Notes and highlights for
The Chickenshit Club
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THE DEPARTMENT OF JUSTICE IS a loose federation of ninety-four offices around the country, each a realm unto itself, run by a US attorney who is almost untouchable by headquarters in faraway Washington, DC. Of all those offices, the Southern District of New York, located at the bottom tip of Manhattan, has the smartest and ablest prosecutors in the land. Any alum of the office will be happy to verify that.
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Today the office specializes in the most complex and difficult criminal cases: corporate white-collar fraud, often securities law violations. Insiders relish its nickname: the “sovereign” district, for its penchant for claiming jurisdiction over any such case from any corner of the United States, the other ninety-three offices be damned.
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In January 2002, early in the George W. Bush presidency, the White House appointed James Comey the fifty-eighth US attorney for the Southern District of Manhattan.
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Then Comey asked the seated prosecutors a question: “Who here has never had an acquittal or a hung jury? Please raise your hand.” The go-getters and résumé builders in the office were ready. This group thought themselves the best trial lawyers in the country. Hands shot up. “Me and my friends have a name for you guys,” Comey said, looking around the room. Backs straightened in preparation for praise. Comey looked at his flock with approbation. “You are members of what we like to call the Chickenshit Club.”
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Comey had laid out how prosecutors should approach their jobs. Prosecuting wrongdoers is an awesome responsibility, to be undertaken carefully and judiciously. But prosecutors—unlike other lawyers—are not simply advocates for one side. They are required to bring justice. They need to be righteous, not careerist. They should seek to right the biggest injustices, not go after the easiest targets. Victory in the courtroom should be a secondary concern, meaning that government lawyers should neither seek to win at all costs nor duck a valid case out of fear of losing. Federal prosecutors should not be judged on their trial record, whether they are criticized, or what the political consequences might be of their prosecutions. Comey wanted his prosecutors to be bold, to reach and to aspire to great cases, no matter their difficulty.
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America’s economic history has unfolded in a series of booms followed by busts followed, crucially, by crackdowns. After the stock market crash of 1929, congressional hearings channeled public outrage and resulted in landmark laws regulating Wall Street and creating the Securities and Exchange Commission in 1934. A few years later, the new SEC helped put the head of the mighty New York Stock Exchange (NYSE) in prison. Though inconsistent, the SEC over the intervening decades emerged as one of the most respected government regulatory bodies. The SEC is the country’s most important corporate regulator, overseeing publicly traded companies and the nation’s capital markets. The agency has civil powers, and must team up with various offices of the Department of Justice when a securities law violation turns into a criminal investigation. After the go-go years of the late 1960s, the SEC worked closely with the Southern District to take on top law firms, top accounting firms, and top executives who had helped perpetrate corporate frauds. After the savings and loan scandals of the 1980s, when hundreds of small banks across the country failed due to reckless real estate loans, the Department of Justice prosecuted over a thousand people, including top executives at many of the largest failed banks. After the Michael Milken–run junk bond boom and blow-up of the late 1980s, prosecutors spent years digging up evidence of stock manipulation and insider trading at major investment banks and law firms, prosecuting some of the most powerful Wall Street figures of the era. In the early 2000s, the burst Nasdaq bubble revealed a corporate book-cooking pandemic. Top officers from giants such as Enron, WorldCom, Qwest Communications, Adelphia, and Tyco International ended up in prison. Recklessness and stupidity fuel booms, but usually so do crimes. By contrast, after the 2008 financial crisis, the government failed. In response to the worst calamity to hit capital markets and the global economy since the Great Depression, the government did not charge any top bankers.
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According to a Wall Street Journal analysis of 156 criminal and civil cases brought by the Justice Department, the Securities and Exchange Commission, and the Commodity Futures Trading Commission against ten of the largest Wall Street banks since 2009, in 81 percent of the cases, the government neither charged nor even identified individual employees. In the remainder, the government only charged forty-seven low and midlevel employees. Merely one was a boardroom-level executive, whom the SEC charged civilly.2
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Today’s Department of Justice has lost the will and indeed the ability to go after the highest-ranking corporate wrongdoers. The problem did not begin in the aftermath of the 2008 crash—and it has not ended. Prosecutors don’t simply struggle to put executives for “Too Big to Fail” banks in prison. They also cannot hold accountable wrongdoing executives from a gamut of large corporations: from pharmaceuticals, to technology, to large industrial operations, to retail giants.
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James Comey’s exhortation came at the beginning of a dramatic and little-understood shift in how the government prosecutes white-collar corporate crime. After the post-Nasdaq-bubble prosecutions of the early 2000s, the Justice Department began to suffer fiascos, losses in court, damning acts of prosecutorial abuse, and years of intense lobbying and pressure from corporations and the defense bar to ease up. Prosecutors lost potent investigative tools and softened their practices, changes that have made it harder to gather evidence and conduct even the most basic investigations. Compounding this issue, the Justice Department has been hurt by budget constraints. The FBI, which usually conducts investigations for the department, shifted resources to antiterrorism efforts in the wake of 9/11. The Justice Department has kept track of white-collar cases only since the early 1990s. In the four years from 1992 through 1995, white-collar cases averaged 19 percent of overall cases. In the four years from 2012 to 2015, that number had fallen to just under 9.9 percent. The Department of Justice wasn’t just going after fewer cases, but easier cases, contrary to Comey’s admonition. In that same period, the conviction rate was slightly higher: 91 percent in the 2012–15 period, compared with 87 percent in the early 1990s.3
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To compensate for these changes, the Department of Justice shifted from targeting individual corporate executives with trial and imprisonment. Instead, prosecutors switched to a regime of almost exclusively settling with corporations for money. In these negotiations with corporations, prosecutors discovered they had great leverage. Since 2001, more than 250 federal prosecutions have involved large corporations. These include some of the biggest names in corporate America: AIG, Google, JPMorgan Chase, and Pfizer among them.4 The majority of these have been negotiated deals, not indictments. From 2002 through the fall of 2016, the Justice Department entered into 419 such settlements, called deferred prosecutions and nonprosecution agreements, with corporations. There had been just 18 in the preceding ten years.5
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These settlements did little to deter corporations from breaking the law. “Over 50 percent of the most serious fraud and larceny culprits were recidivists,” writes University of Virginia law professor Brandon Garrett, a rate “about the same as robbery and firearms offenders and far higher than drug traffickers.”
Chapter One: “There is no Christmas”
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Instead of having Enron disclose those trading profits, Delainey and his executives hid them. They stashed the millions of dollars of earnings and created a cover story: it was setting aside those profits for a possible legal settlement. Ruemmler and Buell had figured out that this reserve, this “cookie jar,” was a lie. Poring over the company’s intentionally complicated and messy financial statements one more time, they’d noticed that a year after creating the reserve, Enron had lost millions in another division and dipped into that money—reserved for legal costs—to cover the losses and make it look like it had made money that quarter. That accounting hocus-pocus was illegal, and Delainey and his top trader had emailed about it. But they’d used a lot of trader jargon, and the emails were vague enough that a jury would need them decoded. The prosecutors understood how the scam had been pulled off but believed they couldn’t prove it yet.
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Despite this success, the Justice Department took the wrong lesson from Enron. Over the next decade, the task force’s legacy, at least for the subsequent leaders of the Justice Department, lay more in its mistakes than its successes. Courts reversed the government in key cases. The defense bar and Justice Department officials came to view the Enron prosecutors as reckless and abusive rather than sufficiently aggressive to meet the prosecutorial challenge. Today it’s an open question whether the Justice Department would be capable of taking on Enron the same way the task force did.
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The honest-services charge, a part of the mail and wire fraud statutes, was useful. In basic frauds, the criminal steals from the victim. But there are whole categories, such as bribery or kickback schemes, in which criminals might enrich themselves that don’t involve direct theft. The victim is the employer or the public, which has an intangible right to honesty. Prosecutors liked the charge because juries grasped it easily. They could explain that executives had a duty to do their best for their shareholders, to take the best deal they could and not to enrich themselves at the shareholders’ expense. The government charged that Lay, in pumping up morale with his deceptions about the state of Enron’s health while selling secretly, had deprived Enron’s employees and shareholders of his honest services. Adding honest-services fraud was overkill.
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Adding the honest-services charge to Lay meant adding it to Skilling, too. They had no way of knowing, but the gamble would later cost the Department of Justice. In 2010 the Supreme Court would reverse that part of the sentence, determining that the government used the honest-services charge too broadly. In doing so, the highest court stripped prosecutors of a significant weapon for battling corporate fraudsters.
