A report in the Wall Street Journal (Nov. 30) indicates that the Bank of New York is negotiating to avoid an indictment for failing to report suspicious activity by a customer. The Bank was at the center of the widely-report Russian mafia money-laundering scandal in the mid-1990s that was reputed to involve billions of dollars. Among other things, Bank of New York promised to comply with all money laundering laws in order to avoid a criminal charge, so this case will be a significant embarrassment to its internal controls in the area of customer monitoring for potential money laundering. The case also may provide an example of how the Department of Justice will apply its Principles of Federal Prosecution of Business Organizations. According to the article, the Bank will pay a $24 million penalty, and the scope of its cooperation will likely be reviewed by corporate counsel to determine how it demonstrated its cooperation with prosecutors to avoid an indictment. (ph)
Category: Investigations
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John Richter, the chief of staff for the Criminal Division in the U.S. Department of Justice, made remarks at an ABA conference sponsored by the Business Law Section on Nov. 19 about how federal prosecutors decide whether to charge a corporation with a criminal offense. In January 2003, the so-called Thompson Memo (Principles of Federal Prosecution of Business Organizations), issued by former Deputy Attorney General Larry Thompson, set forth a series of broad principles for prosecutors to consider in deciding whether to charge a corporation with a federal offense. The principles are quite broad, and Mr. Richter’s comments shed a little additional light on the subject. A BNA report in U.S. Law Week (Vol. 73, No. 20, Nov. 30, 2004) summarized his comments:
Richter allowed that judging corporate culture is a "subjective assessment in some ways," but noted that "hard facts" exist in most cases. He said that because of the inherent timing of a prosecutor’s interest in a company, much of a corporation’s character reveals itself in how it deals with authorities during times of crisis.
A company’s nature "really manifests itself in looking at the corporate response" to an investigation, Richter said. For instance, "corporations always tell us when they first realize they are under investigation that they will cooperate, and typically they’ll publicly say so. But from our perspective, what we are looking at is: Are they actually cooperating? Is the cooperation authentic?"
"This cooperation, this self-reporting, this making facts available to us," he continued, "is part of what we take into account in exercising our prosecutorial discretion in making a determination [about] whether to focus on an individual wrongdoer, or whether the individual wrongdoer is actually an extension and reflection of the corporation that is potentially on a criminal liability hook for their conduct."
Richter said that his most important advice for corporate counsel is: "Don’t just ask whether your client is complying with Sarbanes-Oxley or complying with applicable state law. Rather, ask your client whether its corporate culture is actually healthy." If wrongdoing occurs and is detected, Richter said, "does it get reported to the appropriate lawyers, both inside counsel and outside counsel? Does the board hear about it? And then how does the corporation respond to the information? Does it self-report, and thereafter what action does it take? Those are the key factors from a federal law enforcement standpoint and where we come from."
A corporation could pay a heavy price if it is perceived as uncooperative, although some types of conduct, such as paying the attorneys fees for counsel for individual officers and employees, is perfectly legal, yet may be considered a sign of a lack of cooperation. This area is a minefield for corporate counsel, and Mr. Richter’s comments do not make it any easier to determine what will–and more importantly, will not–constitute cooperation and avoid a criminal charge against the business organization. (ph)
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W.R. Grace & Co., a large chemicals company that filed for bankruptcy due to asbestos liabilities, disclosed in an SEC filing that it is the target of a federal grand jury investigation related to its vermiculite mining and processing activities in Libby, Montana. According to the company’s 8-K filing with the SEC:
Grace understands that the investigation is at an advanced stage and that it is likely to be indicted during the first quarter of 2005, unless a resolution of this matter can be reached with the government within such timeframe. Several current and former senior level employees associated with Grace’s construction products business also have been named as targets of the investigation. On November 15, 2004 the U.S. Bankruptcy Court granted Grace’s request to advance legal and defense costs to the employees, subject to a reimbursement obligation if it is later determined that the employees did not meet the standards for indemnification set forth under state corporate law.
