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Corporate Fraud IssuesII

Interview with United States Attorney Jam es B. Com ey Regarding the Department of Justice's Policy on Requesting Corporations under CriminalInvestigation to Waive the Attorney Client Privilege and Work ProductProtection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Revised Principles of Federal Prosecutions of Business Organizations: AnOverview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

By Sean R. Berry

The Commodity Futures Trading Comm ission's (CFTC) Assault on Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

By Daniel A. Nathan

Expert Testimony in Criminal Securities Cases . . . . . . . . . . . . . . . . . . . . . 16By Bruce M. Bettigole

Corporate Crime Prevention Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23By David M. Nissman

Professional Responsibility Issues in Corporate Fraud Matters . . . . . . . . 29By Claudia J. Flynn and Rim a Sirota

The FBI Response to Corporate Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32By Michael Degnan

Introductory Letters and First Year Highlights of the Corporate FraudTask Force . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

'Zero Tolerance' for Corporate Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47By Deputy Attorney General Larry D. ThompsonReprinted with permission from Wall Street Journal

New York No Longer Has Dibs on Securities Fraud . . . . . . . . . . . . . . . . . 49By Greg FerrellReprinted with permission from USA Today

November 2003Volume 51Number 6

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In This Issue

NOVEMBER 2003 UNITED STATES ATTORNEYS ' BUL LET IN 1

Interview with United States AttorneyJames B. Comey RegardingDepartment of Justice's Policy onRequesting Corporations underCriminal Investigation to Waive theAttorney Client Privilege and WorkProduct Protection

Q: Mr. Comey, the white collar defense bar isagitated about requests to corporations undercriminal investigation to waive the attorneyclient privilege and work product protection.Can you explain DOJ's policy?

A: As you know, the Principles of FederalProsecution of Business Organizations governthis issue by providing guidance toprosecutors making the very importantdecision of whether to criminally charge acorporation. The Principles set forth manyfactors to consider, one of which is whetherand to what extent the corporation cooperatedwith the Government's investigation. Inevaluating cooperation, the Principles tellprosecutors that they can consider whether thecorporation turned over any internalinvestigation it may have conducted, andwaived privileges.

In my view, for a corporation to get credit forcooperation, it must help the Governmentcatch the crooks. Sometimes a corporation canprovide cooperation without waiving anyprivileges. Sometimes, in order to fullycooperate and disclose all the facts, acorporation will have to make some waiverbecause it has gathered the facts throughprivileged interviews and the protected workproduct of counsel.

Q. What exactly are prosecutors looking forwhen they ask a corporation to waiveprivileges?

A: Prosecutors are generally seeking the facts:what happened, who did, how they did it.Although the facts gathered by an attorney

providing advice to a corporation may becovered by both the attorney client privilegeand work product doctrine (Upjohn v.United States, 449 U.S. 383 (1981)),prosecutors are not generally seeking legaladvice or opinion work product; they are justseeking the facts, including factual attorneywork product. Of course, disclosure ofinterview notes or the facts contained in thenotes reflects the questions asked by theattorney, which may result from priorresearch, as well as the attorney's focus duringthe interview. The disclosure, however,involves a minimal intrusion on the privilege,and may be necessary if the corporationchooses to earn leniency through cooperation.

Q. Don't you sometimes ask the corporation toprovide information that is classic attorneyclient privilege, i.e. counsel's advice to thecorporation?

A: Yes, but rarely. For example, where thecorporation is claiming it engaged in theconduct in good-faith reliance on advice ofcounsel, such disclosure may be requested.Or, where employees may have disregardedadvice of counsel that a particular course ofconduct would violate the law, or be ofquestionable legality, successful prosecutionof those employees may require Governmentaccess to that advice of counsel, and theinformation would also be highly relevant tomaking the charging decision on thecorporation.

Q: What about the defense bar complaint thatDOJ requires waivers?

2 UNITED STATES ATTORNEYS' BUL LET IN NOVEMBER 2003

A: The Principles do not require waiver, and donot even require cooperation. Rather, allrelevant factors need to be assessed in makinga charging decision. Moreover, if acorporation that chooses to cooperate can doso fully without waiving any privileges, that isfine. Waiver is not required as a measure ofcooperation.

For example, assume a corporation comes tous to report that they have discovered a billiondollar accounting error. Their lawyers haveconducted an internal investigation and thecorporation has learned exactly whathappened. Further assume that when theymeet with us, they explain that they do notwish to waive privileges, but will immediatelyprovide a briefing on what they have learnedand will bring in all the witnesses thegovernment will need to figure out exactlywhat happened. If the corporation does that,we would likely consider that to becooperation worthy of earning credit in thecharging decision (as well as under theSentencing Guidelines), even though therewas no waiver, because the corporation timelytold us what it knows about what happened,who did it, and how it was done. (Of course,in our experience, many corporations chooseto go farther in order to demonstrate theircommitment to cooperation by voluntarilywaiving privileges and forging a much closerrelationship with Government investigators inorder to uncover wrongdoing.)

On the other hand, if critical witnesses won'tconsent to interviews and, therefore, thegovernment cannot fully reconstruct thecrime, or gather sufficient evidence toprosecute those who are culpable, theGovernment may turn to the corporation andseek the information imparted when thoseparticular employees were interviewed. Thecorporation will then have to decide whetherto waive its privileges. If it does not, and theinvestigation is stymied, or certain high levelofficials have to be immunized and go free,the Government will probably not view this ascooperation in evaluating charging decisionfactors.

Q: Does that mean that if a corporation does notwaive or fully cooperate it will be indicted?

A: Absolutely not. A prosecutor must consider awide range of factors in making a chargingdecision. There is no litmus test. For example,in situations where all the other factorsmilitate against charging, failure to cooperateand/or waive should certainly not lead to

filing charges. Looking at the other extreme,all the cooperation and waivers in the worldmay not obviate the need to charge acorporation that has engaged in very seriousmisconduct, involving high levelmanagement, over a long period of time. So,cooperation will not guaranteenon-prosecution; and cooperation and waiverare not pre-conditions for a decision not toprosecute.

Q: But what about the repeated complaints by thedefense bar that prosecutors routinely ask forwaiver?

A: I have heard the complaints, but I don't seeevidence of such a widespread practice. Ifdefense counsel mean that prosecutorsroutinely ask corporations to cooperate and tofurnish the Government with all theinformation known to them about the criminalactivity, I certainly hope that is going on.Corporations are unique entities that enjoymany privileges. The Department expectsthem to conduct their affairs in a scrupulouslyhonest fashion and maintain effectivecompliance programs that deter and detect anymisconduct. When misconduct is discovered,the Department expects corporations toself-report to law enforcement, including anyregulators, to investigate the misconduct, todiscipline any wrongdoers, and to cooperatefully with government investigations.Cooperation doesn't just mean complyingwith subpoenas. It means–and I hate to soundlike a broken record–telling the Governmentwhat the corporation knows about whathappened, who did it, and how they did it. Inshort, we expect cooperating corporations tohelp us catch the bad guys.

If a corporation can do that without waiver,prosecutors should give them the opportunityto do that. If the questions are fully answeredwithout a waiver, prosecutors should considerthat to be meaningful cooperation inevaluating all factors in making the chargingdecision. If a corporation wishes to go fartherand share work product and privilegedmaterials in order to enhance theGovernment's investigation, so much thebetter. Whether a corporation's failure tocooperate at all, or failure to waive ifnecessary to answer those questions, willresult in a charge, is a separate issue that canonly be answered by evaluating all the factors.

Q: What do you think about the defense bar'scontention that waivers will interfere withtheir ability to investigate the wrongdoing


because employees won't agree to beinterviewed if they know the information theyprovide or their "statement" is likely to beturned over to the Government.

A: I don't agree, and we have not seen thathappen. Experienced attorneys routinelyadvise an employee that the interview iscovered only by the corporation's attorneyclient privilege and that the corporation coulddecide to waive it. Indeed, many corporationshave regulatory obligations to makedisclosure of information learned in suchinterviews. A corporation also has the abilityto require an employee to cooperate with itscounsel on pain of dismissal. On manyoccasions, employees who have stolen fromcorporations willingly confess whenconfronted by counsel, even though theyrealize that the consequences will likely beloss of employment, and possible referral tothe authorities. To be sure, employees whohave engaged in criminal activity may declineto be interviewed. But the fear that theinterview might be disclosed to theGovernment (as opposed to getting theemployee in trouble with the corporation) haslittle impact. In any event, that possibilitydoes not change the fact that, in order to fullycooperate, a corporation has to help theGovernment solve the crime.

Corporations self-report and waive theprivilege all the time without being requestedto do so by the Government. Whencorporations are victimized by employees,they conduct an internal investigation andfrequently decide to voluntarily furnish theevidence to the authorities and seekprosecution. There is no parade of horriblesconjured up by the defense bar when, on theirown initiative, they waive the attorney clientprivilege or work product protection.

Q: What do you think about the defensecontention that requests for waiver willdiscourage corporations from conductinginternal investigations?

A: We have been actively investigating andprosecuting corporations for decades, andseeking corporate cooperation throughout thattime period. We have seen no evidence at allthat corporations refrain from conductinginternal investigations because, in order toobtain leniency for cooperating, they might beasked to waive a privilege. Many corporationshave regulatory obligations to investigate andfind out the facts. In some instances there mayalso be a fiduciary obligation to investigate. If

the corporation is under criminalinvestigation, its attorneys need to uncoverand learn the facts in order to adequatelyrepresent the corporation, as they will alsohave to do, given the likelihood of relatedcivil litigation. In addition, one mustremember that waiver of the privilege isvoluntary and may only be necessary if thecorporation chooses to cooperate in order toobtain leniency from the Government and/orthe Court. In short, I have a hard timeimagining that a corporation would refrainfrom conducting an internal investigationbecause of some fear that they might wish toshare the results of it with the government.

There are also those who contend that the"requirement"–and there is none–thatcorporations waive the privilege, willdiscourage implementation of complianceprograms, and aggressive efforts to deter anddetect fraud. I cannot believe that acorporation will not seek to prevent criminalactivity–for which it will be liable–because, ifit does occur, and it is discovered by theGovernment, the corporation might seek towaive the privilege to obtain leniency fromthe Government or the Court.

Q: Doesn't the corporation's relationship of trustwith its employees sour if the employeesunderstand that the corporation will reportmisconduct to the Government, and won't thatalso undermine the self-reporting theGovernment is trying to encourage?

A: A corporation must explain to its employeesthe premium it puts on obtaining fullinformation about misconduct of any kind andthat reporting wrongdoing to the authorities,including the regulators and whereappropriate criminal investigators, is a goodthing to do, and is part and parcel of goodcorporate citizenship. The message has to besent that disclosure of misconduct will berewarded, and failure to disclose will bepunished. Employees who have only mademistakes will understand; employees whohave information about others will alsounderstand, especially when the corporationprotects them from retaliation; employeeswho have committed crimes, have no trust toundermine.

Q: Doesn't waiver of the privilege allow theGovernment to piggy-back on theinvestigation conducted by the corporation?

A: Yes, and there is nothing wrong with that.This is about the public's interest in

4 UNITED STATES ATTORNEYS' BUL LET IN NOVEMBER 2003

uncovering corporate crime in a timelyfashion, not only to prosecute the wrongdoers,but also to minimize additional losses andmaximize restitution. Some internalinvestigations cost millions of dollars andanalyze hundreds of thousands of documents.Federal prosecutors don't have funds for that,and would be unable to replicate that work.They can, however, work with a report ofsuch an internal effort in order to conduct athorough and complete Governmentinvestigation. Ultimately, however, we goback again to the core issue, which is whethera corporation wants to earn leniency in thecharging decision and under the Guidelines. Ifit does, then it will have to figure out a way totell the Government what is knows about themisconduct and to help us catch thewrongdoers.

No corporation can be forced to cooperate.But isn't cooperation what good corporatecitizenship is all about? If a corporationprefers that the Government not find out thetrue facts, or take a longer time to gather thesame facts the corporation has gathered, thenit won't provide full and timely disclosure.How that will affect the charging decision,which is based on numerous factors, will varyin every case. If the corporation is charged, itwill obviously have a negative effect on theGuidelines calculation.

Q: Doesn't waiver of the privilege causecollateral problems with civil litigants whowill argue that the waiver entitles them to thesame information as the Government?

A: While there is varying case law in this area, itis true that courts have held that waiver to theGovernment during a criminal investigationcan result in a waiver with respect to civillitigants. There is pending litigation about theenforceability of Government agreements tokeep privileged information confidential andthere have also been legislative proposals toprotect information disclosed via waivers tothe SEC. So the landscape in this area may bechanging.

B: What if a corporation enters into a jointdefense agreement claiming it is the only wayemployees will speak to it, and so thecorporation can't waive the privilege even if itwould otherwise want to?

A: It is hard for me to understand why acorporation would ever enter into a jointdefense agreement because doing so mayprevent it from making disclosures it either

must make if it is in a regulated industry, ormay wish to make to a prosecutor.

In any event, how a joint defense agreementwill affect a corporation's ability to cooperatewill vary in every case. If the joint defenseagreement puts the corporation in a positionwhere it is unable to make full disclosureabout the criminal activity, then no credit forcooperation will be factored into theGovernment's charging decision, and it willget no credit for that cooperation under theguidelines. On the other hand, a corporationmay learn only some things pursuant to a jointdefense agreement and still be able to make afull disclosure to the Government of allrelevant information in a sufficient manner toqualify for cooperation credit.

Q: Isn't the Government's desire to obtaininterview notes of employees just an end runaround the Fifth Amendment? You know theemployee has to talk to the corporation onpain of dismissal, and you expect thecorporation to fire employees who won'tspeak, so you indirectly force employees torelinquish their Fifth Amendment rights byputting them between a rock and a hard place.Is that fair?

A: If you are suggesting that a corporation shouldnot have a policy of firing an employee whowon't consent to be interviewed by thecorporation about possible misconduct, I'mnot sure that's a corporation acting in itsshareholders' interests. Should theGovernment request the results of interviewsconducted under pain of dismissal? Yes, ofcourse. The Government needs to find outwhat happened. And interviews withemployees are usually the source of thecorporation's knowledge. It is obviously up tothe corporation to decide whether it wants tocooperate or supply the details of theinterviews.

Q: Don't you ask corporations to fire employeeswho refuse to be interviewed by theGovernment, or who formally invoke the FifthAmendment?

A: Certainly with respect to the FifthAmendment, the Government is not permittedto disclose the invocation of the Fifth in theGrand Jury and should not be discussing thattopic at all with anyone other than thewitness's counsel.

Moreover, the Government does not askcorporations to fire employees who refuse tobe interviewed by the Government. What the


Government focuses on in evaluatingcorporate compliance programs is whether acorporation properly disciplines employeeswho have engaged in or facilitated seriousmisconduct, or who have committed crimes. Ifa company continues to employ an individualwhen it has evidence in its possession thatestablishes criminal activity, the Governmentwill likely view that as a serious flaw in thecorporation's compliance program, andreflective of a problematic corporate culture.

Of course, if a corporation determines in goodfaith that an employee did not commit a crimeor engage in serious misconduct, in evaluatingthe corporation's conduct and culture wewould not "penalize" the corporation for notfiring such an employee even where theemployee declined to submit to a Governmentinterview.

Q: Mr. Comey, overall, how do you think thePrinciples are working?

A: I think they work very well. They have servedthe function of educating all DOJ attorneysabout the need to give careful consideration tocharging corporations, whose conduct cancause immense harm, and whose prosecutioncan result in enormous benefits, not only inrestitution to victims, but in being a catalystfor tremendous changes for the good in manyindustries. They also instruct prosecutors tocarefully consider a variety of criticalmitigating factors, such as cooperation,collateral damage, and alternative remedies.In short, they provide a balanced frameworkfor DOJ attorneys to make difficult decisions.In the process, they also greatly assist privatecounsel and corporations by spelling out thekinds of things that matter to prosecutors.�

Mr. Comey wishes to acknowledge the invaluableassistance of his Chief Counsel, Shirah Neiman,in the preparation of this Q & A.a

Revised Principles of FederalProsecutions of BusinessOrganizations: An Overview Sean R. BerryAssistant United States AttorneyNorthern District of Iowa

I. Introduction

The decision whether to charge a businessorganization with a criminal offense can be one ofthe most complex charging decisions that federalprosecutors face. Recognizing this, on June 16,1999, then-Deputy Attorney General Eric Holderissued a memorandum entitled FederalProsecution of Corporations (the Holder memo),Memorandum from Deputy Attorney General EricHolder to the United States Attorneys' Offices(June 16, 1999) (on file with the Department ofJustice). This nonbinding memorandum was basedon the Principles of Federal Prosecution in theUnited States Attorney's Manual, § 9-27.000, andcontained a number of general principles, withaccompanying commentary, designed to assistfederal prosecutors in evaluating corporatecharging decisions.

