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Recently in Criminal Law and Prosecution Category

James R. Copland

In the wake of the 2008 financial crisis, New York politicians and judges have been itching to broaden the Empire State's Martin Act, which governs securities frauds. And this comes amid an explosion of criminal laws in this state.

It may sound like warranted crackdown, but don't be fooled: It's really part of a move to shift power to pols and prosecutors -- and it leaves average Joes befuddled and at risk of turning into accidental criminals.

The proliferation of criminal statutes undermines a key principle: that folks know in advance what conduct could land them in prison.

It's obvious that crimes like murder, burglary, rape will be criminally punishable. But other laws have increasingly attempted to criminalize violations of government regulations, which often span volumes, leaving the average citizen unsure of what actions might be considered criminal.

Worse, many modern criminal laws are vague or ambiguous, ensuring that we're never truly on notice of what is or isn't a crime.

Compounding this problem is the erosion of the traditional requirement of intent (what lawyers call "mens rea") -- in essence, that we can't be imprisoned for mere accident or negligence. On this front, New York fares poorly. Its modern criminal law expressly permits so-called "strict liability" offenses -- that is, you can be found guilty of a crime whether you violated the law on purpose or by accident.

In some cases, a whole book of regulations becomes crimes by default. The state Environmental Conservation Law, for instance, makes any violation of any environmental rule or order punishable by 15 days in jail for each day a violation occurs. So, if you inadvertently breach a regulation for a year, you could face up to 15 years in prison.

Moreover, many of these laws -- like the Martin Act, former Attorney General Eliot Spitzer's weapon of choice in his efforts to reshape New York's investment banking and insurance industries -- are vague, ambiguous or overly broad.

Unlike the federal securities laws and similar laws in most other states, the Martin Act doesn't require prosecutors to show that alleged wrongdoers intended to defraud, that anyone bought or sold securities relying on the alleged fraud or that anyone was even injured by the fraud.

And it makes criminal any "promise or representation as to the future which is beyond reasonable expectation or unwarranted by existing circumstances." That means that practically any forward-looking statement by any executive (including, perhaps, statements required by the federal securities laws) might be invoked as a crime.

New York law makes corporations themselves criminally liable for violations of such provisions. As such, prosecutors hold vast power to reshape corporate practices. And such reshapings may have serious consequences unanticipated by the politician-attorneys.

Consider Spitzer's deployment of the Martin Act against AIG -- at best, a distraction from the risks that would soon swamp the companies involved; at worst, a direct contributor to the risks (and consequences) themselves.

Threatening criminal action, recall, Spitzer forced AIG to oust longtime CEO Maurice "Hank" Greenberg. As Greenberg's successor, Martin Sullivan, focused on regulatory compliance and cooperation with government probes, he lost sight of AIG's financial-products group, which sold credit-default derivatives. In the nine months after Greenberg departed, AIG wrote as many credit-default swaps as it had in the previous seven years combined.

Those credit swaps ultimately brought both the company and the financial industry as a whole to its knees. It's impossible to know what would've happened had Spitzer not intervened, but UBS credit analyst David Havens maintains that the company would've never gotten into such a dire situation had Greenberg stayed in charge.

Even those who think our corporations are under-regulated should take pause at giving virtually unchecked power to government attorneys who may not fully understand the businesses they're affecting. Rather than protect the average consumer, expanding laws like the Martin Act is more likely to drive up costs, make the New York financial industry less competitive and introduce new systemic risks into the market.

In a very real sense, the expansion of our criminal law has moved us from the rule of law to the rule of prosecutors.

And if our criminal laws are too voluminous -- if we can go to jail for a mistake -- our liberty is seriously compromised.

James R. Copland

The Justice Department appears to have learned a lesson in the 10 years since it indicted Arthur Andersen LLP for alleged improprieties in the firm's Enron bookkeeping. By 2005, when the U.S. Supreme Court unanimously vacated a conviction in the case, the accounting firm had collapsed, and all but a handful of the 85,000 employees worldwide lost their jobs.

