Post-Scandal Charges Still Rare
By AMANDA BRONSTAD
Despite tougher laws, increased budgets and better cooperation among federal enforcement agencies, there's a growing sense that the corporate executives who misled investors into losing hundreds of billions of dollars some of them in Los Angeles will never go to jail.
Top officials at Enron Corp., including Jeffrey Skilling and Kenneth Lay, are unlikely to face charges. Neither, according to recent news reports, is WorldCom's founder and guiding light, Bernie Ebbers.
In Los Angeles, prosecutors have had limited success. Four executives at Homestore Inc. have pleaded guilty to charges related to a massive scheme to inflate revenues. At L90 Inc., one of Homestore's partners, former Chief Executive John Bohan is among those who have been convicted.
Yet there do not appear to be any ongoing criminal probes involving Gary Winnick, despite detailed allegations that the company he founded and headed, Global Crossing Ltd., exaggerated its "cash" revenues using sham swaps of telecom capacity. The U.S. Attorney's investigation into the company has been all but dropped, according to numerous sources.
Likewise, the founder and head of Gemstar-TV Guide International Inc., Henry Yuen, has not been charged with any crime despite civil charges that he booked hundreds of millions of dollars in revenues that customers were disputing.
Even at Homestore, former Chairman and Chief Executive Stuart Wolff, who was dumped by his board after the scandal erupted, has yet to face charges.
The reality, say former prosecutors and corporate attorneys, is that the flurry of indictments that took place at Enron, Arthur Andersen and Worldcom (now MCI) may be the last of their kind, especially as these investigations drag on.
"These are not black and white cases," said John Libby, a partner at Manatt Phelps & Phillips LLP and former assistant U.S. Attorney. "These are white collar cases that are operating in a gray area. If there is something the prosecutor misses, and the corporation can bring it to his attention, that may change the charging decision."
No smoking gun
The problem, says Clifford Hyatt, counsel for Chadbourne & Parke LLP and former deputy assistant regional director in the Securities and Exchange Commission, is that "each one of these people blames the other for what happened and there's no camera and no witness. All you have are the documents and statements by these people and you have to figure out who is telling the truth."
Above all, he said, prosecutors must deal with complex accounting principles. "It's pretty clear when someone puts a gun to a teller's head or you test a substance and it's heroin, that there's fraud," Hyatt said. "But in accounting, it can be difficult."
Another problem is perception.
In the wake of such high-profile financial disasters, there is an assumption that there's fraud involved. But it isn't necessarily true. "What you're seeing is another cycle of government and public and press fed up with these types of scandals," Libby said. "The expectations are unrealistic."
Federal prosecutors in L.A. are at a further disadvantage to their counterparts in New York because they don't have the same expertise in securities law.
Of the 165 prosecutors in the U.S. Attorney's office, 30 work in the major frauds unit, which includes telemarketing and securities fraud, said Thom Mrozek, spokesman for the Los Angeles office. Deciphering the documents falls to a handful of prosecutors with securities expertise who typically take on more than one case at a time.
"We have investigations that are going on right now in which we have obtained hundreds of thousands, if not maybe one million documents," he said. "When you have one or two prosecutors working on an investigation, and they're handling other cases, you can't synthesize all that information in a month or two."
Additionally, many fraud prosecutors are new to the office, said John Gordon, a partner at Quinn Emanuel Urquhart Oliver & Hedges LLP who served as interim U.S. Attorney in L.A. from April 2001 to May 2002.
"They get minimal fraud-type training in the first year and a half," Gordon said.
As a result, the U.S. Attorney's office has been working closer with the SEC, which has more expertise in bringing cases. Now, the SEC often enlists the help of the U.S. Attorney's office from the first day of the investigation if there are suspicions that a crime has occurred, according to Randall Lee, director of the SEC's Pacific Regional office in L.A. Before, prosecutors rarely got involved until after the SEC had completed its investigation.
The SEC also acquired a new arsenal via the federal Sarbanes-Oxley Act.
In its investigation of Gemstar, for example, the SEC's local office used its new authority to freeze a $37.6 million in severance payments to Yuen and former chief financial officer Elsie Leung.
It was the SEC's first such use of Sarbanes-Oxley. Yuen challenged the SEC in court but lost his case in July. He has since appealed.
"That case is an extraordinarily important one because of the size of the company and the consummate impact on investors from the fraud that was perpetrated," Lee said.
The SEC alleges that Yuen and Leung inflated Gemstar's revenue by $233 million over a two-year period. "Our investigation of that matter is ongoing," Lee said.
Credit for the better cooperation is partly due to the Corporate Fraud Task Force, which was established last year by President Bush. L.A.'s U.S. Attorney, Debra Yang, is on its board. The joint efforts, also involving the FBI, have proven instrumental to investigators.
But bringing criminal charges, as opposed to civil fines, requires a higher burden of proof that has been difficult to attain, said Alejandro Mayorkas, former U.S. Attorney in L.A. and a partner at O'Melveny & Myers LLP.
In criminal cases, the prosecutor must prove guilt beyond a reasonable doubt that someone intended to defraud or commit a crime. That requires interviews of former and current employees, as well as third parties who may have done business with the company, he said.
