Thursday
Sep102009

Stockman v. Heartland Industrial Partners: In the Case of Indemnification, Goals Trump Contract

This blog extensively covered United States v. Stockman, involving criminal charges brought against officers and directors of Collins & Aikman Corporation (“C & A”) for defrauding investors, banks, and creditors. The U.S. Attorney dropped its charges on January 9, 2009, providing a cursory explanation for its decision.

 

The case illustrated the problems that arise in connection with the costs of defending a complex, high profile and very expensive piece of litigation.  The defendants in Stockman confronted a rapid burn rate of the Director & Officer Insurance used to fund the defense, ultimately exhausting the proceeds.  This included proceeds from the D&O policies held by C&A and by Heartland, the private equity fund that had acquired C&A.  When the insurance proceeds ended, the parties turned to Heartland directly.  

 

In doing so, the defendants had to deal with the problem of private ordering.  Whether an LLC or a partnership, Delaware (with other states following) has moved in a direction of freedom of contract, providing for default rules in the statute but allowing parties great freedom on altering them contractually.  The state even permits, with respect to LLCs, the waiver of fiduciary duties, saving only the duty of good faith and fair dealing.

 

Freedom of contract, however, is not necessarily good for management.  There is a discernable trend in these cases to see the contracts turn on principles and language that is not in the contract, arguably negating the concept of freedom of contract.  There is an argument that this is exactly what happened here.    

 

Two defendants, David Stockman and J. Michael Stepp (“defendants”), filed suit against C & A and its majority investor Heartland Industrial Partners, L.P. (“Heartland”). The defendants sought advancement of legal fees and indemnification in accordance with Heartland’s Partnership Agreement.  In Stockman v. Heartland Industrial Partners, L.P., 2009 WL 2096213, *1 (Del. Ch. July 14, 2009), the Court of Chancery of Delaware granted the defendant’s summary judgment on their advancement claims and denied Heartland’s motion to dismiss the indemnification claims.

 

In connection with the claim for indemnification, the partnership agreement borrowed from § 145 of the Delaware General Corporation Law.  Both the Section and the Agreement provided that indemnification was only permissible if "in the case of a criminal action or proceeding, the Indemnitee had no reasonable cause to belive his conduct was unlawful."  Section 145, however, also required payment of expenses where the party involved "has been successful on the merits or otherwise." The Indemnification Agreement contained no similar requirement. 

 

The absence of the language suggested that payment was not automatic upon success.  Instead, there had to be specific findings that the officers acted in "good faith."  The court, however, chose instead to read the language of Section 145 into the agreement itself and to make indemnification mandatory.

 

Doing so required a two step analysis.  First, the Vice Chancellor concluded that "[a]n indemnitee in a criminal proceeding is successful any time she avoids conviction," including when the government simply dismisses the case.  The authority for the proposition was thin, a single sentence from a 1974 Superior Court case.  There was no analysis and no attempt to examine why the case was dismissed, suggesting that any dismissal was equal to exoneration.  

 

To the extent that this is an accurate reading of Section 145, it would explain why parties might change the default rule and instead require an affirmative finding of good faith.  It would protect the company in cases where there was a dismissal of a case yet the evidence of bad faith remained clear.  Thus, for example, a case might be dismissed because of the statute of limitations, not because of exoneration.  In those circumstances, a company might want the ability to deny indemnification.

 

Having made a leap with respect to Section 145, the opinion had to address the problem that the language (and the leap in logic) was not expressly in the partnership agreement.   

  • Here, the drafters of the Partnership Agreement used their contractual freedom to craft an approach to indemnification that employs language drawn from § 145, but in a selective way that creates some room for confusion. In a nutshell, the Indemnification Provision adopts § 145’s standard for good faith and lawful conduct, but is silent about the effect of a disposition of the underlying proceeding in favor of the Indemnitee, which is a key consideration when determining whether a corporate official is entitled to indemnification under § 145.

Nonetheless, the court read it into the agreement.  It did so on "public policy" grounds.  As the court reasoned: 

  • Given these realities, the requirements of §§ 145 (a) and (b) seem best read as public policy limits designed to prevent corporations from indemnifying corporate officials in only the most incentive-distorting circumstances: when the officials have been convicted or otherwise incurred liability as a result of culpable conduct and that liability was the result of conduct that involved a certain level of scienter. Nothing cited by Heartland suggests that these requirements — which are baked into the Indemnification Provision — were designed to require an indemnitee who faced civil or criminal liability claims and had those claims dismissed to then put on, or even defend, a merits case about the purity of their state of mind regarding the conduct alleged in the dismissed claims.

In short, the court found in favor of the officers seeking indemnification by first concluding that a criminal dismissal amounted to vindication and then by reading a provision from the statute into the agreement, despite its explicit absence. 

The motivation was clear. "[T]urning an indemnification case into a hypothetical trial on the merits of a dismissed case is a bizarre notion to propose and would be counterproductive to Delaware’s policy goal of assuring indemnitees 'that their reasonable expenses will be borne by the corporation they have served if they are vindicated.'"  The goal, apparently, was more important than the language of the agreement.

Given that "success" could be dismissal, Heartland had a reason why it might require evidence of good faith before agreeing to indemnification.  The omission of the language from Section 145, therefore, had a reasonable explanation.  The court, however, was unwilling to give much weight to what could have been the intent of the parties.  In an era of freedom of contract, this case did not turn on the contract but on a judicial rewriting of the contract. 

The primary sources for this post are available at the DU Corporate Governance website.

Wednesday
Jan282009

Summary of United States v. Stockman

This post concludes and summarizes our coverage of the case United States v. Stockman. The government filed the Indictment in March of 2007 in the Southern District of New York. The named Defendants were David Stockman, Paul Barnaba, David Cosgrove, and J. Michael Stepp. Stockman was the CEO and Chairman of the Board of global auto parts manufacturer Collins & Aikman, Inc (C&A). Barnaba was the Director of Financial Analysis for the Purchasing Department, and later the Vice President and Director of Purchasing for the Plastics Department. Cosgrove served as Group Controller for the Plastics Group. Stepp was Vice Chairman of the C&A board.

 

According to the Indictment:

 

·          under Stockman’s control, C&A availed itself to a variety of sources of debt financing including: notes, revolving credit lines, and securitizing accounts receivables. C&A’s debt financing was subject to financial covenants. Failure to comply with these covenants would constitute a default by C&A and warrant demand for immediate payment. The covenants required C&A to maintain a performance ratio measured by C&A’s net debt divided by EBITDA. Discussed here.

 

The indictment alleged that Stockman and the other defendants joined in a scheme to defraud C&A’s investors, banks, and creditors by manipulating C&A’s reported revenue and earnings because of the operational pressures and covenants to keep C&A’s financial performance at certain levels.