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Berkowitz and Ruemmler and the team set about ridding the trial of anything debatable. They reduced the witness list to sixty-two from seventy-nine and trimmed counts against Skilling.20 If something Enron had done smelled wrong but could be depicted as just a bad business decision, they excised it. They concentrated all their energy on the gut punches—actions everyone would agree were wrong. Berkowitz, in one of his highest moments, had discovered a perfect example. During the crucial second quarter of 2000, Enron had been a penny short on the earnings-per-share estimates. Missing by a penny would be a calamity for the stock. Shareholders expected Enron to outdistance estimates by miles, not fall short. Berkowitz had gone to Enron headquarters to look at the corporate ledger. Sure enough, right in the corporate books was a reserve that had been whited out after the close of the quarter. A $21 million reserve had been changed to $14 million and then to $7 million.
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But the Enron prosecutions led to a weaker Justice Department. After the Enron prosecutions came a backlash against aggressive government action, led by corporations and the defense bar. The courts overturned several Enron verdicts. The Justice Department began to lose the institutional knowledge necessary to bring such complicated corporate cases successfully. The DOJ would turn against task forces, forgetting the Enron successes. It would not centralize decision making. Prosecutors began settling with corporations. The Justice Department steered away from going after the enablers of corporate fraud: bankers and accountants. By 2016, the Justice Department did not approach cases the way it had with Enron. Its ability to hold corporate executives accountable for their actions suffered as a result. The most unfortunate lesson learned from the Enron Task Force experience came from its first success. The team’s first victory in court was its most consequential. The business lobby, the defense bar, and even today’s Justice Department came to believe that the government had made a grave mistake. It had convicted Arthur Andersen.
Chapter Two: “That Dog don’t Hunt”
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In 2002 alone, Andersen clients WorldCom, Sunbeam, Boston Chicken, and Qwest had to restate billions in earnings. In 1998, after revealing a massive financial fraud that falsely inflated its profits, Waste Management had to take what was then the largest restatement
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So egregious was the Waste Management scandal that the SEC sanctioned Andersen, too. The accounting firm entered into a consent decree—a binding agreement—permanently enjoining the firm from violating securities laws again. It was the first time the SEC had ever accused a top accounting firm of securities fraud because of bookkeeping failures.11 The SEC found that Andersen partners had not only known that Waste Management’s financial statements were inaccurate but also had enabled the company’s financial shenanigans. During the SEC investigation, Andersen promoted one of the partners who had contributed most to helping the fraud, making him the firm’s head of global risk management. In this role, he would write a new document retention policy that provided the framework for the later Enron file destruction. This policy stated that information gathered or considered in connection with Andersen work should be culled and “only essential information to support our conclusions should be retained.”12
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Andersen faced thirteen major state and federal investigations over accounting frauds in the years before and just after Enron. Among them: McKessonHBOC, Global Crossing, Supercuts, and the Baptist Foundation of Arizona, then the largest bankruptcy of a nonprofit in history.16 Bernie Sanders, then the left-leaning congressman from Vermont, excoriated an Andersen partner at a hearing of the House Financial Services Committee on July 8, 2002: Arthur Andersen failed in their audit of WorldCom. You failed in the audit of Enron. You failed in the audit of Sunbeam. You failed in the audit of Waste Management. You failed in the audit of McKesson. You failed in the audit of Baptist Foundation of Arizona. What was Arthur Andersen doing? I mean, how do you—it is incomprehensible to me that a major accounting firm can have such a dismal record in trying to determine what the financial health of a company is. It’s almost beyond comprehension.17
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In a matter of three days, the firm shredded more documents than were usually destroyed in a year. It also deleted around 30,000 computer files and emails.22 On just one day, October 25, in an orgy of policy compliance, Andersen employees obliterated 2,380 pounds of documents, compared with the average of about 80 pounds a day.23 One executive testified at trial that he told Duncan he could not delete an email about a conversation with Sherron Watkins, an Enron whistle-blower. Duncan deleted it anyway. Andersen would receive the SEC’s official subpoena for Enron-related records only on November 8. That notice prompted an Andersen secretary to send out an emergency email the next day: stop the shredding. The firm had been “officially served.”
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In July 2002 Congress passed a would-be landmark law, Sarbanes-Oxley, named after Maryland Democratic senator Paul Sarbanes and Ohio House Republican Michael Oxley. Sarbox, as it came to be known, required corporations to have tighter internal bookkeeping controls. Chief executives and chief financial officers had to certify their companies’ books. Over objections, lobbying, and corporate resentment,
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Law professor Kathleen Brickey predicted, “Sarbanes-Oxley firmly puts Andersen’s legal and factual arguments to rest while placing broad power in prosecutors’ hands.”34 She was wrong. Instead, Andersen became the great symbol of unjust white-collar prosecution. Andersen was the improbable terrain on which the American business and legal lobby chose to fight against the excesses of federal prosecutorial power. Those forces prevailed.
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Initially, the media was Andersen’s implacable enemy. The horde of reporters covering the firm rooted for its collapse, the Andersen team thought. Dorton and Leonard figured a way to counter it. Then at CNN, the conservative host Lou Dobbs was fighting a ratings war with CNBC. Nothing stokes cable ratings like a sustained campaign of outrage. The PR masters assigned an Andersen executive to check in with Dobbs’s show every day. Dobbs embraced Andersen, hammering the Feds for having gone after the accounting firm while supposedly letting Enron executives off. Andersen had its first media ally.
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Andersen’s voice mattered more than its heart. All that work Dorton and Leonard did in their PR war room may not have kept the firm alive, but it had succeeded. Through an intentional strategy, they had put a human face on Andersen. No longer was Andersen about accounting fraud. It now stood for the government putting a major American company out of business. The firm, its PR team, Andersen, the corporate lobby, and the defense bar succeeded by changing the subject.
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The notion that the indictment was solely responsible for putting Andersen out of business is a myth. (Technically, Andersen surrendered its accounting license but never filed for bankruptcy.) Between 2001 and 2010, no publicly traded company failed because of a conviction, the attorney and scholar Gabriel Markoff has found. According to him, “[T]he risk of driving companies out of business through prosecutions has been radically exaggerated.”36
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Yet opinion turned. In the later years of the 2000s and 2010s, top Justice Department officials invoked Andersen when discussing corporate investigations, certain that the government had gone too far. Expressing a commonly held belief, the former US attorney in Manhattan and future SEC chair Mary Jo White said in 2005: The Justice Department came under a lot of criticism for indicting Arthur Andersen and putting it out of business. That was justified criticism. What has happened is that since Arthur Andersen, the Justice Department, to its credit, has focused on the awesome collateral consequences of moving against an entire entity criminally. The stigma of that, the reputational hit of that, is too severe for most companies to survive. And so, they have turned to what they consider to be a lesser sanction with lesser collateral consequences.38 By the end of the aughts, top Justice Department officials didn’t even have to mention the firm by name.
Chapter Three: The Silver Age
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In 1974 Sporkin became the SEC’s director of enforcement. Sporkin had been at the agency since the early 1960s. He became that rare creature: the superstar bureaucrat who overshadows his superiors and becomes an untouchable political force. By the end of his run at the SEC in 1981, Sporkin had become a hero regulator, feared by corporate America. He became one of the most accomplished figures in the history of corporate regulation. He would come to be known as “the Father of Enforcement.”10 Wedged deep in the ugly couch’s cushions, Sporkin gave birth to securities law enforcement.
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They said they were settling with the SEC to make the charges go away. The posture infuriated Sporkin and the agency. In 1972 the SEC amended the agreements to disallow any denial of the charges. “No-admit, no-deny” settlements came to be.17 Over time, the SEC became an addict. The agency would become almost unwilling or unable to enforce laws without relying on consent decrees. The agency seemed incapable of getting an admission of guilt and unwilling to go to trial except in the easiest cases. By the 2000s, no-admit, no-deny settlements would be both habitual and toothless. Arthur Andersen entered into one but continued its lax practices.
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Bribes were often relatively small, especially compared with the revenue and profits of the biggest corporations in the country. Corporations argued that the payoffs didn’t “materially” affect the company’s revenue or profits. Sporkin redefined materiality. When these bribes became known, he noted, the companies’ share prices would often fall. Investors found even these small bribes important. Sporkin added a moral dimension to what constitutes thorough disclosure. A company could participate in an activity that, while small compared with the bottom line, could hurt its reputation if revealed.
