Trends in Corporate Fraud Enforcement

Prosecutors Have More Resources

One reality of the enforcement climate is that prosecutors have more resources to devote to corporate fraud. In July 2002, President Bush announced the Corporate Fraud Task Force (CFTF) — “a financial crimes SWAT team overseeing the investigation of corporate abusers and bringing them to account.” At the same time, through ' 601 of the Sarbanes Oxley Act of 2002 (SOX), Congress increased appropriations to the SEC from $438 million in 2002 to $776 million in 2003. In 2004, Congress appropriated $811.5 million to the SEC. In 2005, the SEC requested $913 million, or more than double the amount appropriated just four years before.

The Department of Justice (DOJ) also has devoted more resources — or at least more attention — to corporate fraud. In addition to the CFTF, DOJ established the Enron task force and other initiatives inside the criminal division. In January 2003, then Deputy Attorney General Larry Thompson issued a memo announcing harsh new principles governing prosecutions of business organizations. In its 2006 discretionary budget, DOJ identified corporate fraud as one of its major programs. Ambitious state prosecutors — most notably New York Attorney General Eliot Spitzer — also have jumped into the fray, filing high-profile criminal cases relating to the securities industry.

More Resources Initially Meant More Cases

Additional resources initially led to an increase in corporate-fraud cases, especially securities fraud. The CFTF reports that the SEC filed more financial fraud and reporting violations in 2002 and 2003 than in prior years: (see Fig. 1). According to U.S. Attorneys' Annual Statistical Report, criminal prosecutions for securities and corporate fraud also jumped in 2002 and 2003: (see Fig. 2). These same statistics reflect that in 2004, the tide may have begun to turn. As noted, DOJ filed fewer corporate and securities fraud cases that year. While the SEC has not released statistics for 2004 or 2005, the CFTF reports that in the first 6 months of 2004, the SEC filed 81 financial fraud and reporting cases, raising the possibility that the pace of newly filed actions has slowed. Overall, the number of organizations receiving fines or restitutions for fraud charges has been variable: 72 in 2001 versus 102 in 2002 and 63 in 2003.

Focus on Senior Executives and Financial Reporting Staff

Nevertheless, senior executives and financial-reporting personnel remain in the hot seat. The CFTF reports that from July 2002 through May 2004, prosecutors obtained 500 convictions or guilty pleas on corporate-fraud charges against 900 defendants, 60 of whom were corporate presidents or CEOs. During this time, DOJ filed charges – and obtained guilty pleas or convictions – against a long line of executives and financial-reporting personnel at companies such as WorldCom, Adelphia, Enron, Qwest, and HealthSouth.

'Gatekeepers' Remain on the Hot Seat

The focus on so-called “gatekeepers” –attorneys, auditors and boards of directors – also remains intense. Post-SOX, both DOJ and the SEC have filed charges against lawyers who allegedly knew about or participated in corporate fraud. Consider Franklin C. Brown, the former chief legal counsel at Rite Aid Corp. Brown's 30-year career at Rite Aid ended when he was convicted on 10 felony counts, including obstruction of justice, conspiracy, witness tampering and lying to federal regulators. At age 76 and after being fitted with a pacemaker, Brown was sentenced to 10 years in prison. A review of SEC releases suggests that the Commission has barred or suspended at least 18 attorneys from practicing before the Commission through August 2005, as compared with three in 2004, five in 2003, and one each in 2002 and 2001.

Auditors and audit firms also remain under scrutiny, as the SEC continues to bar and suspend accountants from practicing before the Commission — 34 in 2000, 29 in 2001, 26 in 2002, 46 in 2003, 38 in 2004 and 35 through August 2005. In addition, as the SEC's actions against KPMG (re Gemstar-TV Guide), PwC (re Warnaco) and E&Y (re PeopleSoft) reflect, the Commission remains willing to target entire firms for allegedly inadequate audits.

Outside directors also remain beleaguered. Frank Walsh, a former outside director for Tyco International, pleaded guilty to securities fraud charges based on his receipt of an undisclosed $20 million payment from Tyco for helping to broker an acquisition. Walsh avoided prison by agreeing to repay the fee plus a $2.5 million fine and a lifetime bar from serving as a director or officer. The private actions against former outside directors of Enron and WorldCom — and the millions directors paid to settle those claims — also reflect current enforcement trends.