Now more than ever, federal prosecutors arefaced with difficult charging decisions involvingcorporate subjects and targets. As a result of theDepartment of Justice's (the Department) everincreasing number of corporate criminalinvestigations, on January 20, 2003, DeputyAttorney General Larry D. Thompson issued anew memorandum concerning corporate chargingdecisions. Federal Prosecutions of BusinessOrganizations (the Thompson memo),Memorandum from Deputy Attorney General,Larry D. Thompson to the United StatesAttorneys' Offices (January 20, 2003) (on filewith the Department), available atwww.usdoj.gov/usao/eousa/foia_reading_room/usam/title9/crm00162.htm. This new memo drewon the combined efforts of the Department'sCorporate Fraud Task Force and the AttorneyGeneral's Advisory Committee, and replaced theHolder memo of June 1999. While retaining thegeneral principles and commentary enunciated inthe Holder memo, the Thompson memo increasesfederal prosecutors' emphasis on, and scrutiny of,the authenticity of a corporation's professedcooperation. It addresses more specifically the

6 UNITED STATES ATTORNEYS ' BUL LET IN NOVEMBER 2003

efficacy of the corporate governance mechanismsin place in order to ensure that these measures aretruly effective, rather than mere paper complianceprograms.

This article will provide an overview of theThompson memo and will highlight the memo'ssignificant additions to the Holder memo.

II. The principles of corporate chargingdecisions

The Thompson memo begins with this generalprinciple of corporate criminal responsibility:

Corporations should not be treated lenientlybecause of their artificial nature nor shouldthey be subject to harsher treatment. Vigorousenforcement of the criminal laws againstcorporate wrongdoers, where appropriate,results in great benefits for law enforcementand the public, particularly in the area ofwhite collar crime. Indicting corporations forwrongdoing enables the government toaddress and be a force for positive change ofcorporate culture, alter corporate behavior,and prevent, discover, and punish white collarcrime.

Memorandum from Deputy Attorney General,Larry D. Thompson to the United StatesAttorneys' Offices, supra.

The Thompson memo explains that, indeciding whether to seek charges against acorporation, prosecutors generally should firstapply the same factors used in determiningwhether to seek charges against natural persons.Id. at § II.A. Thus, the prosecutor should weigh allof the factors normally considered in the soundexercise of prosecutorial judgment: thesufficiency of the evidence; the likelihood ofsuccess at trial; the probable deterrent,rehabilitative, and other consequences ofconviction; and the adequacy of non-criminalapproaches. See USAM §§ 9-27.220-9.27.320.

However, due to the nature of the corporate"person," some additional factors must beconsidered when conducting an investigation,determining whether to bring charges, andnegotiating plea agreements. As set forth inFederal Prosecutions of Business Organizations,these factors are:

• the nature and seriousness of theoffense – including the risk of harm to thepublic, and any applicable policies andpriorities governing the prosecution ofcorporations for particular categories ofcrime;

• the pervasiveness of wrongdoing withinthe corporation – including thecomplicity in, or condonation of, thewrongdoing by corporate management;

• the corporation's history of similarconduct – including prior criminal, civil,and regulatory enforcement actionsagainst it;

• the corporation's timely and voluntarydisclosure of wrongdoing and itswillingness to cooperate in theinvestigation of its agents – including, ifnecessary, the waiver of the corporateattorney-client and work productprotections;

• the existence and adequacy of thecorporation's compliance program ;

• the corporation's remedial actions –including any efforts to implement aneffective corporate compliance programor to improve an existing one, to replaceresponsible management, to discipline orterminate wrongdoers, to pay restitution,and to cooperate with the relevantgovernment agencies;

• collateral consequences – includingdisproportionate harm to shareholders,pension holders, and employees notproven personally culpable, and theimpact on the public arising from theprosecution;

• the adequacy of the prosecution ofindividuals responsible for thecorporation's malfeasance; and

• the adequacy of non-criminal remediessuch as civil or regulatory enforcementactions.

Id. at § II.A. (citations omitted).

As with the factors relevant to charging naturalpersons, the Thompson memo makes clear thatthese factors are intended to provide guidancerather than to mandate a particular result. Id. at §II.B. Indeed,

[t]hese factors are intended to be illustrativeof those that should be considered and not acomplete or exhaustive list. Some or all ofthese factors may or may not apply to specificcases, and in some cases one factor mayoverride all others. For example, the natureand seriousness of the offense may be such asto warrant prosecution regardless of the otherfactors.


Id.

While some of the above factors would appearto be self-explanatory, Federal Prosecutions ofBusiness Organizations provides additionalguidance and discussion as to these factors insubsequent sections, and prosecutors involved incorporate criminal investigations should carefullyreview these sections prior to making theircharging decisions.

III. Scrutiny of corporate cooperation effortsand voluntary disclosure of wrongdoing

Perhaps the most significant additioncontained in the Thompson memo concerns theprosecutor's evaluation of corporate cooperationand voluntary disclosure of information andwrongdoing.

In determining whether to charge acorporation, that corporation's timely andvoluntary disclosure of wrongdoing and itswillingness to cooperate with thegovernment's investigation may be relevantfactors. In gauging the extent of thecorporation's cooperation, the prosecutor mayconsider the corporation's willingness toidentify the culprits within the corporation,including senior executives, to makewitnesses available, to disclose the completeresults of its internal investigation, and towaive attorney-client and work productprotection.

Id. at § VI.A.

The Thompson memo begins its analysis ofcorporate cooperation by discussing two factorsfrom the Holder memo, and then it addresses anew factor to be considered by prosecutorsevaluating a corporation's cooperation in acriminal investigation.

First, in assessing the adequacy of acorporation's cooperation, the prosecutor mayweigh the completeness of the corporation'sdisclosure including, if necessary, a waiver of theattorney-client and work product protections, bothwith respect to its internal investigation and itscommunications between specific officers,directors, and employees and counsel. Suchwaivers permit the government to obtainstatements of possible witnesses, subjects, andtargets, without having to negotiate individualcooperation or immunity agreements. In addition,they are often critical in enabling the governmentto evaluate the completeness of a corporation'svoluntary disclosure and cooperation. Prosecutorsmay, therefore, request a waiver in appropriatecircumstances. Id. at § VI.B.

A second factor that may be weighed by theprosecutor in making his or her charging decisionis whether the corporation appears to beprotecting its culpable employees and agents. Forexample, a corporation's promise to supportculpable employees, financially or otherwise, maybe considered by the prosecutor in weighing theextent and value of a corporation's cooperation.Id.

The new factor to be considered whenassessing the authenticity of a corporation'scooperation during an investigation "is whetherthe corporation, while purporting to cooperate, hasengaged in conduct that impedes the investigation(whether or not rising to the level of criminalobstruction)." Id. Examples of such obstreperousconduct include:

• overly broad assertions of corporaterepresentation of employees or formeremployees;

• inappropriate directions to employees ortheir counsel, such as directions not tovolunteer information or to declineinterviews;

• making presentations or submissions thatcontain misleading assertions oromissions;

• incomplete or delayed production ofrecords; and

• failure to promptly disclose illegalconduct known to the corporation.

Id.

By adding this third factor, the Thompsonmemo increases the emphasis on, and scrutiny of,a corporation's cooperation. "Too often businessorganizations, while purporting to cooperate witha Department investigation, in fact take steps toimpede the quick and effective exposure of thecomplete scope of wrongdoing underinvestigation." Cover Memorandum from DeputyAttorney General Larry D. Thompson toUnited States Attorneys' Offices, supra . This newfactor makes clear that such conduct should weighin favor of a corporate prosecution. Id.

IV. Detailed evaluation of existing corporatecompliance programs

The second significant addition in theThompson memo concerns the prosecutor'sevaluation of the adequacy of a corporation'sexisting compliance program. Complianceprograms are established by corporatemanagement to prevent and to detect misconduct,and to ensure that corporate activities are


conducted in accordance with all applicablecriminal and civil laws, regulations, and rules.Federal Prosecutions of Business Organizationsat § VII.A.

Like the Holder memo before it, theThompson memo recognizes that no complianceprogram can ever prevent all criminal activity bycorporate employees. Critical factors in evaluatingany compliance program are whether the programis adequately designed for maximum effectivenessin preventing and detecting wrongdoing byemployees, and whether corporate management isenforcing the program or is tacitly encouraging orpressuring employees to engage in misconduct toachieve business objectives. Id. at § VII.B.

Also like the Holder memo, the Thompsonmemo notes that the Department has no formalguidelines for corporate compliance programs.The Thompson memo, however, includes a newframework to assist prosecutors in evaluatingexisting compliance programs. "Prosecutors mayconsider whether the corporation has establishedcorporate governance mechanisms that caneffectively detect and prevent misconduct." Id.For example, prosecutors should considerwhether:

• the corporation's directors exerciseindependent review over proposedcorporate actions rather thanunquestioningly ratifying officers'recommendations;

• the directors are provided withinformation sufficient to enable theexercise of independent judgment;

• internal audit functions are conducted at alevel sufficient to ensure theirindependence and accuracy;

• the directors have established aninformation and reporting system in theorganization reasonably designed toprovide management and the board ofdirectors with timely and accurateinformation sufficient to allow them toreach an informed decision regarding theorganization's compliance with the law.

Id. By considering these factors, prosecutors maybetter determine whether a corporation'scompliance program is merely a "paper"compliance program or whether it is trulydesigned and implemented in an effective mannerto detect and prevent misconduct. See CoverMemorandum from Deputy Attorney GeneralThompson, to United States Attorneys' offices,supra .

V. Attorney-client and work productprotection waivers

One significant "non-revision" of the Holdermemo is noteworthy. Amidst controversy, nochange in the use of waivers of the attorney-clientand work product protections has been included inthe Thompson memo.

As in the Holder memo, prosecutors maycertainly take into account a corporation'swillingness to waive its attorney-client and workproduct privileges in evaluating the corporation'scooperation. See Federal Prosecutions of BusinessOrganizations at §§ II.A(4) & VI(A & B). Aprosecutor may also request a waiver whennecessary to enable him or her: (1) to determinethe completeness of the corporation's disclosure;(2) to evaluate the accuracy of that disclosure; (3)to identify potential targets and witnesses; and(4) to obtain evidence to use in its investigationand any resulting prosecution. Id. at § VI.B. Anyrequested waiver, however, "should ordinarily belimited to the factual internal investigation andany contemporaneous advice given to thecorporation concerning the conduct at issue.Except in unusual circumstances, prosecutorsshould not seek a waiver with respect tocommunications and work product related toadvice concerning the government's criminalinvestigation." Id. at § VI.B n.3.

As in the Holder memo, the Department stilldoes not, as a matter of course, consider waiver ofa corporation's attorney-client and work productprotections an absolute requirement incooperating with the government's investigation.Indeed the principles contained in FederalProsecutions of Business Organizations do notrequire, or even encourage, a prosecutor to seek awaiver in all circumstances, and they make itperfectly clear that such waivers are not absoluterequirements for a corporation's cooperation. Id. at§ VI.B.

VI. Conclusion

Corporations can be, and often are, validtargets of criminal investigations.

Vigorous enforcement of the criminal lawsagainst corporate wrongdoers, whereappropriate, results in great benefits for lawenforcement and the public, particularly in thearea of white collar crime. Indictingcorporations for wrongdoing enables thegovernment to address and be a force forpositive change of corporate culture, altercorporate behavior, and prevent, discover, andpunish white collar crime.


Federal Prosecutions of Business Organizationsat § I.A. The general principles and commentaryin Federal Prosecutions of BusinessOrganizations provide a framework within whichto make the difficult charging decisions that ariseduring the investigations of corporate subjects andtargets.�

ABOUT THE AUTHOR

�Sean R. Berry is an Assistant United StatesAttorney in the Northern District of Iowa wherehe is responsible for the investigation andprosecution of white collar and computer crimes.Mr. Berry was Chief of the Major Frauds Sectionin the Central District of California prior tojoining the Northern District of Iowa'sUnited States Attorney's Office.a

The Commodity Futures TradingCommission's (CFTC) Assault onFraudDaniel A. NathanChief, Office of Cooperative EnforcementDivision of EnforcementCommodity Futures Trading Commission

The bad news is that commodities fraud istaking its place on the corporate and consumerfraud landscape alongside financial fraud, primebank schemes, front-running, and otherunfortunate by-products of the modern financialera. The good news is that the Commodity FuturesTrading Commission (CFTC) is up to the job ofpursuing this fraud, and has been pursuing it inclose cooperation with the Department of Justiceand U.S. Attorneys, among others.

As a result of increasing recognition byregulators of the prevalence of commodities fraud,and the CFTC's aggressive enforcement programattacking that fraud, the CFTC's Division ofEnforcement has gained recognition and respectfor its important role in financial regulation. Thesignificance of the CFTC's regulatory regime inthe broader worlds of corporate fraud andsophisticated white collar schemes is evidencedby the CFTC's membership in the President'sWorking Group on Financial Markets and thePresident's Corporate Fraud Task Force. Alwaysactive in pursuing matters within its jurisdiction,in recent years the Division of Enforcement(Division) has participated in joint fraudinvestigations and enforcement actions with otherfederal and state civil and criminal agencies, andpresented training in commodity violations,

including energy-related and foreign currencytrading violations, to other regulators.

From a public protection standpoint, this is allto the good. Greater awareness by the lawenforcement community of the CFTC'sjurisdiction, and the Division's ability toaggressively prosecute commodities fraud, meansthat more of this fraud will be addressed by theCFTC, on its own or together with criminalauthorities. Moreover, as more regulatorsnationwide pursue criminal and civil commoditiesfraud cases on the federal and state level,members of the public will learn to recognize themany common forms this fraud takes and bebetter able to protect themselves against it.

I. The CFTC's jurisdiction

A. What commodities fraud looks like

Consider these increasingly commonscenarios:

• An individual invests funds in a pool, or selfdescribed "hedge fund," only to find that themoney and the promoter have disappeared.

• An individual receives an unsolicited "coldcall" or spam e-mail, or sees an ad ontelevision, promoting investments in heatingoil options based on the brokerage firm'spurported track record. The ad encourages thepublic to take advantage of the approachingwinter and the inevitable rise in heating oilprices.

• An investor receives an aggressive solicitationfor the purchase of a specified foreign


currency, such as the yen or euro, in order totake advantage of volatile exchange ratescaused by an uncertain global economy.

• An energy company reports false informationabout the price and/or the volume of itstransactions in natural gas or crude oil.

These are all common forms of commodityfutures and options fraud–which are not limited tofraudulent trading practices occurring in the hectictrading pits as depicted by Eddie Murphy and DanAckroyd in TRADING PLACES (Paramount Pictures1983). These varieties of fraud are all within theCFTC's enforcement jurisdiction, and have beenthe subject of numerous CFTC investigations andenforcement actions over the years. This articlewill attempt to explain how these violations fitinto the CFTC's statutory scheme.

As with virtually all financial investmentvehicles, investing in commodity futures andoptions is subject to fraud. It is difficult toquantify how prevalent such fraud is, or tocompare the numbers to those of securities orcorporate fraud. As with much securities fraud,the superficial indicia of commodity fraud,including false representations and omissions,artificial prices, and illegal instruments, do notspring into existence until proven throughtypically sophisticated investigations andanalyses.

The public's frequent lack of familiarity withthe commodity futures and option markets oftenserves to obscure the very existence of theseschemes. Often, when a member of the public isdefrauded in a commodity scheme, he does notknow what hit him. A commodities scheme mayappear as an investment in a pool of funds thatmore resembles a securities investment. Theinvestment might be disguised as an interest in anactual physical commodity such as precious metalor foreign currency, whereas the economic realityis that the transaction is in a future based on thosecommodities. The "come on," that is, thesolicitation inducing the investment, might looklike mere puffery best addressed by a stateconsumer agency or the Federal TradeCommission. Consequently, customer complaintsabout such transactions might not reach theagency that most effectively and directly regulatessuch conduct–the CFTC.

B. Som e CFTC history

The CFTC originally was part of theDepartment of Agriculture. In 1974, Congressestablished the CFTC as an independent agencywith the mandate to regulate commodity futuresand option markets in the United States. In the

early days of the agency, "futures" typicallyreferred to futures on agricultural and otherphysical commodities such as corn, wheat andsoy, as well as metal and energy products. Suchtraditional futures contracts have been traded inthe United States for more than 150 years, andhave been under federal regulation since the1920s. These days, the majority of futures andoptions are based upon a wide variety of financialinstruments, including foreign currencies, U.S.and foreign government securities, stock indexes,and, most recently, futures on individual stocks.

The futures markets play an important role inthe nation's economy by providing a means forprice discovery and for offsetting price risk. TheCFTC is responsible for securing the economicutility of futures markets by, among other things,ensuring their integrity and protecting marketparticipants against manipulation, abusive tradepractices, and fraud. By investigating possibleviolations, bringing enforcement actions when itfinds violations, and working closely withcriminal authorities on the more egregiousviolations, the Division of Enforcement plays avital role in meeting these responsibilities.

As in the securities industry, fraud takes onmany forms in the futures and options industry. Itcan occur at any stage of a transaction incommodity futures and options, from the initialtrade recommendation given by a broker oradvisor to the ultimate execution of the trade onthe floor of a futures exchange. The CFTC and theindustry's self-regulatory organizations, includingthe futures and options exchanges and theNational Futures Association, oversee all stages oftransactions, and have jurisdiction and authority topolice these transactions and the registered firmsand people who commit them.

