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.

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.

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.

 

Yesterday, the 10^th Circuit panel reversed Nottingham’s “gain” and forfeiture determinations and remanded the case back to the district court to follow the 10^th 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 10^th 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 8^th 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 10^th 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 10^th 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 10^th 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 10^th 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 10^th 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 10^th 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 10^th Circuit has squarely placed this issue front and center for consideration by the U.S. Supreme Court unless reversed by the entire 10^th 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 10^th 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 10^th 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 10^th 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 10^th 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 9^th, 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.

 

 

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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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.

Last week, the United States Court of Appeals for the Fifth Circuit affirmed Jeffrey Skilling’s convictions for conspiracy, securities fraud, making false representations to auditors, and insider trading. The court, however, vacated his 24-year sentence and remanded it for resentencing. United States v. Skilling, No. 06-20885, 2009 WL 22879 (5th Cir. Jan. 6, 2009).

 

Skilling argued the court should reverse his convictions because the government convicted him by using an invalid theory of “honest-services fraud.” According to Skilling, the government’s theory did not apply to his case because the fraud was in the corporate interest and therefore not self-dealing. The court, of course, disagreed because no one at Enron sanctioned Skilling’s conduct.

 

Skilling also alleged negative pre-trial publicity made it impossible for him to receive a fair trial in Houston and that actual prejudice tainted the jury box. Proof of “poisonous publicity” raises a presumption the jury was prejudiced. The government may rebut the presumption by showing vior dire impaneled an impartial jury. The court of appeals found sufficient “inflammatory” pretrial publicity because local newspapers ran over one hundred stories that humanized victims and “expressed anger and betrayal towards Enron.” Of the sitting jurors, Skilling only challenged one, Juror 11, for cause. The trial court denied the motion to disqualify Juror 11 because ‘“[it] looked him in the eye . . .’ listened to his answers, and believed he would make the government prove its case.” Although Skilling demonstrated sufficient community bias, the government met its burden of showing the impaneled jury was impartial.

 

Skilling also challenged his sentence under the 2000 Sentencing Guidelines. He argued the trial court's sentence enhancement for jeopardizing the safety and soundness of a financial institution was improper because the “retirement plans” are not “financial institutions.” Resolving the dispute in favor of the defendant, the court found retirement plans, like Medicare, is not a financial institution because it does not require registration with the SEC.

 

On remand, some predict the court could reduce Skilling’s sentence by as many as nine years, leaving him with a sentence from fifteen to nineteen years.

 

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

The NYT reports, based upon a study out of Syracuse, that the number of prosecutions for securities fraud has declined precipitously in recent years.  According to the article:

• There were 133 prosecutions for securities fraud in the first 11 months of this fiscal year. That is down from 437 cases in 2000 and from a high of 513 cases in 2002, when Wall Street scandals from Enron to WorldCom led to a crackdown on corporate crime, the data showed.

The article is a confusing discussion since it attempts to blame the SEC for the decline.  The SEC, of course, has no criminal authority and can only bring civil suits.  Thus, it is a bit confusing to note that the SEC has been placing "increasing emphasis on using non-criminal means."  The article does reveal a decline in the number of referrals made by the SEC to criminal authorities.   But this overstates the importance of referrals and understates the interaction between the two agencies.  Often, the Justice Depatment doesn't need a referral from the SEC, having learned of the fraud the same way the SEC did (often through information that has found its way into the public domain).

Second, while the SEC has a formal referral system, there is plenty of opportunity to informally share information about cases, something more likely to occur when the relationship between the SEC and US Attorneys offices in the regions is strong.  Finally, even when referrals do not occur, the two agencies can share information and cooperate on cases.

The article points out that one reason for the shift in criminal cases is the Bush Administration's emphasis on terrorism after 9/11.  Obviously, as that recedes into the past and events like the Madoff Ponzi scheme surface, the emphasis will shift again. 

One thing ought to be very clear from the article.  The refrain is made constantly that private litigation in the securities area should be cut back and more reliance made on government enforcement (this was a big part of the argument in Stoneridge and one largely bought by Justice Kennedy in his opinion). 

