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.   

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.

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.

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.

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.

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 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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• 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.

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.

• 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.

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.

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 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.”  

• 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 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.