 

C&A provided Defendants with Director & Officer Insurance (D&O Insurance) to help with the cost of defending against the indictment. The burn rate of the D&O policies quickly became another issue as the policy depleted by an estimated $1.67 million per month for Defendant Paul Barnaba. Total coverage under the policy was $50 million. For discussion of the adequacy of $50 million D&O insurance for a company the size of C&A see Stockman and the Limits of D&O Insurance and US v. Stockman and the Burn Rate on the D&O Policy.

 

As the D&O policy diminished, the number of documents increased to 12 million. On April 8, 2008 Barnaba filed a motion to dismiss, alleging violation of his constitutional right to a speedy trial. Discussed here. The government argued that the number of documents in discovery justified the trial delay. Judge Barbara Jones agreed with the government, and denied Barnaba’s motion to dismiss in the July 24, 2008 status conference.

 

Barnaba continued his effort to speed the trial along by filing a motion to sever on August 25, 2008. Discussed here. Barnaba argued that he:

 

·       has not been able to pay counsel for 2.5 months and his Motion for Appointment of Counsel under the Criminal Justice Act filed August 18, 2008 was still pending. Barnaba claimed that he was ready for trial and making him wait until May 2009 would “impair [his] ability to put on an effective defense due to his limited resources.

 

Judge Jones orally denied Barnaba’s Motion to Sever during the August 25, 2008 status conference. Barnaba filed a second Motion to Sever in October of 2008. Discussed here.

 

On January 9, 2009 the Government filed a Nolle Prosequi, dismissing the charges against Stockman, Barnaba, Cosgrove, and Stepp. The Government provided little reasoning for the dismissal by stating:


·          After a renewed assessment of the evidence, including evidence and information acquired after the filing of the Indictment, it has been concluded that further prosecution of David A. Stockman, J. Michael Stepp, David R. Cosgrove, and Paul C. Barnaba would not be in the interest of justice.


Professor Brown speculated as to what may have happened in his post The Stockman Dismissal: What Really Happened? He indicated that contributing factors to the dismissal may have included the amount of government resources exhausted by the 15 million documents in discovery, the vigorous defense put up by defense counsel, and the Southern District’s preparation for the Madoff case.

 

For documents filed in the Stockman case (including many of the status hearings before the trial judge), go to the DU Corporate Governance web site.

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Monday
Jan122009

The Stockman Dismissal: What Really Happened?

The decision of the government to drop the case came as a surprise. We can only speculate on the reasons for the decision but we present some of our thoughts on the matter.

The criminal case against David Stockman had been ongoing for almost two years (the indictment was filed in March 2007).  The case at its core was a fraud suit alleging that the defendants had inflated operating income by improperly recognizing certain supplier rebates.  According to the complaint, C&A improperly accounted for rebate payments from suppliers.  Some of the rebates allegedly came with secret promises of repayment while others were alleged to have been booked prematurely.

The government, therefore, confronted what looked like a relatively complicated accounting case, not the best thing to put before a jury.  Moreover, the case was extraordinary in its volume, encompassing more than 15 million documents.  Logistics and case management would be a chore.  At the same time, defense counsel was putting on a vigorous defense despite exhaustion of the D&O insurance policy. 

Finally, a decision needed to be made quickly.  The trial was looming, with the date set in May.  While there was a possibility some of the defendants would seek a continuance, Paul Barnaba had a motion to sever pending (filed by his counsel Solomon Wisenberg) and, consistent with his position throughout, was seeking a trial date as quickly as possible.  Even if a continuance had been granted, the trial judge would have been hesitant to delay Barnaba's trial beyond May.  One way or another there was likely to be a trial in May.

In addition, decision may have been influenced by a series of high profile losses for the US Attorneys Office in the Southern District in securities/while collar cases, including a recent acquittal of a stock trader who worked for a NYSE specialist and a mixed verdit in the KPMG case (after most defendants had been dismissed).  Add in that the Stockman trial was eating up resources just as the Southern District was gearing up to handle the Madoff case, another matter likely to involve considerable attorney/investigator time.

All of this was taking place just as the new administration was coming into office, with a pending decision on the new US Attorney for the Southern District.  The existing US Attorney, Michael Garcia, stepped down in December, replaced by Acting USA, Lev Dassin.  This is, as a result, a good time to get rid of problematic cases, both to clear the docket of the new US Attorney and to avoid the potential for another embarrassing loss.

For documents filed in this case including many of the status hearings before the trial judge, go to the DU Corporate Governance web site.

Friday
Jan092009

Stockman (et al) Indictment Dismissed

The Government announced today that it is dismissing the criminal case against David Stockman and the other three defendants.  According to the nolle prosequi filed today, the Government made the decision after a "renewed assessment of the evidence" including "information acquired after filing the indictment."  As a result, further prosecution would not be "in the interests of justice." 

The Race to the Bottom has followed the prosecution and has many of the filings in the case (including the nolle prosequi order) posted on the DU Corporate Governance web site.

Friday
Dec192008

US v. Stockman: Discovery Issues Resolved

The Stockman case has involved millions of documents (fifteen million to be semi-precise).  The fight over discovery in contrast has involved a relatively modest number.  According to an order filed in early Novemember, the government has conceded one discovery issue and agreed to provide:

  • (1)  the entire set of interview memoranda from the 2005 Audit Committee Investigation, and (2) the notes of witnesses interviewed during the Government's investigation.

The next status conference in the case is scheduled for January 21, at 10:00 am.  At the conference, "Defendants will be expected to advise the Court as to the status of discovery."

The order, along with other primary material, is posted on the DU Corporate Governance web site.

Friday
Dec192008

US v. Stockman: Agreement (Sort Of) on the Briefing Schedule

At a status hearing held in October, the main topic once again was the problem of discovery, the concern arising out of the need to review something like 15 million documents.  In addition, the trial judge (Barbara S. Jones) took care of a number of housekeeping measures.

Most of the parties (Paul Barnaba excepted) agreed to a briefing schedule with the parties due to file on January 15, the government having until Feb. 12, and the replies due Feb. 27th.   Oral argument will follow, presumably sometime in March.  (A subsequent letter from counsel at Morvillo, Abramowitz sought a two week extension, altering the dates to January 30, Feb. 26 and March 13).

Similarly, deadlines were worked out for expert discovery were resolved.  With Karen Seymour, counsel for defendant J. Michael Stepp taking the lead, she got the government's agreement to complete expert discovery by Feb. 27.  Defense would do the same by March 20.  What would this entail?

  • THE COURT: Now, by discovery, you mean they're going to declare they have one and give you a report, is that what we're talking about?
  • MS. SEYMOUR: That's what we're anticipating.
  • MR. BERGER: Yes, an expert notification letter.

The issue of appointed counsel was more or less resolved.  Once the D&O insurance proceeds evaporated, the issue of counsel and the payment of fees came to the fore.  Solomon Wisenberg, counsel for Paul Barnaba, moved to be appointed counsel under the Criminal Justice Act.  At the October hearing, the trial judge approved the appointment.  She also noted that, "[w]ith respect to Mr. Cosgrove, . . .approval should be coming through in another day or two."