In fact, this article reveals the absolute importance of a vigorous private enforcement mechanism.  And how is that mechanism doing?  While the Justice Department reduces its fraud prosecutions, the prviate sector, unaffected by a shift in resources after 9/11, has increased the number of fraud cases that it is bringing.

In December 2006, Jeffrey Skilling, former CEO of Enron, started serving a twenty-four year sentence at a federal prison in Waseca, Minnesota.  Recently, Skilling was moved to a low-security federal prison in Jefferson County, Colorado because the Minnesota institution began its conversion to a women’s prison. At the new facility, Skilling lives in dormitory or cubicle housing surrounded by a double-fenced perimeter. Additional information about the Colorado facility is here and here.

However, Skilling may not be a visitor for long.  His case is on appeal before the Fifth Circuit and some believe that he has a strong chance of winning a reversal.  Skilling’s 2006 conviction included nineteen counts of conspiracy, fraud, lying to auditors and insider trading. Skilling appealed this decision to the United States Court of Appeals for the Fifth Circuit in New Orleans. The court of appeals heard oral arguments on April 2, 2008. Currently, Skilling awaits the court’s decision.  

During oral arguments, Skilling’s attorney, Daniel Petrocelli, focused on two main issues. First, Petrocelli argued that Skilling’s actions were well intentioned and for the company’s benefit; thus, his actions did not deprive Enron of his “honest services.” According to Petrocelli, the government’s entire case rested on the “honest services” theory of wire fraud that the Fifth Circuit subsequently rejected in U.S. v. Brown, 459 F.3d 509 (5th Cir. 2006). And because the defective theory infected every count against Skilling, the court should reverse the entire case.

Second, he argued that the government unlawfully withheld critical exculpatory and impeachment evidence. Specifically, prosecutors concealed critical evidence when it did not turn over 400 pages of notes from FBI interviews with Enron’s former CFO, Andrew Fastow. Instead, the prosecutors gave summaries of the notes to Skilling’s defense attorneys. After the trial, the Fifth Circuit ordered prosecutors to turn over the notes. Petrocelli asserts that the notes reveal that Fastow’s initial statements about Skilling’s knowledge of financial statement manipulation differ from his testimony, in which he testified that Skilling had knowledge.

Federal prosecutor J. Douglas Wilson presented oral arguments for the government. Wilson argued that as CEO of Enron, Skilling worked for the shareholders and if his actions were contrary to shareholder goals, then he deprived them of his “honest services” under the law. Further, Wilson argued that even if the court dismisses the conspiracy count because the “honest services” theory is defective, the remaining counts should stand because prosecutors proved those counts independently. Wilson rebutted the defense’s second argument by asserting that the notes referenced by Petrocelli concern another Enron deal that was not at issue in the trial.

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

The proposal to extend criminal liability to officers for corporate violations has been withdrawn.  It arises, however, out of a frustration that corporate officers ought to be more responsible for the actions of the company.  The reality is that civil liability against the company and the responsible individuals ought to provide sufficient incentive to ensure that legal violations did not occur.  Officers and directors would know that their net worth would be impaired if they were found responsible for the company's violation.  But the difficulty in bringing civil suits (Stoneridge and the PSLRA at the federal level, the demand excusal requirement under state law) make this an unfruitful avenue. 

Moreover, state law (particularly fiduciary duties) often do not make clear who should be accountable for violations by the company.  Sarbanes-Oxley tried to address the problem in the securities area by requiring the CEO and CFO to certify the company's financial statements, making them accountable for the contents.  For more on this, see Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance.

The criminal provision also sidesteps the race to the bottom and the "internal affairs" rule.  Since criminal law is not determined by the state of incorporation, this provision would apply whether or not the corporation is incorporated in another state, including Delaware.  In other words, this type of provision allows states that do not attract large numbers of incorporations to nonetheless get in the corporate governance game.  In other words, this is a provision that arises out of weaknesses in state law.  If state law made fiduciary duties more robust and accountability more clear, this provision would be unnecessary. 

The Colorado Corporate Fraud Initiative, or Amendment 53 to the Colorado Revised Statutes, would hold business executives criminally liable if they break the law or stand by as others commit crimes.  This means that accomplices to criminal fraud cannot plead ignorance.  Under these circumstances, the amendment would also allow any Colorado resident to sue the executives.  The proceeds from successful suits will go back to the state.

