Three Felonies a Day

by Harvey Silverglate

  Whatever his or her motive, each told a “story.” The SEC brought legally dubious civil insider trading charges on the very same day that the DOJ brought criminal obstruction charges—June 4, 2003. The SEC agreed to a common arrangement: to wait until the criminal case ended before pursuing its civil case.

  According to the government’s version of the facts at Bacanovic and Stewart’s joint criminal trial, the broker and his client agreed that they would tell a false cover-up story to investigators. The story centered on a supposed preexisting agreement between Bacanovic and Stewart that if ImClone’s share price were to drop below $60, Bacanovic would sell all of Stewart’s stock in the company. When Bacanovic was interviewed under oath by the feds, this is the story he told. Stewart told the same tale, but not under oath.

  It was not an accident that Stewart stumbled into a false statement prosecution. One of the oddest features of federal criminal law is that, while it is the felony of perjury to lie when under oath, it is likewise a felony to lie even when not under oath. It is the counterintuitive nature of the federal false statement statute that makes it such an effective snare for the unwary citizen. Observers of the federal criminal justice system are often suspicious that investigators are all too ready to give their targets plenty of opportunity to lie, even when the underlying conduct being investigated is likely not criminal at all. (Nor is it entirely irrelevant to note that there are no similar restrictions on the ability of government officials to lie to citizens with impunity.)22

  The feds’ job was made much easier by an intentional policy, developed over decades among legislators, securities regulators, and prosecutors, to keep the securities laws vague. Fundamental to the insider trading laws is the notion that a person who holds an “insider’s” position in a publicly traded company owes a duty of good faith to that company. This does not prohibit him or her from buying and selling securities in the company; indeed, insiders, normally far more than members of the general public, are more likely to invest in the companies they manage. What the insider trading laws make clear, and what the federal courts have affirmed over the years, is that an insider may not trade in the shares of his company while in the possession of material non-public information. While the definition of “material” is subject to considerable latitude, an insider understands that if he is about to buy or sell shares of the company and there is some important development afoot, positive or negative, that has not yet been released to the public, he would be foolish to trade without consulting with a legal specialist for advice or waiting for the public release of the information. The crux of the theory is that the insider has a duty to his company to refrain from taking advantage of such information. (While in effect the restrictions on insider trading might be seen as an effort to level the playing field between insider and other investors, in reality it is highly unlikely that most investors will ever possess the level of knowledge and sophistication that an insider has concerning the company.)

  Insider trading became a crime, though not a clearly delineated one, when Congress enacted the Securities and Exchange Act of 1934 as part of an effort to clean up perceived corruption in the securities markets, thought to have played a role in the stock market crash of 1929. The statute is extraordinarily broad and vague, in part because the SEC, which the act created, is authorized to flesh out the regulatory language putting into effect the intent of the statute. That statutory provision prohibits “any person, directly or indirectly,” to “use or employ, in connection with the purchase or sale of any security…any manipulative or deceptive device.”23 The act authorized the SEC to issue regulations to put into effect the intent of the statute. However, the commission’s regulations often tend to mimic rather than expand significantly upon the statute’s broad-stroke wording.24 And historically, neither the SEC, which is in charge of administrative and civil enforcement of the anti-fraud provisions, nor the DOJ, which handles criminal prosecutions under the act, has been eager to spell out the nature and definition of such concepts as “securities fraud” or “insider trading.”

  Rather—and this is a crucial point—legal definitions of fraud have for the most part been developed in the course of the pursuit of actual cases by the SEC as it has brought enforcement actions, and by the DOJ as it has brought prosecutions, for alleged “fraudulent” conduct in the purchase or sale of securities. These enforcement actions and prosecutions have, of course, come after the fact. Only after an action or a prosecution is won by the government is the investment world thereby put on notice that the activity prosecuted should be added to the inventory of “fraudulent” activities.