Are Courts and Juries Pushing Back?

While the climate is harsh, there is some evidence that courts and juries have started to push back. Consider former HealthSouth CEO Richard Scrushy. On May 7, 2003, the district court concluded that it had the “inherent power” to stay the SEC's civil case against Scrushy, who had not yet been indicted at the time, over the SEC's objections. The district court also rejected the SEC's request for an asset freeze for lack of evidence. The court noted that the SEC had relied upon evidence gathered in the ongoing criminal investigation, and expressed concern that the SEC and prosecutors were using parallel civil and criminal proceedings to gain evidence against Scrushy that they then kept from him.

Things got worse for the government in the criminal case. First, on April 15, 2005, the district court ruled that Scrushy's SEC deposition was not admissible because the government had “manipulated” the parallel civil and criminal investigations “for its own purposes” to procure the testimony and thus “departed from the proper administration of justice.” On May 12, 2005, the district court dismissed four of five SOX-related counts against Scrushy on the grounds that prosecutors had failed to present sufficient evidence. Then, on June 28, 2005, a Birmingham, AL, jury acquitted Scrushy on all counts, including the one remaining SOX charge.

Less than 1 month later, a jury in the Southern District of Texas returned a mixed verdict in the criminal prosecution of five former executives of Enron's broadband division. The government alleged that the defendants had inflated the value of the division, either by lying about the company's technological achievements or by fabricating a sale to boost earnings and inflate Enron's share price. The jury acquitted three of the defendants entirely and deadlocked on the other two.

Other examples of pushback against federal prosecutors include the U.S. Supreme Court's reversal of Arthur Andersen's conviction for obstruction of justice, and a Manhattan jury's acquittal of former Tyco general counsel Mark Belnick on charges of grand larceny, securities fraud and falsifying business records. NY Attorney General Spitzer was dealt a similar blow when the jury largely rejected his claims against Theodore Sihpol. Spitzer had obtained a 40-count indictment against Sihpol, a former broker at Bank of America, for allegedly facilitating the “market timing” (described as frequent purchases and sales) and “late trading” (described as trades authorized after 4:00 p.m. EST, but priced as of 4:00 p.m.) of mutual-fund shares by a hedge fund client. Although other defendants settled, Sihpol chose to fight: he argued that he had done nothing illegal. On June 9, 2005, a jury sided almost entirely with Sihpol, finding him not guilty on 29 counts, including several of grand larceny. The judge declared a mistrial on the remaining four counts as to which a single juror allegedly had held out for a conviction.

Prosecution Trends

Taken together, these developments may explain why prosecutors in certain cases may open to requests that they take a more flexible approach. Andersen's demise in the wake of prosecution has not stopped prosecutors from holding the hammer over other firms but has made them think twice before crashing it down. The KPMG deferred prosecution is an example of DOJ's backing off from the corporate death penalty. Prosecutors in the Southern District of New York also entered into non-prosecution agreements with Tommy Hilfiger Corp., Adelphia and MCI/ WorldCom.

Persistence Pays Off?

Defense counsel should be prepared for uncertainty. Regulators and prosecutors are exercising their discretion in evolving ways. Reliance on the distant past is pointless, but focusing on more recent signs of openness to moderation may be persuasive. When persuasion fails, de-fense counsel should prepare to push back. As a number of high profile cases reflect, courts and juries do not always rubber stamp the prosecution case.

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For high-profile defendants, timing is everything. In 1989, former junk bond king Michael Milken was indicted on RICO violations, stock manipulation and insider trading. After Milken pleaded guilty to securities, mail and tax fraud and market manipulation, he was sentenced to 10 years in prison, with anticipated actual service of 40 months. Due to cooperation and good behavior, Milken emerged from prison after serving less than 2 years, with a personal fortune in place. He has remained a power broker in financial and charitable circles since his release.