Much of the hearing was devoted to the time needed to prepare for trial, a matter complicated by the number of documents involved.  That number had increased from the already impressive 11 million to 15 million.  Counsel for Dave Stockman (Elkan Abramowitz) indicated a need for 70 to 80 weeks.  With both counsel and the trial judge overwhelmed by the number of documents, the court had this to say about the length of time needed for preparation:

  • THE COURT: Well, I can only -- I see we have a new assistant here today, Mr. Sahni? (Indicating) I can only ask the government to go back and talk to people who may have had cases like this, reach out for lawyers who may have left the office and see if there are some solutions out there or some comparisons that can be made because: One, I don't know what it takes to search 15 million documents. Two, I don't know how search terms work, especially when I'm told there's a first level of review and then another level of review. I can't say to the defendants at this moment that it won't take them 70 to 80 weeks; and under that circumstance, then I have to look at the government and say do you want to wait that long?  The ball is in your court, gentlemen. Unless I'm convinced that 70 to 80 weeks is unreasonable, and no one is telling me that, I think we would be in the situation of waiting a very long time as Mr. Abramowitz is getting us off the dime. The flip side is, of course, Mr. Abramowitz can't guarantee that even if he's given these materials, he can do it any faster. So you're not getting any deal here -- you're not getting an agreement from Mr. Abramowitz that "I can do it six months faster if you give me this." He's hopeful. I think a little more thought has to go into this back at the U.S. Attorney's office just because I'm unaware of there being this length of time between indictment and the ability to get through discovery and set a reasonable trial date. I mean, at the moment I don't think it's overly long, but I haven't gone back and compared it with other cases, and it might be helpful to do that.

In short, unless Paul Barnaba gets his severence and an earlier trial, this matter is not likely to be before a jury for somewhere around 18 months (from October) with even that prediction uncertain.

Primary materials on this case can be found at the DU Corporate Governance web site.

Monday
Nov242008

US v. Stockman: Barnaba Wants to Sever

As we have discussed in previous posts, Paul Barnaba has been pushing for an early trial and previously filed a Motion for Severance in May. The first motion was denied during a status conference on August 25, 2008, but the court invited Barnaba to supplement the motion because “it’s a motion that needs to be looked at in terms of where we’re at.” Thus, Barnaba moved again to sever his trial from his co-defendants on October 14, 2008 and “[a]s before, the Motion to Sever is premised on the substantial risk that Barnaba’s speedy trial and related trial rights will be compromised if his trial is not severed.” United States v. Stockman, No. 07-CR- 220 (S.D. N.Y. filed Oct. 14, 2008).

 

According to Barnaba, recent developments make immediate severance “even more crucial.” On August 7, 2008 Barnaba’s attorneys learned that the D&O insurance had been exhausted effective July 31, 2008. Barnaba first expressed his fear that the insurance would run during the July 12, 2007 status conference, but the Government dismissed this argument as “wholly speculative.” Barnaba has not been able to pay counsel for 2 ½ months and his Motion for Appointment of Counsel under the Criminal Justice Act filed August 18, 2008 is still pending. Barnaba claims that he is ready for trial now and making him wait for trial in May 2009 with his limited resources would “impair [his] ability to put on an effective defense.”

 

Now that the trial has been set for 13 months after Barnaba announced he was ready for trial, Barnaba claims that there is a “greater and more certain” risk his right to speedy trial will be compromised. In addition to waiting 6 ½ months for trial to begin, Barnaba argues that he should not have to wait an additional 4 months for the Government and Stockman to put on their case (each had stated that they would need to 6-8 weeks to present their cases) since his trial would need only a fraction of the time. Barnaba also points out that the length of delay and a defendant’s invocation of his right to a speedy trial are two key Barker v. Wingo elements. The Barker test is used by courts to determine whether a defendant’s right to speedy trial has been violated. A court will consider the length of delay, the reason for the delay, whether the defendant has asserted his right, and prejudice to the defendant. Barker v. Wingo, 407 U.S. 514, 530 (1972).

 

Although the Government believed discovery was complete in February 2008, Barnaba states that it has become clear that discovery is incomplete and the other co-defendants have informed the court that the Government’s discovery delays will delay its readiness for trial. Barnaba argued that he has “stayed out of all discovery disputes” since announcing that he was ready for trial in April 2008 to “avoid any hint or suggestion that he is being disingenuous by simultaneously demanding speedy trial and asking for delays to examine additional Government document productions.” According to Barnaba the Government’s inability to provide him with complete and error-free discovery shows that it lacks of justification for a lengthy delay, which is another key Barker v. Wingo element.

 

Finally, Barnaba is not claiming that his right to a speedy trial has been violated since he tried this argument in his first motion and the court rejected it. He is arguing, however, that if his motion is denied and he does have to wait until May 2009 his right to a speedy trial and other “related trial rights” will be “compromised.”

 

The documents discussed here can be found on the DU Corporate Governance website.

 

Friday
Nov142008

US v. David Stockman: Denying Stockman’s Request for Production of Audit Committee Report and Investigative Work Plan

On October 8, 2008, U.S. District Court Judge Barbara S. Jones filed an order finding that two documents requested by David Stockman’s defense team, (1) the final Audit Committee Report relating to the 2005 Audit Committee Investigation and (2) the Investigative Work Plan created by Davis Polk & Wardwell, were not discoverable either as Brady material or as documents material to defense preparation. Order Denying Stockman’s Request for Production of Audit Committee Report and Investigative Work Plan, US v. Stockman, 07 Cr. 220, SD NY, Oct. 8, 2008.

 

The documents for which discovery was denied relate to a 2005 internal investigation initiated by the Collins & Aikman board of directors and conducted by New York-based Davis Polk & Wardwell. Bloomberg reports that Collins & Aikman dismissed David Stockman after investigating lawyers discovered evidence pointing to Stockman’s alleged issuance of bogus earnings projections.

 

At a July 24, 2008 status conference, Stockman attorney Elkan Abramowitz argued that the documents from the Davis Polk investigation were critical to the defense’s theory that Davis Polk was misled by Collins & Aikman CFO Bryce Koth and that it was Koth's false information that caused the bankruptcy, not the conduct of David Stockman and the other defendants. Because the Davis Polk materials were the basis for the government’s allegations, Abramowitz also maintained that they were needed if the defense was to review the 12 ½ million documents already produced by the government in anything approaching a timely fashion or a reasonable cost. Status Conference, US v. Stockman, SDNY, July 24, 2008.

 

As we have discussed in previous posts, cost is a critical issue because Collins & Aikman’s $50 million D&O insurance policy was exhausted as of July 31, 2008. This means that defense costs are now coming out of the defendants’ own pockets or are being paid, at a greatly reduced rate, by the court out of public funds.