II. The Division of Enforcement investigatesand brings actions alleging violations of thecommodities laws and regulations

The CFTC's Division of Enforcement has thepowers of an independent federal agency toinvestigate possible violations of the federalcommodity laws that it enforces and, whereviolations are found, bring enforcement violationsto obtain, among other things, proscriptive andmonetary relief. These laws encompass theCommodity Exchange Act (CEA) and the Rulesand Regulations promulgated by the CFTC. Forthose prosecutors who have worked on securitiescases, it is helpful to think of the Division'sinvestigative powers and procedures as beingquite similar to those of the Securities andExchange Commission. For those new to the


agency, a general outline of the Division'sinvestigative powers follows.

The Division commences its investigationsbased upon information received from a variety ofsources. These include: members of the public,including commodity broker customers; thefinancial community, including the futures andoptions industry and self-regulatory organizations;other Commission divisions; state, federal, andinternational regulators; and the media. TheDivision, itself, identifies possible violationsthrough proactive means, by focusing on areas ofpossible fraud and applying its techniques ofmarket analysis and surveillance.

Information is obtained in investigations inone of two ways. It may be obtained on avoluntary basis through the power to examineregistrants granted by CEA § 4g(a); 7 U.S.C.§ 6g(a) (with respect to futures commissionmerchants, introducing brokers, floor brokers, andfloor traders), and § 4n(3); 7 U.S.C. § 6n(3) (withrespect to commodity trading advisors andcommodity pool operators). It may also beobtained through use of investigative subpoenas.The power to issue subpoenas is granted by theCommission to the Division through entry of anorder of investigation. 17 C.F.R. § 11.4(b).

At the conclusion of an investigation, the staffmay recommend that the Commission authorizethe Division to initiate an administrativeproceeding, which would be assigned to one ofthe Commission's administrative law judges, or acivil injunctive action in federal district court.Sanctions available in an administrativeproceeding include a cease and desist order, anorder denying, suspending, revoking or restrictinga registration, a trading prohibition, restitution,and civil monetary penalties. CEA § 6(c); 7U.S.C. § 9. In a federal court action, theCommission may obtain an injunction, as well asrestitution, civil monetary penalties, and a fullrange of equitable remedies. CEA § 6c; 7 U.S.C.§ 13a-1. The Division frequently files actions infederal court to obtain emergency relief, such as arestraining order which, as specifically authorizedby the CEA, can include an order preservingbooks and records, granting immediate access tobooks and records, freezing assets, and appointinga receiver. Section 6c(a); 15 U.S.C. §13a-1(a).

Recidivists are a problem in an industry thatrelies heavily on the integrity of its professionalsto attract customers. The Division pursues theseviolators of the orders obtained in enforcementactions. Violation of a cease and desist order canbe enforced administratively or in federal court,and violation of a civil injunction can be enforced

through a contempt proceeding in federal court.Unlike many executive branch agencies, theCFTC possesses "independent litigatingauthority," meaning that the CFTC litigates itsown enforcement actions instead of referring themto the Department of Justice (Department). TheCFTC handles federal appeals through its ownOffice of General Counsel.

Commodity-related violations can be referredto the Department as well as state prosecutors.The CEA has specific criminal sanctions makingit a felony to, among other things, steal or convertfunds received for futures transactions, manipulatethe price of commodities or commodity futures ininterstate commerce, make a false report to afutures exchange, or willfully violate anyprovision of the CEA. CEA § 9; 7 U.S.C. § 13.Criminal activity involving commodity futuresand options and other commodity-relatedinstruments can also constitute mail fraud, wirefraud, or conspiracy.

III. Comm odities fraud pursued by theDivision of Enforcement

The Division pursues fraud both in theregulated futures and options environment and inthe unregulated environment. The regulatedenvironment consists generally of thoseindividuals and firms, including exchanges,registered under the CEA and Regulations toparticipate in some way in futures or optionstransactions. The unregulated environmentpotentially includes a much broader group ofunregistered individuals and firms who offer ortrade in financial instruments that, as a legalmatter, are fu tures or options, but operate withlittle regulation in a manner that is quitesusceptible to fraud. Many of the typical factualand legal claims made in cases charging fraud inthe two environments are quite similar. Forexample, lying to a potential customer about theprofitability of a futures investment is solicitationfraud whether done in a regulated or unregulatedenvironment. This is not surprising, since many ofthe individuals who perpetrate scams in theunregulated environment started out as futuresindustry registrants, and brought with them theschemes they first developed in the regulatedenvironment. In the Division's experience therehas been a "revolving door" between the regulatedand unregulated environments for perpetrators ofcommodities fraud.

This article will focus on five areas ofcommodities fraud in which the Division has beenactive. The investigations conducted and casesfiled in these areas revealed schemes that alsowould be appropriate criminal cases in that the


fraud was egregious, often involving outrighttheft, with many victims who were elderly, ethnic,or otherwise particularly vulnerable to fraud.Fraudsters reach their targets through aggressivetelemarketing practices, dubious televisioninfomercials and radio spots, and deceptiveadvertising over the internet. In addition, theDivision has been particularly active in the lastyear investigating energy-related conduct, both onits own and in conjunction with other civil andcriminal authorities.

The CEA's general anti-fraud provision,Section 4b, makes it unlawful, among otherthings, for any person, in connection with anyorder to make, or the making of, any futurescontract for or on behalf of any other person, tocheat or defraud the other person, willfully tomake any false statement, or willfully to deceiveor attempt to deceive such other person. CEA§ 6(c); 7 U.S.C. § 9. Section 4c of the CEA, 7U.S.C. § 6c, and Regulation 33.10, 17 C.F.R.§ 33.10, apply the same fraud prohibition tocommodity options.

A. Sales solicitation fraud by introducingbrokers

To understand how an introducing broker candefraud its customers, it is necessary tounderstand its role in the transaction process. Inthe futures and options industry, the customer-broker relationship is often established with anintroducing broker who solicits and accepts ordersfor the purchase or sale of commodity futures oroptions. Introducing brokers do not, however,accept money in payment for these orders. Rather,introducing brokers forward orders to a futurescommission merchant, who also can solicit oraccept orders, and who sends the orders to thefloor of an exchange for execution.

Introducing brokers are barred by the CEA'sgeneral anti-fraud prohibitions from cheating ordefrauding a customer on whose behalf it solicitsan order. CEA § 4b; 7 U.S.C. § 6b. Theprohibition includes misrepresentations made topotential or existing customers when soliciting anew account or an order. An introducing broker,or an associated person of an introducing broker,cannot misrepresent, among other things: futureprofitability, Commodities Futures TradingComm'n v. Sidoti, 178 F.3d 1132, 36 (11th Cir.1999); the risk of futures or options trading,Clayton Brokerage Co. of St. Louis v.Commodities Futures Trading Comm'n, 794 F.2d573, 580 (11th Cir. 1986); the broker'sperformance history, In re JCC, Inc., [1992-1994Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶26,080, 1994 WL 183817, *8 (CFTC M ay 12,

1994), aff'd, JCC, Inc. v. Commodities FuturesTrading Comm'n, 63 F.3d 1557 (11th Cir. 1995);or the broker's background–in short, any fact thata reasonable investor might consider material inmaking an investment. Commodities FuturesTrading Comm'n v. R.J. Fitzgerald & Co., 310F.3d 1321, 1332 (11th Cir. 2002). TheCommission has taken numerous administrativeand civil injunctive actions against registeredintroducing brokers engaged in solicitation fraud.

A common variety of fraud by introducingbrokers involves so-called "seasonality"misrepresentations, or misrepresentations basedon well-known and expected weather patterns orevents. For example, it is illegal to tout heating oilfutures or options in the fall based on the claimthat one can profit from the increase in heating oilprices that accompany the advent of cold weather.These statements are false and misleading becausethe prices charged by the futures and optionsmarkets already factor in the trends in the weatherand, therefore, profit is only available from theoccurrence of unpredictable events or pricemovements. R.J. Fitzgerald & Co., 310 F.3d at1332 ("[A]s with the Commercial, the Seminar, inits heating oil mathematical illustration, misleadspotential customers by suggesting that historicalmovements and known and expected seasonalpatterns can be used reliably to predict profits onoptions.").

Seasonality fraud also can occur withreference to other well-known non-seasonalevents. An example is a claim that one can profitin energy futures or options based on the waragainst terrorism in the wake of September 11,2001, or on the war in Iraq. This suggests that theseller has superior knowledge to that of the typicalinvestor or professional trader. The marketsalready factor in the anticipated effect of apossible disruption in the Middle East on energysupplies.

In the last several years, the Commission hasreleased three Consumer Advisories on this issue:

• warning the public about investing based onseasonal demand and other publicinformation,http://www.cftc.gov/opa/enf98/opacaw.htm;

• warning about promises of profits fromfutures and options trading based on the tragicevents of September 11, 2001 and otherpublic information relating to the war onterrorism,http://www.cftc.gov/opa/enf01/opa4584-01.htm;


• and one in November 2002, warning aboutclaims that futures or options trading will beprofitable because of a possible war with Iraq,http://www.cftc.gov/opa/enf02/opa4724-02.htm.

B. Commodity pool fraud

In the commodity futures and optionsindustry, investment vehicles known ascommodity pools aggregate investor funds for thepurpose of trading commodity futures or optionscontracts. Commodity pools often are aninvestor's first avenue into the futures and optionsmarkets. They represent a very loose analogue toinvestment companies or mutual funds in thesecurities industry, which pool investor funds forinvestment in securities. Like those entities,commodity pools are subject to regulationsregarding registration, reporting, and record-keeping. They are managed by commodity pooloperators (CPOs), which are individuals or firmsthat solicit or accept funds, securities, or property,for the purpose of trading commodity futurescontracts or commodity options. CEA § 1a(5)("commodity pool operator" defined); 7 U.S.C.§ 1a(5).

Similar to the introducing brokers discussedabove, commodity pool operators cannotmisrepresent the profitability or risk of futures andoptions, or the pool's performance history. CEA§§ 4b, 4o; 7 U.S.C. §§ 6b, 6o; CommoditiesFutures Trading Comm'n ex rel. Kelley v.Skorupskas, 605 F. Supp. 923, 932 (E.D. Mich.1985)(CPO committed fraud by misappropriatingcustomer funds, issuing false monthly statementsto customers, and soliciting with deceitfulperformance tables). CPOs also must accuratelydescribe the anticipated use of the funds and thefees charged. On the most serious level,commodity pool operators often are guilty ofoutright theft of the funds. Many of the casesbrought by the Commission, often in coordinationwith criminal authorities, have involved "affinityfraud"–that is, commodity pool operators whoraise money from victims who have preexistingethnic, religious, or social ties to the operators.Frequently these cases are termed "Ponzischemes" because the pool operator uses the fundshe solicits from new investors to pay purportedprofits to existing investors, rather than fromtrading profits, as the investors anticipate. TheCommission has issued a Consumer Advisorieswarning about pool investment opportunities,even when offered by someone known to you.http://www.cftc.gov/opa/enf02/opa4610-02.htm.

C. Commodity trading advisor fraud

Individual retail investors also frequentlyenter the futures markets through the services ofCommodity Trading Advisors, (CTAs), which ingeneral are individuals or firms that, for pay, issueanalyses or reports concerning commodities,including the advisability of trading in commodityfutures or options. CEA § 1a(6); 7 U.S.C. § 1a(6).CTAs provide advice with varying degrees ofinvolvement in their customers' trading decisions,from giving general instructional manuals abouttrading, to managing customer accounts withauthority to place trades at their own discretion. Inbetween those extremes are services that providereal-time trading signals by fax, e-mail, ortelephone, computer programs that generatesignals based upon technical factors by tappinginto market pricing services, and instructionalseminars. As with other commodity professionals,CTAs are prohibited from fraudulent conduct,which includes misrepresentations aboutprofitability, risk, and performance history. CEA§§ 4b, 4o; 7 U.S.C. §§ 6b, 6o. The CFTC has alsofound that other types of falsehoods constitutematerial misrepresentations, such as statementsabout the background and experience of the CTA,or illusory money-back guarantees. See, e.g.,R&W Technical Services v. Commodities FuturesTrading Comm'n, 205 F.3d 165 (5th Cir. 2000).

CTAs commonly promote trading systems byuse of the internet. The low cost of operating aweb site to advertise on the Internet makes it easyto reach a worldwide audience. Many such CTAsdo not register, and often are not required toregister, with the CFTC.

The Commission's regulations single out onetype of claim about performance for specialattention, and the Commission has beenaggressive in warning the public about, andpursuing, this conduct. In soliciting customers,many CTAs will provide so-called hypotheticaltrading performance records. These are trackrecords that reflect how the advisor's tradingformula or program would have performed hadtrades actually been placed in the market, basedupon application of the formula to actual marketprices. Such performance records might havevalue to demonstrate, on a theoretical basis, thatthe CTA's formula responds to the market in away that generates profits. In extreme cases, thehypothetical performance record reflects aformula that was generated by nothing more thanperforming a regression analysis on actualhistorical data and, in effect, connecting the dots.Therefore, the resulting formula reflects nothingmore than hindsight, without the benefit of


economic analysis, a circumstance which certainlyshould not be misstated by the CTA. However, theCommission has long recognized that suchhypothetical results have very limited predictivevalue, and has enacted a Regulation thatprescribes a disclaimer that must accompany thepresentation of any hypothetical results. Thatrequired disclaimer well expresses thoselimitations:

Hypothetical or simulated performance resultshave certain inherent limitations. Unlike anactual performance record, simulated resultsdo not represent actual trading. Also, since thetrades have not been executed, the results mayhave under-or over-compensated for theimpact, if any, of certain market factors, suchas lack of liquidity. Simulated tradingprograms in general are also subject to the factthat they are designed with the benefit ofhindsight. No representations being made thatany account will, or is likely to, achieveprofits or losses similar to those shown.

Commission Regulation §4.41. The Commissionalso issued an Advisory in 2000 that warns abouttrading systems that guarantee high profits withminimal risks.http://www.cftc.gov/opa/enf00/opa4397-00.htm.Misrepresentation of hypothetical trading resultsas real constitutes fraud under the CEA andCommission Regulations. R&W TechnicalServices, 205 F.3d at 169-70.

D. Off-exchange fraud–foreign currency(forex) and precious metals

Recent years have seen a sharp rise in theincidence of foreign currency trading scams.Much foreign currency trading is legitimate andfutures and options on foreign currencies, whosevalue typically is based on the exchange ratebetween the relevant foreign currency and thedollar, trade on the Chicago Mercantile Exchange.However, various forms of foreign currencytrading have been promoted in recent years todefraud members of the public. Promoters oftenattract customers through ads in newspapers, radioor cable television promotions, attractive Internetsites, and cold calling. As with the other forms ofcommodities fraud, these ads might claim highreturns and limited risks from these investments,boast a profitable trading history, and purport tohave extensive experience and expertise in thissophisticated area. Some solicitations mightfalsely claim to give retail investors access to theso-called "interbank market." However, theinterbank market, which is the informal networkof banks and other large financial institutions thattrade an estimated $1.5 trillion in currency on a

daily basis, is effectively closed off to the retailpublic. Finally, many forex shops offeremployment to members of the retail public astraders in foreign currency. Those who take up theoffer often end up being fleeced while becomingunwitting participants in the fleecing of others.Commodities Futures Trading Comm'n v. NobleWealth Data Information Services, 90 F. Supp. 2d676, 681 (D. Md. 2000) ("Friends and family ofthe traders were thus subjected to the same claimsthat Noble Wealth used to lure traders into itsscheme.") aff'd, Commodities Futures TradingComm'n v. Baragosh, 278 F.3d 319, (4th Cir.2002).

The CEA makes it illegal to offer foreigncurrency futures or option contracts that are nottraded on a designated exchange to retailcustomers, unless the offeror is a regulatedfinancial entity, including a futures commissionmerchant or broker-dealer, or an affiliate of suchan entity. Further, for those contracts not offeredby a regulated financial entity (or by a futurescommission merchant), the CFTC has anti-fraudjurisdiction. As an initial legal hurdle, theCommission must establish that the foreigncurrency investments offered by the defendantsare futures or options within its jurisdiction.Promoters typically identify options as such,however, futures typically are presented asphysical or "spot" commodity interests. To provethat these interests actually conform to the legaldefinition of "future," the Commission has todemonstrate that they exhibit the "facilitatingcharacteristics" of a future, that is, for example,that they are capable of being settled through acash payment.

The Division of Enforcement has broughtmany actions in recent years to shut down illegalforex operations. The majority of these actionshave been emergency civil injunctive actions infederal court, in which the court granted theCommission's request to freeze assets and give theDivision immediate access to books and records.Roughly half of those actions were broughtcooperatively with a federal or state criminalauthority or another regulator. Cumulatively, thenumber of investors and the amount of money lostin the schemes that were the subjects of theseactions is enormous. The Commission has alsoissued Consumer Advisories warning aboutunregistered foreign currency schemes.http://www.cftc.gov/opa/enf98/opaforexa15.htm.

E. Energy-related violations

In the wake of the collapse of Enron, theCFTC has joined its fellow agency-members ofthe Corporate Fraud Task Force and the Enron


Task Force in investigating improper conductwithin its jurisdiction that affected the energymarkets. The possible violations being looked atare natural applications of the CFTC'senforcement jurisdiction to trading in energyproducts in the energy markets. The actions filedto date, and investigations being pursued, involve:

• manipulation, or attempted manipulation, ofthe price of natural gas, crude oil, or electricityfutures, or of the physical commodity in a mannerlikely to effect the price of the future;

• round-trip trading, also known as wash sales,in order to, among other things, report artificialvolume or fraudulent revenues;

• false reporting of trading volumes or prices;and

• failure to maintain required records.