In 2005, former WorldCom, Inc. CEO Bernard Ebbers was indicted for conspiracy, securities fraud and filing false statements with the Securities and Exchange Commission (SEC) after WorldCom announced that it had overstated earnings. After a New York jury found Ebbers guilty, Judge Barbara Jones sentenced 63-year-old- Ebbers — a first-time violator — to 25 years in prison, of which he must serve at least 21. Judge Jones commented that, while she recognized that this was “likely to be a life sentence for Mr. Ebbers,” anything else “would not reflect the seriousness of the crime.” Separately, Ebbers agreed to pay $5.5 million in cash and to hand over his home and other assets worth as much as $40 million to resolve claims filed by WorldCom shareholders — a settlement commentators estimate will chew up most of Ebbers' estate.

As the change in approach from the Milken case illustrates, today the enforcement environment for business crimes is harsh. Statistics, however, suggest that 2003 might have been the high-water mark. In addition, in the past 6 months, courts and juries have handed prosecutors a number of high-profile setbacks. Corporations and their employees may find that regulators' and prosecutors' zeal, while still intense, has moderated somewhat.

Prosecutors Have More Resources

One reality of the enforcement climate is that prosecutors have more resources to devote to corporate fraud. In July 2002, President Bush announced the Corporate Fraud Task Force (CFTF) — “a financial crimes SWAT team overseeing the investigation of corporate abusers and bringing them to account.” At the same time, through ' 601 of the Sarbanes Oxley Act of 2002 (SOX), Congress increased appropriations to the SEC from $438 million in 2002 to $776 million in 2003. In 2004, Congress appropriated $811.5 million to the SEC. In 2005, the SEC requested $913 million, or more than double the amount appropriated just four years before.

The Department of Justice (DOJ) also has devoted more resources — or at least more attention — to corporate fraud. In addition to the CFTF, DOJ established the Enron task force and other initiatives inside the criminal division. In January 2003, then Deputy Attorney General Larry Thompson issued a memo announcing harsh new principles governing prosecutions of business organizations. In its 2006 discretionary budget, DOJ identified corporate fraud as one of its major programs. Ambitious state prosecutors — most notably New York Attorney General Eliot Spitzer — also have jumped into the fray, filing high-profile criminal cases relating to the securities industry.

More Resources Initially Meant More Cases

Additional resources initially led to an increase in corporate-fraud cases, especially securities fraud. The CFTF reports that the SEC filed more financial fraud and reporting violations in 2002 and 2003 than in prior years: (see Fig. 1). According to U.S. Attorneys' Annual Statistical Report, criminal prosecutions for securities and corporate fraud also jumped in 2002 and 2003: (see Fig. 2). These same statistics reflect that in 2004, the tide may have begun to turn. As noted, DOJ filed fewer corporate and securities fraud cases that year. While the SEC has not released statistics for 2004 or 2005, the CFTF reports that in the first 6 months of 2004, the SEC filed 81 financial fraud and reporting cases, raising the possibility that the pace of newly filed actions has slowed. Overall, the number of organizations receiving fines or restitutions for fraud charges has been variable: 72 in 2001 versus 102 in 2002 and 63 in 2003.

Focus on Senior Executives and Financial Reporting Staff

Nevertheless, senior executives and financial-reporting personnel remain in the hot seat. The CFTF reports that from July 2002 through May 2004, prosecutors obtained 500 convictions or guilty pleas on corporate-fraud charges against 900 defendants, 60 of whom were corporate presidents or CEOs. During this time, DOJ filed charges – and obtained guilty pleas or convictions – against a long line of executives and financial-reporting personnel at companies such as WorldCom, Adelphia, Enron, Qwest, and HealthSouth.

'Gatekeepers' Remain on the Hot Seat

The focus on so-called “gatekeepers” –attorneys, auditors and boards of directors – also remains intense. Post-SOX, both DOJ and the SEC have filed charges against lawyers who allegedly knew about or participated in corporate fraud. Consider Franklin C. Brown, the former chief legal counsel at Rite Aid Corp. Brown's 30-year career at Rite Aid ended when he was convicted on 10 felony counts, including obstruction of justice, conspiracy, witness tampering and lying to federal regulators. At age 76 and after being fitted with a pacemaker, Brown was sentenced to 10 years in prison. A review of SEC releases suggests that the Commission has barred or suspended at least 18 attorneys from practicing before the Commission through August 2005, as compared with three in 2004, five in 2003, and one each in 2002 and 2001.

