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The Victories, Defeats and Casualties of the War on Corporate Fraud

The American Lawyer

November 8, 2007

The American Lawyer's report on the Justice Department's Corporate Fraud Task Force illuminates themes and trends of the last five years of criminal fraud cases. The Qwest trial revealed tensions within a U.S. Attorney's Office unaccustomed to complex fraud prosecutions. Jurors had to deal with complicated accounting issues in an AOL fraud trial. KPMG defendants got a painful lesson in the costs of defending a major fraud case. And Reliant Energy took a gamble when it refused to make a deal.

Daphne Eviatar
The American Lawyer
November 1, 2007

In his summer of discontent, there were few days of undiluted glory for Attorney General Alberto Gonzales, and July 17 was no exception. Just six weeks before he resigned, Gonzales stood before hundreds of federal prosecutors and investigators in the U.S. Department of Justice's Great Hall to celebrate the fifth anniversary of the department's Corporate Fraud Task Force and declare victory over white-collar corruption.

But the white-collar crime news that day was not dominated by Gonzales' recitation of notches on his prosecutorial belt. Instead, the headlines focused on a federal judge in New York who dismissed indictments against 13 former KPMG executives, a very pointed rebuke to the Justice Department for some of the more aggressive tactics used by federal prosecutors over the past five years.

Along with raining on the AG's victory parade, that confluence of events also served as a neat summary of the Justice Department's corporate fraud record: a long litany of achievements punctuated by disappointment and controversy.

Created by President George W. Bush's executive order in July 2002, the task force was the president's signature response to the flood of revelations of criminal wrongdoing in America's boardrooms. Enron Corp. had collapsed the previous fall. Its accounting firm, Arthur Andersen LLP, was charged in March 2002 with obstruction of justice. Later that spring, Adelphia Communications Corp. announced it would restate earnings by a billion dollars to account for hundreds of millions of dollars looted by senior executives. By the time allegations of a $3 billion fraud by WorldCom Inc. executives surfaced in June 2002, the leading stock indexes seemed locked in a death spiral, with investors panicked about which public company holding their retirement funds might topple next.

The new task force, by marshalling the firepower of nine different federal law enforcement agencies, was designed to restore investor confidence -- and to deliver a strong dose of deterrence to executive suites.

Today, the Department of Justice and the White House say the task force did just that. At the five-year anniversary event, Gonzales announced that the task force had won an unprecedented 1,236 corporate fraud convictions, including the convictions of 214 chief executive officers and presidents, 53 chief financial officers, 23 corporate lawyers and 129 vice presidents.

"Our victories have been about more than just compiling statistics or making an example out of one or two bad actors," Gonzales said. "They have been about preserving the integrity of our corporate boardrooms and our financial markets ... about changing a culture [and] about redefining the way companies do business."

But how much did the Corporate Fraud Task Force truly accomplish? Last spring The American Lawyer began investigating the Justice Department's record on corporate fraud prosecution. It was a massive undertaking made all the more so because the Justice Department does not formally account for its corporate fraud cases. (Indeed, according to Joan Meyer, senior counsel to the deputy attorney general, it cannot provide a complete list of the cases that were the basis of the victories Gonzales cited at the July 17 anniversary celebration.) So we relied on our own research, gathering data on 124 investigations (resulting in 440 indicted defendants) identified by the Justice Department as major Corporate Fraud Task Force prosecutions. Our analysis included cases cited on the task force Web site and in two published task force reports, as well as corporate fraud prosecutions mentioned in speeches or public comments by Justice Department officials.

The Justice Department refused to provide much of the information we requested. In addition to declining to provide a complete list of corporate fraud cases since 2002, the Department would not disclose such basic information as Justice resources allocated to corporate fraud or pre-2002 conviction rates in white-collar cases.

Nevertheless, from publicly available case records and performance statistics, as well as interviews with dozens of current and former prosecutors, task force members, and white-collar criminal defense lawyers, we were able to derive a detailed portrait of the Justice Department's corporate fraud prosecutions over the last five years. We found a highly publicized, top-down strategy that encouraged local prosecutors to charge both corporations and individual defendants with fraud. The effort resulted in hundreds of convictions -- 337 in the cases we tracked -- with the vast majority, 76 percent, coming through plea deals. Corporate criminals paid dearly for their crimes, with more than 50 -- including former WorldCom CEO Bernard Ebbers; Adelphia CEO John Rigas; and Computer Associates International Inc. CEO Sanjay Kumar -- sentenced to spend upwards of five years in prison.

