Why Corporate Crooks Are Tough to Nail

Prosecutors are on the prowl, but given the hurdles they have to clear, convictions may be few

The day of reckoning finally seems to be at hand. Emboldened by the criminal conviction of Arthur Andersen LLP for obstruction of justice on June 15, government lawyers are steaming ahead with the Enron Corp. investigation--and are probing malfeasance at an ever expanding list of companies that now includes Tyco International (TYC ), Adelphia Communications (ADELA ), Computer Associates (CA ), Qwest Communications (Q ), and Global Crossing.

As more scandals come to light, the White House is growing increasingly enthusiastic about throwing corporate crooks in jail. Although the Bush Administration is skeptical of new business regulation, it has no qualms about vigorously enforcing existing rules--and is, in fact, on a campaign to convince the public that energetic prosecution is a better way of coping with America's white-collar crime wave than cumbersome legislation. "Cops who maybe were asleep at the switch when a lot of the abuses were taking place are now aggressively patrolling," says Chief White House Economic Adviser Lawrence B. Lindsey. "Boards of directors and management are now on notice that this is a new day."

So does this mean that the rogue's gallery of irresponsible execs who have populated the business pages over the past several months will finally go to jail? Will the little guy finally be avenged? Don't count on it. While there will certainly be more prosecutions--and some of them will bear fruit--criminal enforcement is a risky game. The laws regulating companies are ambiguous, juries have a hard time grasping abstract financial concepts, and well-counseled executives have plenty of tricks for distancing themselves from responsibility.

The Andersen case underscores the difficulties ahead for the government. The feds almost lost Andersen--even though they had an inside whistle-blower, a simple story line, and a hometown jury packed with people who had seen the devastation Enron caused close-up. "After Arthur Andersen, nobody is going to talk about slam-dunk cases anymore," says Columbia University Law School securities law professor John C. Coffee.

What's more, many of the abuses that have enraged the public are entirely legal. Companies can file misleading accounting statements that are in complete compliance with generally accepted accounting principles (GAAP). They can boost their income, for example, simply by assuming that their pension plan investments will earn a higher rate of return in the future. Executives are also allowed to enjoy outrageous incomes and baronial perks without breaking any laws at all--so long as the board approves. And because so many of the laws governing corporate conduct are weak, there's no way criminal or civil prosecution can ever be a complete substitute for regulatory reform--no matter how aggressive the White House promises to be. "Enforcement works for the tiny percentage of people who engage in truly egregious behavior," says Henry T.C. Hu, a corporate and securities law professor at the University of Texas. "But for the far more numerous instances of lesser behavior, it is hard to reach them through enforcement."

Of course, the fact that criminal law applies only to extreme cases is probably little comfort to those under scrutiny. In the wake of the Andersen victory, government lawyers are turning their attention to the biggest target of all: Enron. Using their verdict against the energy giant's auditor as leverage, they're hoping to win the cooperation of insiders and build a case against top executives Kenneth L. Lay, Jeffrey K. Skilling, and Andrew S. Fastow. Enron and the individual officers all deny they've broken any laws.

Many of the scandals that have emerged since Enron are also on the government's radar screen. Criminal charges have already been leveled against former Tyco CEO L. Dennis Kozlowski for tax fraud and former ImClone Systems Inc. CEO Samuel D. Waksal for insider trading. Both claim they are innocent. Meanwhile, several other companies and their executives, including Global Crossing and Adelphia, are under investigation.

Sensing the public's anger, law enforcers across the country are taking a new interest in corporate crime. While most federal securities fraud suits have historically been filed by U.S. Attorneys in Manhattan and Brooklyn, cases are currently pending in an unprecedented 17 offices, ranging from San Francisco to Miami to Alexandria, Va. State and local prosecutors, such as New York State Attorney General Eliot Spitzer and New York City District Attorney Robert Morgenthau, are also getting in on the act. "In the aftermath of Enron, it is becoming easier to interest criminal prosecutors in complex securities cases," says Stephen M. Cutler, director of the Securities & Exchange Commission's Enforcement Div., which lacks the ability to file its own criminal prosecutions. "Their reluctance in the past came from a fear that these cases wouldn't play wellin front of juries."

