Stockman Reveals Reputations Don’t Return When Prosecutors Walk

David Pinkerton had just left his 8- year-old twins at his in-laws’ home in Morristown, New Jersey, when he learned he was no longer a suspected felon.

Pinkerton’s lawyer called to say that the U.S. prosecutors who had charged the former American International Group Inc. managing director with bribery -- which could have led to a decade in prison -- had dropped the case, Bloomberg Markets reports in its August 2010 issue.

The relief was so great that day in July 2008 that the 6- foot-2-inch-tall (1.88-meter-tall) executive, who had fought the stress of the 31-month-long ordeal with intense gym workouts, broke down and cried.

David Stockman, a former U.S. budget director, lived under the shadow of a fraud indictment for two years before prosecutors dropped the charges without explanation or apology.

“They wrecked my reputation, my business career,” Stockman, 63, says. “I don’t know how you compensate for that.”

Stockman and Pinkerton are among a growing number of executives who have been indicted for corporate crimes in recent years and then had the charges dropped. From 2006 to 2008, the most recent period available, U.S. prosecutors dismissed charges against 42 such defendants for which the most serious charge was securities fraud. That’s more than twice the 20 dismissals in the prior three years, according to the Federal Justice Statistics Resource Center.

Photographer: Douglas Healey/Bloomberg

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Photographer: Douglas Healey/Bloomberg

David Stockman, a former U.S. budget director, lived under the shadow of a fraud indictment for two years before prosecutors dropped the charges without explanation or apology.

Surprising Statistic

The collapse of so many cases is surprising, legal experts say, because U.S. prosecutors are expected to have thoroughly investigated the facts and law before asking a grand jury to bring charges.

At least five indictments were returned -- and then dropped -- by the U.S. Attorney’s Office in Manhattan, which oversees Wall Street.

“This strikes me as very unusual,” says Duke University law professor Samuel Buell, a former prosecutor who brought fraud cases stemming from the collapse of Enron Corp. “These are some of the best prosecutors in the Justice Department.”

The increasing number of dismissals may signify that the transactions in some corporate cases have become so intricate that even top prosecutors have trouble mastering them, Buell says.

The phenomenon may become more widespread as investigators sift through the wreckage of the global financial crisis. Criminal investigators have probed Lehman Brothers Holdings Inc., which filed for bankruptcy in 2008; Countrywide Financial Corp., which Bank of America Corp. acquired that year; and AIG, which got $182 billion in the U.S. bailout, according to people familiar with the probes.

‘Tough to Prove’

If indictments stem from the collapse, Peter Henning, a former Justice Department fraud prosecutor, says he doubts they’ll focus on sophisticated transactions involving mortgage- backed securities.

“Those are very tough cases to prove,” says Henning, who now teaches at Wayne State University Law School in Detroit, citing the acquittals in November of former Bear Stearns Cos. hedge fund managers Ralph Cioffi and Matthew Tannin on fraud charges. Instead, prosecutors will look for clear instances where executives lied about company finances, he says.

Compassionate Decision

Yusill Scribner, a spokeswoman for U.S. Attorney Preet Bharara in New York, who took office after the Manhattan dismissals, declined to comment. A dismissal -- or what lawyers call a nolle prosequi -- may result when the evidence or law changes or because prosecutors make a tactical or even a compassionate decision, says Bruce Green, a professor at Fordham University School of Law.

“It should only be necessary in the rarest of circumstances,” says Michael Garcia, who was U.S. attorney in Manhattan from September 2005 to November 2008. “But the circumstances arise.”

Kevin McDonald, who was acting U.S. attorney in South Carolina until May, says prosecutors owed no apology after dismissing fraud charges against four former executives of a company acquired by WebMD Corp. His office would have pressed the case, which was developed by agents with accounting expertise, had there not been adverse legal rulings before the trial, he says.

“A grand jury indicted them based on the strength of the evidence,” he says. “It’s not unusual during the course of the case and the investigation for the facts and circumstances to change and for rulings to limit the admissibility of evidence.”

Silent Blackberry

Alan Vinegrad, U.S. attorney in Brooklyn, New York, in 2001 and 2002, praises prosecutors for reconsidering cases while also urging them to ask what went wrong.

“My own view would be, ‘How come we didn’t think of this before we indicted the case?’” he says.

Though exonerated defendants may sue for fees, there is no legal provision for repairing a damaged reputation.

