White Collar Crime Prof Blog

Third GC Charged for Options Backdating

Another general counsel has been charged with fraud related to options backdating.  Kent Roberts, the former GC at Network Associates -- now McAfee Inc. -- was charged by the U.S. Attorney's Office for the Northern District of California (indictment below) with two counts of mail fraud, one count of wire fraud, three counts of making false statements to the SEC, and one count of falsifying corporate books and records.  The SEC also filed civil securities fraud charges.   Previously, the general counsels for Comverse Technology and Monster Worldwide have been charged, and both agreed to plead guilty and cooperate. 

The allegations against Roberts concern two instances when he is accused of backdating options, once for himself and once for the former CEO, George Samenuk.  Roberts was responsible for the company's SEC compliance, and even served as a founding member of the "Ethics First Committee."  Network Associates created the committee in 2002 in response to internal control problems, and its responsibilities included investigating instances of employee fraud.  Needless to say, Roberts did not mention himself at any point in time.

The mail and wire fraud counts include both money/property and right of honest services theories of fraud.  While the recent Fifth Circuit decision in U.S. v. Brown limited the scope of private right of honest services fraud cases, the fact that Roberts backdated his own options grant may help the government by showing the kind of personal skimming that was missing in the Enron Nigerian Barge transaction at issue in Brown. 

A more troublesome issue for the government could be the statute of limitations for the counts related to the alleged backdating of Roberts' options, unless he waived the application of the limitations provision.  The mailing was on January 9, 2002, and the SEC filing was on January 10, 2002, both related to the Form 4 disclosure of the options grant.  The statute of limitations is five years, and the usual rule for mail fraud charges is that the limitations period begins running on the date of the mailing.  Similarly, the date of the false filing is the usual trigger for beginning the clock on that charge.  The indictment alleges an ongoing scheme because Roberts did not reveal the fraud, but that may not be sufficient to rescue those counts because there was no active concealment, just a failure to disclose.  Those appear to be two of the government's strongest counts because they allege Roberts acting in his own self-interest, which can be powerful evidence.  Absent a waiver of the statute of limitations, look for defense counsel to challenge those counts and try to have them stricken from the indictment. (ph) 

Download us_v. Roberts Indictment Feb 27 2007.pdf

Lawyer Charged in PIPE Securities Fraud

Former McGuireWoods LLP partner Louis W. Zehil was charged with securities fraud in a criminal complaint filed in the Southern District of New York, and the SEC filed civil securities fraud charges.  Zehil is accused of defrauding corporate clients by taking shares from so-called "private investment in public equity" (PIPE) transactions, which are used by small companies (and those with substantial financing problems) to raise money by selling securities at below-market prices.  As part of the deal, the securities issued are restricted, with a legend placed on them that prohibits sales to the public for a period of time.  According to the charges, Zehil acquired the shares through two front companies, Chestnut Capital Partners and Strong Branch Investors, without informing his clients about these transactions.  A press release issued by the U.S. Attorney's Office (here) describes how the shares were acquired:

ZEHIL, as counsel for the issuers in the Charged Transactions, sent opinion letters to the issuers’ stock transfer agents directing that all of the issued shares should bear restrictive legends except the shares issued to ZEHIL’s nominees,Strong and Chestnut. ZEHIL’s letters falsely claimed that the shares issued to Strong and Chestnut satisfied legal criteria permitting them to be issued without a restrictive legend. As a result, ZEHIL was able to receive shares without restrictive legends and, almost immediately thereafter, he sold them in the public market. In all cases, he did this before the issuers had filed registration statements with the SEC. By obtaining stock free of the restrictive legends, ZEHIL was able to sell these shares immediately in the public market at a profit in advance of the other PIPE investors. The Complaint alleges that ZEHIL reaped over $10 million in profit through these illicit sales.