The impetus for Amendment 53 comes from Protect Colorado’s Future, an alliance of advocacy groups.  Qwest’s troubles serve as motivation for Amendment 53, according to Jess Knox, executive director of Protect Colorado’s Future.  Knox stated that: 

• “The economy will be much stronger in the long-term because we are raising the integrity of the corporate environment for those who want to come to Colorado and have a good business.”  

Lew Ellingson, a former Qwest employee and "the public face of the proposed ballot measure," said the proposal would hold top business officers individually accountable in an unprecedented manner.  Moreover, “If nothing else, these folks in charge will think twice about cutting corners to make themselves look more profitable than they really are.”   Ellingson further stated, “I don’t know who can oppose this.  This is common sense.  We need businesses to survive, but we don’t need criminals running them.”  Ralph Nader also stated, “The amendment is long over due because the corporate crime rate is getting bigger and bigger and corporate wrongdoers are throwing their wrongdoings on the backs of state citizens to bail them out.”

The Official Summary for the initiative lists some arguments for the proposal.  These include:

• Amendment 53 addresses a gap in state law. While business entities themselves can be prosecuted, their executives can currently avoid responsibility for their businesses' failure to follow state law. The measure helps ensure that these executives are held accountable when they know of a legal duty that their business has failed to perform. Over time, Amendment 53 can foster a business environment that attracts and retains responsible employers.
• Amendment 53 may encourage a healthy and moral economic climate for Colorado. When businesses fail to comply with state law, the state's economy can be impacted in a variety of unexpected or far-reaching ways.  The measure seeks to eliminate cases where executives' failure to act or take responsibility for their businesses'  legal obligations affects the lives of employees, shareholders, or even the state's citizens as a whole.
  
• Amendment 53 could lead to additional disclosure about and charges for illegal corporate conduct. The measure establishes a defense from prosecution for executives, which may make executives feel more secure about reporting their business's failure to perform duties required under the law.
  

The proposed amendment is available here.

In addition to being in the eye of the storm with respect to presidential politics (Colorado is a purple state targeted by both sides), the citizens of Colorado will also vote on, as usual, a raft of ballot proposals, at least one of them directly applicable to officers and directors.  The proposal has been withdrawn in a compromise worked out between business interests and unions.  Nonetheless, it was an interesting proposal.  Before it was withdrawn, Pardis Ostadi, a student on the Blog wrote two posts.  We will go ahead and publish her analysis.

The Colorado Corporate Fraud Initiative, or Amendment 53 to the Colorado Revised Statutes, would hold an executive officer criminally liable for failure to discharge a specific duty imposed on the business entity by law. 

Liability occurs, for example, when the executive knew or should have known of the specific duty to be performed. Amendment 53 is unclear regarding what constitutes the specific duties of executive officers.  Additionally, Amendment 53 provides a defense to certain criminal charges if the executive officer, prior to being charged, reports all relevant facts concerning the conduct of the business entity to the Attorney General.

The business community strongly opposes Amendment 53.  The Denver Metro Chamber of Commerce filed suit challenging the ballot measure claiming the measure would hurt Colorado businesses and trigger baseless lawsuits.  Amendment 53 survived that challenge.  The Denver Metro Chamber of Commerce also launched a group called Coloradans for Responsible Reform, which is raising money from business interests to oppose what they see as an anti-business measure.

According to Coloradans for Responsible Reform, this amendment’s likely effects include hindering recruitment of talent, higher insurance costs, and politically motivated and frivolous charges filed against business executives.  The National Federation of Independent Business of Colorado has also joined Coloradans for Responsible Reform in opposing Amendment 53.  Additionally, the board of the Colorado Women’s Chamber of Commerce voted collectively to oppose this measure.  Donna Evans, CEO of the chamber, said the initiative, if passed, “would damage businesses, especially small and medium sized businesses.”  

The Colorado Economic Leadership Coalition came out against the proposed amendment because they believe the amendment will make it hard to recruit businesses to Colorado.  They further stated that the initiative is an economy killer and businesses will not move to Colorado if this measure passes.”

