before Nottingham made his determinations, see my July 11, 2007 post entitled: The Extreme Importance of the Gain on Nacchio’s Insider Trades. For background on how I viewed the error by Nottingham as harmless one since his error still resulted in a sentence within the range of the government’s and my perspective: see my July 30th, 2007 post entitled: Judge Nottingham's Sentencing Error a Harmless One.




Enron Executive Facing Double Jeopardy or Evading Justice?

The fallout of the Enron collapse is still with us. In November 2004, the government indicted F. Scott Yeager, an Enron Broadband Services executive, on charges relating to securities and wire fraud, insider trading, and money laundering. The jury acquitted Yeager on some of the counts, but did not reach a verdict on others. The court declared a mistrial and the government subsequently recharged Yeager. Yeager filed a motion to dismiss and argued that the government was collaterally estopped from pursuing these charges because of the previous acquittals. The district court denied the motion to dismiss, and the appeals court affirmed that decision. Yeager petitioned the Supreme Court, which has now granted certiorari to resolve a split among the circuits. Yeager v. United States, 129 S. Ct. 593 (U.S. 2008).

The Fifth Amendment ensures that a citizen need only prove facts in their favor once. Collateral estoppel is part of the Fifth Amendment protection against double jeopardy. Ashe v. Swenson, 397 U.S. 436 (U.S. 1970). The circuits are divided, however, as to the impact of collateral estoppel on elements common to both the acquitted and hung counts. 

Yeager argued that collateral estoppel bars a retrial on the mistrial counts when two conditions are satisfied: First, a jury must acquit the defendant on multiple counts but fail to reach a verdict on other counts that all share a common element. Second, the court must determine that the only rational basis for the acquittals was also an essential element in the mistrial counts. With those elements already decided in favor of the defendant, a new trial would force the defendant to relitigate an issue of fact that the jury already decided. Yeager argued that this was a violation of double jeopardy, and his Fifth Amendment rights. 

The government had two arguments for why collateral estoppel did not bar a retrial of the hung counts. First, they argued that estoppel applied only if the jury, in acquitting on some counts, necessarily decided a fact that the government must prove beyond a reasonable doubt in order to convict on the second charge. The government also argued that the jury’s rationale was inconsistent since the same facts were essential to both counts yet jury acquitted on one but was hung on the other. With inconsistent verdicts, a defendant has no right to argue that the verdict of acquittal was "the one the jury ’really meant.’" United States v. Powell, 469 U.S. 57 (U.S. 1984).

If the Supreme Court bars the Government from re-trying these counts, Yeager could walk away with no jail time. Yeager will have to face these charges again if the Supreme Court holds that the Fifth Amendment does not bar the previously hung counts. While the public outrage over the Enron debacle might have cooled, for a defendant in a financial scandal case, these are not the best of economic times to face a jury. 

The primary materials for the post, including materials connected to the cert petition, are available on the DU Corporate Governance Website

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Madoff the Murderer?

We look back on the extraordinary testimony given by Harry Markopolos.  There are a number of interesting comments in his written testimony.  One of them concerns his belief that the investigation into the Madoff Ponzi scheme might result in harm to his family or his team.  As he stated:

  • Because nothing was done, I became fearful for the safety of my family until the SEC finally acknowledged, after Madoff had been arrested, that it had received credible evidence of Madoff's Ponzi Scheme several years earlier.

Sometimes the concern about harm was to Markopolos and "his team."  This impacted the material submitted to the SEC.  As he states: 

  • "In order to minimize the risk of discovery of our activities and the potential threat of harm to me and my team, I submitted reports to the SEC without signing them.  My team and I surmised that if Mr. Madoff gained knowledge of our activities, he may feel threatened enough to seek to stifle us.  If Mr. Madoff was already facing life in prison, there was little to no downside for him to remove any such threat.  At various points throughout these nine years each of us feared for our lives.  Or analysis lead us to conclude that Mr. Madoff's fund and the secret walls around it post great danger to those questioning and investigating them."

Markopolos goes on to acknowledge that "neither my team nor I had any personal knowledge of Mr. Madoff or his psychological make up.  As such we had only the conclusions of our investigation into his fund to surmise of what he may have been capable."  Markopolos did know, though, that in fact Madoff "was one of the most powerful men on Wall Street and in a position to easily end our careers or worse."

That Madoff was a crook now seems clear enough.  Was he also a potential thug, prepared to harm those investigating his scheme (or their families?).  Markopolos apparently thinks he was.