“Somebody made an allegation that I did something improper, and everything got thrown under the bus,” Pinkerton, 49, says. “One day, 100 people around the world want to talk to you. The next, your BlackBerry goes silent and you have three friends.”

For a public figure such as Stockman, the impact was magnified. Television cameras rolled at a packed press conference on March 26, 2007, as Garcia announced the indictment of the former director of the Office of Management and Budget under President Ronald Reagan.

Allegations of Fraud

Flanked by investigators, Garcia said Stockman had lied in regulatory filings and defrauded investors of $1.35 billion in a scheme to raise capital and save Collins & Aikman Corp., the Southfield, Michigan-based auto parts maker of which he was chairman, from bankruptcy.

Stockman’s private-equity firm, Heartland Industrial Partners LP, paid $260 million for the parts maker in 2001 and snapped up other auto-supply companies in a bid to create the dominant supplier of fabric, consoles and other components for automakers. Four years later, in May 2005, Collins & Aikman, with more than $1 billion in debt, filed for bankruptcy as Ford Motor Co. and General Motors Corp. slashed production.

After appearing in court in March 2007 to deny fraud charges that could have brought him two decades in prison, the gray-haired Stockman retreated to his home in Greenwich, Connecticut. He spent much of his time in his home office, which is decorated with framed tributes including one dated Aug. 13, 1981, from Reagan after the president signed a $750 billion tax cut.

“You rode point on this,” Reagan’s note says.

‘Prospect of the Guillotine’

Hunched over company documents, Stockman spent weeks reviewing the rebate transactions and accounting at the heart of the case. Then he penned a 31-page memo to his lawyers outlining how he had tried to rescue his company.

“The prospect of the guillotine tends to focus the mind,” says a now-relaxed Stockman, in jeans and a white baseball cap, from the office where scores of binders filled with company documents still line his bookshelves.

Stockman hasn’t lost any of the combativeness he showed decades earlier in Reagan’s cabinet when he was forced to apologize to lawmakers after saying they lacked courage to truly slash government spending.

Ignoring his lawyers’ warnings that the government rarely dismissed fraud cases, he insisted that his attorneys seek to convince prosecutors that they were wrong. Stockman helped lead dozens of lawyers, paralegals, accountants and investigators through 15 million documents that the government turned over.

“I was naive enough not to understand how bad the odds were,” says Stockman, a former Harvard Divinity School student and U.S. congressman.

47 Binders of Documents

After more than a year of research, Stockman’s attorneys produced a 221-page report backed by 647 footnotes and 47 binders of documents. Evidence was overwhelming that he was innocent, the report said, adding that prosecutors hadn’t done their homework and had relied too heavily on an internal probe done by Davis Polk & Wardwell LLP, the law firm that guided Collins & Aikman after its 2005 collapse.

“The government gave far too much credit to private counsel’s unfounded conclusions,” the report said. “Much of the documentary evidence most directly relevant to this case appears not to have been reviewed at all -- by anyone -- prior to Mr. Stockman’s indictment.”

The report, financed by Stockman’s indemnification policies, argued that Collins & Aikman was never in jeopardy of violating loan covenants and that the accounting issues in the case were ambiguous.

‘15 Million-Page Swamp’

The defense found documents indicating that outside auditors knew of deals prosecutors said Stockman hid, transcripts of conference calls showing that Stockman never made statements attributed to him and records demonstrating that lenders weren’t deceived about collateral.

“We found a lot of these,” Stockman says. “You’d find these nuggets everywhere, but it was a 15 million-page swamp.”

Stockman’s defense delivered the report to prosecutors on Oct. 20, 2008. On Jan. 9, 2009, the government released a brief statement saying it had dropped the case against Stockman “in the interests of justice.” By then, the lead prosecutor had left for private practice.

Elkan Abramowitz, Stockman’s lawyer, says the case underscores a wider issue. Lawyers for companies that come under government scrutiny have discovered that corporations won’t be prosecuted if they deliver to authorities evidence against top executives, and sometimes they find crimes where there are none, he says.

‘Institutional Bias’

“There is almost an institutional bias to find and expose criminality,” he says.

Davis Polk partner Dennis Glazer defends his firm’s confidential probe and refuses to characterize its findings.

Today, Stockman’s anger is palpable. He leans forward, his voice urgent.