The SEC Litigation Release (here) estimates the loss to the corporate clients at over $17 million, while prosecutors peg it at $10 million -- either way, this is a substantial fraud.  Because the transactions were related to Zehil's legal representation, I suspect McGuireWoods and its malpractice carrier are figuring out how much they are on the hook for to the clients.  Unfortunately for the firm, malpractice policies usually exclude criminal conduct from coverage, so there may be a fight in the offing about who bears the loss from the conduct of the former partner. (ph)

The Libby Jury's Emily Litella Moment

The jury considering the charges against I. Lewis Libby has been remarkably quiet since receiving the case on February 21, initially asking only for some office supplies and pictures of witnesses.  Aside from the dismissal of a juror for contact with media reports about the trial, not much has emerged about the pace of the deliberations, and even when they asked a puzzling question they took it back the next morning.  A note from the jurors (here thanks to TalkLeft) asked about the meaning of Count 3 of the indictment, charging Libby with making a false statement to the FBI about his conversation with Time reporter Matthew Cooper.  Another note (here), sent before U.S.  District Judge Reggie Walton could answer the question, came out saying that "we are clear on what we need to do.  No further clarification needed.  Thank you.  We apologize."  This may be among the most courteous juries around.  It's not clear where they are in the deliberations, unless one assumes they began with Count 1 and so are at least through the first two, which may not be the case at all.  The jury watch continues, second only to watching paint dry on the courthouse walls. (ph)

Another E-Mail Appears in the Scrushy-Siegelman Case

The post-trial phase of the prosecution of former HealthSouth CEO Richard Scrushy and former Alabama Governor Don Siegelman just keeps dragging on, and each month seemingly brings a new purported e-mail between two jurors that could show the deliberations were tainted by outside influences.  The defendants' new trial motion based on other e-mails was rejected, in part because the e-mails were never authenticated as involving the jurors.  More e-mails appeared in December as part of a motion for reconsideration, and now another one (here) has shown up.  Whether any of this will make a difference is still hard to tell, but the more time that elapses the more these e-mails seem to materialize.  A story on WSFA TV-12 in Montgomery, Alabama, notes (here) that there may be an "email fairy" in the vicinity. (ph)

Hacking the News for Fun and Profit

The SEC brought an emergency action against a Hong Kong company, Blue Bottle Ltd., and its named owner, Matthew C. Stokes, for alleged insider trading.  The SEC's complaint (here) asserts that Stokes (or others) obtained advanced information about company announcements by hacking into computer networks to view press releases and other documents shortly before the information was released into the market.  They are accused of trading in advance of the information by buying or shorting the securities of twelve companies to take advantage of the effect of the news on the stock prices, reaping profits of approximately $2.7 million.  The trading took place in January and February 2007, and it appears that Stokes is only a front name on the account.  The SEC Litigation Release (here) describes the most lucrative trading before the release of negative earnings news:

[W]ith respect to the defendants' trading in Symantec, the complaint alleges that on January 12, 2007 at approximately 1:03 p.m. EST, the defendants began buying 10,000 SYMC Jan07 20 put contracts, which represented 20 percent of the total trading in that security for the day. Those contracts were out-of-the money when purchased. Later that same day, at approximately 1:37 p.m. EST, the defendants began buying 500 SYMC Jan07 22.5 put contracts, which represented 41 percent of the total trading in that security for the day. All of the put contracts were to expire on January 20, 2007. Essentially, buying the put options was a bet by the defendants that the price of Symantec stock would decrease. The Commission further alleges that on the next trading day, January 16, 2007, at 7:48 a.m. EST, Symantec issued a downward revision of its third quarter 2007 earnings and revenue forecast. Shortly following Symantec's announcement, the defendants began selling the put contracts, amassing a profit of $1,030,471.

Not a bad profit on an investment made for only a couple days, at most. From the SEC complaint, it appears that approximately $1.6 million is still in the U.S., while about $1 million has joined Elvis in leaving the building.  The Commission likely moved now to keep the money here, and will have to continue its investigation of the source of the well-timed trades through civil discovery.  This kind of trading is sure to draw the interest of the Department of Justice. The U.S. District Court for the Southern District of New York froze Blue Bottle's assets and ordered a hearing for March 7, although any individuals who might want to claim the money are unlikely to show up and risk an immediate arrest on criminal charges. (ph)

No News in Libby Case

The jury continued to deliberate today, with no clue as to whether they will be able to reach a verdict in this case. The press describes every move here (San Diego.Com - AP)

(esp)

Pair Engaged in Illegal Activity Related to MySpace Enter Plead

According to Yahoo News (AP) here two men plead guilty to illegal computer access for crimes related to MySpace.  Perhaps the more interesting aspect of the case is that these young men were arrested in LA for crimes occurring in New York.  When the crime relates to a computer, jurisdiction can be almost anywhere- the location of the keystroke, the location of the damage, or the location it passes through.  This is yet another example of this happening. (see also here)

(esp)

Plea in Hedge Fund Case

The U.S. Attorney's Office for the Central District of California issued a press release telling of a plea being reached in a hedge fund case. The release states that, "[a] former account vice president at a major brokerage firm pleaded guilty today to conspiring with the founder of an investment company that operated a hedge fund to commit securities fraud."  Justin Paperny's plea to "to one count of conspiracy to commit mail fraud, wire fraud and securities fraud" includes an agreement for "cooperate with investigators in an ongoing criminal probe into Valencia-based Capital Management Group and its GLT Venture Fund."