Under the Department of Justice’s Principles of Federal Prosecution of Business Organizations, a company’s payment of the legal fees of its employees, at least when they are not required by law to be paid by the organization, can be a basis for finding that the company did not cooperate with the federal investigation. (ph)
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American International Group Inc. (AIG) issued a terse press release Tuesday evening (Nov. 23) stating,
AIG and its subsidiary AIG Financial Products Corp. (AIGFP) have submitted an offer of settlement to the Staff of the Securities and Exchange Commission (SEC) that the Staff has agreed to recommend to the SEC, and reached agreement in principle with the U.S. Department of Justice, with respect to issues arising from certain structured transactions with The PNC Financial Services Group, Brightpoint, Inc., and related matters. Final settlement is subject to approval by the Securities and Exchange Commission, the Department of Justice, and the United States District Court.
A report in the Wall Street Journal (Nov. 24) describes the insurance products that AIG sold to companies to help "smooth" their earnings that is the subject of the civil and criminal actions. The purchasers, Brightpoint Inc. and PNC Financial Services, used the insurance to spread losses over a longer period of time (Brightpoint) and remove underperforming loans and investments off the company’s balance sheet (PNC). According to the Journal:
The probes involve two very different financial products, with an element in common, according to regulators: They were aimed at helping the buyers hide adverse financial developments from their shareholders. One of the products was an alleged bogus insurance policy that in reality was little more than a loan, regulators have maintained. This allegedly sham policy allowed Brightpoint Inc., a Plainfield, Ind., cellphone distributor, to spread a large quarterly loss from a United Kingdom trading unit into future periods by using the more-favorable accounting treatment that insurance allows.
The other was an off-balance-sheet investment vehicle, into which Pittsburgh-based PNC Financial Services Group Inc. allegedly stuffed $762 million of underperforming loans and venture-capital investments, avoiding write-down charges, regulators have said.
What does it cost to enter into a global settlement with the government? According to the Journal:
People familiar with the matter said the pact could obligate the company to an independent review of its past transactions with other customers, a move regulators have sought as part of a widening campaign to crack down on companies’ use of financial engineering to manipulate their earnings results.
Another person familiar with the discussion said the cost of the SEC portion of the settlement to American International Group would be between $60 million and $90 million. At the high end, such a penalty would rank among the largest paid by any of the financial-services firms that have come under scrutiny for allegedly helping clients cook their books. Under the tentative SEC pact, the agency would file civil securities-fraud charges against AIG, which would neither admit nor deny wrongdoing, according to one of the knowledgeable people.
The settlement only covers the federal government, and does not resolve the various private law suits by shareholders and securities purchasers. That will add to the final tab for AIG. Another interesting question is whether Maurice Greenberg, AIG’s long-time CEO and Chairman, will last much longer in his position. Greenberg’s son, Jeffrey, was forced out as CEO of Marsh & McLennan last month shortly after New York Attorney General Eliot Spitzer sued the company for bid-rigging in the insurance brokerage industry. (ph)
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An article in the Washington Post (Nov. 23) discusses the recent push to investigate the conduct of lawyers for corporations who assist their clients in wrongdoing. Defense lawyers have complained that the authority granted to the SEC in the Sarbanes-Oxley Act to discipline lawyers will be used to chill proper legal representation. Apparently, the complaint is falling on deaf ears at the SEC:
Responding to complaints from defense lawyers at yesterday’s American Bar Association meeting that the agency was moving too aggressively, deputy enforcement director Linda Chatman Thomsen said, "I’m delighted that you’re all worried. It’s part of the job."
As Sgt. Phil Esterhaus used to intone at the end of roll call on Hill Street Blues: "Let’s be careful out there."
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An earlier post (Nov. 17) discussed the government’s investigation of Boeing and the guilty pleas of two former executives, one of whom had been a senior Air Force official, for negotiating employment while the official worked on a contract awarded to Boeing. The Air Force’s favorable treatment of Boeing has created a very significant enemy for the company: Senator John McCain (R-Arizona). On Friday, November 19, Senator McCain released a statement in the Congressional Record detailing the Air Force’s favoritism toward Boeing and its attacks on the company’s main rival, Airbus. Two days before the Senator released his statement, Secretary of the Air Force James Roche and Assistant Secretary of the Air Force for Acquisitions Marvin Sambur announced their resignations. Both were prominent proponents of Boeing.