To the extent that this conduct, if proven,affects the legitimate forces of supply and demandin the energy marketplace, it harms consumers byincreasing the prices paid for energy.

IV. Conclusion

The CFTC's Division of Enforcementinvestigates and prosecutes financial fraudviolations that hurt a broad range of retailcustomers. The CFTC's ability to meet itsresponsibilities is enhanced when the lawenforcement community and the public recognizesthat this fraud comes within the CFTC'sjurisdiction, and refers that fraud to the CFTC'sDivision of Enforcement. The Division'sincreasing cooperation with other lawenforcement entities and participation ininteragency enforcement activities is designed toraise the consciousness of federal and stateregulators, and thus increase the likelihood thatmalfeasors will be caught and prosecuted beforethey can do much harm.v

ABOUT THE AUTHOR

�Daniel A. Nathan has been the Chief of theOffice of Cooperative Enforcement since thatOffice was created within the Division ofEnforcement of the Commodity Futures TradingCommission in September 2002. In that position,he is responsible for outreach to other federal andstate civil and criminal authorities, and forcoordinating the CFTC's investigations andlitigations of commodity-related violations withother authorities. Mr. Nathan was Deputy Directorof the Division from July 1997 until September2002. From 1985 until 1997, Mr. Nathan was inthe Securities and Exchange Commission'sDivision of Enforcement, the last seven of thoseyears as an Assistant Director, where hesupervised investigations of financial fraud,insider trading, and market manipulation, amongother things.X


Expert Testimony in CriminalSecurities CasesBruce M. BettigoleChief Counsel, Criminal ProsecutionAssistance GroupNASD (formerly known as NationalAssociation of Securities Dealers)

I. Introduction

Expert testimony is an essential part of thegovernment's case in virtually any criminalsecurities trial. Securities cases generally involveunfamiliar concepts, impenetrable industry jargon,and activities whose criminal nature is not alwaysobvious to the average juror. A good expert cango a long way toward overcoming these obstacles.At NASD's Criminal Prosecution AssistanceGroup (CPAG), our assistance to prosecutorsroutinely includes recommending governmentexpert witnesses, providing supporting dataanalyses, assisting with expert witnesspreparation, and providing outlines of cross-examination of defense experts. But what are thecontours of admissible expert testimony insecurities cases? This article examines theavailable case law, predominantly from theSecond Circuit, and offers guidance concerningpotential issues of admissibility.

II. The District Court's "gatekeeper"obligations

In Daubert v. Merrill Dow Pharmaceuticals,509 U.S. 579 (1993), the Supreme Court rejectedthe requirement that expert testimony havereceived general acceptance in the relevantscientific field, a standard that originated withFrye v. United States, 293 F. 1013, 1014 (D.C.Cir. 1923). Daubert found the Frye test toorestrictive, and held instead that the Federal Rulesof Evidence require trial courts to excludescientific expert testimony that is not sufficientlyrelevant or reliable. Daubert, 509 U.S. at 589,597. The Court specified that the trial courts mustbe flexible in performing this essential gatekeeperfunction, and identified level of acceptance,testing, peer review, and error rates, as specificfactors that might prove helpful in making thereliability determination. Id. at 593-94.Subsequently, the Court held that this gatekeeperfunction of the district courts extends tononscientific experts as well. Kumho Tire Co. v.

Carmichael, 526 U.S. 137, 147 (1999) (testimonyof engineer in automobile accident trial).

Kumho specified that trial courts

may consider one or more of the more specificfactors that Daubert mentioned when doing sowill help determine that testimony'sreliability. But, as the Court stated in Daubert,the test of reliability is 'flexible,' andDaubert 's list of specific factors neithernecessarily nor exclusively applies to allexperts or in every case.

Id. at 141 (emphasis in original); FED. R. EVID .702 advisory committee's notes (2000 amends.)(explaining why Daubert factors were notcodified into the Rule).

This clarified the trial court's gatekeeper roleregarding expert testimony in securities cases,because other than economists (Blech SecuritiesLitigation, 2003 U.S. Dist. LEXIS 4650, at *69(S.D.N.Y. 2003)), most experts in securities casesdo not offer scientific testimony based on peer-reviewed methodology. Securities experts insteadroutinely testify on the basis of their ownexperience, whether as regulators, industryparticipants, or outside counsel or consultants. SeeSEC v. U.S. Envtl., 2002 U.S. Dist. LEXIS 19701,at *12-13 & n.7 (S.D.N.Y. 2002) (holdingapplication of specific Daubert factorsunnecessary, where expert relied on tradingrecords and other documents and compared thatinformation with his knowledge of the industry;court noted finding no cases in which Daubertfactors were applied in evaluating testimony ofsecurities expert).

It is worth noting that Blech permitted anexpert to testify "as to what ordinary brokeractivity entails and as to the customs and practicesof the industry," Blech, 2003 U.S. Dist. LEXIS4650, at *57, but excluded testimony that certaintrades were proper, because this was based almostentirely on trading records, utilized no "expressmethodology," and involved no discussions withthe firm's trader. Id. Other rulings regardingexpert testimony in that case, however, seeminconsistent with any notion that work experienceand trading analyses are insufficient indicia ofreliability. Id. at *61-62.

Under Rule 702 of the FED. R. EVID ., expertsmust possess sufficient "knowledge, skill,


experience, training, or education." Thedisjunctive phrasing of this list of qualifications isparticularly important for securities experts.Although some of the most respected governmentexperts are drawn from academia, manyprosecutors have turned to current and formerattorneys of NASD and consultants who formerlyserved as attorneys or investigators with theSecurities and Exchange Commission (SEC). Onrare occasions, current attorneys or otheremployees of broker-dealers have been availableas government expert witnesses as well.Generally, courts do not have much difficultyaccepting such witnesses, even though most oftheir expertise is drawn from their workexperience rather than formal education. SeeUnited States v. Russo , 74 F.3d 1383, 1394-95 (2dCir. 1995) (expert had sufficient experience as aconsultant, general securities principal, andcontroller of a large options trading firm to testifyregarding impact on stock price of unauthorizedtrading and parking of securities); U.S. Envtl.,2002 U.S. Dist. LEXIS 19701, at *13(qualifications of government expert consistedprimarily of his experience as a regulator,compliance director, and securities consultant,who had testified as an expert in approximatelythirty securities cases, and his "knowledge oftypical trading activity and the types of tradingpatterns that an experienced trader wouldrecognize as irregular"); Blech, 2003 U.S. Dist.LEXIS 4650, at *50-70. As the advisorycommittee's notes to FED. R. EVID . 702 expresslystate, "In certain fields, experience is thepredominant, if not sole, basis for a great deal ofreliable expert testimony."

This is consistent with the generally liberalacceptance of expert testimony. Daubert, 509 U.S.at 587; United States v. Dennis, 625 F.2d 782, 797(8th Cir. 1980); Blech, 2003 U.S. Dist. LEXIS4650, at *68; FED. R. EVID . 702 advisorycommittee's note (2000 amends). As stated inDaubert, "Vigorous cross-examination,presentation of contrary evidence, and carefulinstruction on the burden of proof are thetraditional and appropriate means of attackingshaky but admissible evidence." Daubert, 509U.S. at 595. Of course, the substance of thetestimony must still be within the area of thewitness' expertise. See United States v. Chang,207 F.3d 1169, 1172 (9th Cir. 2000) (excludingtestimony of defense expert on history andpurpose of Japanese notes, who admittedly had notraining or experience in identifying counterfeitnotes, in case where issue was whether the notesin question were known to be counterfeit).

The trial judge has broad discretion as to thenecessity of a "reliability" hearing. Kumho , 526U.S. at 152-53; FED R. EVID . 702 advisorycommittee's note (2000 amends). Althoughdefense counsel may seek a reliability hearing, inpart to obtain material for cross-examination,courts generally appear to recognize and rejectsuch ploys in criminal securities cases.

III. Subjects of expert testimony

Expert testimony in securities cases, at aminimum, involves background information aboutthe securities industry and an explanation of therelevant normal industry practice. Thegovernment may also want to have the expertperform analyses of trading activity, reviewdocuments or transcripts of testimony, considerhypothetical questions, and opine on whether thetrading activity and other evidence is consistentwith normal industry practice. The governmentmight want the expert to explain the history,purpose, and meaning, of various statutes andregulations, as well as the rules of self-regulatoryorganizations (SROs), or even offer an opinion onwhether the defendant's conduct was consistentwith these statutes, regulations, and rules. Not allof these forms of expert testimony arepermissible, but the contours of forbidden areasare not always clear, and the fact specific natureof the analysis makes it difficult to predict how aparticular case will be resolved. This is especiallytrue outside the Second Circuit, where the relevantcase law is limited.

A. Securities 101

The least controversial use of governmentexperts in securities cases is to providebackground information concerning the securitiesindustry, sometimes referred to as "Securities101." The securities expert is generally calledupon to ensure that the jury has a basicunderstanding of what a public company is, thenature of common stock, warrants, or otherrelevant types of securities, the roles played bycorporate officers and directors, auditors, marketmakers, clearing and introducing firms,stockbrokers, and other relevant actors, the natureof stock quotations and transactions, the existenceand contents of relevant documentation, andsimilar matters. See United States v. Bilzerian,926 F.2d 1285, 1294-95 (2d Cir. 1991) (expert'stestimony regarding general background onfederal securities regulation deemed permissible);Marx & Co. v. Diners Club, 550 F.2d 505, 512(2d Cir.1977) (stating in dicta that securitiesexperts can testify on valuation issues, "how thebid and asked price of an over-the-countersecurity gets into the 'pink sheets,' how price


stabilization works, or how a stock exchangespecialist operates .... the nature of an optioncontract, or of a convertible preferred stock....")Expert testimony about ordinary practices in thesecurities industry is properly offered "to enablethe jury to evaluate a defendant's conduct againstthe standards of accepted practice." Bilzerian, 926F.2d at 1295, citing with approval Marx, 550 F.2dat 509. Testimony regarding SRO rules isgenerally permitted as evidence of industrypractice. United States v. Jensen, 608 F.2d 1349,1356 (10th Cir. 1979) (expert permitted tointerpret NASD rules as rules of a "privateassociation" which were outside the court'sexpertise); Blech, 2003 U.S. Dist. LEXIS 4650, at*10-11. (SRO rules "are evidence of industrypractice but do not constitute an exemption fromliability"). Since juries do not possess anymeaningful background in these areas, thereshould be no question that it would assist the juryto have a government expert provide essentialbackground information and definitions, andexplain the normal functioning of the industry,without offering to address the conduct of thedefendants.

The advisory committee's notes to FED. R.EVID . 702 state that expert testimony mayproperly "educate the fact finder about generalprinciples, without ever attempting to apply theseprinciples to the specific facts of the case," andoffer the specific example of testimony "on howfinancial markets respond to corporate reports."This type of testimony may be useful not only inaccounting frauds and other cases involvingmisrepresentations in annual and quarterly reportsof public companies, but also by inference insecurities prosecutions involving fraudulentresearch reports or misleading Internet postings.

B. Usurping the role of the judge or jury

The admissibility of expert testimonybecomes more problematic when prosecutors seekto have the expert state opinions concerning thefacts of the case and/or interpret statutes andregulations. FED. R. EVID . 704 expressly providesthat "testimony in the form of an opinion orinference otherwise admissible is notobjectionable because it embraces an ultimateissue to be decided by the trier of fact." However,as the advisory committee's notes point out, Rule702's requirement that the testimony be "helpful"to the jury and Rule 403's proscription againstevidence that "wastes time" preclude experttestimony that "would merely tell the jury whatresult to reach, somewhat in the manner of theoath-helpers of an earlier day." See alsoUnited States v. Duncan, 42 F.3d 97, 101 (2d Cir.

1994) (noting in tax evasion case that "[w]hen anexpert undertakes to tell the jury what result toreach, this does not aid the jury in making adecision, but rather attempts to substitute theexpert's judgment for that of the jury's"); Hygh v.Jacobs, 961 F.2d 359, 364 (2d Cir. 1992)(excluding testimony that use of force by policewas "not justified" and "totally improper");United States v. Wood, 207 F.3d 1222, 1236 (10thCir. 2000) (medical expert testimony thattreatment was "reckless" improperly describedrequisite mental state for manslaughter).

These Rules also exclude legal conclusions,or, as the Advisory Committee put it, "opinionsphrased in terms of inadequately explored legalcriteria." See Russo , 74 F.3d at 1395; Bilzerian,926 F.2d at 1294; Molecular Tech. Corp. v.Behbehani, 925 F.2d 910, 919 (6th Cir. 1991)(expert testimony concerning "the requirements offederal securities disclosure laws" held improperand not harmless error; no discussion of specifictestimony). The example provided by theAdvisory Committee is that the question, "Did Thave capacity to make a will?" would beexcluded, while the question, "Did T havesufficient mental capacity to know the nature andextent of his property and the natural objects ofhis bounty and to formulate a rational scheme ofdistribution?" would be allowed. FED. R. EVID .704 advisory committee notes (1972 proposedrules).

The line between helpful testimony regardingultimate factual issues and inadmissible testimonythat tells the jury what result to reach, or what thelaw provides, is not always clear. The poster childfor improper testimony of a government expert ina criminal securities case is United States v. Scop,846 F.2d 135 (2d Cir.), rev'd in part on othergrounds, 856 F.2d 5 (2d Cir. 1988), in which thewitness repeatedly testified that the defendantswere "active participants and material participants. . . in a manipulative and fraudulent scheme," andadmitted on cross-examination that his opinionswere, in part, based on his personal views of thecredibility of fact witnesses. Id. at 138. However,the Second Circuit pointed out that had the expert"merely testified that controlled buying andselling of the kind alleged here can create artificialprice levels to lure outside investors, nosustainable objection could have been made." Id.at 140. This was consistent with Marx where theSecond Circuit emphasized that an expert maytestify "whether he thinks the method of tradingwas normal, but not, in our view, whether itamounted to illegal manipulation under Section 9of the Securities Exchange Act of 1934." Marx,550 F.2d at 512; see also SEC v. Lorin, 877 F.


Supp. 192, 196 (S.D.N.Y. 1995), aff'd in part andremanded in part on other grounds, 76 F.3d 458(2d Cir. 1996) (expert testimony that the bid andasked quotations and general practices inexecuting transactions "were inconsistent withthose of a lawful market maker").

Testimony that utilizes statutory terminologythus may be viewed as usurping the role of thecourt, and testimony regarding the credibility ofwitnesses tends to be considered usurping theprovince of the jury. The courts have been muchmore receptive to the testimony of securitiesexperts if they avoid using key statutory terms orvoicing their opinions on the credibility ofwitnesses. See Russo , 74 F.3d at 1395; Bilzerian,926 F.2d at 1294.

In Bilzerian, the court excluded, as animpermissible legal conclusion, testimony by adefense expert that certain loans obtained by thedefendant to purchase securities were "personalfunds" within the meaning of Section 13 D of theSecurities Exchange Act. This was viewed astantamount to saying that the defendant'sdisclosures on his 13 D form were not misleading.926 F.2d at 1295. By contrast, the court permittedthe government expert to explain ambiguities in ablank Schedule 13 D. The Second Circuit, in part,seems to have distinguished the governmentexpert's testimony based on a limiting instructiongiven by the district court that the expert wasfurnishing "background concerning the meaningof terms, the procedures which are followed andhis opinion as to the reason for these procedures.He is not here to give his opinion as to what thelaw requires. That is a matter which must bepresented to you by the court." Id. at 1295. It isnot clear how the government expert's testimonyon the meaning of terms in a blank Schedule D,even if not coupled with testimony applying thefacts of the case to that interpretation, was not alegal opinion, albeit one that did not seek to tellthe jury whether the funds in issue were "personalfunds."

In Russo , the government expert summarizedand described a small brokerage firm's tradingpatterns, including how the stock of two smallcompanies was kept off the market throughunauthorized trading and parking, and concludedthat the price of these stocks would have declinedsignificantly in the absence of these measures.Russo, 74 F.3d at 1388-89. The expert's testimonythat certain securities transactions constituted"parking," without offering any opinion regardingthe defendants' state of mind or whether they hadviolated the securities laws, was held to be proper.Id. at 1395. The court rejected the defense

argument that the expert's testimony implicitlyinvolved the legal conclusion that the defendantsintended to park stock. Id.

In AUSA Life Insurance Co. v. Dwyer, 899 F.Supp. 1200 (S.D.N.Y. 1995), the court rejectedexpert testimony that expressed conclusions thatapplied the facts to specific statutory provisions,stating it was:

hard to imagine expert opinions that moreclearly usurp the function of the trial judge ininstructing the jury . . . than [expert witness]Coffee's assertions that Gallo was not acontrolling person of JWP within the meaningof Section 15 of the Securities Act of 1933 orSection 20 of the Securities Exchange Act of1934 [record citation omitted], and that thestatements made by Gallo in the certificateshe signed are not actionable under Rule 10b-5. . . .