As it turns out, that fear is not entirely unfounded. Indeed, the current flurry of activity may not necessarily yield a string of convictions. In a country with a long-established tradition of criminal rights, prosecutors always face high hurdles. They must, for starters, prove their cases beyond a reasonable doubt. In business cases, they also have to educate jurors about sophisticated financial concepts. That's no small job. Andersen should have been a prosecutor's dream: a clear-cut case of obstruction of justice where no one disputed that reams of documents had been destroyed. But the prosecution nearly unraveled under the skilled counteroffensive of the defense. And just getting jurors to understand the basics can be a chore. According to one news report, an Andersen juror initially believed that the case involved the National Aeronautics & Space Administration.

Imagine how much harder it would be to teach jurors about special-purpose entities or complex derivatives, as the prosecutors in any potential case against Enron would probably have to do. That's why government lawyers will try to steer clear of arcane minutiae, stick to clear themes, and try to pose their arguments as simple human morality tales. "What you really need to win any of these cases is an insider who can recount the conversations people were having and explain what people were thinking," says New York litigator Richard A. Martin, a former Assistant U.S. Attorney.

Finding such a whistle-blower is tough. Enough evidence has to be marshaled to persuade an insider to cooperate and then turn on his or her associates. And that's not the biggest challenge. To win a criminal case, prosecutors have to prove that an exec willfully broke the law--that he or she knew, for example, that the 10-K was fraudulent. If the executive has any legitimate reason for believing that the document was accurate, no matter how implausible, criminal charges will fail. In contrast, the plaintiffs in a civil lawsuit would have to prove only that the exec was reckless about the legitimacy of the 10-K--that he or she should have been aware it was misleading.

Big companies have lots of lawyers, and these lawyers specialize in creating exactly the type of paper trail that will exonerate top execs. Aggressive actions are routinely fortified with sanitizing formalities: file memos that justify iffy decisions, board approvals, and blessings from outside lawyers and accountants. Even if they helped nurture a corrupt corporate culture, CEOs and CFOs can often plausibly claim that they knew nothing about wrongdoing three or four levels down the hierarchy. All of these factors help to create the type of reasonable doubt that kills criminal prosecutions. In the Enron case, Lay, Skilling, and Fastow are all likely to argue that the company's disclosures were approved by Andersen. "They're going to say, `Look, I'm not an accountant. I told them what I wanted to do, and they said it was O.K.,"' says Houston criminal and civil defense attorney David Berg.

The difficulty of proving what's going on inside an executive's head makes it hard to prosecute cases where the law is unclear. The more ambiguity there is, the easier it is for execs to plead ignorance. As a result, government lawyers may have a tough time pinning blame on corporations and individuals in cases focusing on new types of derivatives, complex tax dodges, and exotic partnerships and joint ventures. That's a broad category that could include many recent accounting controversies, including the off-balance-sheet partnerships used by companies such as Enron and PNC Financial Services Group Inc.

Still, despite the obstacles, public anger is on the rise, so prosecutors are likely to keep the heat on. Jail is the best way ever invented to grab executives' attention. A busy CEO can buy insurance to cover legal damages. But there's no way to hire someone to serve jail time. And prison can't be counted as a business expense. Had government lawyers been more aggressive about bringing criminal cases a decade ago, says Joel Seligman, a securities expert at Washington University School of Law, many of the recent abuses might never have occurred. "Fraud is not a steady-state phenomenon," says Seligman. "It's binge and purge. What has become absolutely clear is that the late '90s were a binge period--in part, because the sensitivity to prosecution was reduced." That sensitivity is increasing. What's not clear, though, is how effective the coming purge will be.

By Mike France and Dan Carney

With Mike McNamee and Amy Borrus in Washington

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