But the Corporate Fraud Task Force suffered important failures as well.

Among the cases highlighted on the task force Web site, we found several high-profile acquittals, hung juries and appellate reversals -- and some of those prosecution failures were due specifically to questionable tactics by the Justice Department. In all, 27 of the defendants whose cases we examined, including executives from Adelphia, America Online Inc., PurchasePro.com Inc. and Qwest Communications International Inc., were acquitted at trial. Another 28 cases were dismissed. There were 22 mistrials. And nine convictions were overturned on appeal, including those of such high-profile defendants as Credit Suisse First Boston Corp. banker Frank Quattrone and the Enron "Nigerian Barge" defendants from Merrill Lynch & Co. Inc.

Moreover, say many former prosecutors and defense lawyers, credit for the Justice Department's successes in corporate fraud prosecution is due to the local U.S. Attorney's Offices that handled the cases -- not to the Corporate Fraud Task Force in Washington, D.C., that urged them on, often without providing much tangible assistance. And while many of the lawyers we interviewed say that the task force's directives did result in more corporations cooperating with the government, defense lawyers and even some federal judges came to believe that that cooperation was won at a high cost: the erosion of such basic defendant's rights as the attorney-client privilege and the right to counsel.

Perhaps the most curious of our findings -- and one not highlighted by the Department of Justice -- is the precipitous decline in the number of major corporate fraud indictments in the two years since the re-election of President Bush. After issuing detailed reports in 2003 and 2004, the task force stopped reporting on its efforts in 2005, just as corporate fraud indictments slowed to a trickle. Our analysis shows 357 indictments in major corporate fraud cases between 2002 and 2005. But only 14 indictments were identified by the Justice Department as significant corporate fraud cases in 2006. There have been only 12 major corporate fraud cases indicted so far in 2007.

That decline raises a critical question: Has the problem of corporate fraud really been solved, as Gonzales suggested at his celebration in July? Or has the Justice Department simply stopped trying as hard to prosecute it?

The Corporate Fraud Task Force was the administration's attempt to forestall a crisis. "The task force was formed in the middle of the market free fall," recalls Debra Wong Yang, now a partner at Gibson, Dunn & Crutcher but then the U.S. Attorney in Los Angeles and a member of the original task force.

"There was concern that foreign countries would start calling in notes. There was a real concern there would be an economic free fall. At the same time, you had a number of companies where things were coming to light that looked like egregious conduct." Congress had responded by quickly cobbling together the Sarbanes-Oxley Act, which passed the House in April and the Senate Banking Committee in June. The administration was right on Congress' heels; on July 9, 2002, President Bush issued the executive order creating the new task force.

That September, the president gathered hundreds of federal prosecutors, agency directors and regional U.S. Attorneys for a special daylong conference. "Over the past year, high-profile acts of deception in corporate America have shaken people's trust in corporations, the markets and the economy," the president told his audience at the Washington Hilton. "The American people need to know we're acting, we're moving, and we're moving fast."

The conference was carefully orchestrated to convey that impression. The president and then-attorney general John Ashcroft, in announcing their initiative, declared that they would root out corporate crime through more aggressive federal investigations, faster prosecutions, and the threat of all-out destruction for companies that resisted cleaning up their act.

Chaired initially by then-deputy attorney general Larry Thompson, the task force included senior Department of Justice officials, seven U.S. Attorneys from major districts around the country, and the heads of eight different federal agencies, from the Securities and Exchange Commission to the U.S. Department of Labor. The idea was to improve coordination among federal officials, speed up investigations and prosecutions, motivate U.S. Attorneys nationwide to bring complex corporate fraud cases, and convince corporations to cooperate in the investigations. Although the focus was largely on criminal prosecution, the SEC received an infusion of funds in 2003 to step up civil investigations of corporate fraud as well.

Statistics suggest that initially, the task force did just what the administration had intended. By the end of its second year, according to the task force's 2004 report, the Justice Department had obtained more than 500 corporate fraud guilty pleas or trial convictions. And new corporate fraud charges had been filed against more than 900 defendants, including 60 corporate CEOs and presidents.

The increased volume of corporate fraud prosecutions was largely the result of the task force's prodding of U.S. Attorney's Offices around the country.