Id. at 1203; see also Kidder, Peabody & Co. v.IAG Int'l Acceptance Group, N.V., 14 F. Supp. 2d391 (S.D.N.Y. 1998) (granting motion to precludeexpert testimony of law professor who sought toopine that party had acted reasonably and in goodfaith, holding that these were questions for thejury).

In SEC v. U.S. Environmental, the courtdistinguished the impermissible expert testimonyin Scop that the defendants were activeparticipants in the "manipulation," which the courtviewed as implying knowledge of their mentalstate regarding the manipulation and "more alongthe lines of a legal conclusion." SEC v. U.S.Envtl., 2002 U.S. Dist LEXIS 19701, at *20. Thecourt permitted testimony that certain defendantsin U.S. Environmental were essential participantsin an attempt to increase the price of the stock,which the court viewed as a factual conclusion"arrived at by studying the trading records...." Id.at *19-20. The defense unsuccessfully argued thatexpert testimony that prearranged tradingproduced artificial prices and mislead investorswas just an indirect way of saying that"manipulation" had occurred. The court expresslyfound that there was a "material difference" in thelanguage, such that the expert had not improperlyusurped the province of the jury. Id. at *17-19.

Blech, 2003 U.S. Dist. LEXIS 4650, noted therestrictions of Scop on the use of statutory andregulatory language like "manipulation" and"scheme to defraud," but appeared to allow verysimilar testimony:

Berg [the expert], therefore, cannot simplystate that he knows the market wasmanipulated. He can, however, point to


factors indicating to him that marketmanipulation occurred, testify as to BearStearns' practices, and provide his reasoningas to why he believes they were manipulative.Rather than asserting, "Bear Stearns activelyengaged in manipulative conduct aimed atdirectly affecting the market prices of theBlech Securities" [affidavit citation omitted],Berg should describe the evidence indicatingthat Bear Stearns' actions were manipulative.He cannot conclude, "Bear Stearns knowinglydirected material components of a complex,concealed manipulative scheme to artificiallyinflate and maintain the market prices forBlech Securities during the time in which itacted as the clearing [firm] for DBCO."[affidavit citation omitted]. Instead, he shouldlimit himself to explaining why he believesthat Bear [Stearns] had knowledge that theredid not exist a viable market for BlechSecurities and that it acted upon thisknowledge.

Id. at *63-64. Blech also permitted testimonyregarding "painting the tape," "parking," and"withholding of supply," all of which are forms ofmanipulation. Id. at *66.

The extent of the list of terms that securitiesexperts are forbidden from defining or using todescribe the facts of the case is, at best, uncertain.Scop, found the expert's use of the terms "fraud"and "manipulation" inappropriate in part becausethey "are not self-defining terms but rather havebeen the subject of diverse judicialinterpretations." 846 F.2d at 140. This concern attimes has led other courts to preclude the use ofspecialized, but nonstatutory terms. SeeUnited States v. Pereira, 281 B.R. 194, 199-200,2002 U.S. Dist. LEXIS 13008, at *13 (S.D.N.Y.2002) (expert testimony regarding whetherdefendant was the "alter ego" of the corporationdeemed improper). On the other hand, somecourts appear willing to permit expert testimonyregarding subsidiary legal issues. See Note, ExpertLegal Testimony, 97 HARV. L. REV. 797, 802(1984) (noting lack of clarity in case law, andopining that courts may "admit legal testimonymore readily when it concerns a collateral issue(particularly a complex one) than when it relatesto the main subject in dispute"). Testimonyregarding forms of manipulation, such as parkingand painting the tape, might well be viewed bysome courts as indistinguishable fromimpermissible testimony regarding specializedstatutory terms like "manipulation." But seeRusso , 74 F.3d at 1393-94 ("parking" held not tobe a legal term requiring jury instruction).

In United States v. Barile, 286 F.3d 749 (4thCir. 2002), the court held that the defense expertshould have been permitted to testify that thedefendant's statements in a pre-market notificationto the Food and Drug Administration concerning aproduct enhancement for cardiac monitors werereasonable, but not that there were no materiallymisleading comments. Id. at 761. The decision toexclude "materiality" testimony was based on thisword having a "specialized legal meaning." Id.This would seem to be at least as appropriate inthe securities context, where materiality is oftenan element of the offense. In United States v.Cohen , 518 F.2d 727 (2d Cir. 1975), however, theSecond Circuit permitted expert testimony by anSEC witness regarding the "reach of the conceptsof 'underwriter' and 'materiality.' " Id. at 737.Materiality was an element of the crimes charged,which included the mailing of a fraudulentoffering circular. This decision thus seemsinconsistent with Barile and Scop, as "materiality"has been the subject of extensive judicialinterpretation (See TSC Indus., v. Northway, 426U.S. 438, 449 (1976)) and is generally defined bythe court in jury instructions. See alsoUnited States v. Lueben, 812 F.2d 179, 184 (5thCir. 1987) (defense expert should have beenpermitted to testify that false statements regardingincome, employment, or net worth would not havehad "capacity to influence" loan officer, since thiswas distinguishable from the legal question ofwhether the statements were "material").

In Police Retirement System of St. Louis v.Midwest Investment Advisory Service, 940 F.2d351 (8th Cir. 1991), the testimony of the SEC'sformer Director of Market Regulation regardingthe history and purpose of Section 28(e) of theSecurities and Exchange Act as to "soft dollar"arrangements and the securities industry'spractices and procedures would apparently havebeen deemed proper. However, his additionaltestimony regarding the meaning of the provisionand his conclusion that the conduct of thedefendants was completely sheltered by theprovision was held to have been improper. Id. at357. The Eighth Circuit in that case expresslyrejected the erosion, evident in some courts, of theprohibition against experts testifying on themeaning of the law.

The case law thus indicates that attempts toexplain statutory language or to give opinions asto whether the conduct in question was illegal,fraudulent, or manipulative, seem unlikely to bepermitted. Other terms that may be deemedsufficiently specialized, such as materiality,parking, or painting the tape, may also be offlimits in some courts. Background information,


descriptions of standard industry practice, andanalyses of the facts concerning the conduct inquestion, are likely to be permitted, althoughopinions on whether the conduct was consistentwith normal practice may be excluded as too closeto simply telling the jury what result to reach.

C. Commenting on witness credibility

Experts are generally not permitted tocomment on the credibility of witnesses, as this isviewed as outside their area of expertise andconstitutes improper usurpation of the role of thejury. In Scop, the government expert had beenextensively involved in the investigation, andadmitted on cross-examination that his opinionswere based in part on his views on witness'credibility. The Second Circuit found this to be animpermissible intrusion on the jury's fact finding.Scop, 846 F.2d at 142; see United States v.Benson, 941 F.2d 598, 604 (7th Cir. 1991). InSEC v. U.S. Environmental, the defenseunsuccessfully sought to exclude testimony by thegovernment witness as having "weigh[ed] in" onwitness credibility because he relied, in part, oncertain depositions. The court found, however,that to the extent the witness relied on depositions,this reliance was limited to undisputedadmissions. 2002 U.S. Dist. LEXIS 19701, at*20-21.

Similarly, in United States v. Duncan, theSecond Circuit held that an IRS agent who hadinterviewed other government witnesses properlylimited his expert testimony to factual conclusionsthat were not based on the credibility of otherwitnesses, because his testimony concerned taxreturns whose falsity was apparent from land andtax records. 42 F.3d at 102. In Blech, however, thecourt ruled that an expert's opinions concerningthe "tenor" and "tone" of certain depositiontestimony was improper testimony about witnesscredibility, as such issues were within the jury'scompetence. 2003 U.S. Dist. LEXIS 4650, at *58-59. The safest procedure is to have the expert statethat he is assuming the truth of specific testimony,without making any judgment about whether thetestimony is, in fact, true. See Scop, 846 F.2d at143.

D. Commenting on the state of mind of thedefendant

The general rule is that a securities expertcannot testify concerning the defendant's state ofmind. Scop, 846 F.2d at 148; Russo , 74 F.3d at1395. This is due to a lack of relevant expertise, aswell as the express prohibition against suchtestimony in FED. R. EVID . 704(b), which states:

No expert witness testifying with respect tothe mental state or condition of a defendant ina criminal case may state an opinion orinference as to whether the defendant did ordid not have the mental state or conditionconstituting an element of the crime chargedor of a defense thereto. Such ultimate issuesare matters for the trier of fact alone.

Less direct forms of expert testimony relevantto the defendant's mental state, however, may bepermissible. In U.S. Environmental, thegovernment's expert was permitted to testify thatcertain irregular trading patterns were "red flags"that any experienced trader would haverecognized. 2002 U.S. Dist. LEXIS 19701, at *10.Blech, surprisingly accepted testimony that abrokerage firm "was aware of" sham transactionsto inflate the price of the stock, i.e. "painting thetape." 2003 U.S. Dist. LEXIS 4650, *66. Blechsimilarly approved of expert testimony that thefirm in question knew there was no viable marketfor particular securities and that the firm "actedupon this knowledge," both areas that arguablyinvolve testimony about the mental state of thedefendant. Id. at *64. Such testimony might wellbe deemed inadmissible in other courts, whereinferences as to the knowledge of a criminaldefendant might be reserved for the jury.

Defense experts, at times, seek to testify aboutthe lack of clarity in the law as a means of provingthe absence of criminal intent. United States v.Garber, 607 F.2d 92, 95 (5th Cir. 1979), held thatsuch testimony should have been permitted,regardless of whether the defendant was aware ofthe lack of clarity or relied on the advice ofcounsel. Garber has been heavily criticized, andthis type of testimony is generally excluded. Thedissent in Garber was followed by the SecondCircuit in United States v. Ingredient Tech. Corp.,698 F.2d 88, 96-97 (2d Cir. 1983), which held thatwhen the evidence shows the defendants thoughtthey were acting unlawfully, expert testimony onthe vagueness or uncertainty of the law isirrelevant. Indeed, as Ingredient Tech. pointed out,the Fifth Circuit severely limited Garber inUnited States v. Herzog, 632 F.2d 469, 473 (5thCir. 1980), without expressly overruling it.Ingredient Tech., 698 F.2d at 97; Kidder, Peabody& Co. v. IAG Int'l Acceptance Group N.V., 14 F.Supp. 2d 391, 402 (S.D.N.Y. 1998). Similarly,expert testimony regarding the reasonableness ofreliance on advice of counsel, as a means ofshowing a lack of criminal intent, should beexcluded. United States v. Klaphake, 64 F.3d 435,439 (8th Cir. 1995); United States v. West, 22F.3d 586, 598 (5th Cir. 1994); Kidder, 14 F. Supp.2d at 402-04.


E. Hallmarks of fraud

Expert witnesses in various nonsecuritiescases have been permitted to testify regarding thetypical structure and operation of criminalorganizations and transactions. See United Statesv. Locascio, 6 F.3d 924, 937 (2d Cir. 1993)(structure and terminology of organized crimefamilies); United States v. Tapia-Ortiz, 23 F.3d738, 741 (2d Cir. 1994) (use of accounting booksand beepers by drug dealers). There have evenbeen cases in which opinion testimony waspermitted as to whether the defendant's conductwas consistent with such a typical scheme. SeeScop, 846 F.2d at 141-42 (reviewing case law andnoting concern expressed in one case that therewas "something offensive" about allowing thetestimony to go this far). In United States v.Robinson, 2000 U.S. Dist. LEXIS 694 (S.D.N.Y.2000), aff'd, 28 Fed. Appx. 50, 2002 U.S. App.LEXIS 402 (2d Cir. 2002), the court held pretrialthat testimony regarding the "hallmarks" of PrimeBank schemes would be admissible. However, thecourt noted that a more detailed proffer from thegovernment would be necessary to ensure that thetestimony not improperly invade the province ofthe jury by conveying the conclusion that thedefendants' scheme "featured these hallmarks."2000 U.S. Dist. LEXIS 694, at *5.

In Robinson, the defense raised no objectionto expert testimony that Prime Bank instrumentsdo not exist, that the Federal Reserve does notauthorize or issue clearance for any suchinstruments, and did not do so in the case at issue.The expert was permitted to go further, however,over the objection of the defense, and offertestimony that "claims regarding Prime Bankinstruments, secret restricted markets, and specialtrading clearances are 'hallmarks' of financialfraud schemes." Id. The expert was furtherallowed to testify about the role of the "recruiter"to counter the defendant's claim that his movingnear the victim's residence was inconsistent withcriminal intent. In its pretrial rulings, however, thecourt did exclude testimony that the defendants'scheme contained the hallmarks of prime bankfraud or that one defendant's conduct fit the roleof the typical prime bank recruiter, due to the riskof improper usurpation of the role of the jury. Id.Despite this ruling, at trial the court apparentlyallowed the government expert to testify aboutwhat the prime bank notes "really meant," thatcertain terms were "bogus" and had "no legitimatemeaning," and that various aspects of thedefendants' scheme were "often used bywrongdoers who are trying to scam money." TheSecond Circuit, in an unpublished opinion, notedthat such testimony "was close to, if not beyond,

the bounds of propriety," but held that any errorwas harmless. United States v. Robinson, 28 Fed.Appx. 50, 2002 U.S. App. LEXIS 402 at * 3.

It may be that similar testimony would bepermissible in "boiler room" sales practice cases,pyramid schemes, and other forms of securitiesfraud, that arguably follow a well-establishedformula. Boiler rooms, for example, typicallyinvolve unlicensed cold callers who pretend to belicensed brokers, lie about having made successfulrecommendations to the victim in the past, andutilize fraudulent sales scripts to sell essentiallyworthless stock and receive vast, inadequatelydisclosed commissions. Such firms typically hireonly new, inexperienced employees who can moreeasily be trained in these methods, or licensedbrokers who have successfully utilized thesetechniques at other notorious firms. Boiler roomsalso typically enforce undisclosed restrictions onthe ability of customers to resell their securities,an illegal practice that is generally enforced by thefirm's traders and owners. Although no reportedcases appear to address the use of experttestimony in this context, it logically should bepermitted. Whether it is necessary to have suchexpert testimony is another matter. The prosecutormay not want to risk creating an appellate issue,especially where cooperators are available totestify from their own experiences that these illicitpractices were utilized throughout the firm,including by the defendants.

IV. Conclusion

Expert testimony regarding the basic conceptsand normal practices of the securities industryshould virtually always be a part of thegovernment's case. With careful avoidance ofstatutory or other specialized terms that have beenthe subject of judicial interpretation, or commentsregarding the defendant's mental state or thecredibility of other witnesses, an expert should bepermitted to explain why the normal practice ofthe industry is vastly different from the conductdescribed by cooperating witnesses, withoutattempting to state that final inference for the jury.Prosecutors who push the envelope beyond theseareas, however, may find that they have created anappellate issue in return for, at most, a marginaladvantage at trial.�

ABOUT THE AUTHOR

�Bruce Bettigole has been the Chief Counsel ofNASD's Criminal Prosecution Assistance Groupsince its inception in April, 1998. CPAG assistsfederal, state, and local prosecutors throughout thecountry in criminal securities-related


investigations and prosecutions. He was anAssistant Chief Litigation Counsel with the SECfrom 1991-1998, and served as a Special AUSAfrom 1994-2001 in several jurisdictions. From1981-91, Mr. Bettigole was in private practice inthe District of Columbia. a

Corporate Crime PreventionProgramsDavid M. NissmanUnited States AttorneyDistrict of the Virgin Islands

I. Introduction

When Assistant United States Attorneys TomWatts-FitzGerald and Environmental CrimesSection (ECS), Department of Justice(Department) attorney Richard Udell wereconfronted with an early settlement offer fromNorwegian Cruise Lines (NCL) in anenvironmental criminal case, their initial reactionwas typical of most of us. They would not agreeto a settlement until a complete and thoroughinvestigation was done. NCL then turned over theresults of its own internal investigation whichgrew out of a corporate compliance program. Thecompany waived applicable privileges, turnedover witness statements that included aconfession, and repeated its offer to settle early.The cooperation it offered, however, was notconditioned on a quid pro quo as to the eventualoutcome.

The government was already investigatingNCL for discharging oily bilge water and formisreporting the condition of oily water separatorson NCL's cruise ships. An ex-employee, who hadserved on the SS Norway, made allegations to theUnited States prior to the time that NCL cameforward. NCL was purchased in a hostile takeoverand the new owner learned that the ex-employeehad spoken to the government. The new ownerhired an outside auditor to look at the ships andthe auditor actually witnessed one of the shipstampering with required pollution preventionequipment (the oil water separator). Promptdisclosure was then made by the new owner, witha pledge of total cooperation.

After analyzing the company's internalinvestigation, the prosecutors conducted aninvestigation and NCL maintained a rollingproduction of investigative reports as they werebeing written. The corporation wanted closure,and due to NCL's extraordinary cooperation, thegovernment's investigation proceeded andconcluded quickly. While NCL's conduct hadbeen ongoing, (repeated discharges of bilge oilinto the ocean without processing it through anoily water separator, and false statements intotheir Oil Record Book during subsequent U.S.Coast Guard inspections) they approached thegovernment with an offer to cooperate prior to thetime that there were any overt steps taken in thegovernment's investigation.

