In the Courts

The government's loss estimates were based on the results of an event study, which is an examination of the association between news about a company and stock price movement. The government's expert suggested that the amount of loss was between $1.2 and $1.4 billion, according to a leakage event study. A critical assumption of that study was that from Feb. 14, 2005 to March 15, 2005, the stock market reacted to the continual leak of information related to the LPT fraud. Alternatively, the government's expert offered a standard event study which estimated loss by reference to the decline in AIG's stock price on three specific dates on which the market would have reacted to news about the fraud. The standard event study produced an estimated loss of $544 to $597 million. The defendants' expert estimated the loss to be zero.

The court rejected the government leakage event study, which produced the highest estimate of loss, because the government had not justified the 30-day event window or accounted for confounding factors that may have affected AIG's stock price. The court did accept the government's standard event study as a reasonable estimate of loss.

The issue before the court was whether it should consider the individual mutual fund shareholders as victims, which would trigger the six-level increase. Reasoning that each investor suffered pecuniary harm from the fraud, the court applied the six-level increase for more than 250 victims.

The court also considered whether restitution was required under the Mandatory Victims Restitution Act of 1996 (“MVRA”) or whether it would exercise its discretion to award restitution under the Victim and Witness Protection Act of 1982 (“VWPA”).

As a result of the court's rulings, each defendant's offense level was increased by 36 levels, which will be added to their base offense level of 7. United States v. Ferguson, et al., No. 3:06 CR 137 (D. Conn. Oct. 31, 2008).

Kozlowski Appeal Denied By New York Court of Appeals

Former Tyco International Ltd. (“Tyco”) CEO Dennis Kozlowski and CFO Mark Swartz lost their appeal of their convictions and sentence in an opinion by the New York Court of Appeals. People v. Kozlowski, — N.E.2d —-, 2008 WL 4585261 (N.Y. Oct. 16, 2008).

Kozlowski and Swartz were convicted by a jury of multiple fraud charges stemming from their former positions as executives at Tyco. The defendants were found by a jury to have used company funds to illegally direct bonus payments and loans they didn't repay to themselves. The primary issue on appeal was whether the testimony of well-known lawyer David Boies, who was retained by Tyco in connection with an internal investigation, was improper opinion testimony. The Court of Appeals also upheld the Supreme Court's decision to quash a subpoena duces tecum that sought the factual portions of certain interview notes and memoranda prepared during the internal investigation. Finally, the court found the defendants' Apprendi claim to be harmless error.

In 2002, Tyco hired David Boies, and his firm, to investigate Kozlowski's payment of a $20 million investment banking fee to a member of the company's board. The internal investigation expanded that same year after Kozlowski resigned from his position as CEO after being indicted for failing to pay sales tax on expensive artwork that he had purchased. That was when Boies and his firm began to investigate whether Kozlowski and others had engaged in improper transactions with Tyco's funds. Part of the internal investigation included conducting interviews of Tyco employees.

Kozlowski and Swartz argued on appeal that Boies's testimony at their criminal trial was prejudicial because Boies was permitted to offer opinion testimony, even though he was just a fact witness. The defendants also claimed that the prosecutor's summation, which referenced Boies's testimony, compounded the error. Defendants argued that it was prejudicial to allow the prosecution to elicit Boies's background, an overview of internal investigations in general, and the scope of the Tyco internal investigation. The court rejected the challenge, finding that “the testimony and summation complained of merely set forth facts enabling the jury to draw an inference of defendants' guilt.” Because Boies had limited himself to the facts of the investigation, the court found no error.

The defendants' second claim was that a subpoena duces tecum that they issued to obtain certain
witness statements collected in the internal investigation was improperly quashed. The key issue on appeal was whether the documents and memoranda containing those witness statements were privileged. The court held that they were. Although the court agreed with defendants that the witness statements were not absolutely privileged, their argument ultimately failed because they did not establish an inability to obtain the substantial equivalent of the facts sought without undue hardship. Defendants failed to at least attempt to interview the witnesses that gave statements to Boies and his firm's lawyers. The court also held that Tyco had not waived any privilege over the interviews.

Finally, the court rebuffed the defendants' claim that the fines imposed on them violated their Sixth Amendment jury trial right, because the fines were determined by the court, rather than a jury. The defendants' argument relied on the Supreme Court's decision in Apprendi v. New Jersey, which held that,
“[o]ther than the fact of a prior conviction, any fact that increases the penalty for a crime beyond the prescribed statutory maximum must be submitted to a jury and proved beyond a reasonable doubt.” The Court of Appeals dismissed the defendants' appeal because any error was harmless; the defendants trial testimony “established gain that correspond to or exceeded the fine amounts.”

In the Courts and Business Crimes Hotline were written by Associate Editor Jason Hernandez, Kirkland & Ellis LLP, Washington, DC.

Former AIG Employees' Fraud Caused More Than $500 Million in Losses

A fraudulent reinsurance contract between American International Group, Inc. (“AIG”) and General Reinsurance Corp. (“Gen Re”) resulted in more than $500 million in losses to investors, according to an Oct. 31, 2008 ruling issued by United States District Court Judge Christopher F. Droney. The losses arose from a loss portfolio transfer (“LPT”) reinsurance transaction negotiated between AIG and Gen Re. Five defendants were convicted for their role in the fraud and will be sentenced this month.

