Sunday, May 6, 2012

WSJ: SEC fraud crackdown; BP oil spill

  • The Wall Street Journal

Weighing SEC's Crackdown on Fraud

More than 100 people and firms have now been charged with fraud by the Securities and Exchange Commission, but criticism persists that the agency hasn't cracked down hard enough, Jean Eaglesham reports on Markets Hub. Photo: Joshua Roberts/Bloomberg.
More than 100 people and firms have now been charged with fraud tied to the financial crisis by the Securities and Exchange Commission, but that hasn't quelled criticism that the agency hasn't cracked down hard enough.
The SEC passed that milestone Friday when the regulator filed civil-fraud charges against two former Texas bank executives accused of using a loan-modification scheme to make bad real-estate loans look good.
[SETTLE] Guy Stauber for The Wall Street Journal
SEC enforcement chief Robert Khuzami said the current total of 101 cases shows the agency is "highly effective in tackling financial-crisis wrongdoing." Of the 74 cases filed against individuals so far, the SEC went after 55 chief executives, finance chiefs or other top officers. In an interview, Mr. Khuzami said the number is "significant" and "sends a strong deterrent message."
The agency's critics, however, aren't budging. Sen. Charles Grassley (R., Iowa) sees in the same numbers signs that the SEC isn't tough enough even when it amasses strong evidence of crisis-related lawbreaking.
Since the start of 2009, the SEC has reached settlements with 24 of the 74 people charged by the agency, averting court trials. Executives who settled civil charges by U.S. securities regulators include former Countrywide Financial Corp. Chief Executive Angelo Mozilo, who agreed in October 2010 to pay $67.5 million. He didn't admit or deny wrongdoing.
"The SEC's weak settlements need scrutiny," Mr. Grassley said. "The lack of accountability from Wall Street encourages recidivism."
Almost four years after the SEC filed its first civil charges alleging illegal behavior during the financial crisis, the results of its enforcement push are piling up. Officials regularly update a tally on the SEC website, and the agency has several likely enforcement actions in the pipeline, including a number that are related to mortgage-backed securities, according to people familiar with the matter.
But there isn't an end in sight to the battle over how to interpret the numbers. Critics claim the SEC has been too soft, outsmarted or underfunded as it pursues civil cases. Mr. Khuzami, who took over as enforcement chief in 2009 under current SEC Chairman Mary Schapiro, adamantly defends the agency's track record.
And some outside experts say the SEC is in an impossible position that it can't escape. Proving that a senior executive broke the law during the crisis is harder because defendants can argue the financial losses were due to a failure to predict the meltdown, rather than any fraud, they say.
In the 24 crisis-related cases where the SEC reached a settlement with a person, the median sanction was $203,751, according to calculations by The Wall Street Journal. The same defendants paid a combined $80.7 million in penalties.
Nearly all those penalties came from executives at collapsed mortgage lenders Countrywide, American Home Mortgage Investment Corp. and New Century Financial Corp. Their investors sustained losses of about $31 billion based on the three companies' peak stock-market value before the financial crisis erupted.
Mr. Khuzami said in the interview that it is "silly" to judge the penalties against much-bigger shareholder losses. One reason: Financial firms sank during the financial crisis for reasons that had nothing to do with fraud or illegal conduct.

Settling Up

Settlements in SEC enforcement actions against individuals related to the financial crisis.
"When you fine an auto-company executive, the fine doesn't include losses that occur when the company went bankrupt because it produced only gas guzzlers, had excessive pension costs and fell behind the competition," he said.
Still, some federal judges have denounced large gaps between losses to investors and the financial punishment agreed to by the SEC with company executives. In February, U.S. District Judge Frederic Block in Brooklyn, N.Y., said $1.05 million in penalties paid by two former Bear Stearns Cos. hedge-fund managers, Ralph Cioffi and Matthew Tannin, in a proposed deal to settle civil-fraud charges against them was "chump change" compared with the $1.8 billion lost by investors.
"You had some tough adversaries," the judge told an SEC lawyer. "They brought you down to your knees."
The judge has yet to approve the proposed settlement. A lawyer acting for Mr. Cioffi and a spokesman for Mr. Tannin declined to comment.
In a letter to Judge Block, SEC lawyers said the proposed punishment was "serious and comprehensive," noting that the two former hedge-fund managers agreed to temporary bans from working in the securities industry. The SEC also said it had to consider the risk of losing the case if it went to trial. In 2009, a Brooklyn jury acquitted the Bear Stearns managers of criminal charges related to the collapse of their funds.
Mr. Khuzami said no one at the SEC is "settling cases unless the settlement makes sense." The agency's power to expel people from the securities industry or from serving as directors of public companies is "probably one of the most powerful sanctions we have," he added.
The amount of money SEC officials can claw back from an ill-gotten profit is limited to pay or other profits that the agency can show were a direct result of the wrongdoing.
Executives often argue that most of their remuneration had nothing to do with the alleged misconduct.
SEC enforcement chief Robert Khuzami says the agency has been 'highly effective' in crisis-related cases.
The repayment of such illegal profits is tax-deductible and covered by some corporate insurance policies. In 2010, Mr. Mozilo, the former Countrywide CEO, agreed to pay a $22.5 million penalty and disgorge $45 million of profits to settle civil-fraud charges.
At the time, Mr. Khuzami said the penalty was a fitting outcome for someone who concealed a "looming disaster" from investors, while dumping nearly $140 million in stock. Nearly half of the $45 million payment came from Countrywide's current owner, Bank of America Corp. BAC -3.25%
SEC officials said all of Mr. Mozilo's $67.5 million of sanctions went to help compensate investors for their losses, adding that it is hard for the agency to challenge indemnification rights in employment contracts or insurance policies.
A lawyer acting for Mr. Mozilo declined to comment, as did a spokesman for Bank of America.
In November, Ms. Schapiro asked federal lawmakers for the legal power to impose tougher sanctions, including penalties that reflect investor losses. Sen. Jack Reed (D., R.I.), the top member of a Senate banking subcommittee, hopes to introduce legislation soon that would give the SEC its sought-after firepower, according to a spokesman for Mr. Reed. "Stiffer penalties will help deter illegal behavior and crack down on repeat offenders," he said.
James Cox, a law professor at Duke University in Durham, N.C., said enhanced powers for the SEC probably wouldn't have a "bit of effect," Mr. Cox said. "The calculating of settlement amounts is clearly more art than science—and the real art is working out what the other side will accept."
Write to Jean Eaglesham at