At the conclusion of the negotiations NCLpleaded guilty to a single felony count in onejurisdiction and received a fine of $1 milliondollars. In contrast, for similar conduct, but with acorporate stance that was more than mildlyobstructionist, Royal Caribbean Cruise, Limitedpleaded guilty to felonies in six differentjurisdictions and paid over $25 million dollars incriminal fines.

The NCL offer came on the heels of aninternal audit conducted by new owners of thecompany. Internal audits are often components ofcorporate criminal compliance programs.

II. What is the purpose of a corporatecompliance program?

Whether it is the money laundering abuses ofBCCI or the accounting horrors of Worldcom orEnron, corporations have begun to recognize thatself-policing can help them avoid seriousproblems. As stated in the Criminal ResourceManual of the United States Attorneys' Manual:

Compliance programs are established bycorporate management to prevent and to


detect misconduct and to ensure that corporateactivities are conducted in accordance with allapplicable criminal and civil laws,regulations, and rules. The Departmentencourages such corporate self-policing,including voluntary disclosures to thegovernment of any problems that acorporation discovers on its own.

Federal Prosecutions of Business Organizations,Criminal Resource Manual 162, § VII. A.

Various legal sources suggest thatcorporations may be able to enhance their legalstatus as putative defendants when they have aneffective corporate compliance program. In theEighth Circuit there is a Model Jury Instruction(5.03) that allows a corporation to use itscompliance program as a way of challenging theculpable mental state of a charge against it. TheU.S. Sentencing Guidelines provides that thecorporate sentencing penalty may be lower (bythree points) if the company has an effectivecorporate compliance program. U.S. SENTENCING

GUIDELINES MANUAL § 8C2.5(f) . The SentencingGuidelines also reward voluntary disclosure andcooperation with a reduction (by as much as fivepoints) in the corporation's offense level. See U.S.SENTENCING GUIDELINES MANUAL §§ 8C2.5(g).U.S. SENTENCING GUIDELINES MANUAL § 8A1.2(k) provides that an "effective program to preventand detect violations of law" means a programthat has been reasonably designed, implemented,and enforced so that it generally will be effectivein preventing and detecting criminal conduct.Failure to prevent or detect the instant offense, byitself, does not mean that the program was noteffective. The hallmark of an effective program toprevent and detect violations of law is that theorganization exercised due diligence in seeking toprevent and detect criminal conduct by itsemployees and other agents.

Due diligence requires, at a minimum, that theorganization must take the following types ofsteps:

• The organization must have establishedcompliance standards and procedures to befollowed by its employees and other agentsthat are reasonably capable of reducing theprospect of criminal conduct;

• Specific individual(s) within high-levelpersonnel of the organization must have beenassigned overall responsibility to overseecompliance with such standards andprocedures;

• The organization must have used due care notto delegate substantial discretionary authority

to individuals whom the organization knew,or should have known through the exercise ofdue diligence, had a propensity to engage inillegal activities;

• The organization must have taken steps tocommunicate effectively its standards andprocedures to all employees and other agents,for example, by requiring participation intraining programs or by disseminatingpublications that explain, in a practicalmanner, what is required;

• The organization must have taken reasonablesteps to achieve compliance with itsstandards, for example, by using monitoringand auditing systems reasonably designed todetect criminal conduct by its employees andother agents, and by having in place andpublicizing a reporting system wherebyemployees and other agents can reportcriminal conduct by others within theorganization without fear of retribution;

• The standards must have been consistentlyenforced through suitable disciplinarymechanisms, including, as appropriate,discipline of individuals responsible for thefailure to detect an offense. Adequatediscipline of individuals responsible for anoffense is a necessary component ofenforcement. The form of discipline that willbe appropriate will be case specific;

• After an offense has been detected, theorganization must have taken all reasonablesteps to respond appropriately to the offenseand to prevent further similar offenses,including any necessary modifications to itsprogram to prevent and detect violations oflaw.

As prosecutors, we wrestle with the equities inmaking a decision to charge a corporation. Acorporation is often a powerful entity thatdevelops a culture of its own. If it engages inrepeated or pervasive acts of criminal behavior, itshould be treated as a criminal. On the other hand,by charging a corporation we place scores ofinnocent people in jeopardy. Innocent people maybe put out of work. Innocent pension holders,whose trustees have invested in the subjectcompany, may have their financial futuresjeopardized when a successful criminal case islaunched against the corporation. For these andother reasons we proceed temperately. Analyzingthe corporation's culture may help determine whatmeasure of enforcement is necessary in a givensituation. One of the best ways to analyze a


company's overall behavior is to examine itscompliance program.

As stated in the USAM:

the existence of a compliance program is notsufficient, in and of itself, to justify notcharging a corporation for criminal conductundertaken by its officers, directors,employees, or agents. Indeed, the commissionof such crimes in the face of a complianceprogram may suggest that the corporatemanagement is not adequately enforcing itsprogram. In addition, the nature of somecrimes, e.g., antitrust violations, may be suchthat national law enforcement policiesmandate prosecutions of corporationsnotwithstanding the existence of a complianceprogram.

Federal Prosecutions of Business Organizations.Criminal Resource Manual 162, § VII. A.

The absence of a compliance program in alarge company may be a good place to begin aninquiry into corporate culture. Why was aprogram not started? Did the company recognizethrough various operations that it was at riskofviolating the law? Were there discussions amongcorporate officers about starting such a program?Why was the concept shelved?

In companies where programs do exist, doesthe program function or is it merely a paperprogram?

[C]ritical factors in evaluating any programare whether the program is adequatelydesigned for maximum effectiveness inpreventing and detecting wrongdoing byemployees and whether corporatemanagement is enforcing the program or istacitly encouraging or pressuring employeesto engage in misconduct to achieve businessobjectives. The Department has no formalguidelines for corporate complianceprograms. The fundamental questions anyprosecutor should ask are: "Is thecorporation's compliance program welldesigned?" and "Does the corporation'scompliance program work?" In answeringthese questions, the prosecutor shouldconsider the comprehensiveness of thecompliance program; the extent andpervasiveness of the criminal conduct; thenumber and level of the corporate employeesinvolved; the seriousness, duration, andfrequency of the misconduct; and anyremedial actions taken by the corporation,including restitution, disciplinary action, andrevisions to corporate compliance programs.

Federal Prosecutions of Business Organizations,Criminal Resource Manual 162, § VII. B.

III. The audit issue

In the environmental context, corporations, aspart of a compliance program, conduct audits.These audits oftentimes point out potentialcriminal activity. A decade ago, the regulatedcommunity asserted that it was unfair for thegovernment to subpoena these audits and use acorporation's best efforts at self-policing againstit. Attorneys working on behalf of regulatedcorporations even tried to develop an auditprivilege. We were successful in resisting thedevelopment of such a privilege, but at the sametime, we recognized that it was in the best interestof the environment and law enforcement toencourage corporations to conduct these audits.Consequently, we did not want to engage inactivities that would make companies hesitate toundertake them. The Environmental ProtectionAgency (EPA) codified a limited use policy toaddress the equities. In a document entitled"Incentives for Self-Policing: Discovery,Disclosure, Correction and Prevention ofViolations," EPA sets out several importantlimiting doctrines.65 Fed. Reg. 19,618 (April 11,2000).

The summary states:

The purpose of this Policy is to enhanceprotection of human health and theenvironment by encouraging regulated entitiesto voluntarily discover, promptly disclose andexpeditiously correct violations of Federalenvironmental requirements. Incentives thatEPA makes available for those who meet theterms of the Audit Policy include theelimination or substantial reduction of thegravity component of civil penalties and adetermination not to recommend criminalprosecution of the disclosing entity. ThePolicy also restates EPA's long-standingpractice of not requesting copies of regulatedentities' voluntary audit reports to triggerFederal enforcement investigations.

Id.

In this way, regulated companies are notexposed to risk for doing the right thing. Thegovernment is not collecting audits merely todetermine if it should undertake an investigation.However, once a criminal violation is discovered,the government will not hesitate to request copiesof the audits. These audits are also helpful inmaking a determination about the efficacy of acompliance program which may be one factor in


determining whether or not to charge thecorporation.

It goes without saying that any considerationthat might enure to the benefit of the corporationfor having undertaken a crime prevention program(or governmental self-imposed restraint on the useof compliance documents), is irrelevant in thecontext of what to do with an individualwrongdoer who works for the business entity.

IV. Features of a good compliance program

In the USAM 's Federal Prosecutions ofBusiness Organizations, Criminal ResourceManual 162, as well as U.S. SENTENCING

GUIDELINES MANUAL § 8 , business organizationsare encouraged to have real, versus paper,compliance programs. In deciding whether tocharge, what to charge, and what sentencingconsiderations are appropriate, prosecutors needto evaluate the merits of a business organization'scompliance program. While much has beenwritten about certain aspects of corporatecompliance programs, it is instructive to analyzethe formation of the program in order to determineif it was doomed to failure at the outset.

To begin with, compliance programs shouldbe designed to detect the types of misconductmost likely to occur in that corporation's particularline of business. Criminal Resource Manual 162.Did the company thoroughly analyze its ownbusiness in its compliance program? For example,if a company is a manufacturing concern, did itcomplete a cradle to grave analysis, fromacquisition to storage, use and disposal of raw andused materials, for purposes of determiningcompliance with environmental and otherregulatory laws? If a business' complianceprogram made no effort to analyze its ownoperations, the program could not possibly beeffective. Step one should be to review thecompliance program's efforts to analyze its ownbusiness operations.

The next question a prosecutor may want toask is, did the compliance program do a thoroughreview of all of the relevant federal, state, andlocal laws and regulations relevant to thecompany's business? If the company is a coveredfinancial institution that accepts foreign bankaccounts (correspondent accounts), did the bankassign people to review the USA PATRIOT Actand applicable United States Treasuryregulations? Has the compliance section generatedresearch to instruct employees on the newobligations to investigate the opening of foreignaccounts? Are there documents in the financialinstitution's files that, for example, discuss

Sections 352 and 319 of the PATRIOT Act andthe impact these laws currently have on bankoperations and procedures? See 18 U.S.C. 1960.Section 352 requires financial institutions todevelop internal controls and complianceprograms. Section 319 requires banks to knowtheir customers, and in the case of correspondentaccounts, to know their customers when theyaccept foreign banks as account holders.

If the business maintains offices in foreigncountries and engages in, for example, publiccontracting, has it familiarized itself with theForeign Corrupt Practices Act, PUB. L. NO. 95-213, 91 Stat. 1494 (1977)? Has it researched thelegal requirement to do due diligence backgroundinvestigations on prospective foreignrepresentatives, agents, and consultants?

If the business is a publicly traded company,has it familiarized itself with the specificprovisions of the Sarbanes-Oxley Act? Do thefiles of the corporate compliance program indicatethat the company is required by Section 406 ofSarbanes-Oxley to develop a code of ethics forsenior financial officers? PUB. L. NO. 107-204,116 Stat. 745 (2002). Has such a code beendeveloped? What instructions did the compliancesection distribute to senior managementconcerning this obligation?

If the business operates in foreign countries,was a similar effort undertaken to acquaint itselfwith relevant foreign laws and regulationsaffecting the industry? One can learn much aboutthe nature of corporate citizenry from the researchit undertakes prior to the implementation of acompliance program. For example, if a multi-national industrial concern has a wonderfullythorough compliance initiative in theUnited States, but has taken no similar pains toacquaint itself with relevant foreign law, do weconclude that its corporate culture is to be a goodcitizen or merely a compliant one due to fear ofprosecution in the United States?

Having conducted an inquiry of the factsleading up to the establishment of the complianceprogram, the next question is does the companyhave a written compliance program? Is it regularlyfollowed? For example, having determined that afinancial institution is aware of USA PATRIOTAct requirements, what steps did the bankregularly follow to determine the true identity of aforeign holding company that has an account inthe domestic financial institution? Did thedomestic bank review the holding company'scorporate certificate of good standing? Did it sendsomeone to verify the address and residence of the


holding company or of the people using theaccount?

In a publicly traded company, review therequired code of ethics for senior financialofficers. What does the code require? Is itenforced? What are the penalties for violation ofthe company's code of ethics? Have violationsbeen discovered? Were penalties meted out? Howdoes that company's code of ethics compare withsimilarly situated companies? Is there an industrystandard?

In examining the written compliance program,does the program or industry lend itself tomeasurable performance standards? If so, arethere any? Are there orientation and trainingprograms to prevent corporate crime? Arestandards effectively communicated toemployees? Does the company reward ordiscourage whistle blowers?

Are there spot and full audits to determine ifthere are criminal violations occurring inside thecompany? For example, a company engaging ininternational public contracting is not going tohave a category in company financial records forbribes. Those companies should, however, watchfor bribes that appear in other cost recoveryattempts. Has the company considered this? Doesit have an audit and monitoring program? If thebribes go undetected, it may subject the companyto problems beyond the Foreign Corrupt TradePractices Act, because the Internal RevenueService (IRS) code says that bribes arenondeductible. The discovery of a bribe mayoccur during an IRS audit and the company'scompliance program should attempt to ferret outthese kinds of problems internally in order toprevent future occurrences.

What did the company do when it discovereda criminal violation? Were employeesreprimanded? What efforts were made to rectifythe behavior? Was the violation disclosed toauthorities? Were attempts made to providerestitution to injured parties?

The USAM instructs us to:

consider the promptness of any disclosure ofwrongdoing to the government and thecorporation's cooperation in the government'sinvestigation. In evaluating complianceprograms, prosecutors may consider whetherthe corporation has established corporategovernance mechanisms that can effectivelydetect and prevent misconduct. For example,do the corporation's directors exerciseindependent review over proposed corporateactions rather than unquestioningly ratifying

officers' recommendations; are the directorsprovided with information sufficient to enablethe exercise of independent judgment; areinternal audit functions conducted at a levelsufficient to ensure their independence andaccuracy and have the directors established aninformation and reporting system in theorganization reasonably designed to providemanagement and the board of directors withtimely and accurate information sufficient toallow them to reach an informed decisionregarding the organization's compliance withthe law. In re: Caremark, 698 A.2d 959 (Del.Ct. Chan. 1996).

Federal Prosecutions of Business Organizations,Criminal Resource Manual at 162, VII. B.

In evaluating how serious a company is inpreventing corporate crime, it is instructive to seewhere the compliance program is in the corporatehierarchy. Does the person in charge of corporatecompliance have a senior management positionwithin the company? Is it the officer's primaryresponsibility or is it simply added to a host ofother duties? How does the corporate structurerate the importance of its criminal complianceprogram? Does the person running the complianceprogram have the authority to implementprograms or simply the responsibility ofrecommending them to a group whose interestsmay be antithetical to the development of aneffective program?

V. Disclosure policy

The paramount question for prosecutors inevaluating a compliance program is: does thecompany have a policy of disclosure to thegovernment? If so, what are the parameters ofsuch a program? Does the company promptly andregularly report violations of law in which it hasengaged? Does it take all reasonable methods tostop the negative effects of the criminal conduct?Does it turn over its investigative reports? Does itwaive applicable privileges (usually attorneyclient and work product privileges are the relevantconcerns) in an effort to make a full disclosure?Does the company encourage or discourage itsemployees to respond to law enforcementinquiries?

A full and complete disclosure policy is oneof the best ways of demonstrating to thegovernment that the corporation has a non-criminal culture where the criminal behavior isnot pervasive. Section VI, A of the FederalProsecutions of Business Organizations, CriminalResource Manual at 162 states that:


In determining whether to charge acorporation, that corporation's timely andvoluntary disclosure of wrongdoing and itswillingness to cooperate with thegovernment's investigation may be relevantfactors. In gauging the extent of thecorporation's cooperation, the prosecutor mayconsider the corporation's willingness toidentify the culprits within the corporation,including senior executives; to makewitnesses available; to disclose the completeresults of its internal investigation; and towaive attorney-client and work productprotection.

While the Department, EPA, the Securitiesand Exchange Commission (SEC), and manyother governmental bodies have reward policiesfor voluntary disclosure, self reporting doesexpose the company to some initial risk.However, the company runs a much greater riskby nondisclosure.

If a company discovers a problem andchooses not to report it, there is great temptationto engage in behavior designed to hide theconduct. The company can rest assured that adisgruntled employee will, at some point, notifythe authorities, and then efforts to hide the crimeare magnified and the penalties escalate.Moreover, as demonstrated by the NCL case, aninvestigation by law enforcement may already beunderway, the details of which are unknown to thetarget.

The decision not to make disclosure to thegovernment for fear of regulatory action can leadto far more disastrous results than the remedialmeasures the government might require. USAToday recently reported that, as early as 1997,manufacturer Airbus had knowledge of a defect intail fin design. Alan Levin, Near Crash UncoversCrack in Air Safety System, USA TODAY, May27, 2003. American Airlines Flight #587 crashedon November 12, 2001 due to a tail fin break inmid flight. Two hundred and sixty-five peopleperished in that accident. USA Today reportedthat Airbus did not report to federal regulators thatthere was a near accident on a 1997 flight whereina tail fin on one of its jets nearly snapped off inflight. Id. "Had federal regulators known earlierhow easily tail fins could break in flight, the crashof Flight 587-and the deaths of 265 people-mighthave been prevented, according to some accidentinvestigators and aviation safety experts." Id.