 

After an in camera review of the documents, the Court found that the report and work plan contained nothing that would significantly help the defendants uncover admissible evidence, prepare witnesses, corroborate testimony, or assist impeachment or rebuttal. Because the documents did not meet the Brady standards for exculpatory evidence and were not deemed material for defense preparation, the Government does not have to turn them over.

 

The Court is still reviewing 42 memoranda containing statements from government witnesses that the defendants argue should be produced now to “move the case along.” But, unless the memoranda contain Brady material, the Government does not have to produce them at this point in the discovery process. 18 U.S.C. § 3500 provides that no prior statements of government witnesses shall be discovered until the witness has testified on direct examination at trial.

 

In her order, Judge Jones stated, “I am not certain that early discovery of the 3500 material will speed up the Defendants’ review of discovery, but even so, I do not have the authority to order the Government to turn over its 3500 material before the statute requires it.”

 

However, the custom in the Southern District for New York is to turn over 3500 material to the defendant before trial and Judge Jones has directed the Government to advise the Court and counsel when they will produce the 3500 materials. In recognition of the unique circumstances of this case, Judge Jones has urged the Government to turn over the memoranda of statements well in advance of trial to give the defense counsel sufficient time to prepare.

 

For now though, the defendants’ attorneys must continue to review discovery documents without the aid of statements by prospective government witnesses or other materials from the Audit Committee investigation.

 

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

Wednesday
Nov052008

Anjan Sahni Joins the Prosecution Against Stockman

United States v. Stockman, 07-0220 (S.D.N.Y. filed Mar. 21, 2007), is moving forward.  Recently, Judge Barbara set the trial date for May 4, 2009.  On September 4, the United States Attorney's office for the Southern District of New York filed a Notice of Appearance and Request for Electronic Notification.   Assistant United States Attorney Anjan Sahni joined the complex prosecution against Stockman and his co-conspirators.

Sahni studied at Emory University as an undergraduate. Sahni also received the McMullan Award, an award given to a graduating senior who demonstrated outstanding citizenship, exceptional leadership, and great potential to improve their local and global community. Sahni attended Yale law school. As a United States Attorney Sahni has lead prosecutions against gunrunners, drug dealers, and investment fraud linked to terrorists. These cases have yet to go to trial to provide practical experience. However, Sahni's apparent talent for prosecuting conspiracies could prove a useful supplement to the other United States Attorneys.

The primary materials for this post are available on the DU Corporate Governanceweb site.

Monday
Oct272008

Covering the Criminal Trial of David Stockman

The Race to the Bottom is a collaberation between faculty and students.  One of the roles played by students is to follow ongoing cases that address important issues in the realm of corporate governance.  Students form a team and monitor any activity in the case.  When a filing surfaces or a hearing held, students digest the information and write a post.  A faculty member then reviews the post and holds a tutorial on the importance of the issues raised by the filing.  Students both develop writing skills and learn first hand about the process of handling a case.  The posting process is slow but results in an important learning experience for students and useful information for those following the case.

One of the cases followed by students is the criminal trial of David Stockman.  Students have produced the first post in the case.  It was written by William McEachron, an articles editor for the Blog.  Professor Jeff Hartje supervised the post and discussed the matter with students.

Monday
Oct272008

The United States' Response to Barnaba's Motion to Dismiss

The claims of Paul C. Barnaba and the problems with the discovery process have delayed prosecution of United States v. Stockman, 07-0220 (S.D.N.Y. filed Mar. 21, 2007) . On April 8th, Paul C. Barnaba filed a motion to dismiss the conspiracy to commit securities fraud, wire fraud, and bank fraud in the United States v. Paul C. Barnaba, 07-0220 (S.D.N.Y. filed Mar. 21, 2007) . Barnaba argued for dismissal based on violations of his statutory and constitutional rights under the Speedy Trial Act and the 6th Amendment. This post outlines the United States’ memorandum to reject Barnaba's motion. Previously on the Race to the Bottom we discussed the initial indictment and selection of counsel for the defendants.

Barnaba was the CFO of Collins & Aikman, Inc., (“C&A”) during the period of the accused fraud. The charges center on a conspiracy between the Board of Directors to defraud C&A’s creditors. The complex nature of the fraud and the subsequent collapse of C&A generated over 10 million documents.

The staggering number of documents prompted the parties to support the creation of an internet based search system. Barnaba and the other defendants consistently rejected offers for hard copies of the documents. Barnaba is the only defendant to file a motion to dismiss based on a violation of his right to a speedy trial.

The Speedy Trial Act requires that a trial commence within seventy days after filing or first appearance, whichever occurs last. The statute contains automatic and discretionary exclusion periods that prevents the seventy days from running against the prosecution. Unique or complex cases often trigger these exclusions to promote the interests of justice. Barbana’s own motions triggered some of the automatic exclusions.

The Speedy Trial Act permits discretionary exclusions when necessary to: (a) organize and prosecute an unusual or complex case; (b) provide the defense with enough time to prepare their case; (c) and prevent injustice. These exclusions do not require the consent of the defendant and are at the judge’s discretion. Discretionary exclusions for one defendant apply to all the defendants when prosecuting multiple defendants or a conspiracy.

Barnaba argued the discretionary exclusions violated the Speedy Trial Act. The United States responded by describing the unique and complex nature of the case. The millions of documents, the complex conspiracy, and the collapse of C&A all make the case difficult to prosecute. In addition, the development of the internet search system proved more challenging and time consuming than initially anticipated. The defendants were aware of this delay, but continued to deny hard copy documents at each of the status meetings. The United States contended they were diligent in developing the system and the discretionary exclusions were reasonable.

The United States then responds to Barnaba's 6th Amendment argument. The United States argued the delay was reasonable due to the amount of the discovery and the complex nature of the case. Barnaba ’s own motions and the development of an internet based search system caused the delays in the trial. The United States was not responsible for the delays in the trial.

Barnaba argued the delays depleted the defense’s coffers, thus creating a situation where he could no longer afford to defend himself. The United States was unimpressed. For the United States, Barnaba’s argument appeared speculative because he failed to state any precedence supporting his position. The United States requested that the court reject Barnaba’s motion to dismiss because he failed to show a violation of his rights under either the Speedy Trial Act or the 6th Amendment.

On July 24th, United States District Judge Barbara S. Jones denied Barnaba’s motion. The Judge followed the United States’ lead in finding the complexity of the case, Barnaba’s own motions, and the defendants’ continued denial of hard copy discovery caused the delays in the case. These delays failed to trigger the Speedy Trial Act or infringe on Barnaba’s rights under the 6th Amendment.

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

Thursday
Aug212008

US v. Stockman: What Happens When the D&O Insurance Is Gone?

From the indictment, Paul Barnaba appears to be a bit player in the criminal action against David Stockman. Yet he is in the middle of a criminal case involving at least two other defendants and some 12 million documents, with no trial date in sight. He has sought severance (along with dismissal) in order to get his criminal exposure resolved. The severance issue is still undecided.