Chapter Four: “Unitedly Yours”
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The ability for the government to prosecute corporations dates to a 1909 Supreme Court ruling, United States v. New York Central and Hudson River Railroad Company. In that case, the high court recognized, for the first time, a notion of corporate criminal responsibility. Two railroad employees had charged a sugar company a secretly discounted rate, a violation of a law that proscribed railroad side deals and favoritism. The company had countered the government with an argument that companies continued to make over the next century whenever they faced legal jeopardy: to “punish the corporation is in reality to punish the innocent stockholders, and to deprive them of their property without opportunity to be heard, consequently without due process of law.”10 In turning back that entreaty, the court showed that corporations had been held criminally liable often through history.11
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The Southern District charged United Brands with conspiracy and five counts of wire fraud. The theory was a classic Rakoffian feat of far-reaching imagination. For the charge against United Brands, Rakoff and Wing combined two legal concepts. Prosecutors could charge American companies for frauds committed abroad. An American company selling fraudulent stamps to Canadians could be indicted in the United States. Rakoff combined that notion with a second piece of the puzzle. He and Wing took an old concept and repurposed it marvelously. It was possible to charge corrupt public officials with depriving their constituents of their honest services, the same charge prosecutors would use fatefully with Enron’s Lay and Skilling. Public officials were not permitted to enrich themselves at the expense of the public. Rakoff and Wing used the charging theory, but in this case, they argued the violation was that the Honduran foreign minister had deprived his country’s citizens of his honest services. United Brands had helped him do it.
Chapter Five: The Backlash
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IN 1994 MARY JO WHITE’S southern district made the most significant advance in corporate prosecutions in the modern era, forming the first deferred prosecution agreement, or DPA, a special kind of settlement with a company. The office didn’t plan it. Beyond the one agreement, they put little thought into what they had done. No one understood that they were creating the model for twenty-first-century corporate law enforcement.
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In the mid-1980s, Congress authorized the creation of the US Sentencing Commission to examine prison terms and codify norms to correct the arbitrary punishments meted out by unaccountable judges. First, in 1989 the commission’s guidelines for individuals went into effect, establishing a point system for how many years of prison a convicted criminal might get, based on the seriousness of the misconduct and a person’s criminal history. In 1991, amid public and congressional outrage that sentences for white-collar criminals were too light and fines and sanctions for corporations too lenient, the Sentencing Commission expanded the concept to cover organizations. It formalized the Sporkin-era regime of offering leniency in exchange for cooperation and reform. The new rules delineated factors that could earn a culprit mercy. In levying a fine, the court should consider, the sentencing guidelines said, “any collateral consequences of conviction.”1
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The defense bar worked the new system. Lawyers complained to any official who would listen that they were being extorted into an agreement before the government had amassed evidence to support its suspicions. Defense attorneys, however, would also accept deals when offered early because they stopped an actual investigation.
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As a prosecutor, Thompson came to believe that white-collar crime could be just as serious as blue-collar street crime. It sapped the economy and created an uneven playing field. A sense that no one was above the law fired him. As a US attorney, he heard all kinds of excuses. He liked a thought experiment: a drug dealer is caught, say, in Brooklyn. The dealer says, “I gave a lot of money to charities in the Eastern District of New York. I’m willing to resolve this problem, but I’m not going to plead guilty to a crime. I want a civil resolution. You can take my money and give it to the charities. You can do all kinds of things. You can do all kinds of things to me, but I cannot agree to a criminal resolution.” It was preposterous. This country put kids in prison for carrying drugs. But the United States should accept corporate bigwigs going free because the company settled with the Justice Department?
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The result, known as the Thompson memo, came out on January 20, 2003, six months after Arthur Andersen had been found guilty. The only substantive change was a new factor to consider, number eight of nine: “The adequacy of the prosecution of individuals responsible for the corporation’s malfeasance.” Thompson still wanted prosecutions of individuals to be the government’s priority. Additionally, the Thompson memo formalized the policy outlined by its predecessor, the Holder memo. That memo was only advisory, but US Attorney’s Offices around the country had to follow Thompson. In his preface, Thompson emphasized how necessary the guidelines were. Companies, he wrote, purport to cooperate while impeding exposure of the full account of a company’s wrongdoing. The Thompson memo offered a deal. It was not intended to be a generous one. Companies could win Brownie points for being cooperative. Prosecutors could push companies to waive their attorney-client privilege and share detailed materials with the government. They needed to cooperate with the prosecutions of individuals. And they had to eschew tactics such as joint defense agreements, in which the various counsels for various targets of investigation share information about government tactics and prosecutorial knowledge. Sophisticated companies with their sophisticated lawyers had defenses when the government began to investigate. The government wanted to tear those down. Thompson had a goal for prosecutors and a message for business. He wanted to make certain that the Justice Department wasn’t going to indict a corporation willy-nilly, even though it could by law. He wanted to make sure, however, that companies understood what they had to do. Pervasive bad behavior, a lack of contrition, a phony compliance program—his Department of Justice would treat these transgressions sternly. Members of the white-collar bar howled in outrage.
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Christie told him some bad news: the furor over the Thompson memo had the White House scared. In its early years, when Thompson was there, the Bush administration refrained from meddling in Justice Department decisions. Now Alberto Gonzales was attorney general. He had never adjusted to the transition from having been White House counsel, acting like a political operative rather than the head law enforcement officer in the land. Christie told Thompson that some Justice Department politicos were preparing to renounce the Thompson memo. US attorneys around the country were angry. They thought the memo brought corporations to the negotiating table.
Chapter Six: Paul Pelletier’s White Whale
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The bank had done three such deals with AIG FP involving a total of $762 million in assets. PNC and AIG FP created a new entity, “off” PNC’s balance sheet, to hold on to the souring assets. The key element to make the deals acceptable to PNC’s auditors was that an independent third party—in this case, AIG FP—needed to invest in the newly created company. AIG FP was supposedly in control of the vehicle, not PNC. Ostensibly, the deal conformed to the rules about such vehicles at the time. But the deals had a slick element: AIG FP got fees that equaled its investment, plus a little bit, and PNC took all the risk. PNC wasn’t getting rid of the assets in any meaningful sense. If the value of the assets fell, PNC took the losses; if it rose, PNC retained the gains. AIG wasn’t taking any true risk, nor could it get any rewards. This arrangement violated the rules. When it revealed the vehicles and unwound them, PNC admitted that it had overstated earnings by 38 percent, or $155 million.3
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The head of AIG Financial Products was a little-known executive, Joseph Cassano, who displayed his scrappy working-class background ostentatiously. He did not attend an Ivy, but Brooklyn College with financial aid. He worked his way out of back offices at investment banks until he arrived at that emblem of Gordon Gekko–like 1980s ambition, Drexel Burnham Lambert. Cassano joined right at the beginning of the decade. In 1987 he moved to AIG Financial Products, becoming head of the unit in 2001. With total control at AIG Financial Products, he blessed the PNC products.
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In the end, the Department of Justice did not indict PNC. It wouldn’t risk going through Arthur Andersen again. Chertoff vented at Biern and the other regulators, but caution prevailed. In June 2003, about nine months into the investigation, PNC entered into a deferred prosecution agreement but continued to operate. Pelletier felt content with the DPA. He liked that Chertoff backed him and wanted to go after individual executives anyway. Neither man perceived the larger picture: the deferred prosecution era had arrived. After embracing a more recalcitrant legal strategy, AIG FP signed its own DPA in November 2004. The company paid just over $126 million in fines and disgorgement of profits. Pelletier and Atkinson were satisfied. The department assigned AIG a monitor, James Cole of the law firm Bryan Cave.5 Cole would go on to become a deputy attorney general in the Obama administration Justice Department. AIG bore Cole’s costs. He communicated with the board of directors and produced regular reports, which weren’t made public. Cole was required to examine only narrow aspects of the financial firm’s business, and he expected initially to keep an eye on the firm for just a year. As deferred prosecution agreements went, it was strict. But it did not have an appreciable effect on the culture at AIG Financial Products. Nobody there was fired. “All show and no go,” they said in the Department of Justice. AIG periodically called Pelletier to complain about Cole’s high billings. Meanwhile, Cassano went on to consolidate his power and influence over the company.