Some argue that the ballot measure could be a great disincentive for individuals seeking to serve as directors or officers. The measure would make directors, officers, and executive staff criminally liable for knowing or being in a position to know about criminal conduct by the organization even if they were not directly involved.  Groups opposing the amendment are concerned that the amendment will impose criminal penalties on individual executive officers based on what they are presumed to know given their position and not necessarily actual knowledge of or participation in criminal activity.

The Official Comment provides a number of possible objections to the proposal.  These include:

• Amendment 53 may negatively impact a business climate in which most businesses and their executives comply with the law. For example, the new criminal penalties could drive higher insurance costs for law-abiding executives, which may ultimately be passed along to consumers. Additionally, fear of prosecution could hinder recruitment of top business talent and may leave community leaders reluctant to serve on nonprofit boards.
• State and federal laws already hold business executives accountable. For example, executives can be prosecuted under Colorado law for their own criminal conduct on behalf of their business. Recent federal laws have strengthened criminal and civil penalties for business executives who commit fraud. High-profile prosecutions of business executives demonstrate that current laws are sufficient to address corporate wrongdoing.
• Amendment 53 creates a way to avoid accountability. Business executives who are aware of their business's failure to comply with the law, and who should be held responsible, may escape prosecution through reports to the attorney general.
  

The proposed amendment is available here.

Should the two managers at the Bear Stearns hedge funds have been indicted?

The funds were highly invested in CDOs--mortgages, in other words.  The indictment indicates that the two defendants were aware that problems in the CDO market were affecting the funds in March 2007.  But of course concerns over CDOs and subprime mortgages were already rife in the markets.  As the indictment noted, a major investor in the fund announced in April 2007 that it intended to redeem its entire $57 million investment.  Similarly, part of the allegations in the indictment are that the defendants understated the level of redemptions by other investors.  In other words, without any disclosure from the funds, the investor was presumably concerned enough about the investments in the fund to eliminate its position.  All of this suggests that the market had considerable information and concern on the investment content of the funds.

Similarly, the alleged fraud lasted, according to the indictment, only about three months, during a period of turmoil in the market and apparent turmoil within the funds.  Discussions of closing the funds only occurred in late April 2007.  In other words, had Tannin and Cioffi announced then that they were shutting down the funds, they would have done so only about a month before the funds actually closed. 

Finally, it is not clear from the indictment that investors would have saved anything had the funds shut down even sooner.  The assets in the funds were apparently illiquid and probably worthless before June.  Had the funds shut down in late April or early May, most investors would still have lost their investment.  The only real difference is that the funds would not have processed withdrawals in May and not accepted any new investments during the month. 

The indictment makes considerable hay out of the fact that Cioffi withdrew $2 million.  It makes far less out of the fact that he left in the fund $4 million, an investment presumably lost.

None of this discussion is meant to excuse the behavior of the two managers.  It sounds from the indictment as if they had serious problems internally and understated them to the market.  The broader question, however, is whether this behavior should be ciminalized.  It shouldn't, is the short answer.  Unlike Enron, this was not a fraud of massive proportions.  Unlike Enron, the funds went into bankruptcy not because of a fraudulent conspiracy but because of bad investments.  Unlike Enron, this was a short term event during a period of turmoil.  Moreover, those investors that lost funds appear sophisticated and likely aware of the problems in the subprime market.

In this case, civil penalties are enough.  The careers of Tannin and Cioffi in the securities business are essentially over.  The SEC can bankrupt them by taking away the rest of their net worth.  And, as noted, Cioffi has already lost $4 million.  Jail, however, is not the answer.  Moreover, the criminal action will not address the broader, more significant issue.  Why were these hedge funds almost entirely unsupervised by management at Bear Stearns?  While the indictment makes a great deal out of the failure of the two defendants to reveal the true state of affairs to management at Bear Stearns, this was not a subtle matter.  Bear Stearns had two hedge funds highly invested in CDOs and other debt instruments.  Yet somehow management apparently never inquired or looked into the condition of the funds, sitting back and waiting for their managers to report any problems. 