The most recent development in the case shows the consequences to people like Barnaba. Unable to severe and get a trial date, he has stood by while the D&O policy for Collins & Aikman, the bankrupt auto parts company, has vanished. What is the latest? The insurance is gone. In his motion of appointment of counsel, counsel for Barnaba, Solomon Wisenberg, noted that the D&O policy had a cap of $50 million, with four layers. The fourth tier, as predicted, is now exhausted, having been exceeded by the last round of bills. As he notes: 

  • On August 7, 2008, Barnaba’s attorneys received word that all proceeds of the D&O Policy were exhausted as of July 31, 2008. Indeed, the final insurance carrier’s preliminary estimate is that open invoices submitted on or before that carrier’s July 31, 2008, deadline exceeded the final $10,000,000.00 layer of coverage by $1,600,000.00.

With no more funding coming, Barnaba has moved for appointment of counsel under the Criminal Justice Act, 18 USC §3600A, and has asked that his current lawyers, Solomon Wisenberg and Adrienne Wisenberg of Wisenberg & Wisenberg, PLLC be appointed. The Criminal Justice Act is no great substitute. According to the statute:

  • Any attorney appointed pursuant to this section or a bar association or legal aid agency or community defender organization which has provided the appointed attorney shall, at the conclusion of the representation or any segment thereof, be compensated at a rate not exceeding $ 60 per hour for time expended in court or before a United States magistrate [United States magistrate judge] and $ 40 per hour for time reasonably expended out of court, unless the Judicial Conference determines that a higher rate of not in excess of $ 75 per hour is justified for a circuit or for particular districts within a circuit, for time expended in court or before a United States magistrate [judge] and for time expended out of court.

In other words, Barnaba's counsel will be paid a modest amount (despite the statute, the amount in New York is apparently $100 an hour), something that might be described as a pittance in an era when some lawyers bill at over $1000 an hour.

Barnaba is, of course, lucky.  He has counsel willing to stay with him for very little compensation.  David Stockman likely has the financial wherewithal to continue to pay his attorneys, although even his personal fortune may not be enough if the current billing levels remain constant.  The next defendant to need his circumstances resolved will be David Cosgrove.  Cosgrove is represented by Craig Stewart at Arnold & Porter.  Stewart noted this at the last status hearing.

  • MR. STEWART: But maybe that we are back in front of you on his behalf asking that he receive appointed counsel because he simply would not have the money to retain private counsel, given the scope and scale of this case, to defend it. And so I think actually, your Honor's hesitation is understandable, but I think it's fortuitous that the issue has come up because, really, I think within a week, there won't be any more insurance money to cover the cost of defense.

It remains to be seen whether appointed counsel is Arnold & Porter.  When we know, we will report it here.

The motion of appointment of counsel, along with most of the other important primary documents in this case, can be found at the DU Corporate Governance website.  

Friday
Aug082008

US v. Stockman: Number of Documents Up, Remaining D&O Insurance Down

What's going on in the David Stockman case?  Sixteen or so months after the indictment, there is still no trial date and the parties are sweltering in more than 12 million documents.  As for the D&O policy, the fourth and last tier has been exhausted.  That insurance spigot has run dry.

A status conference was held on July 24.  Stockman's team, headed by Elkan Abramowitz (Morvillo, Abramowitz), made the case for delaying the trial selection date.  Abramowitz noted that the case looked to involve more than 12.5 million documents and that although there had been 29 to 32 lawyers reviewing the documents for six months, they had not yet finished examining one third of the materials.  As he noted:

  • I would urge you not to fix a trial date today.  We are nowhere near ready to say that we could -- we're ready to try this case.  And even if you arbitrarily put it a year from now, it won't make -- it's not a realistic -- it's not a realistic judgment on your Honor's part.  It wouldn't be, because we're in no position to say that we've got a handle on what we're doing here, so I couldn't -- I really urge you not to do that.

The argument convincing, the trial judge did not set the date.  As part of the argument, Abramowitz gave some insight into the defense that he was developing for trial.  

  • This is not a standard securities fraud case.  This is an unusual one, not only in the size and scope of the documents, that certainly makes it unusual, but most of the time, cases deal with established fraudulent acts and the defense is, generally, I didn't know about it or I didn't do it.  This case deals more often than not with situations where the facts are there and the facts happened, but where our -- our defense is, there is no crime here, that the accounting principles that are enunciated in the indictment and the accounts re -- the factoring principles that are enunciated in the indictment, the disclosure principles that are dicussed in the indictment and the particular transaction called the Joan Transaction, we -- our defense is those were pefectly legitimate transactions and that the fraud that's alleged is essentially saying that the accounting standards that were used were not the correct ones.
It has also become clear that the concern raised by Solomon Wisenberg (Wisenberg & Wisenberg), counsel for Paul Barnaba, about the burn rate of the D&O insurance has in fact come to fruition.  Abramowitz noted that the issue of reimbursement was "getting to be a very serious problem."  The policies were "going to run out in a matter of weeks; not months, weeks, for all of us."  Wisenberg indicated more specifically that the "fourth and final layer carrier has informed us that -- basically, not to assume there's going to be any money after invoices submitted on July 31st . . . "  Craig Stewart (Arnold & Porter), counsel for Cosgrove, another defendant, indicated that his client lacked the funding "to continue having us represent him as it stands, and that will be true as soon as the insurance money runs out."  As a result, he might have to return to the court to ask that Cosgrove "receive appointed counsel because he simply would not have the money to retain private counsel, givne the socpe and scale of this case, to defend it."    

The depleting policies was a factor in Barnaba's argument for severence and an earlier trial date.  Although the judge hasn't ruled on the motion (specifically reserving decision), Barnaba may get his wish.   The government conceded that it was considering a superseding indictment.  "If we do supersed, I imagine there will be a motion or motions for severence, and your Honor may be inclined to grant those motions.  And if that's the situation, we may not oppose in that particular situation." 

 A transcript of the hearing and other materials on this case can be found on the DU Corporate Governance website.