  In fact, in the 1980s, both Congress and the SEC had an opportunity to provide clarity to securities fraud law and decided not to. At that time, Congress enacted two statutes meant to bolster the SEC’s and DOJ’s “war against insider trading”: The Insider Trading Sanctions Act of 1984 substantially increased the penalties for insider trading. The Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) further upped the ante for both civil and criminal insider trading violations, provided for sanctions against people who “recklessly…failed to take appropriate steps to prevent” violations by others, and provided bounty payments for whistleblowers. The ITSFEA passed Congress by a unanimous vote (410-0) in the House and by voice-vote in the Senate. Yet remarkably, neither statute does anything to define precisely what insider trading is.25

  At the time, a few witnesses protested that it was inappropriate for Congress to increase penalties for insider trading without defining the practice once and for all. But the SEC opposed any such effort, telling the committee that it was not a good idea to be “freezing into law either a definition which is too broad, or too narrow to deal with newly emerging issues,” and Congress went along. The same problem emerged when ITSFEA came before Congress four years later. This time the penalties were increased so drastically that clearer definitions became even more urgent. But Chairman John Dingell of the House Committee on Energy and Commerce claimed that any definition of criminal insider trading would provide criminals with a “roadmap for fraud.” Dingell explained that his committee “did not believe that the lack of consensus over the proper delineation of an insider trading definition should impede progress on the needed enforcement reforms encompassed within this legislation.”26

  Now, given that the law of insider trading is basically made up as it is enforced, the first person accused of a particular innovation in the panoply of fraud becomes an instrument by which the law is extended. Often such people plead guilty and make a deal to avoid the risk of conviction and a higher sentence. Others who contest the charges have their cases resolved by court rulings that extend, or contract, the definition of “securities fraud.” Published court opinions are deemed “notice” to the world that henceforth a particular practice will be considered fraudulent. Of course, the individual whose conviction produced that opinion had no such notice. Besides, not all court opinions are clear, and often they are sufficiently narrow so as to not provide much guidance for similar (but not precisely the same) conduct.

  Most securities lawyers would agree that Martha Stewart’s sale of ImClone shares did not fall within the recognized range of insider trading activity.27 After all, she never had substantive inside information that she got directly or indirectly from Waksal. All she learned from her broker was that Waksal was selling. She did not know why. This is doubtless the reason why the DOJ chose the safer route of charging obstruction. Plus, there was the added advantage that the SEC had reason to believe that Stewart would settle a civil insider trading case, and in a manner favorable to the government’s expansive definition of the term, if she were to first lose the criminal obstruction case. Had there been no obstruction to prosecute, it is anyone’s guess whether the DOJ would have tried to use this case as a vehicle for expanding the judicially-accepted definition of insider trading. But the fact is that a potential obstruction or false statement charge can almost always be teased out of an agent�
��s interview of an individual. Even if the feds cannot put their finger precisely on a statement that the interviewee made that is demonstrably false, they may always rely on the obverse side of the coin and allege that there is something that the target omitted that, in the context of the full investigation, was intended to mislead the authorities. Since the citizen is damned by what he or she says, or even fails to say, it is very hard to envision a citizen’s encounter with a fed that cannot be the basis for such a prosecution.

  While the DOJ did not include cutting-edge criminal insider trading charges in the Martha Stewart indictment, leaving that to the SEC in its companion civil action, which Stewart settled for $195,000 after her criminal conviction,28 the feds could not resist the temptation to include a charge of securities fraud, albeit a quite novel one.29 The count charged that Stewart engaged in fraud following press reports about her sale of ImClone stock that hinted at a coming scandal, as a result of which stock in her own company, MSLO, began to plummet. “In an effort to stop or at least slow the steady erosion of MSLO’s stock price,” alleged the indictment, and in order to calm investor concerns, Stewart “made or caused to be made a series of false and misleading public statements during June 2002 regarding her sale of ImClone stock.” These public statements, released by MSLO, omitted, according to the indictment, the true reason why Stewart sold her ImClone shares—namely, her secret possession of information concerning Waksal’s sales activity. “These false and misleading statements” were contained in Stewart’s written public statements, statements she made “at a conference for securities analysts and investors,” and statements made “on behalf of Stewart by Stewart’s attorney to The Wall Street Journal published on June 7, 2002.” The information conveyed to the Journal contained the same defense that Stewart and her co-defendant and their lawyers later offered to the jury at the criminal trial, that Stewart’s sales were put into effect based upon a preexisting plan to sell if the share price dropped below a preset trigger point.