(esp)

KPMG - Guest Posting - Part III

Professor J. Kelly Strader (Southwestern) - Guest Blogging - KPMG PART III -

KPMG produced two of the most interesting white collar crime decisions of 2006. In addition to the attorneys’ fees holding discussed in the last entry, Judge Kaplan issued another groundbreaking decision ("Stein II, discussed here). The holding had two essential components. First, the judge held that certain KPMG employees had been coerced into given statements to the government, in violation of their Fifth Amendment right not to be witnesses against themselves. Some defendants had met with the government and made "proffers," statements given with the agreement that they could not be used by the government in its case in chief, but could be used on cross examination and could be used to produce leads. The court found that had KPMG had threatened both to withhold payment of the employees’ attorneys’ fees and to fire certain employees if the employees did not cooperate with the government. These threats amounted to economic coercion that rendered the employees’ waivers of their right to remain silent invalid.

Second, the judge held that KPMG made these threats because of government pressure; if KPMG employees did not cooperate – and assertion of the Fifth was deemed failure to cooperate – the firm risked trial. Thus, KPMG was a government actor and its actions violated the Fifth Amendment. Because of that violation, the judge granted the defendants’ motion to suppress certain of their statements.

Unlike Stein I, this was an appealable decision. Both sides and various amici have filed briefs, and the issue is now pending before the Second Circuit. In their briefs, the parties recognize the significance of the issues. For its part, the government asserts that the sky is falling -- that it will never again be able to gain an entity’s cooperation if Judge Kaplan’s decision is allowed to stand. The defendants’ briefs both support Stein II, and further argue (correctly) that the government’s attack on Judge Kaplan’s fact-finding is in effect a backdoor attempt to appeal Stein I.

The legal issues are fascinating, and raise core Fifth Amendment issues of the sort rarely encountered in white collar cases. As to the first holding – that the threatened loss of employment and loss of legal fees amounted to coercion – the defendants are on solid ground – certainly at least with respect to loss of employment.

As to the second holding – that KPMG was a government agent – the law is hardly settled. This is the holding at which the government aims its biggest guns, and deservedly so, for this ruling would hardly be welcome precedent for the government. One interesting note -- as Judge Kaplan observed in Kaplan II, the DOJ takes the position that a person may commit obstruction of justice when that person makes a false statement to private attorneys representing a corporation that is cooperating in a government investigation. In taking the position that corporate counsel in this position are effectively acting as hired help for the DOJ, while at the same time asserting that KPMG was acting completely independently when threatening its employees, the government does seem to be speaking out of both sides of its mouth. (Next time: what does all this mean for white collar litigation?)

(JKS)

Juror Dismissed from Libby Trial

U.S. District Judge Reggie Walton dismissed a juror from the I. Lewis Libby case because she was exposed to information about the prosecution during the weekend break.  Jurors are routinely instructed not to look at any media reports about a case or discuss it with anyone, an admonition particularly important during the deliberations.  According to an AP story (here), Judge Walton decided not to call on one of the two remaining alternate jurors to join the deliberations because that would require the jury to restart the consideration of the case from the beginning.  Instead, the court relied on its discretionary authority under Federal Rule of Criminal Procedure 23(b), which provides that "a jury of fewer than 12 persons may return a verdict if the court finds it necessary to excuse a juror for good cause after the trial begins."   The D.C. Circuit recognizes that judges have significant discretion in deciding what is "good cause" for the dismissal and the decision to proceed with eleven jurors (see United States v. Harrington, 108 F.3d 1460 (D.C. 1997) ("Rule 23(b) explicitly and without reservation assigns the stop/go decision to the discretion of the trial court, and nothing in the accompanying Advisory Committee notes, or in any case of which we are aware, cabins this discretion in a way that would call this judge's decision into question.").  The judge's decision may indicate that the jurors are close to a verdict, but that is not necessarily the case for the decision to go with an eleven-person jury, and only time will tell how far the jurors had gotten.  While Libby could object to the use of an eleven-person jury, it is very difficult to win an appeal on this issue if he is convicted. (ph)