Tuesday
Jun032008

Stockman and the Limits of D&O Insurance

We note that Kevin LaCroix at the D&O Diary, a one stop shop for all things about D&O insurance, has commented on the post on this Blog that discussed the burn rate of the D&O policy used to pay legal expenses in the current litigation against officers and other personnel from the bankrupt Collins & Aikman.  His comments are worth repeating:

  • The first and most basic point is the importance of defense expense in the limits adequacy analysis. The potential for defense expense to exhaust or substantially deplete the available limits is most obvious in a catastrophic claim like the one involving Collins & Aikman, but even in less catastrophic circumstances, accumulating defense expense can substantially reduce the indemnity protection available even in a large insurance program. And the insurance is supposed to able to respond adequately in all circumstances, even the unlikely event of a catastrophic claim. In considering the requirements that a catastrophic claim can present, it is important to note that the aggregate defense expense related to the Collins & Aikman claim consumed $15 million in just nine months.
  • The second point is that one of the problems in the Collins & Aikman claim is that so many different people are accessing the policy, for a wide variety of different matters. The potential for the policy limits to drain away through so many different access points is perhaps inherent in the current standard D&O policy structure, in which so many different people are included as “insured persons” and so many different kinds of matters fall within the definition of a covered “claim.”
  • While this breadth of coverage is generally viewed as a positive thing from the policyholder’s perspective, it has the inherent potential (a potential that is being dramatically realized in the Collins & Aikman claim) for accelerated policy erosion and even depletion. The erosion potential inherent in the breadth of available policy coverage is a consideration that is too infrequently considered in connection with the question of limits adequacy.
  • Third, the problem Barnaba faces is not just his alone – all of the other “insured persons” are also facing imminent insurance program depletion. Once the available insurance is used up, these individuals will face continued complex litigation without further insurance available to defend or indemnify themselves. Among other things, it could prove difficult and painful for the defendants in the civil lawsuits to extricate themselves without insurance available.

In short, for a multi-billion dollar company like Collins & Aikman, $50 million in insurance limits may not be enough.

Monday
Jun022008

US v. Stockman and the Burn Rate on the D&O Policy

We have been following the criminal action filed against David Stockman, the former director of OMB under Ronald Reagan. Most of the parties are mired in discovery, with the Government having produced somewhere around 10 million documents.

With one exception. Defendant, Paul Barnaba, is pushing for a quick trial, having originally sought a date this summer. One (but by no means the only) reason for the quick trial date has been concern over the burn rate of the D&O policy. The Government described the concern as "wholly speculative and unsubstantiated."

In reply, Barnaba vigorously disagrees. In so doing, he provides considerable insight into the terms of the D&O insurance policies applicable in this case. Total coverage is $50 million, with the first tranche exhausted in June 2007 and has an estimated $1.67 million per month burn rate. As the memorandum provides:

  • the impending exhaustion of these funds is neither speculative nor unsubstantiated. The D&O Policy in question provides four layers of coverage—a total of $50 million. It provides coverage to a wide array of former Collins & Aikman (“C&A”) executives and employees, including those who have been charged in this case, those who have been sued or subpoenaed in the civil SEC matter, and those who have been sued or subpoenaed in various class actions and other civil suits taking place around the country. The first $15 million layer of coverage was exhausted on or about June 15, 2007. The second $15 million layer of coverage was exhausted on or about March 31, 2008. Invoices were submitted to the second layer carrier between in or around July 2007, and in or around March 2008, invoicing for work performed between in or around June 2007 and in or around February 2008. In other words, the second $15 million layer of coverage was exhausted in nine months at a rate of approximately $1.67 million per month. The monthly burn rate was higher at the end than at the beginning of this nine-month period.

The bottom line? The remainder of the policy may well be exhausted by year's end.

  • This leaves $20 million of coverage remaining, but this amount is for invoices submitted beginning on or about April 1, 2008 for work that was performed beginning on or about March 1, 2008. Assuming a monthly burn rate of $2 million to $3 million, which is realistic and likely conservative, all policy proceeds will be exhausted sometime between mid-September 2008 and December 31, 2008.

The $50 million amount seems typical for a company the size of C&A.  The burn rate is substantial but then so is the amount of litigation swirling around the company, with charges filed by the Securities and Exchange Commission augmenting the criminal proceedings. 

Barnaba likewise continues to assert that his efforts at a speedy trial are supported by his limited role in the criminal charges, something born out in the indictment.  As he notes: 

  • And even if those usual rationales, such as the public’s interest in economy, convenience, and prompt trials, are not trumped, they are of limited application here. Here, granting Barnaba’s severance request will insure the accused’s prompt trial. Here, because of Barnaba’s relatively limited role in the charged offenses, because he is the only Purchasing Department employee charged with a crime, and because he has virtually no involvement in any alleged scheme other than the Supplier Rebate Fraud Scheme, severing him will entail only limited duplicative effort.

We are redoing the corporate governance web site.  Once completed, we will post this pleading. 

Friday
May302008

The Stockman Case: Paul Barnaba Wants Out

We are following the criminal case filed against David Stockman, the former head of OMB under President Reagan.

Among the other defendants is Paul Barnaba. The indictment describes him as "employed by [Collins & Aikman] in the Purchasing Department." Specifically, he served as the Director of Financial Analysis and eventually Vice President and Director of Purchasing for the Plastics Division. According to the indictment, the defendants inflated income by "systematically recognizing 'rebates' from C&A's suppliers before those cost reductions had in fact been earned." The rebates were price reductions provided by suppliers. Barnaba allegedly played a role in this part of the scheme.

The case has settled into the discovery phase. The government finished providing documents on Feb. 27th. The government produced somewhere around 10 million pages. Counsel for Stockman (Elkin Abramowitz of Morvillo Abramowitz) disclosed that all of the defendants had "at various times between 40 and 60 contract lawyers" working on reviewing the documents, including 30 or so employed on behalf of Stockman.

Most of the defendants were apparently wading through the morass, with one exception. At a status conference held in January 2008, counsel for Barnaba (Solomon and Adrienne Wisenberg, Wisenberg & Wisenberg) asked for a short trial date, seeking a trial in June. Counsel noted that "under the insurance policies, the money may run out by the end of 2008." In a hearing in April, counsel for Barnaba indicated that he was ready to go to trial. At the hearing, the other defendants indicated that the determination of a trial date was "premature" and indicated a need for additional time.

Counsel for Barnaba promptly filed a motion to sever. As the brief noted:

  • Barnaba bases this motion on the applicable law in combination with two important facts: first, Barnaba is ready to go to trial and his Codefendants are not; and second, Barnaba’s purported involvement in the charged offenses pales in comparison to that of his Codefendants. This Motion is premised on the substantial risk that Barnaba’s speedy trial and related trial rights will be compromised if his trial is not severed.

According to the brief, Barnaba's life has been in shambles. He was "[i]mmediately fired from his job upon being indicted." He formed a consulting group "in order to feed his family" but was fired "when the customer learned of the Indictment." Moreover, the information about the indictment was easy to find.

  • In the Internet Age, one Google search can reveal an indictment to any prospective employer. The detrimental publicity, disgrace, and censure resulting from the charges have only been heightened in Barnaba’s case by the prominence of Stockman, and by Stockman’s decision to comment on the case in highly public forums.