  Stewart’s efforts to defend herself publicly were, according to the indictment, “acts, practices and courses of business which operated and would operate as a fraud and deceit upon purchasers and sellers of MSLO common stock.” In other words, the DOJ claimed that Stewart’s public statements following the breaking of the scandal constituted a separate crime because it might have been intended to stem the precipitous drop in her own company’s shares. Put more starkly, a press release suddenly was capable of constituting an act of securities fraud—a decidedly cutting-edge interpretation that would not readily have occurred to most corporate executives or even lawyers.

  The idea of criminalizing a target’s pre-indictment efforts to launch a public defense was ultimately too much for Judge Miriam Goldman Cedarbaum. She dismissed the count after the prosecution’s case ended but before it reached the jury. But since the issue never made it to the Court of Appeals, there is no authoritative precedent preventing prosecutors from bringing such a charge against another person with the temerity to defend himself or herself in the press and before industry groups while facing a criminal investigation. The chilling effect this ploy will likely have on those under investigation in the future is incalculable. Meanwhile, brokers and investors still did not know authoritatively whether they were allowed to trade after learning that an insider is buying or selling.

  It is hard for most people to have much sympathy for former Enron Corporation chairman Kenneth L. Lay, and perhaps rightly so. His energy company became the poster child for George W. Bush-era corporate excess and cronyism. His public image is that of a chief executive who made sure that the lowly worker bees in his employ lost their pensions, while those in the highest echelons reaped huge windfall profits from the corporate failure. When he died after his conviction but before his appeal, the government, which had to pick up the pieces of his employees’ broken financial futures, got little from his once-astronomical fortune.30

  In a New York Times article headlined “The Enron Case That Almost Wasn’t,” published after Lay’s conviction, reporters Alexei Barrionuevo and Kurt Eichenwald laid out what they described as “the legal hurdles on the path to Mr. Lay’s conviction.”31 These hurdles “were so daunting that some prosecutors privately worried that they would never even be able to charge Mr. Lay with any crimes.” In the face of “millions of pages of documents, deconstructing complex accounting mechanisms, unwinding complex trading transactions,” the prosecutors focused on a more basic gut-wrenching rather than mind-boggling theme: “Mr. Lay chose to lie—to his shareholders, his employees and his banks—and those lies were his crimes.” The reporters characterized this new approach as resting on proof “that the company publicly portrayed itself as strong and vibrant, even though executives like Mr. Lay knew that it was rotting from the inside.”

  This strategy, concluded the reporters at the end of the trials, enabled the government to vastly simplify a case that otherwise would have to focus on the details of “a hodgepodge of often impenetrable activities.” Based on the transactions involved, “the case against Mr. Lay was never clear-cut, prosecutors say.” For a while it even seemed “that their quarry might remain permanently beyond their reach.” The reporters made clear that they had direct access to members of the Department of Justice’s Enron prosecution task force, including the lawyer who headed the force for its first two years, Leslie R. Caldwell. “We had to focus on the big picture, and not just the individual transactions,” Ms. Caldwell told the Times. In short, the prosecution’s case was built on a platform of supposedly fraudulent optimism not supported by the underlying facts and transactions, which were in turn supposedly too complex for jurors to understand and which were, in any event, not fully and accurately disclosed to the investing public.