White-collar prosecution had traditionally been dominated by the U.S. Attorney's Office in Manhattan, but by 2003, cases were underway in Birmingham (HealthSouth Corp.); Harrisburg, Pa., (Rite Aid Corp); Houston (Arthur Andersen LLP) and Alexandria, Va. (AOL/Purchase Pro). And prosecutors from outside New York were increasingly likely to work in collaboration with the SEC. "The SEC has a long history of working with the Southern District of New York on these [fraud] cases," says James David Fielder, who spent 10 years as an SEC enforcement attorney until this past July, when he became a partner at Haynes and Boone's Washington, D.C., office. "But generally speaking, other U.S. Attorney's Offices weren't interested in doing them. I don't know if it was because of the task force, or if it was the whole paradigm shift, but from that point on, U.S. Attorney's Offices were much more interested in referrals from the SEC."

Cases were also being filed quickly after fraud allegations surfaced. In perhaps the biggest change in prosecutorial policy, the Corporate Fraud Task Force emphasized "real-time enforcement" -- bringing indictments quickly. "The idea was to segment investigations and not let the perfect become the enemy of the good," explains William Mateja, a former senior Justice Department official and coordinator of the corporate fraud task force, first under deputy attorney general Thompson and later under his successor, James Comey Jr. "We really worked with prosecutors to not get into the mind set that you have to wrap your arms around everything. The rule of thumb was, if this is a case you're going to pursue, we need to look toward bringing charges within six months." As Christopher Wray, former assistant attorney general of the criminal division, now a litigation partner at King & Spalding, puts it: "Better to convict them quickly than to take years and convict them four times over."

Wray cites the example of the case against Adelphia, in which the Justice Department began looking into accounting fraud in April 2002, just days after allegations first surfaced -- and arrested key players in July. "Within four months you had the CEO and four other top executives arrested," he says. Indeed, 77-year-old John Rigas was led away in handcuffs before dozens of news cameras in July 2002, only two weeks after the task force was created. He and his son were found guilty at trial two years later and sentenced to 15 years and 20 years, respectively. (Another son and senior Adelphia official was acquitted of all charges.) Similarly, in the HealthSouth case in Alabama, the government took only seven months before it charged 16 people, including CEO Richard Scrushy, who was accused of masterminding the fraud. (Scrushy was acquitted on all counts in 2005, though he was subsequently indicted four months later on new charges related to a different scheme. In June 2006 he was convicted of bribery, mail fraud and obstruction of justice.)

But while the task force was pressing these new policies from Washington, the cases themselves were being prosecuted by local Assistant U.S. Attorneys, often without significant help from the Justice Department, aside from the daylong conference in September 2002 and some additional training sessions for prosecutors the following year. Many prosecutors say that while Justice officials turned up for press conferences at which corporate fraud indictments were announced, they typically provided little assistance in the actual prosecutions. "If you look at their reports," says F. Joseph Warin, head of litigation at the Washington, D.C., office of Gibson Dunn, "it's essentially work that was being done by various U.S. Attorney's Offices across the United States."

And those offices were frequently hard-pressed to come up with the manpower and money to investigate and prosecute complex fraud cases. "We found the [Justice] Department was challenged by a lack of resources, both technical and in terms of personnel," says John Hueston, a co-lead prosecutor in the investigation and trial of former Enron chairman Kenneth Lay and CEO Jeffrey Skilling. Although he says the Justice Department did what it could to help, "we often felt that the defense was outgunning us on both levels." The Assistant U.S. Attorneys on his team, for instance, didn't have the resources to create a searchable electronic database of Enron documents until shortly before trial, Hueston says, leaving them anxious that they wouldn't be able to convince the jury that Enron's top officers were guilty.

"The types of corporate fraud cases the department decided to take on were of a size and scope unprecedented for almost all U.S. Attorney's Offices," says Hueston, now a partner at Irell & Manella. "Most offices really labored to find the right resources."

The task force, meanwhile, had no prosecutorial staff or budget of its own.

The Justice Department's criminal fraud section actually lost two of its 54 attorneys between 2002 and 2007. And while the SEC has added more than 1,000 accountants, lawyers and economists to its staff since late 2002, budget cuts at the Justice Department forced many U.S. Attorney's Offices to impose a hiring freeze. The number of federal prosecutors peaked in 2003, when the Justice Department added about 200 Assistant U.S. Attorneys to its then total of 473, but has declined steadily since then. By 2006, according to Syracuse University's Transactional Records Access Clearinghouse (TRAC), there were 529 lawyers in U.S. Attorney's Offices, just 56 more than in 2002. And as the government shuffled limited resources, the U.S. Attorney's Office in Manhattan -- which, as the chief prosecutors of corporate fraud, had previously received additional money -- actually lost about $5 million in personnel and other assistance from the SEC, according to two former prosecutors in the office. (The Justice Department and the U.S. Attorney's Office would not confirm.) Meyer acknowledges that U.S. Attorney's Offices were not given additional staff to prosecute corporate fraud cases, but emphasizes that corporate fraud prosecution "has always been an extremely important part of what it means to be a federal prosecutor. The U.S. Attorney's Offices have to prioritize and pick the best cases."