The troubles have not ended with employment. The charges created havoc in his personal life and with his finances. As the memorandum noted:

  • Barnaba is going through a divorce and is down to his last $16,000.00 in savings. He has no other liquid assets and no guarantee of future employment, until these charges are resolved through trial. Once his savings run out, he will be forced to dip into his modest 401(k) pension fund. He maintains a separate residence from his soon-to-be ex-wife, and has two small children to support. The psychological and financial strains of his uncertain legal status are exacting a heavy toll. As Barnaba puts it in his sworn affidavit: “The delay in getting to trial in this case has caused, and continues to cause, excruciating stress in every aspect of my life. It is extremely difficult to exist in a state of uncertainty and limbo. The presumption of innocence may apply in the courtroom, but not in many other areas of life. I appear to be presumed guilty in the eyes of the business community, until proven innocent.”

Likewise he expressed concern with the D&O Policy, noting that "the proceeds of that policy are quickly dwindling." See also Memorandum, at 10 ("Barnaba’s legal team estimates, based on the recent burn rate, that the D&O Policy funds could easily be exhausted by the end of September and will last no longer than December 2008.").

Although acknowledging that it was ready to go to trial, the government opposed the motion to sever.  The government said little about the personal issues but described the concern over the demise of the insurance proceeds as "wholly speculative and unsubstantiated."  As for the argument that he played a lesser role than his codefendants, the government argued that "[r]egardless of how he attempts to characterize the charged conduct attributable to him, Barnaba cannot escape the reality of being charged together with each of his codefendants in all of the securities fraud-related counts in the Indictment."  Severing would result in duplication and represent an inefficient use of the court's time.  

  • The Government intends to call witnesses who worked alongside Barnaba and the other codefendants, and offer documents and emails, many of which Barnaba and his codefendants created or reviewed at the time the frauds were being committed. Separate trials would therefore result in a wasteful duplication of the presentation of this evidence, and offer an unfair advantage to the second group of defendants being tried, who will have an opportunity to assess the Government's witnesses and theories beforehand. (citation omitted)

The motion is pending.  Barnaba has also filed a motion to dismiss the indictment and, in the alternative, a motion to set a trial date, and a motion to recuse one of the government's lawyer in the case.

Thursday
Nov152007

The Trial of David Stockman: Counsel for the Defense

United States Attorney, Michael Garcia indicted David Stockman and three others on March 21, 2007 for securities fraud, obstruction of justice, and charges of conspiracy. The lead prosecutor on the case is Assistant U.S. Attorney Helen Cantwell. Ms. Cantwell is the sole prosecutor responsible for investigating this matter; the Government intends to have additional prosecutors appointed to the case. This case will be heard before the Honorable Barbara S. Jones in the United States District Court for the Southern District of New York. Before Judge Jones joined the bench in 1996 she was the Chief Assistant United States Attorney to Robert M. Morgenthau.

The defendants have enlisted the help of several prominent attorneys: Elkan Abramowitz, Gandolfo DiBlasi, Craig Stewart, and Soloman Wisenberg.

Stockman’s attorney Elkan Abramowitz is a leading white-collar criminal defense attorney. According to New Yorker Magazine Mr. Abramowitz’s firm, Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C., is “the crème de la crème of white-collar criminal defense.” Mr. Abramowitz entered private practice in 1979. Prior to entering private practice he was an Assistant U.S. Attorney for the Southern District of New York, Assistant Deputy Mayor for the City of New York, Special Counsel to the Select Committee on Crimes for the U.S. House of Representatives and Chief of the Criminal Division in the U.S. Attorney’s Office.

In addition to Abramowitz Stockman’s team of attorneys includes Jodi Peikin, and James Stovall, both are attorneys of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C.

Gandolfo DiBlasi is a partner at Sullivan & Cromwell in New York. Mr. DiBlasi has experience as lead counsel for cases involving: securities investigations of the Salomon Brothers treasury auction scandal, pay-to-play investigations in the municipal securities market, back dated options, and various Enron-related matters.

Craig Stewart is a litigation partner at Arnold & Porter LLP in New York. Mr. Stewart has extensive experience defending regulatory prosecutions. Prior to entering private practice, Mr. Stewart spent eleven years as an Assistant United States Attorney in the Southern District of New York.

Solomon Wisenberg is equally familiar with white-collar litigation. Prior to starting his own firm, Mr. Wisenberg was the chair of the White Collar Crime Practice Group at Rossi, Dixon & Bell, a Washington D.C. firm. Mr. Wisenberg was also an Assistant U.S. Attorney in Texas and North Carolina. During his time as an Assistant U.S. Attorney he received the Directors Award from Attorney General Janet Reno for his work on a $200 million Victoria Savings Scandal. During the 1980’s Mr. Wisenberg was Acting Special Counsel for Judicial Selection and Attorney Advisor in the U.S. Department of Justice under Attorney General Edwin Meese. The defendants have already moved to disqualify Ms. Cantwell for her involvement in earlier discussions with the defendants regarding pleas and related matters.

The primary materials for the Stockman Case including a summary of the indictment may be found on the DU Corporate Governance website.

Thursday
Oct112007

The Race to the Bottom and the Case of David Stockman

The Race to the Bottom has as part of its mission the analysis and examination of cases that raise important issues of corporate governance.  This Blog will follow the case of David Stockman, the former Congressman and head of the Office of Management and Budget under President Reagan.  During the era of trickle down and the Laffer curve, Stockman helped push through the Reagan budgets.  His most famous moment was probably an unguarded comment made in an interview published in The Atlantic when he referred to the Reagan tax cuts as a "trojan horse." 

He left politics, went to Wall Street, and helped found the Blackstone Group, leaving the public eye but presumably becoming very rich in the process.  He's back, having been indicted for his role in overseeing Collins & Aikman, a auto parts manufacturer.  In defending himself from charges he manipulated financial information, one article reported that Stockman will rely on the "I am a moron defense".  

Students will obtain all filings in this case and post on them.  Jeff Hartje, a faculty member at the University of Denver Sturm College of Law, and an expert on litigation and evidence will discuss the filings with students and supervise the posts.  Most of the posts will appear in a separate tab on this page labeled "Stockman".  When developments occur of high significance, the posts will be on the main page. 

Enjoy the coverage.   

Thursday
Oct112007

United States v. Stockman, 07- 0220 (S.D.N.Y. filed Mar. 21, 2007) – Indictment

We will be following the case of United States v. Stockman, 07-0220 (S.D.N.Y. filed Mar. 21, 2007) through a series of posts as the case progresses. This post outlines the background of the case as well as the Grand Jury charges found in the Indictment.

The Grand Jury charges flow from activities between 2000 and 2005 of Collins & Aikman, Inc., (“C&A”), which was a public company listed on the NYSE. C&A was a global automotive parts supplier, who by 2005 had grown to be one of the largest suppliers in the world. In 2001, a private equity firm, formed in part by David Stockman, acquired a controlling interest in C&A. Stockman, served as CEO and Chairman of the Board of Directors of C&A. Under Stockman’s control, C&A availed itself to a variety of sources of debt financing including: notes, revolving credit lines, and securitizing accounts receivables. C&A’s debt financing was subject to certain financial covenants and failure to comply with these covenants would constitute a default by C&A and warrant demand for immediate payment. The covenants required C&A to maintain a certain ratio of performance measured by C&A’s net debt divided by EBITDA.