If a company does not self-report the crime,the company may not have the ability to end thecrime and make injured parties whole. Forexample, assume a United States company does

public works projects in foreign countries. Thecompany discovers that it procured a lucrativecontract by fraud. Assume further that thecompany does not want to complete the contractonce it discovers its own criminal behavior. If itdoes not report the crime, how does it rectify theerror of its ways? Does it have a mechanism tovoid the contract? Does it have the ability todetermine who the victims (the unsuccessfulbidders) are? Can the company alone cause thepublic contracting entity to rebid the contract? It isobvious that in this scenario, in order to do theright thing, the company needs the government'shelp and it starts with self-disclosure.

VI. Conclusion

The Norwegian and Royal Caribbean casesare instructive when comparing the relationship oftheir approaches to the government with casedisposition. NCL voluntarily disclosed itsproblems to the government and opened itsinvestigative files without an agreement on casedisposition. It disclosed all incidents of itscriminal conduct to multiple jurisdictions.Ultimately, NCL pleaded guilty to one felonycount and paid a one million dollar fine. RCCL,on the other hand, was originally caught in aCoast Guard video off the coast of Puerto Ricosurrounded by an oil slick of its own making.After pleading guilty to that incident, it sought tofrustrate the government's efforts to investigate itsworld-wide practices. One by one, separateinvestigations were opened in six other districts.

RCCL finally read the handwriting on thewall, changed counsel, and approached thegovernment with a global settlement offer. RCCLpleaded guilty to multiple felonies in six differentjudicial districts and was fined over $25 milliondollars.

In taking decidedly different positions to lawenforcement inquiry, self-policing, and disclosure,it was appropriate for the government not to viewthese entities as similarly situated defendants.Making the decision to charge a corporationrequires a more far-reaching and complex analysisthan the decision to charge individuals.Examining a corporation's compliance programmay offer great insight into corporate culture andwhether crime is pervasive or rare. In analyzing acorporate compliance program, there are manydifferent components to consider, but perhaps themost telling is a business entity's disclosure policyto the government.�


ABOUT THE AUTHOR

�David M. Nissman is the United StatesAttorney for the District of the Virgin Islands. Heis also the author of PROVING FEDERAL CRIMES

(2001) and the former Editor-in-Chief of theUNITED STATES ATTORNEYS' BUL LETIN .a

Professional Responsibility Issues InCorporate Fraud MattersClaudia J. FlynnDirector, Professional ResponsibilityAdvisory Office

Rima SirotaLegal Advisor, Professional ResponsibilityAdvisory Office

I. Introduction

Corporate fraud investigations andprosecutions raise a host of professionalresponsibility issues. This article will address suchissues, which may include choice of law, receiptof potentially privileged information,communications with represented persons,conflicts of interest, and confidential information.Because advice from the ProfessionalResponsibility Advisory Office (PRAO) isprovided only to Department of Justice(Department) attorneys and is otherwiseconfidential, this discussion identifies issues thatmay arise in corporate fraud matters but does notpurport to answer the questions raised or to offerany advice as to the appropriate course of action.In analyzing the particular issues in an actualmatter, Department attorneys may consult withtheir office's Professional Responsibility Officersand with PRAO as appropriate. PRAO may becontacted by telephone at 202-514-0458 orthrough the Department's e-mail system at PRAO,DOJ.

Please note that this article discussescorporate fraud issues in the context of the ABAModel Rules of Professional Conduct. Althoughthis discussion provides a general framework foranalysis, attorneys must analyze issues under therelevant bar rules applicable in their particularjurisdiction.

II. An analytical framework

To put the professional responsibility issuesinto context, we will consider the hypothetical,but not atypical, circumstances surrounding thegovernment's investigation of corporate fraudinvolving Company Z and its top officers.

You are assigned to the Company Zinvestigation. You are admitted to the bar inWashington, D.C.; your colleague on the matter isadmitted in Connecticut; Company Z isheadquartered in Delaware; interviews may occurin several states; the grand jury is in Texas. Whichrules of professional responsibility should you beconcerned with?

A. Choice of law

In any matter, the first step is to determinewhich rules of professional responsibility governyour conduct. Each state has adopted its own rulesof professional responsibility. Each federal districtcourt has adopted, by local rule, the rulesapplicable to practice in that jurisdiction. Manyfederal district courts simply incorporate the rulesadopted by the state in which the court sits. Somefederal district courts adopt the state rules withcertain modifications, while others adopt the ABAModel Rules or Code, and still others have draftedtheir own rules. Where the substance of thevarious rules potentially applicable in a matterconflict, a choice of law analysis is required.Some local rules are silent on this subject, leadingthe inquirer to consult traditional choice of lawprinciples for guidance. Other rules, includingModel Rule 8.5(b), specifically set forth choice oflaw principles for professional responsibilityquestions. In addition, the Department haspromulgated guidance for its attorneys on thissubject. See 28 C.F.R. Part 77.4.


B. W orking with agents

You are working with Agent Undercover toinvestigate the Company Z fraud allegations.What are your responsibilities regarding AgentUndercover's actions? How does yourinvolvement affect the agent's investigation?

Non-lawyers, of course, are not bound by therules of professional conduct. Nonetheless,lawyers may be held accountable, under the rules,for the actions of non-lawyers, including agentswith whom they work. In particular, the rulesrequire that lawyers ensure that agents and othernon-lawyers, with whom they are working alsoabide by the rules. Failure to do so may result innegative consequences for the lawyer, includingdisciplinary action by the local bar association.Moreover, the failure of agents to abide by therules governing the lawyers with whom they workmay have negative consequences for the case,possibly including the exclusion of evidence. It istherefore appropriate in this context for lawyers toconsider the potential application of Rules 5.3(Responsibilities Regarding Non-lawyerAssistants) and 8.4 (providing that it ismisconduct for an attorney to violate the rulesthrough the acts of another).

C. Receipt of privileged information

On her own initiative, Ms. Executive, a high-level Company Z employee, mails the FBI a stackof documents that includes copies of lettersbetween Ms. Lawreview, Company Z's GeneralCounsel, and Firm X, Company Z's outsidecounsel. May your team review these documents?

It is not unusual for an employee or otherinsider in the company under investigation toprovide the government with information that ispotentially damaging to the company. Suchinformation arrives at the government's doorstep"tied up with a ribbon" as it were, with nogovernment involvement in obtaining theinformation. Rule 4.4 (Respect For Rights ofThird Persons) may be applicable, dependingupon the circumstances and the local version andinterpretation of the rule. Model Rule 4.4(a)prohibits a lawyer from using "methods thatviolate the legal rights" of a third party, includinga corporation. While the government in thissituation did nothing at all to obtain thepotentially privileged information, you will needto determine the propriety of reviewing and usingsuch information once it has been received. Insome circumstances, it may be that the documentsdo not contain privileged information or theprivilege may have been waived.

D. Comm unications with employees of arepresented company

Ms. Executive then calls the FBI. She saysthat she wants to talk to the government aboutCompany Z's misdeeds. A Firm X partner hasinformed the government that she represents bothCompany Z and all Company Z employees in thismatter. May the agent talk to Ms. Executive?

Model Rule 4.2 prohibits communications"about the subject matter of the representationwith a person the lawyer knows to be representedby another lawyer in the matter, unless the lawyerhas the consent of the other lawyer or isauthorized to do so by law or a court order." Here,you clearly wish to discuss with Ms. Executivethe matter on which Company Z is represented.Accordingly, you will need to determine whetherMs. Executive, herself, is "off-limits" for purposesof the Rule. Generally, declarations by corporatecounsel that they represent all employees of theorganization have been rejected by courts and barassociations. Rather, state rules and local case lawdefine certain categories of employees as"standing in the shoes of" the representedorganization with many states adopting thefollowing test: where an organization isrepresented, a lawyer may not contact employeeswith managerial responsibilities, employeeswhose acts or omissions in connection with thematter may be imputed to the organization forliability purposes, or employees whose statementsmay constitute an admission on part of theorganization. The language and interpretation ofthe rule in this regard vary significantly from onejurisdiction to the next and you will need todetermine whether Ms. Executive is "off limits"under the relevant local version of Rule 4.2. If Ms.Executive is individually represented by counseland that counsel consents, most jurisdictionswould permit you to communicate with Ms.Executive notwithstanding the objections ofcorporate counsel. Finally, note that mostjurisdictions give lawyers significantly greaterlatitude in contacting former employees of arepresented organization.

Once you determine that the rule does notprohibit communications with a particularemployee, other rules of professionalresponsibility may come into play, including theRule 4.3 prohibitions against implying that thelawyer is disinterested in the matter and givinglegal advice to the unrepresented person (exceptthe advice to obtain counsel). Moreover, Rule 4.4cautions against seeking to obtain theorganization's privileged information from itsemployees.


E. Preindictment comm unications

Having obtained the consent of Ms.Executive's individual counsel, you ask Ms.Executive to engage the Chief Executive Officerof Company Z, Mr. Bossman, who is representedby counsel, in a discussion of issues pertinent tothe investigation. May you arrange thisundercover operation?

As noted above, Model Rule 4.2 contains anexception for communications that are "authorizedby law." Most local versions of Rule 4.2 containthis exception as well. In many jurisdictions,preindictment noncustodial covertcommunications by law enforcement agents areconsidered to fall within the "authorized by law"exception. Certain other jurisdictions havedetermined that the Rule simply does not apply tosuch circumstances in the first place. Somejurisdictions have extended this exception to overtpreindictment communications in criminal mattersand precomplaint communications in civilenforcement matters as well.

F. Subject matter of the communication

An indictment is returned against CompanyZ's Chief Executive Officer, Mr. Bossman, andthe case is set in District Court. You learn that Mr.Bossman has offered to pay Ms. Informant to killa government witness. May you wire up Ms.Informant and send her to have a conversationwith M r. Bossman about the alleged murder-for-hire?

Model Rule 4.2 applies only tocommunications regarding the subject matter ofthe representation. Consequently, you will need todetermine whether Mr. Bossman is (indeed,whether he can be) represented on this newalleged crime. If you determine that the rule doesnot prohibit communications regarding this newcrime, you will need to determine what steps, ifany, are required or prudent to avoidcommunications with Mr. Bossman on the subjectmatter of the indictment on which he clearly isrepresented. Depending on the circumstances, onepossibility might be to set up a separate "taintteam" to investigate the new crime.

G. Conflicts and confidential information

You learn that one of the attorneysrepresenting Mr. Bossman also represents Ms.Executive, an important government trial witness,in her ongoing divorce matter. What do you do?

Model Rule 1.7, and most local conflictsrules, define a conflict as the representation of oneclient who is directly adverse to another client, orwhere there is a significant risk that representation

of one client will be materially limited by thelawyer's responsibilities to another client, a formerclient, a third person, or the lawyer's own personalinterests. Moreover, Rule 1.6 provides that alawyer may not reveal confidential clientinformation or use such information to thedetriment of a client. Here you will need toconsider whether opposing counsel's obligationsto his divorce client will likely impair hisrepresentation of Mr. Bossman. For example, willthe lawyer be able to honor his obligation toprotect Ms. Executive's confidences when hecross-examines her? Many courts have noted thata government prosecutor should bring suchpotential conflicts to the court's attention as soonas possible. This obligation is seen to arise fromthe prosecutor's obligation to seek justice, toprotect the record and verdict, and to avoidwasting judicial resources.

H. Proposed amendments to Rule 1.6

Congratulations! The jury returns a guiltyverdict against Mr. Bossman on all counts. TheGeneral Counsel, Ms. Lawreview, returns to heroffice at Company Z where there is a stack offinancial documents awaiting her approval.Noticing that the numbers do not quite add up,Ms. Lawreview goes back over previous financialdocuments that she filed with the SEC onCompany Z's behalf and realizes then that thefraud at Company Z is much bigger than Mr.Bossman's personal transgressions. What may Ms.Lawreview do with this information?

Model Rule 1.6 permits disclosure ofconfidential information in certain limitedcircumstances, such as to prevent reasonablycertain substantial bodily injury, or where thepublic interest in disclosure is deemed tooutweigh the policy protecting client confidences.In light of recent changes in applicable law,including the Sarbanes-Oxley Act of 2002 andrelated rules regulating lawyer professionalconduct by the Securities and ExchangeCommission, various ABA committees haveproposed amending M odel Rule 1.6. Thisproposed amendment would permit a lawyer toreveal confidential client information to the extentreasonably necessary to prevent the client fromcommitting a crime or fraud in which the clienthas used a lawyer's services, and which isreasonably certain to result in substantial financialinjury or to mitigate or rectify such injury that hasalready occurred. Such provisions already exist inthe local version of Rule 1.6 in a number ofjurisdictions.


III. Conclusion

The rules of professional conduct must betaken into account at every stage of a corporatefraud matter, from investigation throughsentencing. Familiarity with these issues at theoutset will help guide your decisions throughout.As always with these sometimes difficult issues,when in doubt seek guidance at the earliestopportunity from the professional responsibilityresources available to you.�

ABOUT THE AUTHORS

�Claudia J. Flynn is the Director of theProfessional Responsibility Advisory Office. Priorto being appointed to that position in January2000, she held a number of positions in theDepartment of Justice: Senior Counsel to theDirector, Executive Office for United StatesAttorneys (September 1997 to January 2000);Chief of Staff to the Assistant Attorney General,Criminal Division (February 1996 to September1997); Chief of the Criminal Division(1994-1996); Deputy Chief of the CriminalDivision (1989-1992); Assistant U.S. Attorney forthe District of New Jersey (1984-1989); andAssociate Independent Counsel at the Office ofIndependent Counsel (Adams) (1992-1994).

�Rim a Sirota is a Legal Advisor in theProfessional Responsibility Advisory Office. Ms.Sirota has been with the Department since January2000, when she became Counsel for Legal Ethicsin the Environment and Natural ResourcesDivision. Prior to joining the Department, Ms.Sirota was a partner in private practice at aWashington, D.C. litigation firm. M s. Sirotacurrently serves as an appointed HearingCommittee member for the District of ColumbiaBoard on Professional Responsibility.a

The FBI Response to Corporate FraudMichael DegnanSupervisory Special AgentEconomic Crimes UnitFederal Bureau of Investigation

When the Enron scandal surfaced in late2001, stockholders and business analystsstruggled to comprehend how a seeminglyindestructible energy giant could lie in ruinsamidst one of the largest business frauds inUnited States history. At that time, Enronappeared to be an anomaly in terms of fraudulentfinancial reporting to the public. Less than twoyears later, the FBI is investigating 118 cases ofcorporate fraud and the list continues to expand.Approximately three to six new investigations areinitiated each month. The majority of these casesinvolve losses to investors in excess of $100million dollars. The shareholder loss surpasses $1billion dollars in at least ten cases.

Although investigations regarding Enron,Worldcom, and HealthSouth, attract significantmedia attention, the impact of corporate fraud on

individual shareholders is similar whether theyinvested with a Fortune 500 Company or a lesserknown corporation. After the fraud is exposed, thevalue of their shares decrease significantly orbecome worthless.

In July 2002, President Bush formed a taskforce comprised of Senior Executives fromnumerous federal agencies to address the barrageof corporate fraud cases which surfaced afterEnron.

As the lead agency dedicated to investigatingcorporate fraud, the FBI has focused its efforts oncases which involve accounting schemes,self-dealing by corporate executives, andobstruction of justice designed to conceal illegalactivities from criminal and regulatory authorities.By utilizing this approach, the FBI is pursuingallegations which parallel the Department ofJustice's (the Department) definition of corporatefraud.

Based on the number of cases which emergedin early 2002, the FBI developed an investigative


strategy designed to tackle this crime problem andprosecute the executives engaged in corporatefraud. The actions implemented within the FBIinclude:

• An Emphasis on Quick Turnaround -Although these cases can be long anddocument intensive, the FBI assigns seasonedinvestigators with excellent interpersonalskills to cultivate informants within eachcompany for a roadmap of the fraud.

• Formation of Reserve Teams - Special Agentswho are Certified Public Accountants orpossess strong business backgrounds aremembers of a reserve team which supportsFBI Field Offices with large corporate fraudinvestigations. The reserve team membersreceive temporary duty assignments to assistwith witness interviews, search warrants, andreview of financial records.

• Telephone Hotline - The FBI opened an 800line to receive assistance from the public oncorporate fraud. Since February 2003, over1300 calls have been logged. Numerous caseshave been initiated from tips provided byprivate citizens who contacted the hotline.The telephone number for the CorporateFraud Hotline is 888-622-0117.

• Investigative Partnerships - The FBI formedeffective partnerships with the Securities &Exchange Commission (SEC), Department ofLabor (DOL), Commodity Futures TradingCommission (CFTC), Federal EnergyRegulatory Commission (FERC), InternalRevenue Service (IRS), and U.S. PostalInspection Service, to pool the investigativeresources of agencies with proficiencies inspecific arenas (tax, pension, energy,securities).

To date, 142 individuals have been chargedwith violations related to the Department'sdefinition of corporate fraud. There have beensixty-two convictions, and numerous cases arepending trials.