Chapter Seven: KPMG Destroys Careers
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Kaplan wrote that the government, including Weddle, had let “its zeal get in the way of its judgment” in pressuring KPMG to stop paying the attorneys’ fees for former KPMG executives under investigation. The company had no choice, the judge believed. It was fighting for its corporate life, negotiating with a “proverbial gun to its head.”1 Judge Kaplan hadn’t wanted to go that far. But he felt Weddle and the other Southern District prosecutors had not only interfered with the executives’ constitutional right to counsel but also misled him. Weddle read on, as Kaplan assailed the prosecutors, writing that they had been “economical with the truth.” He was sitting in his office, experiencing the greatest catastrophe of his professional life. Weddle had been killing himself on this case. KPMG, prosecutors came to believe, had sold illegal investments, knowingly designing them to help wealthy American clients avoid taxes while allowing them to claim to the IRS that they were investment vehicles. By the government’s reckoning, it was the largest criminal tax case ever brought. KPMG had created at least $11 billion in phony tax losses, which cost the United States at least $2.5 billion in uncollected revenue.2 The degree of difficulty in putting together this case dwarfed anything Weddle had worked on before. The tax shelters were monumentally complex, full of exotic derivatives. The prosecutors believed they were sham transactions with no purpose but to exploit the accounting rules. But to prove such an assertion beyond a reasonable doubt for a jury was going to be like translating Aramaic into Mandarin and then English. Multiple law firms had signed off on them. They had no whistle-blower. Prosecutors did not have a big internal investigation into KPMG, served up by some top law firm. No employee had flipped or started giving the government evidence. The investigators had no wiretaps. All the charged executives were upstanding citizens in their communities. To bring the perpetrators to justice would take hard work, brilliance, and every good break available.
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Running with Weddle’s invitation, Bennett and the Skadden team laid out the apocalyptic scenario. Pursuing this matter could put KPMG and its eighteen thousand employees out of business.8 Arthur Andersen had upward of twenty-eight thousand. An indictment would not just be bad for the firm, but also could wreak havoc with the capital markets, throwing corporate bookkeeping in disarray as companies scrambled to find other auditors. The standard playbook.
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KPMG and Skadden took it to mean something else: the prosecutors were warning the company that the government would view KPMG as uncooperative if it continued to lay out the attorney payments for current and former employees. Weddle asked about the company’s plan regarding fees. A lawyer for Skadden, Saul Pilchen, piped up, “Why do you ask?” According to what Pilchen recorded in his notes, Weddle responded, “if u have discretion re fees—we’ll look at that under a microscope.” For an exchange that would change Weddle’s life, it was barely noticeable. He wouldn’t think anything of it coming out of the meeting and soon forgot all about it.
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“Ashcroft can’t be responsible for putting another accounting firm out of business,” Comey told the Southern District prosecutors. “They are two totally different cases!” Neiman replied. “We would try to help them avoid that.” This edict removed the Southern District’s leverage. Any further threat was empty, because Skadden understood that Main Justice was too scared to allow a KPMG indictment. There went the Manhattan prosecutors’ ability to indict KPMG or wring out a guilty plea. Neiman fumed. Judge Kaplan later would accuse the prosecutors of strong-arming KPMG as it begged for its life. Begging? KPMG and Skadden had gone over their heads to the top. On August 29, 2005, the company secured a deferred prosecution agreement with the Southern District.11 The government charged the firm with one count of fraud, but it was deferred, per the agreement. KPMG paid a $456 million fine. Weddle and the team were happy that the agreement included a tough statement of facts detailing the wrongdoing (to which KPMG stipulated). KPMG admitted that its partners “assisted high-net-worth United States citizens to evade United States individual income taxes on billions of dollars in capital gain and ordinary income by developing, promoting and implementing unregistered and fraudulent tax shelters.”12 KPMG further conceded how it worked. Its partners engaged in a two-step: They prepared representations for wealthy clients that mischaracterized the way the shelter deals worked. Then they wrote opinion letters that approved the transactions, based on those false representations. Judge Kaplan would later regard the agreement as a significant punishment.
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The KPMG settlement may have been unsatisfactory, but the Southern District prioritized bringing culpable individuals to justice. On the same day that it announced the deferred prosecution agreement, the government indicted nine people involved in the KPMG tax shelters—eight of them former KPMG executives. Later, the figure would rise to eighteen individuals, including seventeen ex-KPMG executives. By the spring of 2006, KPMG defense attorneys began to argue that the government had violated the indicted executives’ Sixth Amendment rights (which grant the accused the right to a lawyer and fair treatment in court) by pressuring KPMG to stop paying their legal fees.
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The next year, in the summer of 2007, the KPMG fiasco reached its peak. Kaplan, with what he wrote was “only with the greatest reluctance,” threw out the cases against thirteen of the sixteen indicted KPMG executives. He wrote that the prosecutorial misconduct “shocks the conscience,” going on to say that prosecutors “deliberately or callously prevented many of these defendants from obtaining funds for their defense that they lawfully would have had . . . This is intolerable in a society that holds itself out to the world as a paragon of justice.”15 In August 2008 a three-judge panel of the Second Circuit Court of Appeals upheld Kaplan.16
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The new deputy attorney general, Paul McNulty, and his colleagues saw the bill as a dangerous incursion of the legislative branch on its powers. He understood that he had to act before Congress did. Five days after Specter introduced the Senate bill, McNulty issued a new memo about corporate prosecutions. Under the new rules, if a federal prosecutor wanted to ask a corporation to waive its privilege, it would have to get permission from higher-ups at the Justice Department. Critics weren’t mollified. McNulty hadn’t gone far enough. In August 2008 his replacement, Mark Filip, pulled back prosecutorial powers further. Today the new post-KPMG, post–defense bar revolt Justice Department standards prohibit prosecutors from even asking companies to waive their attorney-client privilege. Inquiring about who is paying fees is forbidden. The Thompson memo has been buried.
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The high court affirmed the ruling, and in so doing, restored judges’ discretion over sentences. Some judges now assign lighter white-collar sentences than before. When prosecutors negotiate with midlevel executives, the executives are more inclined to take their chances than to plead guilty or plea bargain, prosecutors say. While mandatory sentences were pernicious, and judicial discretion is generally a good thing, one unintended result is that corporate executives are now harder to flip.
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In a 2010 ruling involving the Jeff Skilling case, the Supreme Court narrowed a law that prosecutors used to get the Enron executive, called the honest-services fraud statute. The court restricted the use of the provision to only the most egregious forms of fraud, such as bribery and kickbacks, disallowing the charge for grayer types of corporate malfeasance.23
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And there were cultural changes, which pushed prosecutors to settle rather than go after individuals. The Southern District of New York believed in prosecuting individuals, not settling with corporations. The case harmed Neiman’s, Okula’s, and Weddle’s careers. The risk of going after individuals in complex corporate cases was already high. Now it became stratospheric. The KPMG case gave prosecutors one more incentive to seek a corporate settlement rather than risk prosecuting individuals. In the post–Thompson memo world, giant companies press their advantages in settlement negotiations. When necessary, corporations and their counsel reach into the corridors of power to be heard and win results. Defense lawyers fight evidence discovery requests, using liberal claims of attorney-client privilege. Courts rarely hear about these battles, and the media hardly covers them. At the least, these fights slow down investigations. Delays are defendants’ friends.
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The Justice Department failed to grasp the implications of the decade’s legal changes. No single modification in the law or policy was momentous, and some have restored defendants’ rights. Together, however, they have added up to a significant—and largely unrecognized—blunting and removal of prosecutorial tools in white-collar corporate investigations. These fights exposed how much the government depends on corporate cooperation to conduct its investigations. But cooperation flows from pressure and leverage. The Justice Department’s defeats and retreats have shifted the balance of power to defense lawyers.
Chapter Eight: The Hunt for AIG
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In 2000, analysts and investors worried that AIG was manipulating the money it reserved to pay out insurance claims, a measure called “loss reserves.” Investors want to see the loss reserves going up in conjunction with new business. If the company isn’t reserving, it may face big losses in the future from all the new insurance contracts it is writing today. Even though AIG was writing new insurance business at a good pace, loss reserves were falling. Investors thought AIG might be drawing down its reserves to boost its earnings. In October 2000, to quell the disquiet, Greenberg called up Ronald Ferguson, the head of Gen Re. The two struck a deal: AIG entered into two sham transactions with Gen Re worth $500 million—deals designed to appear like insurance but, in fact, were merely loans to AIG. For its part, Gen Re charged a secret fee and AIG took on no risk. Thus, the deal boosted AIG’s loss reserves without it taking a hit to earnings. Greenberg would insist that the deals he discussed were not shams and that he did not order a risk-free transaction. Like Buffett, but less credibly, he contended that they didn’t know the details.2
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Between 2000 and 2004, the FBI moved 1,143 field agents from traditional areas—including drugs, organized crime, and white-collar crime—into terrorism. Notionally, the bureau’s number of white-collar agents fell only by about 120. But in addition to the formal reassignments, the agency reduced the workload of 1,200 agents who remained in the traditional areas so they could help with terrorism probes. The shifts affected about a quarter of all agents.5 The Postal Inspection unit, which had been so helpful to the Southern District and Main Justice, retreated from complex corporate fraud investigations. The Post Office changed course to have its remaining agents investigate simple mail fraud. As a result of the leadership vacuum during this period, the Department of Justice struggled with white-collar cases because of prosecutorial inexperience and incompetence, and because it overreached in its notions of what was criminal.