The Justice Department has since avoided large-scale corporate prosecutions that would threaten the disastrous collateral consequences brought on by its case against the former Big Five accounting firm.

But in the place of actual prosecutions, the Justice Department has aggressively pursued what are blandly called "deferred prosecution" or "non-prosecution" agreements -- DPAs and NPAs, for short -- through which prosecutors and companies negotiate terms to avoid a criminal trial. This approach may be avoiding the sort of corporate death sentence visited upon Andersen for what proved to be non-crimes, but nonetheless does something just as worrisome: It insinuates Justice Department career bureaucrats into the day-to-day management of major American businesses.

Although only 17 DPAs or NPAs were reached between businesses and federal prosecutors in the decade before the Andersen indictment, more than 200 have followed in its wake, through both the Bush and Obama administrations. Seven Fortune 100 companies are currently operating under the supervision of federal prosecutors: CVS Caremark (CVS) Corp., Google (GOOG) Inc., Johnson & Johnson, JPMorgan Chase & Co., Merck & Co., MetLife Inc. and Tyson Foods Inc.

Wal-Mart on Deck

Seven other of the 100 largest businesses have been under a DPA or NPA in just the past few years. Others, such as Wal-Mart Stores Inc., currently facing scrutiny for alleged Mexican bribes prohibited under the Foreign Corrupt Practices Act, are sure to follow.

In each of the past three years, fines and penalties levied under federal deferred-prosecution and non-prosecution agreements have exceeded $3 billion. While such fines are not insignificant, of far greater concern are the sometimes sweeping powers that prosecutors have asserted over business practices. In recent DPAs and NPAs, federal prosecutors have variously pressured companies to change long-standing sales and compensation practices; to restrict or modify contracting and merger decisions; to carry out onerous compliance and reporting programs; to appoint corporate monitors with broad discretion over management decisions; and even to oust executives or directors.

Businesses accept the agreements with such aggressive terms because they can ill afford to fight a criminal investigation. A certified public-accounting firm like the former Arthur Andersen is uniquely vulnerable to criminal indictment and conviction. But criminal inquiries place significant pressure on stock prices for all companies and can impair the ability to obtain credit. Companies can be debarred from government contracting or denied licenses upon an indictment or conviction, making businesses in certain industries, such as health care and financial services, particularly unable to fight back against a prospective prosecution.

Just since 2009, finance companies have entered into 18 federal DPAs and NPAs and health-care businesses into 11 such agreements. The finance companies alone have a collective market value exceeding $690 billion, with more than $20 trillion in assets under management.

There is essentially no evidence that DPAs and NPAs, for all their sweep, have been effective in combating corporate crime. Some corporate-ethics watchdogs have argued that current Justice Department practices, by failing to credit internal compliance programs, have undermined companies' incentives to self-police.

No Judicial Oversight

What the agreements have been effective in doing is elevating Justice Department lawyers as business regulators who can reshape industry practices without having to engage in the cost-benefit analysis that is the norm for administrative agency action. Prosecutors in this area act largely without any judicial oversight: Judges never see NPAs and routinely rubber- stamp DPAs, and these agreements typically state that determinations of whether a company is in breach are the prosecutor's alone and are beyond judicial review.

It is long past time that Congress asserted itself over the Justice Department's use of DPAs and NPAs to assume broad and unaccountable regulatory authority. Public "tough on crime" sentiment and understandable anger over unprincipled conduct by some business leaders make most politicians hesitant to suggest that the criminal law is being too harshly applied to corporations.

Still, there's little case for prosecuting corporations as entities in the first place. Unlike individuals, they can't be imprisoned. As the Arthur Andersen case demonstrated, business entities often cannot be prosecuted, either -- at least without potentially drastic effects on corporate shareholders, employees, pensioners, customers and suppliers.