The prosecution of corporate fraud cases by Assistant U.S. Attorneys new to the field presented some drawbacks when cases went to trial. The Justice Department touts its recent closely watched victories -- including the convictions of Hollinger International Inc. CEO Conrad Black in Chicago and Brocade Communications Systems Inc. CEO Gregory Reyes in San Francisco -- but other high-profile prosecutions backfired, leading to an embarrassing string of defeats for the Justice Department. These include the acquittals of senior executives at AOL in Virginia, of Capital Consultants in Oregon, and of Duke Energy Corp. in Texas.

U.S. Attorneys Offices outside New York also lost important appeals. In January of this year, the 10th U.S. Circuit Court of Appeals reversed the convictions of two former Westar Energy Inc. executives in Kansas, writing that the government's theory of the case "hung by a thin legal thread." In June 2005, the U.S. Supreme Court reversed the conviction of Enron's accounting firm, Arthur Andersen, after concluding that the trial judge's jury instruction was insufficient to establish obstruction. And the Enron "Nigerian Barge" cases, in which Merrill Lynch executives were convicted of orchestrating a deal that helped Enron illegally inflate earnings, were also largely overturned on appeal.

The Justice Department's Meyer declines to comment on the outcomes of specific cases, or to provide overall acquittal, conviction or reversal rates. "Acquittals are always disappointing," she says. "I believe that prosecutors around the country that are bringing these cases are generally some of the most experienced prosecutors. They've received training in our corporate fraud program, and they handle these cases very carefully. The number of acquittals is an extremely small percentage of cases we bring, and reversals in appellate court can be for a variety of different reasons. I don't agree with notions that some reversals in an appellate court are based on the experience of prosecutors."

Still, former prosecutors say that the pressure to win corporate fraud prosecutions grew more intense as the losses began stacking up. The trial of Enron CEO Jeffrey Skilling, for example, came on the heels of the acquittal of Richard Scrushy. "[Justice] told us, 'The future of white-collar prosecutions may rise and fall on how you perform in this trial,'" says former prosecutor Hueston.

"There was this level of intensity," adds defense lawyer Carey Dunne, a litigation partner at Davis, Polk & Wardwell who represented Credit Suisse First Boston Corp. in connection with the obstruction of justice trial of former trader Frank Quattrone, and ImClone Systems Inc. in the insider trading investigations of Martha Stewart and Samuel Waksal. "There was a sense many of us had ... in dealing with local prosecutors [that] they were accountable to more than their usual local supervisors."

The most controversial of the Justice Department's corporate fraud prosecution tactics were outlined in the Thompson Memo, a document issued to federal prosecutors in January 2003 by then-deputy attorney general Thompson. (The memo updated policies previously issued by one of Thompson's predecessors, Clinton administration deputy attorney general Eric Holder Jr.) Thompson listed nine factors that prosecutors should take into account when considering the indictment of a company, including the corporation's "timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigation of its agents, including, if necessary, the waiver of corporate attorney-client and work-product protections."

The Thompson Memo effectively urged prosecutors to convince companies to lay themselves bare, disclosing reports of internal investigations, waiving privilege and jettisoning employees -- whose legal fees, it was suggested, should not be paid by cooperating corporations.

Such prosecution tactics provoked an angry outcry from defense lawyers. In 2005, at the urging of the National Association of Criminal Defense Lawyers, the U.S. Chamber of Commerce and others, the American Bar Association passed a resolution opposing the government's routine pressure on corporations to waive their rights. "The defense bar and other organizations felt that the department went too far," says Robert Kent, former chief of the complex fraud section of the U.S. Attorney's Office in Chicago, now a partner at Baker & McKenzie.

Several federal judges agreed. In 2005, in the prosecution of Richard Scrushy, the court excluded Scrushy's SEC deposition because the SEC had failed to inform Scrushy of the parallel criminal investigation against him.

In 2006, an Oregon district court in U.S. v. Stringer dismissed indictments against three former executives of FLIR Systems Inc., finding that the SEC and Justice had "engaged in deceit and trickery" by using the SEC's civil investigative authority to gather evidence for the criminal case while concealing its existence from the defendants. And in the most dramatic example of judicial push-back, Lewis Kaplan, a federal district court judge in Manhattan, ruled in 2006 that prosecutors in the KPMG LLP tax shelter case had violated the constitutional rights of former KPMG officials when they pressured the company to condition its payment of attorney fees on cooperation with the government.