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Another scandal began brewing in July 2008, during the waning months of Bush’s second term. A grand jury returned a seven-count indictment of the powerful and long-serving Alaskan senator Ted Stevens for failing to disclose hundreds of thousands of dollars in gifts, including home renovations, from a local businessman. As Bush left office and Obama came in, the case fell apart. Prosecutions operate under a set of rules to preserve the constitutional rights of the investigated and accused. The government must give the defense the evidence it is relying on to build its case, called Jencks material, after a 1957 Supreme Court case. More significantly, the government must give over all exculpatory information it uncovers to the defense, or so-called Brady material, after a 1963 Supreme Court case. The Giglio rule, from a related 1972 Supreme Court case, holds that prosecutors must tell the jury about any deals they have made with witnesses not to prosecute in exchange for testimony. Eventually the court found that prosecutors in the Stevens case violated the Brady and Giglio rules. The judge threw out the case. Eric Holder would request in 2009 that the judge dismiss the Stevens charges. Tragically, in the fall of 2010, one of the prosecutors on the case committed suicide. In 2012 a court-appointed special prosecutor would write that at least two federal prosecutors had “intentionally withheld and concealed” evidence from the defense team that would have helped the late senator’s defense. (Stevens lost a bid for reelection in 2008 and then died in a plane crash two years afterward.) Lower-level prosecutors were blamed. Supervisors escaped. The message was clear: be cautious in any high-profile case. All prosecutors worried a little about losing cases. But the Stevens debacle held a more acute lesson: a trauma like that might destroy your career and drive you to suicide.
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During the rebuttal summation, Patricco made a humanizing argument: that the fraud hit the stock price. He argued, “Behind every share of [AIG] stock is a living and breathing person who plunked down his or her hard-earned money and bought a share of stock, maybe to put it in their retirement accounts, maybe to put it in their kids’ college funds, or maybe to make a little extra money for the family.” This line was a mistake. The prosecution’s argument was not predicated on the notion that the fraud had caused shareholder losses. Instead, the prosecution’s argument was that the fraud mattered to shareholders—that it was “material.” The distinction was significant but fine. Each was a different charge requiring different proof. This passage would haunt the prosecution on appeal.
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Prosecutors avoided any mention of lawyers’ fees, joint defense agreements, and the employment status of the executives under investigation. They were working in the post-KPMG, post–Thompson memo world. Eventually, on January 20, 2010, prosecutors reached a nonprosecution agreement with Gen Re, which paid more than $90 million. The company admitted that its senior management knew the point of the deal was to enable AIG to falsely report increasing loss reserves to both the public and the SEC. Years later, the Gen Re–AIG case ended in frustration. On August 2, 2011, a panel of judges on the Second Circuit Court of Appeals overturned the convictions of the Gen Re–AIG executives. Dennis Jacobs, a George H. W. Bush appointee and leading libertarian on the court, wrote the ruling, determining that prosecutors had overreached in attributing stock market losses to the particular frauds they hoped to prove. Judge Jacobs manifested hostility to almost every securities law prosecution, in the eyes of the government, at least. He deemed stock charts presented in the trial prejudicial, writing they “suggested that this transaction caused AIG’s shares to plummet 12 percent during the relevant time period, which is without foundation, and (given the role of AIG in the financial panic) prejudicially cast the defendants as causing an economic downturn that has affected every family in America.” There was only one problem with this assertion: the timing was wrong. The trial had taken place in early 2008, concluding in February—a full eight months before the financial crisis hit. It would have been impossible for the jury to have been prejudiced by an event that had yet to happen.
Chapter Nine: No Truth and no Reconciliation
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But the new Obama people got off to a slow start. The Senate did not confirm David Ogden, the deputy attorney general, until March. Lanny Breuer did not take his position as the head of the criminal division until April. Up in New York, Preet Bharara wasn’t sworn in as US attorney for the Southern District until mid-August. Surprisingly, given the historic financial collapse, Obama’s top Main Justice appointees and their staffers had little to no experience with complex white-collar fraud. Breuer had never been a federal prosecutor. Ogden was not a seasoned criminal prosecutor like Larry Thompson, but a partner from the powerful Washington law firm WilmerHale. Although cerebral and respected, he had little criminal prosecution experience. Staff prosecutors grumbled that the front office appointees were clueless about how to make complicated corporate criminal cases.
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In Dodd-Frank, the Obama administration and the Democratic Congress created the ultimate exercise in precision legislation. Sprawling through every corner of the financial world, the law did the opposite of similar legislation from the early twentieth century that reined in business and finance. The Securities Act of 1933 and 1934 had simple language and simple concepts but overweening ambition and structural overhaul. The law made manipulation of securities illegal—while leaving the definition of manipulation unspecified. Now, however, the world seemed more complex. Democrats, especially those with elite educations, thought they needed to solve problems in more sophisticated fashion. They wrote a law that tried to imagine any and all financial problems and apply a solution. It called for the regulatory agencies to craft hundreds of arcane rules to define the parameters of the new laws.
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The financial crisis, percolating since early 2007, accelerated with the collapse of two Bear Stearns funds that summer. Bear Stearns never recovered and was on the brink of collapse when JPMorgan acquired it in a fire-sale merger midwifed by a generous loan from the Federal Reserve. The trial of the executives, Ralph Cioffi and Matthew Tannin, started in Brooklyn in October 2009. It generated worldwide media attention. The trial lasted three weeks. After two days of deliberation, the jury acquitted the two managers. The Department of Justice reeled. The prosecution team had been sloppy and hasty. It had built its case on a collection of seemingly damning emails, but overlooked others that complicated the executives’ actions and motives. The judge in the case barred some of the most damaging messages from the trial. As had the Arthur Andersen and KPMG cases, the Bear Stearns trial loss had seismic reverberations. It eroded the department’s confidence. The loss “was very damaging nationwide,” says a top financial regulator. “It scared everyone.” A former federal prosecutor says, “I felt it. You can’t suffer a loss like that. It was a huge setback. People at the DOJ don’t want to lose. The FBI became more cautious. The DOJ became more cautious. Yes, it put a chill on those cases.”
Chapter Ten: The Law in the city of Results
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Covington’s March 2013 press release announcing Breuer’s return listed eighteen colleagues with law enforcement experience in this country and abroad, including two heads of the Justice Department’s antitrust division and Michael Chertoff, who had been the assistant attorney general of the criminal division before heading the Department of Homeland Security. That didn’t include all the former top regulators at the firm. After John Dugan left his position in 2010 as the head of the US Treasury’s Office of the Comptroller of the Currency, a major banking regulator, he also rejoined Covington. And on and on. The revolving door was not just a way for government employees to cash in. Both sides were changing the other—ultimately to the benefit of corporations.
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White-collar criminal work was not just becoming plentiful, but also it provided healthy profit margins, with companies paying up for legal advice that could preserve their reputations. White-collar criminal lawyers began to be paid better, compared with specialists in antitrust, M&A, intellectual property, bankruptcy, and corporate securities. White-collar departments had higher ratios of partners to associates than other departments. And they, more than partners from other areas, shared a common trait: most white-collar criminal law partners were former government officials, especially federal prosecutors.11
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Litigators had dominated the top ranks of firms in previous decades. Corporate transactional lawyers took over. They did deals, and they tracked the numbers and the bottom line. By the 2000s, law firms had imported the jargon and attitudes of business school.
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Before long, there began to be something of a chicken-and-egg question. A symbiotic relationship between the law firms and the DOJ and SEC arose. It became no longer clear whether the Department of Justice pushed investigations that turned out to be lucrative for the white-shoe big law firms or whether big law firms nudged prosecutors into conducting the types of investigation that required lucrative internal probes.