Federal prosecutors have been having a profound impact on those constituencies, with broad economic consequences, in the way they have been deciding not to prosecute businesses, but rather to control them through DPAs and NPAs. In the decade since Arthur Andersen was indicted, we haven't seen a repeat of that error. But in its place we have watched as federal prosecutors assume vast powers that make them an overarching, if hidden, regulator of American business.

Various members of the media and self-proclaimed ethics "watchdogs" have attacked Majority Leader Eric Cantor and the House Republican caucus this past week for passing -- by an overwhelming 417-2 vote -- a version of the Stop Trading on Congressional Knowledge, or "STOCK," Act.

The legislation is intended to apply federal prohibitions against insider trading to government officials, but a story in Politico ran with a typical headline: "Cantor under fire for STOCK Act tweaks," referring to provisions in the House legislation that departed from the earlier version of the bill passed by the Senate.

Just what were these "tweaks"?

In some respects, the House version of the STOCK Act strengthened rather than weakened limitations on profiteering off of government secrets, relative to the Senate bill.

It's hard to make any objection to extending insider-trading rules to the executive branch and to initial public offerings of securities, apart from the fact that the former would limit Democrats currently in control of the White House and the latter might embarrass former Speaker Nancy Pelosi, who has profited from IPOs of businesses directly affected by House legislation.

But it's similarly difficult to make a strong principled objection to the House bill's two most controversial dilutions of the Senate's STOCK bill.

To begin with, unlike the Senate bill, the House version eliminates sweeping registration requirements for private parties outside the government. The Senate STOCK Act would require registration as a lobbyist for anyone who might be characterized as trading in "public intelligence" -- i.e., facilitating investment-related guesses about the future shape of government policy based at least in part on conversations with government officials.

Such registration requirements clearly affect First Amendment rights to speak and petition the government. Moreover, as legal ethics scholar Richard Painter has suggested, it's perverse to target government officials' leaks of inside information by "requiring people to register before they gather information about their government," rather than by developing "stricter rules for government employees who selectively disclose government information to persons outside the government."

The second way in which the House version of the STOCK Act modifies the Senate bill is by eliminating the latter's provision that would target "undisclosed self-dealing by public officials."

Twice in the last 14 years, the Supreme Court has unanimously rejected prior versions of this rule, largely because the statutory provisions involved were so broad and vague that no one could precisely tell what conduct was actually prohibited.

Unfortunately, the Senate's proposed law would continue to offer little clarity as to what conduct would constitute "self-dealing." It's hard to know exactly what legislation considered by Congress would not affect the interests of, for instance, Sen. John Kerry, D-Mass., who directly and through his wife owns pieces of the Forbes and Heinz family trusts.

Moreover, the Senate bill's self-dealing restriction would reach not only federal officials, but also public servants across state and local governments. The Senate bill would thus impose a new federal mandate, uncertain in scope, which in many cases would depart from states' own disclosure requirements. It's hard to see why the federal government should be the chief ethics enforcer for state governments.

Just as insider trading is a misappropriation of corporate assets -- such that employees profiting off inside knowledge are stealing from the company -- so is government employees' profiting off their inside knowledge a violation of the public trust.

But the fact that we should want our public officials to be bound by the same insider trading laws that govern those in the private sector hardly means that we should support any and all pieces of legislation that would achieve that effect.

The House version of the STOCK Act is an improvement on the Senate version, and its proponents should be lauded, not criticized.

Paul F. Enzinna
Partner, Brown Rudnick

Jim invites Pam, an employee of a potential customer, to lunch. Over the next several years, during which Jim and Pam enjoy dozens of lunches and dinners, and Jim treats Pam to many rounds of golf, Pam's company becomes one of Jim's biggest customers. None of this is extraordinary -- most, if not all, businesses, entertain customers in the hope of developing business. However, a recent decision by the U.S. District Court for the District of Columbia threatens to criminalize this practice. In United States v. Ring, the court held that an individual who provides a "thing of value" to another, with the "corrupt intent to influence" her, may face up to 20 years in prison for violating the federal "honest services fraud" statute.