More Military Related Matters

DOJ reports here on a plea in an antitrust bid-rigging case related to U.S. Navy contracts.  The press release states that the two Pennsylvania executives had agreed to "pay a criminal fine of $10,000 each and to serve up to six months in jail for their participation in a conspiracy to rig bids for Department of Defense (DOD) contracts for metal sling hoist assemblies, which are used to transport bombs and other munitions."  The plea anticipates cooperation.

(esp)

Life for Rigas As He Awaits the Appeal Process

Paul Heimel of the Orlean Times Herald has a story on what life is like for 82-year-old John Rigas as he awaits word from the appellate tribunal on whether he will have to begin serving his 15 year prison sentence.

(esp)

Guest Blogger - KPMG - Part II

Professor J. Kelly Strader - Guest Blogging - KPMG - Part II

KPMG has already produced several extraordinary decision, with more likely ahead. In something of a nuclear explosion for the government, last June, Judge Kaplan, who is presiding over the case, found that KPMG had threatened to withhold payment of attorneys’ fees if its employees failed to cooperate in the investigation. The court also found that KPMG acted under government pressure, in accordance with Department of Justice policies set forth in the Thompson Memorandum. ("Stein I," discussed here, here, here, here and here.   (For a discussion of the Thompson Memorandum policies and the subsequent McNulty Memorandum, see here, here, here, here, and here). The court held that KPMG, as a government agent, had violated the defendant employees’ Sixth Amendment right to counsel and right to substantive due process. The court urged the defendants to pursue a civil action against KPMG for the fees, and exercised ancillary jurisdiction over that action. Because this decision did not directly affect the government’s interests, it was not appealable by the prosecution.

Certainly, the Thompson and McNulty memos raise serious issues of fairness. As to Stein I’s Sixth Amendment holding, though, it is difficult to reconcile with the Supreme Court’s decisions in Caplin & Drysdale and Monsanto that a criminal defendant has a Sixth Amendment right to a court-appointed attorney only, not the right to an attorney of choice. (In those cases, the government had sought forfeiture of funds needed to pay attorneys’ fees.) Those cases were decide by bare majorities, and may be based upon questionable logic, but they are still good law. Judge Kaplan’s decision in reality invokes Justice Blackmun’s comment in dissent that "it is unseemly and unjust for the government to beggar those it prosecutes in order to disable their defense at trial."

KPMG has appealed the district court’s exercise of ancillary jurisdiction over the fee dispute, arguing that the district court did not have subject matter jurisdiction and that the claims should be arbitrated. In just one example of the strangeness of this case, Judge Kaplan filed an "amicus brief" (brief here) with the Second Circuit in support of his original decision. The appeal is pending. (Next time: coerced Fifth Amendment waivers.)

(JKS)

Yet Another US Attorney Gone

We noted here, here, here, and here on the recent exodus of USAs throughout the country.  The Washington Post reports here on yet another. Is this getting a little out of hand?  Is there some correlation here that warrants review?  The bio page of the latest individual leaving the office, Margaret Chiara,here is most impressive.

(esp)

KPMG - Guest Posting

Guest Blogging - J. Kelly Strader - Professor of Law, Southwestern Law School

The KMPG Saga, Part 1

I recently gave a talk on the KPMG case at a symposium sponsored by Chapman University School of Law entitled "Miranda at 40: Implications in a Post-Enron, Post 9/11 World," and I thought I would share some of my observations. KPMG has been an extraordinary case, with fascinating legal and strategic issues for both sides. To avoid overloading the reader, I’ve divided my discussion into four parts. I discuss the latest developments in the case, and end with some views on the impact that the Thompson and McNulty Memos have had on complex white collar litigation.

Because the case has been pending for over a year and a half, with no trial in sight, it might be helpful to recap some key facts. KPMG is one of the world’s largest accounting firms. In 2002, the IRS issued summonses to KPMG in connection with its tax shelter practices. In 2003, the Senate held widely-publicized hearings on those practices. The IRS later referred the matter to the Department of Justice for criminal investigation. The grand jury handed down the original indictment in August 2005, and the superseding indictment later that year. (indictment here) ; press releases here & here.