"It's hard to know who's at the top of the wrongdoing sometimes," Mayorkas said. "But it is very common to see investigators and prosecutors work their way up the ladder of culpability."
Incentives to cooperate
With heightened penalties that arose from Sarbanes-Oxley, more companies are choosing to cooperate making it easier, at least in those cases, for the U.S. Attorney to bring charges. "While there is a heightened vigilance on the government side, there's also a heightened vigilance from the company's side," said Chad Hummel, a partner at Manatt Phelps & Phillips.
Over the past year, companies have plowed significant resources into designing corporate compliance programs and procedures for cooperating with investigators, such as handing over information from internal investigations. Doing so could mean a lighter jail sentence or a possible non-indictment of the company, as occurred with Homestore.
"Nothing is a bigger threat than an indictment," Hummel said. "These are all effective tools, and the government has put increased pressure on corporate America to cooperate."
Yang has leveraged her new power by emphasizing publicly that executives who cooperate may receive reduced sentences. A January memo by U.S. Deputy Attorney General Larry Thompson encourages prosecutors to seek indictments of corporations, not just executives, in all criminal investigations.
The Thompson memo outlines guidelines federal prosecutors should follow. Among the most critical is getting a company to cooperate in the investigation. Similarly, the SEC has turned up the pressure on directors.
Mrozek said the cooperation by corporate insiders who have extensive knowledge of the events and documents in question is a more effective tool than whistleblowers who may not have enough knowledge about the circumstances of the criminal conduct.
In the case of Global Crossing, former vice president of finance Roy Olofson reported to investigators last year that the company had bought and sold fiber optic cable to pad its bottom line. But it wasn't enough to overcome the unified defense of company executives, who maintained that the transactions were legitimate.
"In many cases, the corporate frauds are committed by very high level executives, and the information is kept among a very select few people," Mrozek said.
And the higher up within an organization the crime occurs, the more likely investigators will find "plausible deniability," said Lee. Insiders can explain the roles and responsibilities of multiple layers of management, which speeds up the case considerably, he said.
In many cases when companies cooperate, executives plead guilty before they get indicted. In addition to the four former Homestore executives and L90 (now called MaxWorldwide Inc.), eConnect Inc.'s former chief executive, Thomas Hughes, pleaded guilty Aug. 11 to three counts of securities fraud for issuing false press releases and making false statements on the company's Web site. He faces sentencing in December for up to 30 years in prison.
Cast of Characters
Global Crossing Ltd.
Issues: Pro forma revenue recognition; questionable capacity swaps with Qwest and other partners; timing of stock sales.
Status: Company filed for Chapter 11 bankruptcy in January 2002 Attempted sale to a Singapore government-owned ST Telemedia has run into Defense Department opposition No criminal charges likely, despite accusations of ex-finance executive Roy Olofson Company and senior executives, including ex-chairman Gary Winnick, in global settlement discussions with shareholders, bondholders and former employees.
Issues: Fraudulent three-way transactions with AOL and other partners; inflated revenues.
Status: Board's swift response to scandal helped avoid direct charges Four former company officers have pleaded guilty to charges related to financial fraud SEC investigation ongoing Company has settled disputes with numerous parties, including shareholders and former partners AOL Time Warner Inc. and Cendant Corp . Stock's rebound, to $3.25 a share as of Aug. 19, has yielded a paper profit of $7.7 million for Chief Executive Mike Long, on options granted in January 2002.
Gemstar-TV Guide International INC.
Issues: Aggressive accounting, including recognition of disputed revenues that had to be reversed; timing of disclosures.
Status: Former Chief Executive Henry Yuen lost control to his largest investor, News Corp.'s Rupert Murdoch The SEC has gained a temporary freeze on $37.6 million in severance paid to Yuen and former Chief Financial Officer Elsie Leung SEC Pacific Region Director Randall Lee calls the Gemstar case "extraordinarily important" due to its size and the "impact on investors from the fraud that was perpetrated" CEO Jeff Shell is focused on repairing TV Guide magazine.
Issues: Pending restatement of revenues and failure to file 10K for the year ended March 31.
Status: Company's stock hasn't traded since May, when it disclosed improper accounting of some transactions In unaudited results for the year ended March 31, the company cited high product return rates and receivable collection issues at the recently discontinued Ultraconversions operating unit SEC investigation is ongoing.
EConnect HOLDINGS Inc.
Issues: Issuing false press releases in order to boost the company's stock price.
Status: Former Chief Executive Thomas Hughes pleaded guilty to securities fraud charges earlier this month, and awaits sentencing in December The company, which makes an online payment system, has changed its name to EyeCashNetworks Inc.
L90/Max Worldwide Inc.
Issues: Bogus barter transactions related to roundtripping revenues; booking revenues on adverting that executives knew would never be paid.
Status: Three former executives, including former Chief Executive John Bohan, pleaded guilty to securities fraud and other criminal and civil charges related to falsifying the company's books in April Company has moved to New York and restructured its business Former Chief Financial Officer Thomas Sebastian, who was not sued by the SEC, has filed suit to force the company to cover his legal expenses.
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