This should be a matter left to the Securities and Exchange Commission and private investors.  It should entail an examination of the behavior not only of Tannin and Cioffi but also management at Bear Stearns.  It should not be left to criminal authorities.

It is a tough time to be a hedge fund.  For one thing, the economy is not cooperating and solid returns are hard to come by.  For another, the term "hedge" fund has become pejorative, a term that stands for short term investors who elevate their profit making goals over all other interests.  They have been demonized by the SEC and are not well liked by at least some on the Delaware courts. 

But the news only got worse with the indictment of two portfolio managers, Ralph Cioffi and Matthew Tannin, from hedge funds operated by Bear Stearns.  The SEC filed civil charges as well.

They managed two funds, the High Grade Structured Credit Strategies Master Fund and the the High Grade Structured Credit Strategies Enhanced Master Fund, both formed under the laws of the Cayman Islands but operated out of New York.  The Enhanced Fund invested primarily in collateralized debt obligations (CDOs), instruments backed up by debt obligations, particularly mortgages. 

The indictment alleges that by March 2007 Cioffi and Tannin believed that the funds were at risk of collapse.  They covered up this "bleak state" in order to protect their compensation and reputation.  The indictment quoted internal communications indicating concerns with the funds, including some from emails.  During the same time period, Cioffi began reducing his own investment in the Enhanced Fund, pulling $2 of the $6 million out.  At the same time, the mangers were discussing their "awesome opportunities" and "great possibilities for the coming months" when discussing the funds with the public. 

By April, Tannin sent an email advising that the funds be closed.  He described the subprime market as "damn ugly" and that if their internal report on CDOs was accurate that the subprime market was "toast."  Despite the concerns, they reaffirmed to Bear Stearns management that the funds were in good shape.  They were likewise upbeat in a conference call with investors held on April 25, understating the number of anticipated redemptions. 

On June 7, the Enhanced Fund ceased redemptions; the High Grade Fund did the same on June 27.  The funds filed for bankruptcy later in the summer.  Their collapse largely heralded the beginning of the subprime crisis and raised concerns with the future of Bear Stearns, something that would contribute to the loss of confidence in the investment banking firm the following year and its acquisition by JP Morgan.

The indictment includes counts alleging disclosure violations and insider trading.  We will offer some thoughts on the indictment in the next post. 

The indictment is posted on the DU Corporate Governance web site. 

 

We have, to some degree, followed the claims arising out of the collapse of Refco. It is an example of a fraud uncovered in the post-SOX era, a consequence of a more active audit committee. Please refer to our previous posts for information on the topic.

The latest shoe to drop was the guilty plea, as reported inThe Wall Street Journal and Bloomberg.com, of Phillip R. Bennett, the former CEO of Refco, Inc. plead guilty to 20 criminal charges including bank and securities fraud, conspiracy, money laundering, and wire fraud. Bennett entered the guilty plea a month shy of the scheduled start of a criminal trial to determine his role in an 8-year accounting scheme that cost investors more than $2.4 billion.

Bennett, a British citizen, built Refco, Inc. into one of the biggest independent U.S. futures traders. Its August 2005 initial public offering (IPO) raised $583 million. Although the company appeared successful and attracted significant investment, Bennett and others actively engaged in nearly a decade of fraud to cover up poor financial performance.

Refco’s problems began when the company extended credit to customers who experienced significant trading losses during the Asian debt crisis of the late 1990s and were unable to make payments. To hide the shortfall from auditors and investors, Refco moved more than $1 billion in debt to Refco Group Holdings Inc. In return, the Bennett-controlled holding company gave the brokerage worthless IOUs which Refco characterized as a large receivable. Under Bennett’s direction, and with the help of the Vienna-based Bawag PSK Bank and unnamed customers, Refco was able to hide the fraud for years. Indictment, United States v. Bennett, No. 05-CR-1192 (S.D.N.Y. filed Nov. 10, 2005).