The government has described the case as the largest tax fraud case in United States history, with an alleged two billion dollars of lost tax revenue due to fraudulent tax shelters. The 70-page, 46-count indictment named 19 defendants and included charges of conspiracy, tax evasion, and obstruction of justice. Among the defendants were 16 former partners or employees of KPMG, some of whom were at the highest levels of management.

Under a deferred prosecution agreement, the government also filed an information against firm, with a single tax fraud conspiracy count. (information here) The DPA required that KPMG pay nearly half a billion in fines, restitution, and penalties, and that the firm cooperate fully in the investigation. It is the DPA that has produced most of the notable issues in the case, including some fascinating Fifth and Sixth Amendment-related issues, including issues currently on appeal to the Second Circuit. (Next time: the attorneys’ fees imbroglio.)

(JKS)

Criminal Investigation of KB Home's Options Backdating

The Department of Justice is looking at the options issuance practices of KB Home, joining a previously-disclosed SEC formal investigation.  According to a company press release (here): "KB Home's past stock option grant practices are being investigated by the Securities and Exchange Commission. The Department of Justice is also looking into these practices but has informed KB Home that it is not a target of this investigation. KB Home has and intends to fully cooperate with any government agency looking into this matter."  On November 12, 2006, the company announced (here) that long-time CEO Bruce Karatz was retiring, and he "voluntarily" agreed to repay the difference between the lower, backdated strike price and the proper price on options he had exercised.  In addition, KB Home's human resources director was fired, and its general counsel resigned.  While the disclosure of a criminal investigation does not necessarily mean charges will be filed, the fact that it comes on the heels of the SEC upgrading its investigation from an informal inquiry likely means the government will be looking at a wide range of transactions, and the company's former officers are the probable targets of the investigation. (ph)

Tongsun Park Receives Maximum Sentence in Oil-for-Food Corruption Case

South Korean businessman Tongsun Park first burst on the scene in the 1970s when he was indicted on influence-peddling charges in the Koreagate contributions scandal, although the charges were eventually dropped after he fled the United States.  With the United Nations' Oil-for-Food program designed to get humanitarian aid into Iraq during the embargo after the first Gulf War, Park got involved in helping the Iraq government try to bribe UN officials, including then-Secretary General Boutros-Ghali, to set up the program in a way that favored the Iraqi government..  The government of Saddam Hussein gave Park $1 million in cash, much of which went into a company owned by a UN official.  In July 2006, Park was convicted of conspiracy to act as an unregistered agent of the Government of Iraq.  U.S. District Judge Denny Chin sentenced Park to the maximum five-year prison term authorized for his conviction (see USAO press release here), stating that "[y]ou either bribed a U.N. official or you were acting as if you were going to bribe a U.N. official."  Park was immediately taken into custody at the end of the sentencing hearing.  A Washington Post story (here) reviews the case and Park's history of involvement in various lobbying efforts. (ph)

Considering White Collar Crime Sentences

Blog co-editor Ellen Podgor published an interesting article in the Yale Law Journal Pocket Part about the current nature of white collar crime sentences, "Throw Away the Key."  She discusses the recent phenomenon of lengthy sentence for white collar defendants who are almost always first-time offenders posing no threat to society.  She argues:

No doubt many of these white-collar offenders committed thefts within companies, and in some cases decimated employees’ and investors’ savings. But the sentencing Guidelines limit courts’ abilities to consider factors such as the motive of the perpetrator, the benefit he or she received, and the extenuating circumstances that caused the harm. Instead, the judge may only consider the sentencing Guidelines’ mathematical computation of loss when imposing a sentence. As a result, in some courts the person who steals to benefit the company without personal remuneration can receive a comparable sentence to the rogue employee who cashes in his or her company stock to obtain an immediate personal profit. The accused becomes irrelevant in a sentencing world ruled by the cold mathematical calculations found in the sentencing Guidelines. Not even the Supreme Court’s decision in United States v. Booker, which grants trial judges some flexibility after using the Guidelines, provides much relief. The statistics show that judges usually stick to the sentences provided in the Guideline grid.