The federal mail and wire fraud statutes prohibit schemes to "obtain[] money or property, but prior to 1987, courts expanded the statutes' reach, applying them to reach, in addition, deprivations of "intangible rights," including the right to another's "honest services." This theory of "honest services" fraud was applied most often in cases of bribery of public officials, but was also applied in the commercial context. However, in 1987, the Supreme Court held that the mail and wire fraud statutes are limited by their terms to deprivations of money or property. Congress responded nearly immediately, passing a separate statute defining fraud to include deprivations of "honest services."

After his 2006 conviction for "honest services" fraud, former Enron CEO Jeffrey Skilling argued on appeal that the statute should be struck down for failing to specify what conduct is prohibited. The Court agreed that the statute is vague, but rather than striking it down, held that it must be limited to conduct at its "core" -- i.e., bribes or kickbacks paid to influence decisions. In other words, to prove honest services fraud after Skilling, the government must show not merely a deprivation of "honest services," but also that the deprivation resulted from a bribery or kickback scheme. To prove bribery, the government must show an understanding between the giver and the recipient that there will be a quid pro quo, with the recipient providing something of value in exchange for the bribe. However, in Ring, the court held that a defendant may be convicted of honest services fraud with no showing of any quid pro quo agreement, but on a showing of only a unilateral "corrupt intent to influence." Skilling applied this theory both to charges of honest services fraud involving public officials, and those involving conduct in the private sector -- in each case, the statute covers only bribery or kickback schemes.

Kevin Ring was a Washington lobbyist who worked with Jack Abramoff. Unlike Abramoff and several other of his associates, Ring was not charged with bribery or defrauding clients. Instead, he was indicted for several counts of honest services fraud, for providing members of Congress and their staff with travel, "fundraising assistance," drinks, golf and tickets to sporting events and concerts. The government claimed that Ring provided these items in order to "groom" officials by making them "more receptive to requests for official actions on behalf of [Ring's] clients in the future." However, the government presented no evidence of any agreement between Ring and any public official that there would be any quid pro quo. Instead, prosecutors were permitted to argue that Ring could be convicted upon a showing that he intended to "to influence and reward official acts." And at the government's request, the court instructed the jury that it was "not necessary for the government to prove that . . . the public official actually accepted the thing of value or agreed to perform the official act."

The jury in Ring clearly had difficulty discerning and applying the law. During deliberations, it asked the judge for additional clarification of the line between "legal and illegal gifts," but the court refused any additional instruction. A short time later, the jury returned with a guilty verdict.

The Ring jury -- and the American public -- may have found his wining and dining Congressional staffers in order to obtain access distasteful, but absent a quid pro quo agreement, it was not honest services fraud. The Ring decision represents a disturbing trend toward "overcriminalization," in which regulatory transgressions and other conduct is transformed into criminal offenses by legislators eager to prove they are "tough on crime," abetted by courts that fail to enforce necessary limits on prosecutors' efforts to expand the scope of "criminal" conduct. Kevin Ring's appeal will be heard in the spring. If allowed to stand, the Ring decision would make potential criminal defendants of the millions of men and women who provide current and potential customers with "things of value" in order to make them "more receptive" or to "build a reservoir of goodwill." That prospect should send shivers down the collective spine of American business.

Corporate management decisions should be left to business leaders, not prosecutors.

James R. Copland

[Originally published in the, 8-26-09.]

On Aug. 6, 2009, the Securities and Exchange Commission announced that it had reached a $15 million civil settlement with former AIG chief executive Maurice "Hank" Greenberg. This story has gotten far less attention than it deserves, given that it occurred against the backdrop of the collapse of AIG, which is now mostly owned by the federal government. Both the SEC-Greenberg settlement and AIG collapse help us to understand, in retrospect, the real costs of the war that former New York attorney general Eliot Spitzer waged against the insurance giant and its leader.