Along the way, Boeing also appears to have orchestrated a campaign against Senator McCain, who strongly opposed the award of a multi-billion dollar contract for Boeing to lease plane to the Air Force. Senator McCain’s statement includes the following:
Throughout 2002 and the beginning of 2003, even agencies within the Defense Department and the Air Force, including Program, Analysis and Evaluation; the Office of Management and Budget; and even the Air Force’s own General Counsel’s Office, raised salient concerns about aspects of the proposal. These concerns, however, would not get in the way of Air Force leadership. Rather than resolve these concerns, Air Force proponents continued to aggressively push the deal in the press. A Wall Street Journal editorial, entitled “John McCain’s Flying Circus,” published on the very same day as my tanker hearing in the Commerce Committee, is particularly notable. It was obviously drafted with considerable help from the Office of Air Force Secretary. In it, tanker proponents accused me of “trying to prevent approval by running up my own Jolly Roger” and brazenly exaggerated the Air Force’s need for tankers by describing how, during Secretary Roche’s visit to Tinker Air Force Base, he “peeled back the skin of a tanker being refurbished and found the metal underneath disintegrating before his very eyes.”
By this time, Air Force leadership’s aggressive press campaign was well underway. On April 25, 2002, Secretary Roche’s special assistant William Bodie told Secretary Roche that he “saw Rudy deLeon [who heads Boeing’s Washington Office] at the Kennedy Ctr and politely asked the Great White Arab Tribe of the North [which is what these folks called Boeing] to unleash their falcons on our behalf for once. And, I talked to [defense analyst] Loren [Thompson], who is standing by to comment to this reporter about the national security imperatives of tanker modernization. [Editor of Defense News and Air Force Times] Vago [Muradian] is also standing by. I will get with [Assistant Air Force Secretary for Acquisitions Marvin] sambur first thing to rehearse talking points. We will get with you before we talk to the reporter.”
The Senator also released e-mails from Secretary Roche showing how he favored Boeing over Airbus:
Secretary Roche’s e-mails, however, suggests that he is indeed a man who allows his personal animus to stifle competition. For example, on September 5, 2002, Darleen Druyun wrote to Secretary Roche, “I read with disgust the article on Airbus tankers from the new EADS CEO of North America. What BS … should not have been surprised at the slime … his day of reckoning will come hopefully.”
Secretary Roche answered, “Oy. I agree. I had hoped you would have stayed and tortured him slowly over the next few years until EADS got rid of him!” This, from a person who testified that he “believes” in competition. Secretary Roche’s personal contempt for one defense contractor and, in particular, its CEO, is clearly reflected in his other e-mails. For example, on August 7, 2002, when Secretary Roche learned that Ralph Crosby, with whom Secretary Roche once worked at Northrop Grumman, was appointed to head EADS’ North American operations, Secretary Roche wrote to his special assistant William Bodie, “Well, well. We will have fun with Airbus.”
The day after, William Swanson at Raytheon asked Secretary Roche, “Did you see the notice on Ralph and EADS?” Secretary Roche responded: “Right. Privately between us: Go Boeing! The fools in Paris and Berlin never did their homework. And, Ralphie is the CEO and Chairman of a marketing firm, for that’s all there is to EADS, North America. The [Air Force] has problems with EADS on a number of levels. The widespread feelings about Crosby in the Air Staff, Jumper especially, will only make their life more difficult. Smiles.”
Senator McCain is not the type of enemy a company that does extensive business with the Pentagon wants to make. (ph)
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A recent decision by U.S. District Judge Harold Baer, Jr. on the availability of the work product protection for an internal investigation report shows the difficulty corporations face after the Sarbanes-Oxley Act and the heightened pressure on them to cooperate in government investigations. In Merrill Lynch & Co. v. Allegheny Energy Inc., No. 02 Civ. 7689 (S.D.N.Y. Oct. 26, 2004) [Westlaw citation 2004 WL 2389822], the court considered the following:
Allegheny also seeks production of two reports, which are the results of Merrill Lynch’s internal investigation into the circumstances surrounding [Robert] Gordon’s theft of some $43 million in connection with the Falcon Energy Trade. In the Fall of 2002, shortly after this lawsuit was filed, the United States Attorney’s Office for the Southern District of New York informed Merrill Lynch that it was investigating the Falcon Energy Trade. Merrill Lynch therefore undertook its own internal investigation (conducted by and under the supervision of in-house and outside counsel), which culminated in two reports . . . .