A response to Professor Podgor's article was written by Andrew Weissmann and Joshua Block from the Jenner & Block firm -- Weissmann was head of the Enron Task Force before leaving for private practice.  Their article, "White-Collar Defendants and White-Collar Crimes," agrees with her point that long sentences for white collar defendants do not provide much deterrence, but disagree with the argument that such defendants should be viewed differently.  They argue:

Most troubling are Podgor’s arguments with respect to white-collar criminals. It is one thing to say that certain criminal acts are not as bad as others. But it is quite another to argue that people who commit white-collar crimes as a generalized group should be punished differently from those who commit other crimes. Any such differences often correlate in fact to race and almost always to class. One of the laudatory goals in promulgating the Sentencing Guidelines was to remedy the potential for hidden—or unhidden—bias in favor of “white collar” defendants.

The discussion is especially pertinent because the pace of white collar crime prosecutions continues.  Lord Conrad Black faces securities fraud, conspiracy and RICO charges in Chicago over transactions at Hollinger International when he was CEO, and former Qwest CEO Joseph Nacchio will go on trial in Denver on insider trading charges for selling over $100 million in shares shortly before the company's stock price collapsed due in part to accounting problems.  Like CEOs before them, these men face substantial sentences, which could amount to a virtual life term, for conduct that involved rather mundane corporate transactions. (ph)

Brazilians Settle SEC Insider Trading Case

Just in time for the end of Carnival, two Brazilians settled an SEC insider trading civil suit arising from purchases in the target of an impending tender offer.  The defendants are Luiz Gonzaga Murat was the chief financial officer and investor relations director at Sadia S.A., a Sao Paulo frozen food company, and Alexandre Ponzio De Azevedo, who formerly worked for ABN AMRO's Brazilian affiliate.  Sadia planned a tender offer for Perdigão S.A., another Brazilian company, and ABN AMRO's investment banking unit advised on the deal.  According to the SEC's Litigation Release (here):

[O]n April 7, 2006, representatives of an investment bank met with Murat and another Sadia executive to propose that Sadia make a tender offer for Perdigão. According to the complaint, Murat proceeded to purchase American Depositary Shares ("ADSs") of Perdigão both later the same day and subsequently on June 29, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to Sadia. The complaint alleges that Murat's holdings totaled 45,900 ADSs of Perdigão by the time Sadia announced the tender offer. On July 17, 2006, the price of Perdigão ADSs increased to $24.50, up $4.25 (21%) from the previous closing price. According to the complaint, Murat had imputed illicit profits of $180,404 from his unlawful trading.

The Commission's complaint against Azevedo alleges that he learned of the possible tender offer on April 11, 2006, in his capacity as an employee of ABN AMRO assigned to the tender offer financing team, and that ABN AMRO later placed Perdigão on a list of securities in which ABN AMRO employees could not trade. According to the complaint, Azevedo subsequently purchased 14,000 ADSs of Perdigão on June 20, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to ABN AMRO. Azevedo sold 10,500 ADSs on July 17, 2006, one day after Sadia had publicly announced its tender offer for Perdigão. According to the complaint, Azevedo realized illicit profits of $52,290 on the 10,500 ADSs he sold on July 17 and had imputed profits of $14,875 on his remaining 3,500 ADSs.

Murat agreed to pay $184,028 in disgorgement and a civil penalty of $180,404, while Azevedo will pay $68,215.45 and a civil penalty of $67,165. 

An interesting aspect of the case is that neither defendant ever set foot in the United States in connection with the transaction, and none of their trading involved an American company or even any communications that passed through the U.S.  The jurisdictional hook is the securities of each company, which are traded on the New York Stock Exchange as ADS.  Under Section 10(b) of the Securities Exchange Act, the general antifraud prohibition applies to any person who "directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . ."  The fact that the securities of the target trade on the NYSE brings the case under the Act, although it is a fair question whether conduct wholly outside the United States with only a tangential connection to this country should be subject to a civil enforcement action by the SEC.  The trades were placed in Brazil, and the companies were incorporated and operated there, but the transaction ultimately occurred in New York, bringing it into the SEC's cross-hairs.  The case shows the long arm of the insider trading prohibition. (ph)