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The rise of the internal investigation had an unappreciated consequence. Setting up an enforcement regime based on cooperation and compliance hurt the government’s ability to conduct investigations on its own. Prosecutors look upon sprawling multinationals in despair. They believe they cannot take on giant corporations without their compliance and cooperation. The law firms do the investigating. Prosecutorial skills erode. The government has outsourced and privatized work—to the misbehaving corporations themselves.
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Through the 2000s—with the Enron reversals, the Arthur Andersen backlash, the Thompson memo rollback, the KPMG case, the Bear Stearns trial losses—prosecutors began to focus less on investigations of individual executives. All the changes moved in one direction: to help big corporations and their top officials.
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The common argument, echoed by every prosecutor, is that prosecutors have every incentive to show how tough they are. The bigger the takedown, the plumier the white-collar defense job that awaits. A corollary argument is that big law firms seek prosecutors for their trial experience, so prosecutors have every motivation to get some. But those arguments neglect how deferred prosecution agreements come into being and distort the incentive structure.
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As there have been more settlements and fewer trials, trial skill has become less valuable. What Big Law seeks now is an ability to negotiate the mega-settlements and the inside knowledge of the institution and the government hive mind, to glean what constitutes cooperation for the Justice Department and what settlement it would deem a win. During settlement negotiations, the prosecutors want to appear tough to the defense lawyers on the other side of the table. They want to dazzle them with their knowledge of legal precedent, mastery of details, and bargaining skills. But young prosecutors also want their adversaries to imagine them as future partners. They want to be seen as formidable but not unreasonable. They want to demonstrate that they are people of proportion. Even the rare prosecutions of individuals have become gamed by the defense bar. White-collar investigations of individuals have a ritualized gentility. Prosecutors call it the “dance.” If they want to question a top corporate officer, they will typically first approach the executive’s defense lawyer. These executives hire defense attorneys who are the prosecutors’ idols and mentors; seasoned lawyers from the best law firms who are legends in the office where the prosecutors now work.
Chapter Eleven: Jed Rakoff’s Radicalization
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President Bush’s last chairman of the agency had been Christopher Cox, an undistinguished congressman and deregulation champion. He became chairman in the summer of 2005, doing little to combat the credit or housing bubbles and the increasing speculation and leverage in the markets. During the frenzied bailouts of autumn 2008, the SEC was noteworthy only for its chairman’s absence.
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@ black edge
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On September 14, 2009, Jed Rakoff broke with zombified judicial tradition. He refused to sign off on a settlement that he regarded as a sham. He labeled it “a contrivance designed to provide the SEC with the facade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry.”13
Chapter Twelve: “The Government Failed”
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The insider trading cases became the path to further one’s career. At one point, the office was 85-0 on insider trading cases.6 In the office’s biggest coup, it sent Raj Rajaratnam, who managed the multibillion-dollar fund Galleon Group, to prison. The media noticed. The New York Times celebrated that the Southern District was “back” in action after lackluster years under previous US attorneys. Time put Bharara on its cover, with the headline: “This Man Is Busting Wall St.” Fortune headlined its profile “The Enforcer of Wall Street.” The New Yorker, for its online version: “The Man Who Terrifies Wall Street.” Almost alone among US attorneys in his class, Bharara had achieved celebrity status, even appearing at events such as the Vanity Fair Oscar Party. But Preet Bharara wasn’t taking on Wall Street. He might castigate corporate culture in a speech, but he was busting insider traders at hedge funds, a different beast altogether. Hedge funds were generally small firms. Each was a discrete entity, raising little possibility of systemic consequences if it were closed.7 Though their principals were wealthy, they had few employees and little in the way of political power. Insider trading was a minor offense, a tilting of the seesaw. The victims, to the extent there were some, were often corporations or other big investors. The financial crisis and bank wrongdoing immiserated tens of millions of Americans.
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When one Southern District star got assigned a case on a dodgy Morgan Stanley residential mortgage-backed security, the prosecutor couldn’t get the FBI interested. Then the office lost a turf war, and the San Francisco US Attorney’s Office got the case. Main Justice seized investigations into interest rate and foreign exchange rate manipulation. Since when did the vaunted Southern District lose turf wars on securities fraud cases? Since its priorities now lay elsewhere. The Southern District passed on the case that would become the first trial of the financial crisis: the Bear Stearns hedge fund case, in which two of the investment bank’s employees were accused of misleading investors about the state of their mortgage investments. The Brooklyn US Attorney’s Office picked it up.
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Jenner & Block had about 130 lawyers working on the Lehman case for more than fourteen months. The firm conducted the kind of all-encompassing investigation the government cannot do anymore, given its choices over how to allocate people and time. These lawyers probed more deeply and thoroughly. Their firm put more money into it, organizing documents and breaking down the tasks into manageable pieces. Jenner & Block had a special motivation to uncover wrongdoing. As bankruptcy examiner, it sought to recoup losses for creditors. It could sue culpable entities for damages. Law firms hired by boards of directors lack that motivation. They want to appear cooperative to the government and protect their clients.
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In a September 9 meeting of the finance and risk committee of the board of directors, Tonucci said that the bank “was able to broadly maintain the status quo” for its liquidity. On September 10, 2008, five days before the investment bank would declare bankruptcy, Lowitt told shareholders on a conference call that Lehman’s liquidity “remains very strong.” He did not mention any of the assets on deposit at other banks. Nor did he tell investors that Lehman and JPMorgan agreed to more protection for JPMorgan’s exposure that morning. Some in the market believed the firm. On September 11 one Wall Street research analyst wrote in a research report, “[L]iquidity risk appears low.”
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Attorney Lewis Liman, of Cleary Gottlieb, represented Lowitt. He prepared an elaborate defense of his client, presenting it to the SEC. Liman also spent several hours with Jenner & Block. Liman insisted that Lowitt had not intended to mislead anyone. He said his client wasn’t a numbers guy. Yes, he was the investment bank’s chief financial officer, but he was not an accountant. He had been relying on what his underlings told him, and no one raised red flags to him. That may be a reasonable defense, but it does not appear that prosecutors and federal investigators made a serious attempt to test how much Lehman’s chief financial officer or any other top executives knew about the bank’s financial position. Prosecutors did not work their way up through lower-level employees to get to the top Lehman executives. Multiple midtier Lehman executives and some regulators involved in the bank’s desperate attempts to keep itself liquid were never even interviewed by any federal government officials about the collapse. And, while he was interviewed by the Jenner & Block team, no federal prosecutor ever interviewed Lowitt.
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US attorneys gave up on every probe they took up regarding the failure of Lehman Brothers. No office brought civil or criminal charges against the company or any Lehman executive.
Chapter Thirteen: A Tollbooth on the Bankster Turnpike
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Goldman was still nicknamed Government Sachs for its ability to stock regulatory agencies and presidential cabinets with its former executives. The US Senate had not yet put executives through embarrassing hearings. Rolling Stone magazine’s Matt Taibbi had not yet written one of the most memorable phrases to emerge from the financial crisis: that Goldman was “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”2
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The SEC staff had not taken testimony from any top executives in Goldman’s mortgage businesses or any top Goldman officials. It had not interviewed the German bank, the supposed victim. More bizarre still, the SEC hadn’t even taken John Paulson’s testimony. The SEC could not know if it was charging the right people with the right securities law violations, Kidney felt. The agency conducted much more extensive investigations in small-time insider trading cases. Recently, he had tried a case where the last guy charged was a fifth-level “tippee”—that is, the guy who got a tip from a guy who got a tip from a guy who got a tip from a guy who got a tip from the guy with the information. The whole lot of them had reaped only $1 million in ill-gotten gains, yet the agency brought out the B-52 bombers. Here was one of its first and biggest investigations of the financial crisis, and it was against the marquee bank on Wall Street. Over the next nine months, Kidney would wage a battle within the SEC, making the same accusations internally that wouldn’t emerge in public until much later. Kidney came to believe that the big banks had captured his beloved regulator—that it went after only minor actors and was cautious to the point of cowardice.
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The staff sought direct evidence, as it had against Tourre. The SEC wanted something incriminating that John Paulson, Paolo Pellegrini, or Goldman Sachs executives had written down somewhere—and embarrassing emails such as “Fab”’s would be a bonus. But high-level Goldman executives were savvy about communications. When topics broached sensitive territory in emails, they would often write “LDL”: let’s discuss live.
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The major setback to scheme liability law had come in the Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. case in 2008. The Supreme Court ruled that private investors could not sue a secondary participant in a fraud scheme, unless that participant had made misleading statements directly to the plaintiff.