Last December the Justice Department finally responded. In a revised memorandum, Thompson's successor, then-deputy attorney general Paul McNulty, clarified that prosecutors should only seek privileged information when there was a "legitimate need" for it; and they should not penalize companies for paying their employees' legal fees. "We determined we could put some additional safeguards into our corporate charging policy and we did that with the McNulty Memo," says Meyer. "Now every waiver has to be approved by a senior Justice Department official."

Still, the revision came too late for the Justice Department to avoid Judge Kaplan's harsh rebuke. On July 17 -- the same day that Gonzales and President Bush were celebrating the five-year anniversary of the Corporate Fraud Task Force in the Great Hall in Washington -- Kaplan dismissed the indictments of 13 former KPMG executives. "[Prosecutors'] deliberate interference with the defendants' rights was outrageous and shocking in the constitutional sense because it was fundamentally at odds with two of our most basic constitutional values -- the right to counsel and the right to fair criminal proceedings," Kaplan wrote.

Beginning in 2005, only three years after the Corporate Fraud Task Force was established, the Department of Justice significantly scaled back its prosecution of corporate crimes. According to an analysis of Justice Department statistics by TRAC, the 2007 year-to-date number of white-collar filings is 64 percent lower than the 2006 number -- and 77 percent lower than in 2004. In part, the drop is a matter of priorities. The Justice Department has established several new task forces -- including the Hurricane Katrina Fraud Task Force, the Obscenity Prosecution Task Force and the National Procurement Fraud Task Force. And in part, it's a result of a decline in investigatory resources: According to a 2005 Federal Bureau of Investigation inspector general report, after September 11, 2001, the FBI "reduced its investigative efforts related to traditional crimes by more than 2,400 agents" in order to focus its work on terrorism.

The Justice Department did launch several stock options backdating investigations in 2006, but such cases were not the result of corporate fraud task force enterprise. They were prompted, as even the department acknowledges, by the 2005 backdating study conducted by University of Iowa associate professor Erik Lie and subsequent investigations by The Wall Street Journal. "We read about [Comverse Technology Inc.'s options backdating] in the Journal, and realized this was an issue we should be focused on," says Michael Asaro, the former Eastern District of New York Assistant U.S. Attorney who handled the prosecution of three former Comverse executives. (Two pled guilty; one is fighting extradition from Namibia.) The task force was essentially uninvolved in the July 2007 stock options backdating trial of former Brocade Communications Systems CEO Gregory Reyes in San Francisco, according to Timothy Paul Crudo, the Assistant U.S. Attorney who prosecuted Reyes. The former CEO was convicted on 10 counts of conspiracy and fraud.

The department insists that the recent decline in prosecutions is actually a sign of the remarkable success of the Corporate Fraud Task Force. "You're getting a lot more focus on compliance, and on ethics internally in corporate structures," says Justice's Meyer. "We do believe that the success of the Corporate Fraud Task Force, in conjunction with the Sarbanes-Oxley Act, is making it more likely that fraud is being detected by corporations themselves."

Former task force member Yang, who left the Los Angeles U.S. Attorney's Office last year, agrees. "We picked off the low-hanging fruit," she says.

"We got all the big bad players, or most of them. The mandate has always been not to strangle corporate America, but to put investor confidence back into the market, which I think we have." Adds former Chicago prosecutor Kent: "The companies that were really engaged in the misconduct in a serious way have been identified, and prosecutions and enforcement actions have occurred."

Ultimately, the task force was (and is) neither a prosecuting body nor a provider of resources to support the prosecutions of complex corporate fraud cases around the country. Rather, it was "a working group of U.S. Attorneys and people from regulatory agencies who sat in a conference room, announced policy initiatives, and kept track of results," says Steven Peikin, a partner at Sullivan & Cromwell and former chief of the Securities and Commodities Fraud Task Force of the Manhattan U.S. Attorney's Office. The Corporate Fraud Task Force was just one star in a larger constellation of government efforts to calm investors in an escalating financial crisis.

But as its role diminishes and prosecutors cast their sights elsewhere, new corporate criminal schemes -- whether related to risky hedge funds, options backdating, subprime loans or something else -- are bound to crop up. As Robert Kent notes wryly: "The history of fraud prosecutions is that there's going to be another area [of trouble]."

And likely another new task force to combat it.