Auditors and audit firms also remain under scrutiny, as the SEC continues to bar and suspend accountants from practicing before the Commission — 34 in 2000, 29 in 2001, 26 in 2002, 46 in 2003, 38 in 2004 and 35 through August 2005. In addition, as the SEC's actions against KPMG (re Gemstar-TV Guide), PwC (re Warnaco) and E&Y (re PeopleSoft) reflect, the Commission remains willing to target entire firms for allegedly inadequate audits.

Outside directors also remain beleaguered. Frank Walsh, a former outside director for Tyco International, pleaded guilty to securities fraud charges based on his receipt of an undisclosed $20 million payment from Tyco for helping to broker an acquisition. Walsh avoided prison by agreeing to repay the fee plus a $2.5 million fine and a lifetime bar from serving as a director or officer. The private actions against former outside directors of Enron and WorldCom — and the millions directors paid to settle those claims — also reflect current enforcement trends.

Are Courts and Juries Pushing Back?

While the climate is harsh, there is some evidence that courts and juries have started to push back. Consider former HealthSouth CEO Richard Scrushy. On May 7, 2003, the district court concluded that it had the “inherent power” to stay the SEC's civil case against Scrushy, who had not yet been indicted at the time, over the SEC's objections. The district court also rejected the SEC's request for an asset freeze for lack of evidence. The court noted that the SEC had relied upon evidence gathered in the ongoing criminal investigation, and expressed concern that the SEC and prosecutors were using parallel civil and criminal proceedings to gain evidence against Scrushy that they then kept from him.

Things got worse for the government in the criminal case. First, on April 15, 2005, the district court ruled that Scrushy's SEC deposition was not admissible because the government had “manipulated” the parallel civil and criminal investigations “for its own purposes” to procure the testimony and thus “departed from the proper administration of justice.” On May 12, 2005, the district court dismissed four of five SOX-related counts against Scrushy on the grounds that prosecutors had failed to present sufficient evidence. Then, on June 28, 2005, a Birmingham, AL, jury acquitted Scrushy on all counts, including the one remaining SOX charge.

Less than 1 month later, a jury in the Southern District of Texas returned a mixed verdict in the criminal prosecution of five former executives of Enron's broadband division. The government alleged that the defendants had inflated the value of the division, either by lying about the company's technological achievements or by fabricating a sale to boost earnings and inflate Enron's share price. The jury acquitted three of the defendants entirely and deadlocked on the other two.

Other examples of pushback against federal prosecutors include the U.S. Supreme Court's reversal of Arthur Andersen's conviction for obstruction of justice, and a Manhattan jury's acquittal of former Tyco general counsel Mark Belnick on charges of grand larceny, securities fraud and falsifying business records. NY Attorney General Spitzer was dealt a similar blow when the jury largely rejected his claims against Theodore Sihpol. Spitzer had obtained a 40-count indictment against Sihpol, a former broker at Bank of America, for allegedly facilitating the “market timing” (described as frequent purchases and sales) and “late trading” (described as trades authorized after 4:00 p.m. EST, but priced as of 4:00 p.m.) of mutual-fund shares by a hedge fund client. Although other defendants settled, Sihpol chose to fight: he argued that he had done nothing illegal. On June 9, 2005, a jury sided almost entirely with Sihpol, finding him not guilty on 29 counts, including several of grand larceny. The judge declared a mistrial on the remaining four counts as to which a single juror allegedly had held out for a conviction.

Prosecution Trends

Taken together, these developments may explain why prosecutors in certain cases may open to requests that they take a more flexible approach. Andersen's demise in the wake of prosecution has not stopped prosecutors from holding the hammer over other firms but has made them think twice before crashing it down. The KPMG deferred prosecution is an example of DOJ's backing off from the corporate death penalty. Prosecutors in the Southern District of New York also entered into non-prosecution agreements with Tommy Hilfiger Corp., Adelphia and MCI/ WorldCom.

Persistence Pays Off?

Defense counsel should be prepared for uncertainty. Regulators and prosecutors are exercising their discretion in evolving ways. Reliance on the distant past is pointless, but focusing on more recent signs of openness to moderation may be persuasive. When persuasion fails, de-fense counsel should prepare to push back. As a number of high profile cases reflect, courts and juries do not always rubber stamp the prosecution case.

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