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Through the 2000s and into the 2010s, as courts ruled against the Justice Department and the SEC in corporate and securities fraud cases, the government responded inadequately. The government did not retry Kathy Ruemmler’s Enron case against Merrill bankers. Lanny Breuer and the Obama Justice Department did not seek to restore the honest-services charge. Remarkably, the Justice Department and former SEC commissioners went one step further in the Stoneridge case. They helped the Supreme Court reach its conclusion. The Justice Department and fourteen commissioners of the SEC wrote briefs in support of Charter. Both briefs argued against allowing private actors to hold parties such as the vendors in the case liable. The Bush-era Justice Department, reflecting the conservative hostility to such lawsuits, wrote in its brief: “[P]rivate securities actions can be abused in ways that impose substantial costs on companies that have fully complied with the applicable laws.”
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Kidney posted a slogan at his desk, to help him simplify and encapsulate the deal: “Satisfy the long and sell to the short is legal. . . . Satisfy the short and sell to the long is fraud.”
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Lloyd Blankfein, Goldman’s CEO, testified before the PSI. Levin and the investigators believed that he had misled Congress. The committee referred its report to the Department of Justice for criminal investigation into Goldman’s CDO business and its representations to Congress. Blankfein hired star defense attorney Reid Weingarten. One of Eric Holder’s close friends, Weingarten thought the case was bullshit and going nowhere. When Goldman’s board of directors wondered if it should cut Blankfein loose, Weingarten argued that it should not. He guaranteed that the CEO would not be indicted. The board did not need much convincing to heed Weingarten’s advice. The Department of Justice didn’t seem active. The Southern District of New York had done a cursory investigation of some Goldman CDOs. The investigation didn’t seem hot at all. Now the head of Main Justice’s criminal division, Lanny Breuer, reopened the matter. He did not give the investigation to the fraud section. Instead, Breuer assigned one of his staffers, Dan Suleiman, to review the evidence. Suleiman was a member of the Breu Crew, who, like the others, had been a young associate at Covington. And, like several of the others, Suleiman had no prosecutorial experience. Weingarten and Lanny Breuer were acquaintances. Both had children at Georgetown Day School, a posh private school in the capital. Weingarten had a series of conversations with Breuer about the case. He would call up periodically to wheedle and bellow, “Close this fucking case, will ya?” The Justice Department found nothing criminal in Goldman’s actions. In July 2013 Suleiman rejoined Covington. Lanny Breuer’s staffers had boosted their résumés with government experience and now revolved back into the private sector. On August 9, 2012, the department put out an unusual statement, clearing Goldman in the Abacus case.
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Abacus was a fulcrum point. Had the government taken a different tack, enforcement following the financial crisis might have looked different. If Kidney had prevailed, the SEC would have brought fraud charges against numerous individuals as well as Goldman and Paulson & Co. With the major regulator bringing such fraud charges, the Department of Justice might have found it easier to make a criminal case in Abacus. The Abacus case might have provided a framework for other SEC civil charges against individuals and Justice Department criminal cases. Instead, the SEC stumbled. The Abacus case illustrates how debilitated the government’s investigative skills had become by 2009. Like Gresham’s law, where copper coins drive more valuable gold coins out of circulation, the agency’s focus on corporate accountability (an obsession shared by the Justice Department) drove out the good investigations of individuals.
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He retired. At his retirement, in 2014, he gave an impassioned going-away speech: “It is no surprise that we lose our best and brightest as they see no place to go in the agency and eventually decide they are just going to get their own ticket to a law firm or corporate job punched. They see an agency that polices the broken windows on the street level and rarely goes to the penthouse floors,” he said. “For the powerful, we are at most a tollbooth on the bankster turnpike. We are a cost, not a serious expense.” The speech leaked, and Kidney had a moment of media attention. He went on National Public Radio and Bloomberg Television.
Chapter Fourteen: The Process is Polluted
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On August 9, AIG executives held a conference call with investors. The parent company’s chief risk officer played down the tumult in the subprime market, telling investors, “The risk actually undertaken is very modest and remote.” Joe Cassano, who was also on the call, went further, making a comment that would become infamous as AIG imploded: “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.”
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Cassano explained that if AIG used Goldman’s methodology, AIG’s loss would be $5 billion. The estimate stunned the group. After a moment, Sullivan said that loss would “eliminate” the quarter’s profits. Using AIG’s own methodology, Cassano attempted to reassure the gathered executives, would reduce the loss to $2.5 billion. Immediately after the conference call, the two senior PwC partners took aside AIG’s CEO and CFO, telling them they were concerned about the company’s lack of understanding about how Cassano’s valuation model worked. The accounting firm warned top officials that the problems could be so serious that it would have to classify them as a “material weakness,” an accounting term meaning that a corporation’s numbers cannot be relied upon. The partners cited AIG’s “managing” of the valuation process—a damning phrase suggesting that the company was gaming the numbers to make the problem seem smaller than it was.
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In the fall of 2008, the government effectively nationalized AIG, investing $182 billion (originally putting in $85 billion and more than doubling it later) and taking a stake in the company of 79.9 percent.5 More than $75 billion of that passed through to AIG’s trading partners—mainly Goldman Sachs and Societe Generale, the banks on the other side of Cassano’s fateful contracts.6 The government conducted a backdoor bailout of the banks that had taken advantage of AIG.
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The investigative theory had three prongs: One, Cassano shared information with only a close circle of executives, while terrorizing his employees to make them stop asking questions. People who needed to know information didn’t get it and were afraid to ask. Two, the executives took steps to avoid making the collateral calls. They did not tell the complete truth to the auditors or top management about the size and seriousness of those demands. Three, when they could no longer do so, they changed their valuation techniques, using the negative basis adjustment without fully disclosing to anyone its impact.
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The taxpayers now owned the majority of the company. An indictment of AIG might shut down the insurer, handing the new owners—American taxpayers—a massive hit. They couldn’t indict AIG. They couldn’t reach another deferred prosecution agreement that saddled taxpayers with the penalties. “Oh,” said Holder, appearing to remember. Main Justice would, by necessity, have to pursue individual executives,
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A victory in court was golden, but a humiliating loss damaged prosecutors more than a win boosted them. It could crush careers, as the KPMG case showed.
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HSBC executives repeatedly ignored internal warnings of its shortfalls. At one point, Mexican law enforcement officers told the head of HSBC’s Mexico unit that they had a wiretap of a drug cartel leader saying that his bank was the preferred money-laundering destination. The bank did nothing. The cartels even had especially wide boxes to fit into the deposit windows at local Mexican branches to facilitate their cash deposits.11 The HSBC investigation was not about arcane mortgage securities or arguments about how to value assets on its balance sheet. Here was a simple, straightforward case that would be understandable and outrageous to jurors. The staff pushed for criminal charges.12
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Osborne wrote to Ben Bernanke, the chairman of the Federal Reserve, and Treasury Secretary Timothy Geithner to warn that charging HSBC criminally could lead to a “global financial disaster.”13
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Breuer also canvassed a lawyer who had a direct interest in the outcome: H. Rodgin Cohen, one of the preeminent banking attorneys in the country. Cohen, a partner at Sullivan & Cromwell, was representing HSBC. Breuer pulled Cohen aside during a meeting and asked, “Is any bank too big to indict?” Cohen, soft-spoken and courtly, replied, “That cannot be the rule.”
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In December 2012 the Justice Department entered into a deferred prosecution agreement with HSBC. The bank paid a sum that seemed spectacular to DOJ officials: $1.3 billion in forfeited profits and $665 million in penalties. The bank agreed to management changes, to make large investments in oversight and compliance, and to have a monitor oversee the agreement.14 Not only did the Justice Department not charge HSBC itself, but also it did not charge a single employee.
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The new assistant attorney general of the criminal division appeared unhappy to be put in this position so early in his tenure. “These are my first months on the job, and you guys have me in a tough position,” he said. “You are advocating bringing this case very strongly, and my back is really up against the wall. I am going to remember this. I am not going to forget this.” Pelletier was barely four feet outside Breuer’s office when he said loudly, “Holy shit!” Breuer cared, he thought, about his image. If something went wrong, Breuer would exact revenge. Pelletier was on notice. Pelletier would say, “An orangutan could prosecute Stanford.” His crimes were obvious and easy to prove.
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To help make Stanford’s victims whole, Pelletier wanted to go further: to look at the lawyers, banks, and all the Stanford enablers. He wanted to go after Societe Generale, which had done banking for Stanford. Greg Andres, who replaced Grindler as the number two in the fraud section, told him, “I don’t give a shit about Stanford II,” meaning the follow-on cases. The Main Justice front office passed on investigating the French bank further.