The carefully constructed house of cards finally toppled in October 2005. On October 10^th, Refco announced the discovery of a $430 million receivable owed it by a Bennett-controlled entity. Further, Refco stated that its 2002 through 2005 financial statements were unreliable. Bennett was arrested on October 12^th. On October 13^th, Refco announced that it lacked sufficient liquidity to continue operations and the New York Stock Exchange (NYSE) halted trading of the stock to evaluate the company’s suitability for continued listing and trading. Order Regarding Withdrawals, Unsecured Loans or Advances from Refco Securities, LLC and Refco Clearing, LLC, Exchange Act Release No. 52606 (Oct. 13, 2006).

Refco filed for Chapter 11 bankruptcy protection on October 17th and the NYSE formally suspended trading on October 18^th after concluding its evaluation. In the aftermath, the company’s stock fell from a post-IPO high of over $30 per share to 81 cents per share and resulted in market capitalization loss of more than $1 billion.

On November 18, 2005, the New York Stock Exchange filed an application with the SEC to delist the stock. The SEC granted the application effective November 30, 2005. Refco, Inc., Order Granting Application to Strike from Listing, File No. 1-32604 (Nov. 29, 2005).

Mr. Bennett will be sentenced for the criminal charges on May 20, 2008. If federal sentencing guidelines are followed, the former CEO may spend the rest of his life in jail. Though the criminal phase is drawing to a close, Bennett still faces civil lawsuits by investors. SEC counsel filed a complaint against Bennett in the U.S. District Court for the Southern District of New York on February 19, 2008.

The primary materials discussed in this post may be found on the DU Corporate Governance website.

On January 28, 2007 Carole Argo, former President and CFO of SafeNet, was sentenced to 6 months in jail and fined $1 million for her involvement in a backdating scheme. As wereported in November of last year, Ms. Argo plead guilty to one count of securities fraud admitting she “intentionally and systematically set out in a course of action to create opportunities for her and others to benefit financially through the backdating of stock option grants.”

Ms. Argo’s guilty plea and sentence is in connection with two backdating grants which netted her and a former CEO of SafeNet over $2.5 million. Additionally, Ms. Argo received performance bonuses totaling $650,000, given to her, in large part, based upon corporate earning statements which did not include the backdated information.

Michael J. Garcia, U.S. Attorney for the Southern District of New York issued a release concerning Ms. Argo's sentencing. In the release Mr. Garcia stressed that Ms. Argo’s backdating, which occurred between 2000 and 2006, was part of a larger conspiracy to keep her activities secret from “Safenet’s shareholders and outside auditors, as well as securities analysts, the SEC, and members of the investing public.”

The primary material concerning this case can be found at the DU Corporate Governance website.

Gregory Reyes, the former CEO of Brockade, was sentenced Wednesday in connection with his conviction in a backdating case to 21 months in prison and ordered to pay a $15 million fine. We juxtapose the decision with the Supreme Court's opinion in Stoneridge. In that case, the Supreme Court gave as one of the reasons for not extending liability to vendors the fact that "[s]econdary actors are subject to criminal penalties." Stoneridge, at 15. It seems that the majority in Stoneridge are comfortable with the use of the criminal laws to sanction what might otherwise be left to the civil realm. I suspect that Gregory Reyes would take issue with the approach.

By the way, Reyes got six additional months because he stated in an affidavit attached to a motion to sever that he had not backdated. Later at trial he apparently admitted that he had, a discrepancy counsel contended was a result of "poor drafting." The judge was apparently not happy with the inconsistency, suggesting, according to one report, that it amounted to obstruction.

Primary materials on this case are posted on the DU Corporate Governance website.

George Will wrote an editorial over the weekend slamming John Edwards, using it as an opportunity to rale against  Milberg Weiss and Bill Lerach.  Will adds nothing to the preexisting discussion and provides incomplete, if not misleading, analysis.  He knows better.  In other words, his result oriented approach is a reflection of his own hubris and hypocrisy.

As is well known, some attorneys at Milberg Weiss apparently kicked back to plaintiffs a portion of the attorneys fees as an inducement to bring actions.  Will is right that at the time (and no longer true today), lead counsel was often determined by the first to file the suit, putting a premium on the race to the courthouse and providing benefits to those with a ready stable of plaintiffs.  Will then goes on to make the utterly inconsistent point that these suits were somehow invalid ("How do you convict a company of the crime of having the price of its stock fall? . . . Often you do not prove it, or even plan to.  Rather you threaten to be such a costly nuisance that the company pays you to go away."). 