  The omnibus “lying” theory got a boost when in early 2004 Enron’s former treasurer, Ben F. Glisan, Jr., told a grand jury that Mr. Lay “knew he was lying in 2001 when he provided upbeat statements about Enron’s prospects even as the company was plummeting toward bankruptcy proceedings.” Another task force former director, Andrew Weissmann, told the reporters that this testimony “was a real turning point” in putting together a prosecution of Lay. “I was relieved,” Weissmann said.

  Pursuing this new theory, prosecutors looked into a variety of Lay’s contacts with the investing community and the public, as well as Enron’s employees. There were Lay’s statements made to Enron employees in an “online forum” in which Lay said that he was buying Enron shares, part of an effort to buck up their confidence in the company for which they worked. But, according to prosecutors, his failure to mention his sales of shares “amounted to securities fraud.” (The claim that unduly optimistic or even misleading public statements made by corporate executives can constitute a form of “securities fraud” brings to mind the creative charge in the Martha Stewart trial, i.e., that Stewart issued false public denials of criminality when news of her ImClone trades reached the news media.)

  The Times reporters described the conviction of both Kenneth Lay and his second-in-command Jeffrey Skilling, Enron’s former CEO, as follows: They were “convicted of multiple fraud and conspiracy charges. The jury found that both men carried out their crimes by misleading investors and employees about Enron’s performance.” This was, and remains, the accepted view of what the trial was all about. Even more legally sophisticated and trained observers than Barrionuevo and Eichenwald have characterized the trial in this fashion. Professor Ellen S. Podgor of Stetson University School of Law, a long-time highly-regarded criminal defense practitioner and academic, blogged on June 1, 2006 that the trial “was not a technical accounting fraud case,” but rather “a simple case of—did Lay lie to people—and did Lay & Skilling participate in illegal activities that caused harm to many.” The prosecutors, she noted, “did an outstanding job of keeping the case simple.”

  However, Professor Podgor, unlike the Times reporters, went on to ask the crucial question of whether there was a problem in the case being kep
t so simple. “The government had an array of offenses available in its arsenal that were so broad that it is easy to fit just about any conduct,” she pointed out. Podgor noted, for example, Lay’s conviction “of one count of wire fraud.” She highlighted former Chief Justice Warren Burger’s description of the wire fraud statute: “A stopgap device to deal on a temporary basis with the new phenomenon, until particularized legislation can be developed and passed to deal directly with the evil.”32 Podgor stressed that to some people in the business world, “the criminality” of their conduct “is not apparent” without more specific guidance being available.

  The commentary about the Lay prosecution dances around a fundamental issue not given sufficient attention in trials like Lay’s. Where should corporate executives trying to deal with severe problems that have arisen draw the line between, on the one hand, being completely frank about the problems with employees, the media, and the investing public, and, on the other hand, seeking to avoid the kind of panic (and likely destruction of the company resulting from loss of confidence) that complete transparency is almost certain to cause? And does “spinning” rather than letting it all hang out constitute a federal fraud, especially where more than enough information is publicly available elsewhere from which a careful observer might conclude that the spin is overly optimistic?

  In Enron’s case the issue was particularly acute. A sudden loss of confidence in the company’s fundamental soundness would almost certainly have pulled the plug on, for example, Enron’s ability to obtain crucial financing, as well as on its stock price that was collateralizing a number of large loans. None of this is to say that corporate executives are wise to get their companies into a situation where full disclosure at industry forums, at press conferences, and in press releases likely would lead to a loss of confidence and resulting corporate collapse. Enron’s executive overseers appear to have been exceptionally foolish, even reckless, in executing their precarious balancing act. But whether it is, without specific legislation spelling out the law’s contours, criminal fraud to seek to save the company in a crisis by painting a rosier picture (to take a classic public relations approach) than would be painted with fuller disclosure, is a reasonable question to ask. In a context where the full facts are disclosed in the details (sometimes in the footnotes) to the financial statements, corporate executives’ surface optimism might not so readily and fairly be seen as criminal fraud. This is a question on which reasonable people might disagree.