When Merrill Lynch’s internal investigation was disclosed, the company’s outside auditor, Deloitte & Touche, requested and received copies of the internal report. Allegheny Energy based is discovery request for the report on the ground that disclosure to Deloitte & Touche constituted a waiver of the attorney-client privilege–which Merrill Lynch conceded–and the work product protection. The court rejected the claim, stating:
[C]ourts are split in their treatment of disclosures to a corporation’s accountants or auditors. More precisely, courts differ in their conceptualization of two critical points that are often implicitly intertwined in their analysis: whether the "adversary" contemplated by the work product privilege is necessarily a litigation adversary and whether a corporation’s auditor is such an adversary, to whom disclosure will waive the privilege. While admittedly there are good arguments on both sides, in this case, I answer both questions in the negative and conclude that Merrill Lynch’s disclosure of the reports to Deloitte & Touche did not constitute a waiver of the applicable work product protection.
This is a close question, as Judge Baer states, and presents an issue that will be of continuing concern to corporations. The Sarbanes-Oxley Act imposes increased duties on accountants to discover and report fraud and certify that a company’s internal controls are adequate to prevent misconduct. Therefore, they will demand access to internal investigative reports in order to determine the sufficiency of the company’s internal controls and to assure that there is no deeper misconduct. Similarly, under the Department of Justice’s Principles of Federal Prosecution of Business Organizations there is a strong incentive for corporation’s to cooperate in federal criminal investigations by conducting an internal investigation and providing the results of that to the government by waiving the attorney-client privilege and work product protection. The risk of any disclosure of the internal report is the loss of any protection from discovery requests of third parties, especially in shareholder and securities lawsuits. Whether Judge Baer’s opinion becomes the norm, at least with regard to providing reports to accountants, will no doubt be tested in future cases. (ph)
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One of the more controversial provisions of the Sarbanes-Oxley Act of 2002 was Section 307, which required the SEC to adopt rules requiring lawyers for corporations to report misconduct within the organization to senior management and the board of directors. An implementing rule, since shelved, would have required lawyers to make a so-called "noisy withdrawal" if the corporate client did not respond appropriately to the report of misconduct. Lawyers objected to this rule on the ground that it would make corporate counsel a "cop on the beat" rather than a representative of the client. Regardless of whether that would in fact be the case, Section 307 emphasizes that corporate counsel has a responsibility to protect the client from misconduct by, at a minimum, reporting wrongdoing and, where necessary, withdrawing from representation.
Although it is always hard to tell whether a law has an effect on individual conduct in a particular instance, a story in the New York Times (Nov. 21) by Partick McGeehan (one of their best business reporters) details the fight between TV Azteca, a Mexican media company whose shares are listed on the New York Stock Exchange and hence subject to SEC regulation, and its former lawyers who withdrew from representation because the company refused to make the proper disclosure of a transaction. The article discusses a draft investigative report prepared by Munger, Tolles & Olson, which was hired by independent directors to investigate the dispute between Akin, Gump and management when the company refused to disclose a transaction between TV Azteca’s chairman (Ricardo B. Salinas Pliego) and the company that appears to have provided a personal benefit of $109 million. The company refused to make the disclosure, and Akin Gump resigned as its counsel. According to the investigative report, the company then sought a favorable opinion about not having to disclose the transaction from Clearly, Gottlieb and Hogan & Hartson, both of which counseled disclosing the transaction. The Munger Tolles report alleges that corporate management provided false information about the transaction to the firm in conducting its internal investigation.
The article reports:
Two American directors, James R. Jones and Gene F. Jankowski, did not even wait around for the final report from Munger Tolles. They resigned in early May because they did not believe that they could exercise independence, Mr. Jones said in a brief interview last week. "Gene and I concluded that we needed to leave," said Mr. Jones, a former United States ambassador to Mexico who once ran the American Stock Exchange.