NYSE Floor Broker's Conviction Reversed

U.S. District Judge Denny Chin reversed the securities fraud convictions of New York Stock Exchange floor broker David Finnerty, another in a series of setbacks in high-profile securities fraud prosecutions that began with a big splash and seems to be ending with a whimper.  Fifteen brokers were indicted on charges alleging that they stepped in front of their customers to intercept trades at more favorable prices, leaving the clients putting in orders to pay a higher price or receive a lower one in the transaction.  Called "interpositioning," it is basically front-running in which the floor broker, who is responsible for ensuring that the market trades smoothly, uses his superior position to recognize trends and trade for his firm's own account before executing customer orders -- in elementary school,, it was called "front-cuts."  Judge Chin granted Finnerty's Rule 29 motion for a judgment of acquittal, finding that the government had not proven the defendant's conduct defrauded customers, the key to a securities fraud conviction (opinion below).  Judge Chin held:

Finnerty is not arguing that evidence of customer expectations is an element of the crime that the Government must establish for a conviction under 10b-5. Rather, Finnerty is arguing that, under the facts of this case, the Government could not prove that interpositioning was deceptive without showing what the investing public expected. I agree . . . the Government was required to prove that customers expected one thing and got something different.  Without evidence of what the customers expected, no rational juror could conclude that the interpositioning trades had a tendency to deceive or the power to mislead. A juror would only be able to reach that conclusion by speculating . . . .

Finding no evidence that the customers were misled, the conviction could not stand.  The opinion also questions whether Finnerty even owed a fiduciary duty to customers who had no clue about the floor broker's role in a transaction, which is usually a linchpin in a fraud prosecution based on an omission rather than a misstatment.

The government earlier dismissed a number of cases against other floor brokers, and some were acquitted after trial.  Two broker were convicted of securities fraud in July 2006 after trial before a different judge, and two others entered guilty pleas.  Challenges to the two convictions likely will be bolstered by Judge Chin's decision.  (ph)

Download us_v_finnerty_d_ct_opinion_feb_21_2007.pdf

Make Sure You Go to Lunch When Your Client Goes to Jail

West Palm Beach (Fla.) attorney John Garcia learned the hard way that lawyers have to keep their distance from clients, especially when a client is involved in a significant drug dealing operation.  Garcia received an 18--month sentence after pleading guilty to three counts of failing to file CTRs for cash transactions over $10,000 and one count of making a false statement to a DEA agent.  The case arose out of an investigation of Garcia's client, Joel McDermott, who was convicted on drug distribution charges.  In looking at McDermott's assets after his conviction, the DEA noticed that payments were being made on a house being built in Wellington, Fla., in his name.  Needless to say, McDermott was more than willing to roll over on his attorney, and it came to light that he gave Garcia cash to purchase cashier's checks to make the payments.  As described in a press release (here) issued by the U.S. Attorney's Office for the Southern District of Florida:

Garcia admitted structuring cash transactions in his bank account to avoid the filing of currency transaction reports that would have disclosed the source of the monies and their amounts; he also admitted that he lied to Special Agents of the Drug Enforcement Administration when he said that: (1) he had no financial or equitable interest in the construction of a residence in the name of Joel McDermott located in a real estate development known as “Olympia;” and (2) he did not purchase cashier’s checks from Bank of America for the residence of Joel McDermott located in a real estate development known as “Olympia.” In fact, however, Garcia had a financial and equitable interest in the residence in “Olympia” and had purchased several cashier’s checks at Bank of America with cash given to him by Joel McDermott. Thereafter, Garcia caused those cashier’s checks to be tendered to Minto Homes for the benefit of Joel McDermott and a home McDermott was building in “Olympia.”

A Palm Beach Post story (here) discusses the sentencing hearing for Garcia, attended by a number of defense attorneys and a retired circuit court judge, who attested to Garcia's integrity.  Indeed, the Assistant U.S. Attorney prosecuting the case said that Garcia is "an honorable man of his word."  While U.S. District Judge Daniel Hurley expressed some sympathy, noting the number of supporting letters he received, he also pointed out that Garcia's conduct was "180 degrees at odds with the person we thought we knew."  While the judge mused about possibly giving a higher sentence than called for by the Federal Sentencing Guidelines, he ended up giving Garcia a term at the bottom of the sentencing range.

The old adage is that the client goes to jail and the lawyer goes to lunch (or dinner, or back to the office).  When the attorney crosses the line and starts helping a client launder money, then the last person on earth that client will protect is the lawyer, who will join the client in jail.  (ph)