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The Obama administration Department of Justice was demonstrating its preference for cases against the scammers who made the headlines rather than pursuing the larger, systemic actors who allowed crimes like Stanford’s to flourish. The Enron Task Force, by contrast, had gone after Merrill Lynch and NatWest bankers. Up in the Southern District of New York, Madoff prosecutors took years to go after his enablers at the banks and never charged individual executives from firms that helped him.
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Tom Athan would prove no pushover. He had a powerhouse legal team protecting him: Debevoise & Plimpton’s Mary Jo White and Andrew Ceresney, the same pair that had represented Bank of America chief executive Ken Lewis. Tyrrell heard that White was complaining about Pelletier, concerned that Main Justice had already come to its conclusions about the case. She succeeded in coloring how the case was viewed within the Justice Department. Concerned, Rita Glavin, a front office official, sat in an interview (known as a proffer) with Athan. White and Ceresney accompanied him. Pelletier, Safwat, and Tyrrell were outraged. The front office’s micromanagement during Stanford was one thing, but this meddling took it a step beyond. Such active front office participation in investigations was highly unusual.
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By early 2010, Breuer and Andres and the front office had lost faith in the AIG FP case. The micromanagement hurt the case. The front office received too many updates, seeing the investigative ups and downs.
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In May 2010 the Department of Justice dropped the AIG Financial Products investigation.
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Passing on one investigation is understandable; passing on every single one starts to speak to something else: a cultural rot. Adam Safwat saw it more clearly than most Justice Department staffers. In addition to investigating AIG Financial Products, his job was to keep track of the financial crisis investigations across the country for Main Justice. Safwat made the rounds to prosecutors across the country: to New York to get an update on the Lehman investigation; to Los Angeles to get up to speed on Countrywide; to Seattle to hear about Washington Mutual. The Feds dropped plenty of subpoenas on banking officials, but that was more or less it. Clearly, there wasn’t a commitment to digging in. One by one, the financial crisis criminal investigations fell to the decision not to take the risk: Countrywide, Washington Mutual, CDO wrongdoing, mortgage-backed securities transgressions, Lehman Brothers, Citigroup, AIG, valuation games, Bank of America, Merrill Lynch, Morgan Stanley. There were no indictments. The aftermath of 2008 called for aggressiveness. The people demanded it. The politics were favorable. The Department of Justice had chances to bring cases against companies and executives. Public trials would have presented the evidence. Juries would have decided if crimes had been committed. That this fear of failure took hold when it did is tragic.
Chapter Fifteen: Rakoff’s Fall and Rise
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The judge continued, complaining about the no-admit, no-deny language. How was one supposed to interpret whether the allegations were true or not? “You make very serious assertions,” he said. “Your own complaint labels them securities fraud. And yet your adversary is not in any legally formal way admitting those. They remain unproven in a court of law.”
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“Let’s find out,” said Rakoff. “Let me ask Mr. Karp. Do you admit the allegations?” Karp stood up and stepped forward. “We do not admit the allegations, Your Honor,” Karp said in a low, even voice. He went to sit back down, paused, and then added: “But if it’s any consolation, we do not deny them,” he added. The courtroom tittered. “I understand that. And I won’t get cute and ask you what percentage of Citigroup’s net worth is $95 million because I don’t have a microscope with me.”
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He then exposed the central problem with the settlements: they undermined any notion that justice had been served. The regulator could claim victory, but the corporation could just as easily claim it was making a nuisance payment to make the government go away. A settlement “that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies.”
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Rakoff arrived at a view of the problem with corporate law enforcement. The government did not hold companies and executives accountable. The settlement culture had corroded the Department of Justice and the SEC. As Rakoff says, “When you can settle cases so easily, you lose your edge. You lose your ability to go after the really tough cases and to penetrate the really sophisticated frauds because you haven’t been put to the test” of a public trial. The public went wild, or as wild as it can get over a judicial opinion. The press profiled Rakoff. Letters of support poured in, more than in the Bank of America case and more than in his death penalty case. Rakoff viewed the centerpiece of his argument as a request for facts. He was not calling for an abolishment of the SEC’s mode of settlement. The press, however, focused on the settlements.
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The Citigroup ruling was of a piece with how the courts have been ruling on securities enforcement for years. The business of law had changed. The incentive structure of the prosecutors at the Department of Justice had changed. And the judiciary had changed as well. The Supreme Court turned more sympathetic to business and more skeptical of government regulation and enforcement. The shift began in the 1970s, during the Warren Burger court, but accelerated in the court of John Roberts, who became chief justice in 2005. The Roberts court is the most business friendly since World War II, according to a study looking at about two thousand decisions from 1946 to 2011.6 The 2010 Citizens United v. Federal Elections Commission case, in which the court ruled that corporations were allowed to spend unlimited amounts in elections, is perhaps the best known of the group of rulings that widened corporate rights and protections. But the high court has also moved to protect corporations from class actions and human rights lawsuits; increasingly granted summary judgment, where the court decides quickly, without a full trial, in favor of corporations; and ratcheted up the scientific standards upon which claims against businesses can be made. Over a series of rulings, the Supreme Court has allowed companies to put clauses in their contracts to force customers into arbitration, a forum that favors large companies, rather than the court system. In Wal-Mart Stores, Inc. v. Dukes et al., in 2011, the high court raised the bar on discrimination class action suits. Another ruling, Comcast Corp. et al. v. Behrend et al., in 2013, made certain class actions almost prohibitive. 7
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In 2014 the Second Circuit in United States v. Newman and Chiasson overturned Bharara’s marquee convictions of two hedge fund managers, ruling that the fund managers were too removed from the source of the insider information and did not know that the source was deriving a personal benefit. The decision threw insider trading law into disarray.
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later overturned by SCOTUS in Salman
Chapter Sixteen: “Fight for It”
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That Walmart made its changes and avoided any charges or even a deferred prosecution settlement suggested that the gentle farewells had been carried out with at least the tacit approval of the government. One of the biggest corporate scandals in years faded away to nothing. Similar problems plagued the corporate investigations into Toyota (for the unintended acceleration problems with its cars) and General Motors (faulty ignition switches). Toyota did not cooperate fully with the Southern District’s investigation. As for GM, the Department of Justice could not identify any executives who had the full picture of the carmaker’s problems and responsibility for fixing them.
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Even dedicating resources does not bring success. After the Deepwater Horizon platform exploded in 2010, killing eleven people and causing the largest oil spill off the US coast in history, Lanny Breuer gathered together a task force to investigate. BP paid $4 billion in criminal penalties and pleaded guilty. But by early 2016, the task force had come up almost entirely empty against individuals. It had started by charging low- and midlevel executives with a variety of crimes, but began withdrawing charges and dropping executives from its cases as courts ruled against it. The government ended up withdrawing manslaughter charges against two midlevel supervisors. Some of the cases were dismissed. Finally, the Justice Department lost three trials against executives.4
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Four months later, she published the Yates memo. The memo was the first overhaul of the Department of Justice’s corporate prosecutorial policies of the Obama administration. The Yates memo was seen for what it was: an implicit critique of the previous Holder administration and a tacit admission that it had not done enough to prosecute top executives. Yates created new policy: the department had to go after individuals again. The key element of a corporation’s cooperation, the memo stated, was to identify individuals who had done something wrong. Without naming the people responsible, a company could not get credit for cooperation and softer penalties.
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Despite its fanfare, the Yates memo lacked ambition.
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The government has not grappled with how dependent it is on Big Law’s internal investigations for its own probes. The government gave no indication it understood it needed fewer insiders and more outsiders. The Justice Department published no reports about the issue. The department made no request from Congress for new statutory powers to prosecute white-collar criminals. The lack of public introspection doomed the policy change.
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The marquee panel included Andrew Ceresney, the enforcement director of the Securities and Exchange Commission, and five of his predecessors. Four of those former SEC officials now represented corporations at prominent white-collar law firms: Robert Khuzami, President Obama’s first enforcement director, who now plied his trade at Kirkland & Ellis; Linda Chatman Thomsen, who served at the George W. Bush–era SEC and now worked for Davis Polk & Wardwell; William McLucas, the longest-serving agency enforcement director, who was now at WilmerHale; and George Canellos, who’d just left the Obama SEC to work for Milbank, Tweed, Hadley & McCloy.
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The Southern District star prosecutors who had taken on high-profile insider trading cases all collected lavishly paid partnerships at the best law firms in New York.