Mr. Jones said that he was interviewed by the commission before he resigned but that he had not been contacted since. Only four years earlier, Mr. Salinas Pliego pointed to Mr. Jones and two other directors as evidence of his enlightened embrace of changing standards of corporate governance.
Attorneys have an ethical obligation to ensure that their clients, especially corporate clients, obey the law and make proper disclosures to the investing public. While some may object to this "gatekeeping" role, it is heartening to see that one company could not "buy" an opinion. If the findings in the Munger Tolles report are accurate, one would hope the SEC would bring an enforcement action against the company to reinforce the signal that improper disclosure and attempts to buy a favorable legal opinion are unacceptable. (ph)
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The insurance industry probe took an interesting turn on Thursday (Nov. 18) when California Insurance Commissioner John Garamendi (California Department of Insurance) filed a lawsuit against Universal Life Resources (ULR) for taking undisclosed compensation and bid-rigging. This is the same company that New York Attorney General Eliot Spitzer sued the previous Friday (Nov. 12), alleging the firm took undisclosed compensation and engaged in bid-rigging. Quite a coincidence, isn’t it? ULR settled the California law suit by agreeing to the entry of a Consent Decree, while disputing the factual allegations in the Insurance Commissioner’s complaint, and agreed to cooperate in an on-going investigation.
Is California trying to compete with New York, or at least Garamendi fighting for headlines with Spitzer? According to a Wall Street Journal story, here’s the spin provided by each side on the competing law suits:
Mr. Garamendi’s actions "don’t represent any type of coordinated effort with this office," said Kermitt J. Brooks, a deputy attorney general in New York and head of that office’s ULR probe. Mr. Brooks added that the California settlement with ULR "has no effect in the lawsuit in New York." Mr. Garamendi seemed to play down any conflicts with Mr. Spitzer, calling the two suits part of an "East Coast/West Coast knockout punch."
Spitzer and Garamendi testified together at a U.S. Senate Subcommittee hearing this past Tuesday (Nov. 16) on the topic of insurance regulation, and they certainly had a chance to discuss the matter then. Could Douglas Cox, ULR’s owner, be using the California Dept. of Insurance to fend off Spitzer by agreeing to cooperate with one agency to keep the other at bay?
In a prepared statement given to the Senate Subcommittee, Spitzer declared:
From our work in this area, it is clear that the federal government’s hands-off policy with regard to insurance combined with uneven state-regulation has not entirely worked. There are too many gaps in regulation across the 50 states and many state regulators have not been sufficiently aggressive in terms of supervising this industry. The federal government should not preempt state insurance enforcement and regulation. Nonetheless, I do believe there is a role for the federal government, especially in the areas of off-shore capitalization and investment by insurance companies. At a minimum, federal involvement may be necessary to assure some basic standards of accountability on the part of insurance professionals.
Competition among regulators is not a good thing if cases are filed to establish the regulator’s bona fides as a tough enforcer or, even worse, as a means to garner a share of the national spotlight. It will be interesting to see if theULR case, which involves a fairly small firm with only 80 employees and annual revenue of $25 million, triggers greater cooperation among the state agencies or presages a "race to the courthouse" among state regulators. That alone may be reason enough to call for more federal regulation.
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Today’s News –
New Jersey – According to Newsday, the former head of the New Jersey Assembly’s ethics panel "pleaded guilty to misapplication of entrusted funds, specifically campaign money, and concealing campaign contributions."
Illinois- Newsday AP also reports that "Prosecutors on Friday urged the judge overseeing the racketeering case against former Gov. George Ryan to set a firm trial date, complaining that additional delays could harm their case because witnesses might die before they have a chance to testify." You may recall in the post of November 17th that former Mayor Bill Cambell of Atlanta moved to dismiss his case arguing that prosecutors waited too long in bringing the case. He claimed that a witness died.
New York – And in NY, the AP wires report "[a] former state senator who was released after serving about three months of a one-year sentence in a bribery scheme was ordered back to jail Friday."
All in one day…..
(esp)
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