The SEC's action was not a roar but a whimper: The agency not only failed to make a criminal case against Greenberg but also failed to charge him with civil fraud. Instead, Greenberg was merely accused of being a "control person," ultimately responsible for his company's alleged accounting improprieties (allegations that Greenberg, in reaching the settlement, did not admit).

Still, the SEC's complaint, if credited, is serious enough. AIG was accused of inflating earnings and insurance loss reserves while obscuring actual underwriting losses. The allegations that appear front and center in the SEC's complaint—alleged sham transactions entered into between AIG and General Re, a reinsurer owned by Warren Buffett's Berkshire Hathaway—are those, which Spitzer focused on when going after Greenberg.

But even if Spitzer ultimately zeroed in on a corporate impropriety—he had previously looked into alleged bid-rigging and even Greenberg's 1970s-era charitable endeavors—his obsessive pursuit of AIG's captain, in hindsight, looks foolish indeed. The General Re transactions upon which Spitzer and the SEC focused may have been fraudulent, but their total alleged size—$500 million—pales in comparison to AIG's $99 billion in 2008 losses and the consequent $182.5 billion taxpayer-funded bailout of the company, designed to keep the financial system afloat. And while the transactions at the heart of the SEC's complaint may have resulted in material accounting misstatements, they are immaterial to the company's costly implosion: They occurred from 2000 to 2002 and are wholly unconnected to AIG's massive bet in the credit default markets that precipitated its ultimate collapse.

The chain of events that led to its collapse followed swiftly in Spitzer's wake. Shortly after Spitzer issued subpoenas against AIG in February 2005 related to the General Re transactions, the market began discounting the company's debt. The next month, AIG's board, under intense pressure from Spitzer, ousted Greenberg from the company; the very next day, the Fitch rating agency downgraded AIG's credit rating from AAA to AA, and Standard & Poor's followed suit later that month. The credit downgrades dramatically increased the potential collateral calls that AIG faced on its credit-derivative products.

More critically, as control of AIG shifted hands, vital risk-oversight practices waned. Greenberg's successor, Martin Sullivan, admits that he had "focused on other priorities including repairing AIG's standing with customers and regulators [and] cooperating with several government probes." AIG's financial products group, which sold credit-default derivatives and other financial instruments, wrote as many credit-default swaps over the nine-month period after Greenberg departed as it had in the previous seven years combined.

It is impossible to know whether the large derivative position amassed by AIG would have been accumulated under Greenberg's watch, though Greenberg did have a long track record of closely monitoring the financial products group's risk. David Havens, a credit analyst with UBS, insists, "Had Hank Greenberg still been running the company, I think it's pretty safe to say the situation wouldn't even be close to what is now."

Thus, AIG's downfall powerfully demonstrates the problem with turning over the regulation of corporate governance to criminal prosecutors with political agendas. The SEC's civil-enforcement powers, in addition to private civil actions at the state and federal levels, are more than sufficient to police accounting shenanigans such as those underlying the agency's settlement with Greenberg. (The power of private civil actions, themselves often abused, was exemplified one week after the SEC settlement, when Greenberg and other executives announced a $115 million settlement with class-action plaintiffs.)

Clearly, on occasion, individual business leaders' malfeasance warrants criminal prosecution. But corporate management decisions should be left to business leaders, not prosecutors who cannot understand the businesses they are investigating.

Unfortunately, the government's vast powers in the criminal arena enable prosecutors to coerce corporate boards to do their bidding, and far too often, prosecutors succumb to this temptation. Such abuses extend beyond Spitzer's crusades; federal prosecutors' criminal powers over accounting practices were expanded radically in the Sarbanes-Oxley Act of 2002, and U.S. attorneys regularly use "deferred prosecution agreements" to control corporations in the government's cross hairs. State and federal legislators should rein in such abuses, before we get another AIG.

James R. Copland is the director of the Center for Legal Policy at the Manhattan Institute.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.