One of the most disturbing aspects ofcorporate fraud is illustrated by the cross sectionof companies which allegedly have been involvedin this type of scandal. Over the past year, the FBIhas investigated corporate fraud schemes whichled to the prosecution of executives atHomestores.com, Imclone, K-Mart, Rite Aid,Qwest, Worldcom, and other well knowncorporations. Corporate fraud is not unique to anybusiness segment or geographic area. Its effect hastouched a variety of industries and millions ofshareholders across the United States.

In most of the accounting fraud cases, thepurpose of the scheme is to deceive investors andWall Street analysts about the true financialcondition of the company. In carrying out thisfraud, the share price of the subject companyremains artificially inflated based on fictitiousfinancial performance indicators. Many corporateexecutives become embroiled in illegal insidertrading when their personal stock holdings areliquidated simultaneously with their participationin reporting false information to the public.

In far too many companies, "cooking thebooks" has become part of the corporate culture.In the case of HealthSouth, employee meetingswere held to devise methods in which corporateearnings could be inflated despite the trueoperating results of the company. Thesediscussions became known as "family" meetingsand participants were "family" members. Duringthe meetings, "family" members described theirplans to fill the "hole" in order to achieve thedesired earnings of corporate executives. Thephony accounting entries utilized to fulfill thisgoal were referred to as "dirt". To date, elevenformer HealthSouth employees have been chargedcriminally for their roles in this scheme.

The accounting fraud investigations, over thepast year, have uncovered a variety of recipesutilized by corporate executives to "cook thebooks" of their companies. Each method isdesigned to make the company appear moreprofitable to the outside world. This illicit goal isprimarily accomplished by increasing revenues ordecreasing expenses. The FBI investigation ofRite Aid revealed that bogus accounting entrieswere booked continuously between 1997 and1999 in order to inflate revenues. In the case ofWorldcom, corporate expenses were improperlyreclassified as assets to make the company appearmore lucrative. Overall, FBI investigations haveuncovered schemes involving phantom sales,backdated sales contracts, undisclosed side deals,illegal swap transactions, and hidden expenses,designed to deceive regulators and shareholdersabout the true financial condition of publically-traded companies.

Unfortunately, the number of open corporatefraud investigations has yet to reach a plateau.With several new cases initiated each month, theFBI continues to dedicate its personnel to thiscrisis in order to prosecute corrupt executives andstabilize the public markets which have beennegatively impacted by these scandals.�


ABOUT THE AUTHOR

�Michael Degnan has been a Special Agent withthe FBI for eleven years and is a Certified PublicAccountant licensed in the State of New York.From 1992-1994, he served in the FBI'sWashington Field Office and investigatedespionage cases involving employees of severalU.S. Government agencies. From 1994-2002, hewas assigned to the White Collar crime branch ofthe New York Office where he investigated casesinvolving securities and commodities fraud. Mr.Degnan is currently a Supervisory Special Agentin the Economic Crimes Unit at FBI Headquartersand oversees the FBI's Corporate Fraudprogram.a


'Zero Tolerance' for Corporate FraudCopyright 2003, Wall Street Journal. Reprintedwith permission.

By Larry D. Thompson

Monday, July 21, 2003

A year ago, President Bush created theCorporate Fraud Task Force to oversee acomprehensive law enforcement response to thespate of frauds at major corporations that rockedour markets and damaged investor confidence.Some have argued that certain businesses aresimply too big or economically important to besubjected to criminal prosecution, even forpervasive or serious criminal conduct by seniormanagement. I strongly disagree.

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It is a bedrock principle of American law thatbusiness organizations, including corporations,may be held to account by the criminal law for thewrongdoing of employees or agents. In 1909, theSupreme Court, in the New York Central &Hudson Railroad case, held that "[w]e see no validobjection in law, and every reason in publicpolicy" to extend criminal liability to corporationsfor the conduct of their employees. Even at theturn of the century the court recognized theeconomic power of corporations (it noted that the"great majority of business transactions" areconducted through corporations) and thatcorporations develop cultures that may eitherinstill respect for the law or breed contempt andmalfeasance. In the latter instance, theorganization itself must be held accountable forthe culture and conduct it promotes. Regulatorysanctions are often not sufficient. They canbecome simply a "cost of doing business" -- a costthat can be passed onto customers andshareholders.

In New York Central, the court alsorecognized that without corporate criminalliability, there would be no deterrent to acorporate culture that -- expressly or tacitly --condones criminal conduct. Instead, corporationscould merely appoint a "vice president in chargeof going to jail" who would serve as a scapegoatfor wrongful acts that actually benefitted thecorporation.

Corporations should not be treated lenientlybecause of their artificial nature, nor should theybe subject to harsher treatment. The JusticeDepartment always takes into account the real

world results of prosecutorial decisions. Thedepartment has issued guidance to prosecutorsdirecting them to consider a number of factorsbefore deciding whether to seek an indictmentagainst a corporation. These include thepervasiveness of the wrongdoing in thecorporation, the nature and seriousness of theoffense, the corporation's history of similarconduct and the collateral consequences ofprosecution, including disproportional harm toshareholders and innocent employees. Wherecompanies have fostered a culture of fraud anddeceit, however, it is the company and managerswho bear the blame for harm to employees andshareholders, not the prosecutors who are merelydoing their jobs.

Some have also argued that offering acorporation leniency in return for full and opencooperation with a government investigation issomehow "coercive." I strongly disagree with thisnotion. While it may not redound to the benefit ofcorrupt corporate officers, it is always in thecorporation's interest to cooperate fully with thegovernment so that matters under investigationcan be resolved as quickly and fairly as possible.

The Justice Department has directed itsprosecutors to evaluate the authenticity andcompleteness of cooperation from corporationsunder investigation. This is important because itallows the government to conserve its limitedresources in investigations where cooperation ismeaningful and reflects management'scommitment to an acceptance of responsibility forthe wrongful conduct at issue. The direction wasnecessary because some attorneys who appearbefore the department purporting to represent acorporation are in fact representing the interests ofmanagement. They have forgotten who their clientis. As one learns in a first year corporate lawclass, when you represent a corporation yourclient is the entity -- not its management.Disturbingly, a recent survey by the AmericanCorporate Counsel Association revealed that 20%of in-house counsel felt that their corporateculture emphasized "senior management" as theclient, rather than the corporation as a whole.

The criminal law sets a standard whosetransgression is, and ought to be, swift anddecisive. Vigorous criminal enforcement aimed atboth bad corporate executives and corporations isnot only harmonious with, but also mandatory for,the country's economic vitality. A strong regime


of criminal enforcement leaves honest businesspeople free to compete, while preventing a fewbad apples from spoiling the barrel.

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Mr. Thompson, Deputy Attorney General, chairsthe Corporate Fraud Task Force.

Larry D. Thompson, 'Zero Tolerance' forCorporate Fraud, WALL ST. J., Jul 21, 2003 at A-10.


New York no longer has dibs onsecurities fraudInvestigators across the countrytarget white-collar crime

Copyright 2003, USA TODAY. Reprinted withpermission.

By Greg Farrell

BIRMINGHAM, Ala. -- In a modest office in thislaid-back southern city, Alice Martin is changingthe way the U .S. government fights corporatecrime.

When Martin, the local U.S. Attorney,extracted guilty pleas in March from two formerchief financial officers at HealthSouth, shebecame the first federal prosecutor to enforce aprovision of the Sarbanes-Oxley law holding topexecutives responsible for the earnings statementsthey issue.

With those guilty pleas, she also joined thewave of federal prosecutors across the USA who,following meltdowns at Enron and WorldCom,have suddenly made white-collar crime of utmostconcern. Until recently, most prosecutors leftsecurities fraud cases to experts in New York.

"We have an important role in helping toenforce securities laws and restoring investorconfidence in the market," says Martin. "Investorshave to know that illegal activity is being caughtand stopped."

Corporate fraud has emerged as "one of ourtop priorities, second only to fighting terrorism,"says Jeffrey Collins, the U.S. Attorney in Detroitwho's investigating alleged fraud at Kmart.

In 2002, investigations by the Securities andExchange Commission resulted in 259 criminalfilings brought by 30 U.S. Attorneys' offices."That is an astounding statistic in terms of thenumber of cases and the breadth of interest amongcriminal prosecutors," says Stephen Crimmins, aformer SEC attorney. "Never before in the historyof the SEC has there been such interest bycriminal prosecutors."

The shift is partly due to the popular disgust atcorporate greed that swelled into public view atEnron. "In the old days, a complex accountingprosecution would make a jury's eyes glaze over,and jurors had no particular hostility toward thedefendant," says Jack Coffee of Columbia

University Law School. "Today, they come insuspicious of any corporate officer."

The Bush administration's desire to show it'stough on corporate crime also is driving thetransformation of securities fraud from an arcanespecialty of New York litigators. Last year, inresponse to the rash of high-profile scandals,President Bush formed the corporate fraud taskforce at the Department of Justice. Dismissed atfirst by critics who thought it would be little morethan window dressing, the task force hasdramatically altered the way securities fraud casesare handled.

At an unusual conference of U.S. Attorneyslast September, Deputy Attorney General LarryThompson urged all the attendees to ramp up theirinterest in securities fraud cases, and promisedassistance to any U.S. Attorney who needed it."The reason you are here today is that the entirefederal law enforcement community needs to beinvolved in the task force's efforts againstcorporate fraud," he told the assembledprosecutors. "Significant corporate fraud mattersarise not only in New York and Los Angeles, butin small cities and towns throughout the country."

Those efforts seem to have borne fruit.Notable cases now being handled outside NewYork:

* HealthSouth in Birmingham. Martin, theU.S. Attorney for the Northern District ofAlabama, has gotten 11 guilty pleas so far in theinvestigation of the $2.5 billion fraud atHealthSouth. Former CEO Richard Scrushy couldbe indicted in the next few weeks. In another localcase, against defunct shoe company Just for Feet,Martin has secured one guilty plea.

* Kmart in Detroit. Collins is leading theinquiry into alleged financial mismanagement atKmart. Two former Kmart executives have beenindicted.

* Qwest in Denver. U.S. Attorney JohnSuthers has charged four former managers fromQwest Communications in relation to a criminalprobe of accounting problems at the beleagueredtelecom.

* Freddie Mac in Alexandria, Va.. U.S.Attorney Paul McNulty has opened aninvestigation into allegations that the former


president of Freddie Mac destroyed documentsthat were part of an internal accounting probe.The office is already investigating questionableaccounting at AOL Time W arner.

A few years ago, those cases would probablyhave been handled in New York. Over severaldecades, federal prosecutors in Manhattanfostered a close working relationship with theSEC to handle nearly all major securities fraudcases. But in recent years, the landscape haschanged.

"Orange juice isn't just for breakfast anymore,and securities fraud isn't just for the SouthernDistrict of New York anymore, either," saysCharles Niemeier of the Public CompanyAccounting Oversight Board, created by theSarbanes-Oxley Act to monitor auditing firms."There's a sea change in the way cases are beinginvestigated and prosecuted."

At the September conference, Thompsonarranged for James Comey, the U.S. Attorney forthe Southern District of New York, to speak.Comey's message to his fellow U.S. Attorneyswas simple: If corporate fraud pops up in yourbackyard, you'd better move quickly; otherwise,his prosecutors in Manhattan will swoop in.Comey also offered to provide assistance to anycolleague who requested it.

In the current wave of scandals, Comey'soffice had already snagged one of the biggest:WorldCom. It is also investigating allegations offraud at Adelphia, Vivendi and Royal Ahold. Butthose cases have garnered a fraction of theattention that has been focused on Comey'sobstruction charges against Martha Stewart.

Other New York-area prosecutors are alsoactive in securities fraud cases: RoslynnMauskopf, the U .S. Attorney in Brooklyn, isinvestigating American Tissue; the U.S.Attorney's office in Newark, N.J., is handling thecriminal investigation of financial fraud atCendant; and Manhattan District Attorney RobertMorgenthau is spearheading the investigation offormer Tyco CEO Dennis Kozlowski.

New York street brawls

But it wasn't just Comey's current caseloadthat served as a warning to the other U.S.Attorneys; it was the long history of the SouthernDistrict of New York, particularly under Comey'spredecessor, Mary Jo White, for snagging thebiggest corporate fraud cases, sometimes afterfierce wrangling.

In New York legal circles, stories of White'ssharp elbows in pursuit of securities fraud cases

are legend. Occasionally, the brawls betweenWhite's prosecutors and their counterparts inBrooklyn or rivals at Morganthau's D.A. officespilled into public view.

But current and former prosecutors from eachof those offices say that there's much morecooperation in New York now. Part of the credit,they say, goes to Comey, who has shown littleinterest in internecine combat. Part of it also goesto Deputy Attorney General Thompson, whosnuffs battles before they begin.

"When there are turf disputes," Comey says,"Larry Thompson settles them." Nevertheless, headds, "Competition among U.S. Attorneys ishealthy. Taxpayers will get better lawenforcement if people are working harder to makecases."

Even White -- who joined Debevoise &Plimpton after leaving the U.S. Attorney's office -- applauds the shift. "From an enforcementperspective, you need other offices involved," shesays. "Sometimes, it makes more sense to do acase in San Francisco or Pennsylvania, where theheadquarters are. I considered that a healthymove, despite my reputation. Given the number ofscandals, the proliferation of securities fraud,you've got a lot of volume, and a lot of volumeneeds experts everywhere."

By the late 1990s, at the height of the Internetboom, San Francisco emerged as an importantcenter of securities fraud prosecutions. The U.S.Attorney's office in Miami formed a securitiesfraud task force in 2001, almost a year beforeEnron melted down. Last year, an undercoveroperation called "Bermuda Short" resulted in theindictment of 58 individuals alleged to be part of amassive Florida stock scam.

Tom Newkirk, an associate director of theSEC's division of enforcement, says the shift awayfrom doing cases in a limited number ofjurisdictions kicked into high gear with theestablishment of Bush's corporate fraud task force."It's completely different now," he says. "Thingsare moving much faster."

If prosecutors in the field need assistancefrom Washington, they get it. Says Collins, theU.S. Attorney in Detroit: "No one's operating inthe dark. If the need arose, we would not hesitateto call on them."

Justice delayed, deferred

Speed is the motivating force behindThompson's push to get securities fraud caseslaunched by prosecutors across the nation. The oldsystem of giving the Southern District of New


York major cases threatened to create a backup ofprosecutions at a time when corporate fraud wasemerging as a hot political topic with Democratsand Republicans alike.

Thompson would not comment for this story,but at last September's conference, he told theprosecutors: "Our goal is simple. W e need to hitthe bad guys hard and take away their money.When we work together, we can harness thepower of the SEC to bring civil actions to freezeassets."

But the push to quickly freeze a target's assetsmight have contributed to the task force's onemajor blunder. In March, when Martin secured thefirst of her guilty pleas in the HealthSouth case,the SEC's Atlanta office filed inside tradingcharges against Scrushy. A judge granted theSEC's request to freeze Scrushy's assets.

In May, after a hearing to determine if theSEC could maintain a freeze on his assets, U.S.District Judge Inge Johnson ruled in favor ofScrushy. In a blistering opinion, she criticized theSEC's handling of the case, noting that the JusticeDepartment itself was trying to stop the SEC fromimpinging on its investigation.

If Martin's prosecution of criminalwrongdoing at HealthSouth succeeds, then theasset-freeze setback will be forgotten.

Meanwhile, the national crackdown oncorporate fraud raises the question of whethersome prosecutors are slacking off on other crimes,such as drug-trafficking and money laundering.That's not happening, says Martin: "Other areasare not suffering. Our attorneys are simplyhandling bigger caseloads."

To make sure there's enough manpower toprosecute corporate crime, the Justice Departmentis staffing up. Thompson plans to send 35 newprosecutors and 102 support staff into the field. Asource at the Justice Department says the newpositions should be filled by the end of thesummer.

2002 cases

U.S. Attorneys' district offices that prosecutedsecurities cases

in 2002 (1):

Arkansas - Western

California - SouthernNorthernCentral

Colorado

Washington, D.C.

Florida - Middle Southern

Georgia - Northern

Illinois - Northern

Indiana - Southern

Iowa - Southern

Louisiana - Middle

Maryland

Massachusetts

Michigan - Eastern

Minnesota

North Carolina - Middle

New York - EasternSouthern

Ohio - NorthernSouthern

Oregon

Pennsylvania - EasternMiddle

Texas - EasternNorthernWestern

Utah

Washington - Western


1 -- Year runs from Oct. 1, 2001, to Sept. 30,2002.

Source: Securities and Exchange Commission

_____

Subject : CRIME: FRAUD:INVESTIGATION: SECURITIES

Artwork : PHOTO, Color, Gary E. Tramontinafor USA TODAY; PHOTO, Color, Paul Sancya,AP; PHOTO, B/W, David Karp, AP

Slug : USATTORNEYS02

Cutline : In Birmingham, Ala.: Alice Martin,U.S. Attorney in Birmingham, is leading theprosecution of HealthSouth, a hospital chaininvolved in an accounting scandal. Martin hasobtained 11 guilty pleas so far in the case, whichwas opened this year.

In Detroit: U.S. Attorney Jeffrey Collins ispursuing an investigation of Kmart's financialsituation.

Edition : FINAL

Dateline : BIRMINGHAM, Ala.

Story ID : 5288734

Greg Ferrell, New York no longer has dibs onsecurities fraud, USA TODAY, Jul 2, 2003 at B.01.

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