In general, the Indictment alleges that in response to these operational pressures and covenants to keep C&A’s financial performance at certain levels, Stockman orchestrated a scheme joined by the other defendants to defraud C&A’s investors, banks, and creditors by manipulating C&A’s reported revenue and earnings. The other Defendants include – Michael Stepp, who at various times served as CFO and on the Board of Directors of C&A; David Cosgrove, C&A’s vice president of finance; and Paul Barnaba, Director of Financial Analysis for C&A’s Purchasing Department.

At the forefront of the alleged scheme to defraud was C&A’s improper “rebate” accounting practices. The alleged “rebate” scheme came in three varieties. The first variety took the form of C&A asking for lump sum payments from a supplier, which C&A would characterize as a supplier “rebate.” However, according to an agreement C&A would have with the supplier, C&A systematically repaid this money through additional purchases. Under this variety, C&A improperly recognized what was essentially a loan as a current reduction in costs or “rebate.” Thus, increasing EBITDA and improperly inflating C&A’s current financial performance.

The second variety of “rebate” occurred when C&A negotiated upfront payments called “slotting fees” or “rebates” from its suppliers in exchange for future business. Because C&A’s right to retain the rebate was conditioned on C&A’s promise of future business, GAAP required C&A to recognize these “rebates” as a reduction in cost of sales only after C&A satisfied all the contractual terms entitling it to the lump sum. However, in order to inflate its EBITDA for the current period Stockman and Cosgrove directed C&A’s employees to obtain separate documents that falsely attributed the supplier rebate to past purchases to justify its characterization.

The third variety of “rebate” involved accounting for capital equipment. Under GAAP, discounts on the price of capital assets result in the reduction of the cost basis of the asset, and would have no impact on EBITDA. For the purpose of inflating C&A’s EBITDA, C&A employees, under Stockman’s direction, negotiated contracts whereby C&A agreed to pay a higher price for capital equipment than originally requested by the supplier. In return for the higher price, C&A received a “rebate,” coupled with documentation that falsely attributed the “rebate” to other items, which decreased current expenses. The Indictment alleges that due to the three “rebate” schemes mentioned above, between 2001 and 2004, C&A improperly inflated their operating income by approximately $43.6 million.

It is charged that in furtherance of this scheme, Stockman and the other Defendants made repeated public statements in which they falsely described C&A’s operating performance and financial results, and in order to mislead, omitted material facts necessary to make C&A’s financial performance complete and accurate. In addition, Stockman and the other Defendants caused C&A to file financial statements with the SEC that materially misrepresented C&A’s operating performance and financial results.

The Indictment includes eight counts dealing with the alleged fraudulent activity mentioned above. The first count charges all Defendants with a conspiracy to commit the substantive offenses contained in counts two through eight. (false statements in financial records and documentation, lying to auditors and engaging in bank fraud, wire fraud, and obstruction of an agency proceeding).

Counts two through four charge all Defendants with Securities Fraud violations of 10b-5 in connection with the purchase or sale of common stock, 10.75% senior subordinated notes, and 12.875% senior subordinated notes respectively.

Counts five and six charge Stockman with Bank Fraud, under 18 U.S.C. § 1344, for knowingly executing schemes to defraud General Electric Capital Corporation (“GECC”) and JP Morgan Chase respectively.

Count seven charges Stockman with Wire Fraud, under 18 U.S.C. § 1343, arising from misleading and false statements made during a due diligence conference telephone call with Credit Suisse to obtain $75 million in financing.

Count eight charges Stockman and Stepp with Obstruction of an Agency Proceeding by knowingly causing false and misleading information to be provided to the SEC.

We will continue to follow this case as it progresses. This Indictment and other filings can be found on the

DU Corporate Governance website website.

Thursday
Oct112007

Facts Leading Up to Stockman Indictment

In March 2007, US District Attorney, Michael J. Garcia, filed an indictment against David Stockman, J. Michael Stepp, David R Cosgrove, and Paul C Barnaba. The indictment alleges that all four persons acted either alone or conspired together to commit a series of violations. The list of accusations includes conspiracy to commit securities fraud, false statements in annual and quarterly reports, false entries in books and records, lying to auditors, bank fraud, wire fraud, and obstruction of an agency proceeding.

Both Stockman and Stepp were employed at Collins and Aikman, Inc. Stockman served as the CEO and Chairman of the Board. J. Michael Stepp served as the CFO and advisor to Collins and Aikman. Both defendants were partners in a private equity firm which was the largest single shareholder in Collins and Aikman. Cosgrove served as Group Controller and Vice President and later took on the position as Senior Vice President of the Financial Planning and Analysis Group. Lastly, Barnaba served as the Director of Financial Analysis.

Collins and Aikman was in the business of providing companies around the world a broad range of automotive supply parts. The company owned and operated factories in North America, South America, and Europe, and supplied parts to both domestic and foreign auto manufacturers, such as Ford, General Motors, and DaimlerChrysler. By 2005, Collins and Aikman had grown to be one of the largest automotive parts suppliers in the world.

The companies’ ability to leverage capital was conditioned upon complying with certain covenants as negotiated in their lender agreements. For example, Collins and Aikman had to maintain a level of performance predetermined by their investors. Failure to comply would constitute a default on such agreements and warrant a demand for immediate payment of the full amount of its credit obligations. Maintaining these performance levels also determined whether or not lenders would provide the company with additional financing in the future. Beginning in 2001, Collins and Aikman faced increasing pressures in its business operations, which, along with other issues, threatened to cause Collins and Aikman’s financial performance to fall to levels that might trigger a default on the financial agreements. Such a default would cut off funding that the company desperately needed and also require the company to repay creditors in full the amounts that Collins and Aikman had previously borrowed.

In order to stave off total insolvency, prosecutors allege that Stockman lied to banks about the firm's financial condition, inducing them to loan the company money it couldn't repay. He began structuring transactions as "rebates" that involved masking loans, which were supposed to be repaid as income. He exaggerated the manufacturer's prospects, knowing his claims were untrue, which led people to buy company securities that quickly became worthless.

In May 2005, the Board of Directors discovered that Collins and Aikman had run out of cash. Finding itself on the verge of financial insolvency, the Board was forced to file for bankruptcy. The prosecution asserted that Collins and Aikman’s financial situation occurred largely under Stockman’s direction, and the Board of Directors seemed to agree. Soon after the Board discovered that the company had run out of money, it immediately requested that Stockman resign. By this time, Collins and Aikman’s common stock became nearly worthless. The indictment alleges that the actions of the defendants- which include engaging in securities fraud, lying to auditors, and “cooking” the company books- resulted in hundreds of millions of dollars in investor and creditor losses. Currently, officials are selling off the company in pieces, a process that may be complete long before the Stockman case is set to go to trial in the later part of 2008.

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