Several observations are worth making.  First, if the lawyers at Milberg paid kickbacks to be the first to the courthouse, it is nonetheless clear that other firms would have brought these cases (why, otherwise, would they pay to be first?).  In other words, there is nothing about the kickback scheme that resulted in even a single additional case being brought.  Second, paying kickbacks to be first does not in any way suggest that the cases lacked merit.  If anything, it is the reverse.  Counsel would want to be first in the best cases.  Thus, to even suggest that somehow the kickback scheme resulted in meritless lawsuits is an unfortunate fiction and analytically indefensible.  An example of hubris, in short.  

Finally, we note that securities class actions brought before the PSLRA took on average around four years to resolve.  It required firms with deep pockets to pay all of the costs of litigation, with the payout only coming years later after considerable sunk costs.  In a race to the courthouse environment, firms that filed first were not necessarily the best representatives for shareholders.  They might lack the skill and resources to pursue the case adequately.  In other words, as a result of the kickback scheme, the attorneys at Milberg were able to circumvent the dysfunctional system that determined representation not upon the quality of counsel but upon the speed of arriving at the courthouse.  In the cases where counsel paid kickbacks, plaintiffs received the benefits of a firm with deep expertise and deep pockets. 

It doesn't make what Milberg and Lerach did right.  But violating legal requirements in making improper payments to plaintiffs is not at all the same as saying that companies were improperly sued or shareholders improperly disadvantaged.  Before George Will accuses others of hubris and hypocrisy, he should pay more attention to his own positions. 

Bill Lerach wrote a coruscating op-ed in the Washington Post making several good points about corporate greed. He rails that “[e]xecutive failure is consistently rewarded with giant payments -- or, really, payoffs -- to keep the parting sacrificial lamb quiet so that he or she won't bleat to the stockholders, lawyers and the media that the others at the top of the company (and in the boardroom) knew what was really going on.”

While not expressly suggesting that greedy CEOs be sent to jail, that seems to be his implicit message. Prof. Ribstein, blogged about the op-ed, rebutting this argument for criminalization arguing that “[t]he criminal justice system is wildly inappropriate to deal with this sort of case.” I am with Prof. Ribstein on this one. The problem is that Learch’s examples do not indicate that the actors were morally blameworthy, merely that they engaged in risky business actions. Meting out jail terms in such cases only serves as a temporary palliative for retributive urges. It is almost certain that those clamoring loudest for imprisoning risk-taking CEOs would be bringing down the rafters with their cheering had the risky bets paid off. A man cannot be made a hero one day and a criminal the next, based on the vagaries of the market.

Mr. Lerach is not alone in wanting criminal law punishments. This, almost obsessive, current focus on criminalizing conduct that was traditionally dealt with by other areas of the law is reflected in the fact, that of the approximately 3000 crimes in the federal statute books, almost half were created since 1970. Virtually every new legislation aimed at behavior modification is accompanied by claims about the need for criminalization upon the pretext that civil sanctions do not pack enough punch. This has serious ramifications insofar as it undermines the coercive power of the criminal law by diluting its expressive power. It also makes victims out of those (like Lerach) who do not deserve prison because their actions were not morally wrongful.

In a telling indictment of the system Lerach laments that “[t]he real frustration is that there's so little that can be done. Shareholders supposedly have access to the courts for a remedy, but they won't get far… The government -- forget it. The SEC, and even Congress, appears to be getting ready to cut back shareholder rights and court access even more.” Notwithstanding the system’s current flaws, the answer is not criminalization.

Lerach ends with a rather disingenuous claim: “I'm on my way to prison because, in my zeal to stand up against this kind of corporate greed over the years, I stepped over the line. It turns out that the legal system is a lot tougher on shareholder lawyers than it appears to be on Wall Street executives.” The enormous amounts that he made were at least as much of a motivation for his actions as any “zeal.” The unsavoury squabbling that lawyers engage in for class action booty in the name of shareholder activism is, sadly, yet another agency cost that comes with the territory.