“I think the prosecutors involved in this should be personally liable,” says Stockman, who paid a total of $7.2 million to settle lawsuits by investors and the Securities and Exchange Commission without admitting or denying liability.

Lawyer Andrew Weissman says Stockman, who is writing a book on the banking crisis, wants the case behind him. Seven other Collins & Aikman employees, including four who pleaded guilty, also won dismissals. Prosecutors never announced their dismissal of charges against the four who had earlier pleaded guilty.

Azerbaijan Oil Deal

An indictment is devastating, AIG managing director Pinkerton says. His ordeal began with his decision to invest a fraction of the private-equity and hedge fund money he managed for AIG in an oil deal in Azerbaijan in 1998.

“It wasn’t a bet-the-house,” says Pinkerton, who then managed about $6 billion. “It was $15 million.”

The deal had potential, Pinkerton thought. Clayton Lewis, who oversaw an AIG investment at New York-based hedge fund firm Omega Advisors Inc., was investing $126 million in a bid to buy state assets in the Caspian Sea nation and suggested AIG join.

Pinkerton says his due diligence showed the possibility for big gains: Investors might see a 1,000 percent return if Azerbaijan sold part of its hobbled oil industry. There was also risk: Not only might Azerbaijan choose not to sell the company; media reports said the deal’s promoter, Viktor Kozeny, had stolen assets from public companies in the Czech Republic.

Pinkerton signed on, believing that Omega was a solid partner and that an oil investment was a good hedge against inflation. Kozeny denies stealing assets.

An AIG Blue Blood

The transaction was one of hundreds that Pinkerton authorized over the years. A University of Delaware graduate who later got a degree at night from Brooklyn Law School, Pinkerton joined AIG in 1985 in a $19,000-a-year underwriting job and eventually became its first U.S. employee devoted to hedge funds and private equity. He rose through the ranks overseeing AIG’s investments in Blackstone Group LP, Carlyle Group and others.

“My blood ran blue with AIG,” Pinkerton says.

“He was a guy who you knew could handle bigger and bigger investments,” says Edward Matthews, who was AIG’s vice chairman until 2005. “He grew into the position.”

Personal success followed, as Pinkerton and his college- sweetheart wife, Ana, moved up from a $105,000 condominium in Hoboken, New Jersey, to a 6,000-square-foot (560-square-meter) home in Bernardsville, New Jersey, a leafy community 39 miles (63 kilometers) from AIG’s -Manhattan headquarters. They had twins.

Deal Collapses

The Azerbaijan deal collapsed in 1999 when Azeri leaders didn’t sell the company. AIG and Omega sued Kozeny, claiming he had pocketed their investment. Kozeny denied that and said AIG and Omega should be barred from suing because they had joined him in a plot to bribe Azeri leaders, in violation of U.S. anti- bribery laws. Kozeny also took his allegations to U.S. prosecutors, who launched a probe.

Lewis later pleaded guilty in Manhattan to charges of investing with Kozeny after learning of the bribery scheme. Seeking leniency, he cooperated with prosecutors and, according to court records, claimed Pinkerton knew of the payoffs.

On Oct. 4, 2005, Pinkerton’s lawyer summoned him home from Switzerland, where he was visiting a client. Pinkerton surrendered to the Federal Bureau of Investigation two days later and was jailed for hours in a Manhattan federal court holding pen.

Shredded Dignity

“There’s a process,” Pinkerton says. “It’s really about trying to shred your dignity, putting you in a jail cell and letting you sit.”

Pinkerton’s life slowly fell apart. After first being supportive, friends stopped calling. In December 2005, AIG placed him on leave without pay. Living off savings, Pinkerton immersed himself in his defense, only to grow frustrated at the glacial pace. He curtailed his daily contact with his lawyers.

“I’d wake up some mornings and say, ‘I can’t handle it anymore,’” Pinkerton says. At one point, he fainted from what he feared was a stroke.

“It was all stress-related,” he says. Pinkerton planted bushes at home and began working out with a personal trainer.

Then Ana got sick -- and prison became his second-biggest worry.

“You start to think, ‘What happens to my kids if my wife doesn’t make it and I’m wrongfully convicted?’” he says.

Meanwhile, lawyer Barry Berke worked to prove Pinkerton’s innocence. The co-chief of the white-collar practice at Kramer Levin Naftalis & Frankel LLP in New York, Berke gathered evidence showing that Pinkerton’s due diligence was genuine, including assurances about Kozeny that a top AIG executive had gotten from another investor in the deal.