Most of Judge Droney's ruling was dedicated to resolving the amount of loss associated with the fraud. The presentence report for all five defendants concluded that the amount of loss, as that term is defined in U.S.S.G. ' 2B1.1, could not reasonably be determined. Rather than relying on the amount of loss, the presentence report found that Gen Re gained $5 million from the LPT, which would have added 18 levels to the defendants' guidelines calculations. The government and defendants objected to the presentence report and offered expert testimony on the issue of loss.

The government's loss estimates were based on the results of an event study, which is an examination of the association between news about a company and stock price movement. The government's expert suggested that the amount of loss was between $1.2 and $1.4 billion, according to a leakage event study. A critical assumption of that study was that from Feb. 14, 2005 to March 15, 2005, the stock market reacted to the continual leak of information related to the LPT fraud. Alternatively, the government's expert offered a standard event study which estimated loss by reference to the decline in AIG's stock price on three specific dates on which the market would have reacted to news about the fraud. The standard event study produced an estimated loss of $544 to $597 million. The defendants' expert estimated the loss to be zero.

The court rejected the government leakage event study, which produced the highest estimate of loss, because the government had not justified the 30-day event window or accounted for confounding factors that may have affected AIG's stock price. The court did accept the government's standard event study as a reasonable estimate of loss.

The issue before the court was whether it should consider the individual mutual fund shareholders as victims, which would trigger the six-level increase. Reasoning that each investor suffered pecuniary harm from the fraud, the court applied the six-level increase for more than 250 victims.

The court also considered whether restitution was required under the Mandatory Victims Restitution Act of 1996 (“MVRA”) or whether it would exercise its discretion to award restitution under the Victim and Witness Protection Act of 1982 (“VWPA”).

As a result of the court's rulings, each defendant's offense level was increased by 36 levels, which will be added to their base offense level of 7. United States v. Ferguson, et al., No. 3:06 CR 137 (D. Conn. Oct. 31, 2008).

Kozlowski Appeal Denied By New York Court of Appeals

Former Tyco International Ltd. (“Tyco”) CEO Dennis Kozlowski and CFO Mark Swartz lost their appeal of their convictions and sentence in an opinion by the New York Court of Appeals. People v. Kozlowski, — N.E.2d —-, 2008 WL 4585261 (N.Y. Oct. 16, 2008).

Kozlowski and Swartz were convicted by a jury of multiple fraud charges stemming from their former positions as executives at Tyco. The defendants were found by a jury to have used company funds to illegally direct bonus payments and loans they didn't repay to themselves. The primary issue on appeal was whether the testimony of well-known lawyer David Boies, who was retained by Tyco in connection with an internal investigation, was improper opinion testimony. The Court of Appeals also upheld the Supreme Court's decision to quash a subpoena duces tecum that sought the factual portions of certain interview notes and memoranda prepared during the internal investigation. Finally, the court found the defendants' Apprendi claim to be harmless error.

In 2002, Tyco hired David Boies, and his firm, to investigate Kozlowski's payment of a $20 million investment banking fee to a member of the company's board. The internal investigation expanded that same year after Kozlowski resigned from his position as CEO after being indicted for failing to pay sales tax on expensive artwork that he had purchased. That was when Boies and his firm began to investigate whether Kozlowski and others had engaged in improper transactions with Tyco's funds. Part of the internal investigation included conducting interviews of Tyco employees.

Kozlowski and Swartz argued on appeal that Boies's testimony at their criminal trial was prejudicial because Boies was permitted to offer opinion testimony, even though he was just a fact witness. The defendants also claimed that the prosecutor's summation, which referenced Boies's testimony, compounded the error. Defendants argued that it was prejudicial to allow the prosecution to elicit Boies's background, an overview of internal investigations in general, and the scope of the Tyco internal investigation. The court rejected the challenge, finding that “the testimony and summation complained of merely set forth facts enabling the jury to draw an inference of defendants' guilt.” Because Boies had limited himself to the facts of the investigation, the court found no error.

The defendants' second claim was that a subpoena duces tecum that they issued to obtain certain
witness statements collected in the internal investigation was improperly quashed. The key issue on appeal was whether the documents and memoranda containing those witness statements were privileged. The court held that they were. Although the court agreed with defendants that the witness statements were not absolutely privileged, their argument ultimately failed because they did not establish an inability to obtain the substantial equivalent of the facts sought without undue hardship. Defendants failed to at least attempt to interview the witnesses that gave statements to Boies and his firm's lawyers. The court also held that Tyco had not waived any privilege over the interviews.

Finally, the court rebuffed the defendants' claim that the fines imposed on them violated their Sixth Amendment jury trial right, because the fines were determined by the court, rather than a jury. The defendants' argument relied on the Supreme Court's decision in Apprendi v. New Jersey, which held that,
“[o]ther than the fact of a prior conviction, any fact that increases the penalty for a crime beyond the prescribed statutory maximum must be submitted to a jury and proved beyond a reasonable doubt.” The Court of Appeals dismissed the defendants' appeal because any error was harmless; the defendants trial testimony “established gain that correspond to or exceeded the fine amounts.”

In the Courts and Business Crimes Hotline were written by Associate Editor Jason Hernandez, Kirkland & Ellis LLP, Washington, DC.