Misinterpreted Notes

Berke learned that Pinkerton had heard Azeri officials seeking American investors at a Washington conference. Colleagues of Pinkerton’s agreed to testify that Lewis had said the deal was legitimate.

Berke concluded that prosecutors had misinterpreted notes found in AIG files. For instance, a mention that Azerbaijan’s president was involved in the deal meant only that he supervised the asset sale, not that he had been bribed, Berke says.

Berke says prosecutors didn’t probe deeply enough before filing charges. “The government often views the case with blinders on,” he says.

The indemnification policy that paid Berke also financed a defense investigative team at Nardello & Co., which turned its sights on Lewis.

Investigators hired by Berke traveled to Australia, Azerbaijan, Hawaii and Seattle, following leads that Lewis was more involved in the scheme than he had claimed. They also uncovered documents indicating that Lewis had wrested control of an Australian pearl farm from its owners, which could be used to attack his credibility at a trial.

Background Investigations

“The government doesn’t do the same sort of background investigation of witnesses,” says Dan Nardello, a Manhattan federal prosecutor from 1987 to 1994 and principal of the New York-based international investigative firm.

R. Scott Thompson, Lewis’s lawyer, says Nardello got facts wrong about the pearl farm and his client’s role in the bribes.

“They took a grain of truth and stretched it,” says Thompson, of Lowenstein Sandler PC in Roseland, New Jersey. In a lawsuit that was settled in May, Omega accused Lewis of hiding the bribery scheme from the firm.

Prosecutors, meanwhile, disclosed that Lewis had told Pinkerton that Omega had investigated Kozeny’s arrangement with Azeri officials and concluded it wouldn’t run afoul of anti- bribery laws.

Charges Dropped

On July 1, 2008, after nearly a year of discussions between defense lawyers and prosecutors, the government dropped the charges. Mark Mendelsohn, who was deputy fraud chief in the Justice Department, which brought the charges, declined to comment. Another investor, Frederic Bourke, was convicted of bribery conspiracy last year. He’s appealing.

Now, with his wife recovered, Pinkerton is working to build the asset management firm he launched after his arrest, Pinkerton Capital Management LLC.

“I got a lot of feedback from people,” he says. “They said, ‘That could have been me.’”

Federal agents came knocking at Rick Karl’s door in September 2003 -- three years after he quit Medical Manager Corp. following its acquisition by WebMD. Karl, who earned about $225,000 a year as general counsel of the Tampa, Florida-based software company, had amassed some cash after selling stock options worth about $1.7 million over five years.

“I became a stay-at-home dad,” says Karl, then divorced and the father of four.

‘The End of Life’

Agents were investigating whether Medical Manager had cooked its books to inflate revenue and hide liabilities. In November 2005, Karl was among 10 executives indicted for a $16.8 million fraud.

“To be accused of fraud and money laundering, it felt like this is the end of life,” says Karl, 55, a lanky man who is the son of a judge.

Karl says he focused on software rights as a lawyer at Medical Manager, not financial deals.

“I wasn’t designing transactions or giving advice on how to account for these things,” he says. He thinks prosecutors wanted to pressure him to plead guilty and testify against his former bosses, as others had.

“I had absolutely no idea that something was wrong,” he says.

Late last year, prosecutors gave up on Karl, dismissing charges against him and others after defense lawyers including James Robinson of Cadwalader Wickersham & Taft LLP won pretrial legal rulings.

Forever Linked

For Karl, exoneration came four years too late. By then, he says, he had lost an expected appointment to the Florida judicial bench, seen his reputation besmirched and spent countless sleepless nights wondering what he had done wrong.

The trauma is only now lifting. He works in a $127,000-a- year government job managing the airport in Volusia County, Florida, and lives in his three-bedroom childhood home, which he bought in 2004. His dreams of becoming a judge have evaporated; in the age of Google, he’s aware he’ll be forever linked to a fraud.

“It’s like a shadow that’s out there,” he says.

Wrongful accusations hang over Pinkerton and Stockman, too. Along with a notice of the dismissal in Stockman’s case, press releases announcing his and Pinkerton’s indictments remain on the prosecutor’s website.

To contact the reporter on this story: David Glovin in U.S. District Court in New York at dglovin@bloomberg.net.

To contact the editor responsible for this story: Laura Colby at lcolby@bloomberg.net.

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