First Criminal Case in Spill

Engineer Accused of Deleting Texts on Flow Rate, Which Can Determine Possible Fines

[SPILL@] U.S. Coast Guard/Associated Press
Charges filed Tuesday arise from communications about the May 2010 attempt to plug a BP well in the Gulf of Mexico using a 'top kill' procedure.
HOUSTON—A former engineer for BP BP.LN -3.11%PLC was arrested Tuesday and accused of destroying evidence relating to the 2010 Deepwater Horizon explosion and oil spill, the first criminal case to arise from the incident.
Federal prosecutors charged Kurt Mix of Katy, Texas, with two counts of obstruction of justice for deleting from his iPhone hundreds of text messages about the spill that he exchanged with a co-worker and a contractor, according to a criminal complaint unsealed Tuesday.
Mr. Mix didn't enter a plea when he appeared in a federal courtroom here Tuesday wearing a purple dress shirt, khaki pants and handcuffs. A lawyer representing him at the proceeding, David Gerger, declined to comment after Tuesday's hearing.
Former BP engineer Kurt Mix leaving a federal courthouse Tuesday.
The government said the deleted texts included estimates of how much oil was gushing into the Gulf of Mexico as BP tried to stem the flow, including some estimates that were significantly higher than BP was publicly acknowledging at the time.
Investigators have long been looking into whether BP intentionally withheld or played down the size of the spill, while the company has said it gave its best estimates at a time when its priority was to stop the leak. A tally of the flow rate—which the government eventually said was between 53,000 and 62,000 barrels of oil a day—is significant because any criminal fines under the U.S. Clean Water Act would be based on the number of barrels spilled.
BP said it wouldn't comment on the charges against Mr. Mix but that the company had clear policies requiring preservation of evidence in the case. The company said it was "cooperating with the Department of Justice and other official investigations into the Deepwater Horizon accident and oil spill."
The first criminal charges in the Deepwater Horizon accident were filed against a former BP engineer for allegedly destroying evidence. Tom Fowler has details on Mean Street. AP Photo.
Prosecutors said Mr. Mix was part of an internal team BP set up to estimate the amount of oil leaking from the well and to work on stopping the leak. The spill went on for 87 days after the initial explosion that killed 11 workers aboard the Deepwater Horizon drilling rig.
Magistrate Judge Stephen Smith approved Mr. Mix's release Tuesday on a $100,000 unsecured bond. He is to appear before a federal judge in New Orleans, where the charges were filed, a week from Thursday.
Mr. Gerger, the attorney, said he was standing in on behalf of Mr. Mix's Boston-based lawyer, Joan McPhee. Mr. Gerger also represents Robert Kaluza, one of two BP engineers stationed on the rig at the time of the accident.
Ms. McPhee didn't respond to messages seeking comment.
According to a Federal Bureau of Investigation affidavit filed with the criminal complaint, BP sent several notices to employees requiring them to save all electronic records concerning the well, including text messages. But in October 2010, Mr. Mix allegedly deleted about 200 messages he exchanged with a supervisor, and in August 2011 he deleted more than 100 texts that he had exchanged with a contractor, the government said.
A file picture released by the U.S. Coast Guard on April 22, 2010, shows the fire aboard the drilling rig Deepwater Horizon in the Gulf of Mexico.
Although some of the texts weren't recovered, the government said, others were through the use of "forensic tools."
Among those texts, according to the government, was an analysis of how much oil was flowing from the well as BP tried to plug the gusher by flooding the well with high-pressure drilling mud, an effort known as "top kill."
On May 26, 2010, the first day of the top-kill effort, Mr. Mix wrote, "Too much flowrate—over 15,000," the affidavit said. That was at a time when the company was saying publicly it estimated 5,000 barrels a day were flowing from the well.
What BP knew about the size of the spill and whether it was hiding that information from the government has been a major question surrounding the post-accident response, said David Uhlmann, a University of Michigan law professor and former head of the Justice Department's Environmental Crimes Section.
But Tuesday's charges "leave open the larger question of who will be held responsible for the spill itself," Mr. Uhlmann said.
Rep. Ed Markey (D., Mass.), who challenged BP estimates in the early days of the spill, said in a statement that the federal complaint "raises additional questions about what the company knew about the size of the spill at the time."
Though Tuesday's charges relate to efforts to stop the spill, federal investigators are also looking into whether several BP engineers involved in drilling the well provided false information to regulators about the risks associated with the project while drilling was in progress.
—Ángel González contributed to this article. Write to Tom Fowler at

Thursday, May 3, 2012

Deterrence research inquiry

Sent: 5/3/2012 7:01:09 A.M. Central Daylight Time

Subj: A Framework for Analyzing Influences and Outcomes of Mass Litigation Episodes

Dear Dr. Garber,

I have embarked on this project concerning entity level liability versus officer and employee individual liability as a means to try to deter corporate wrongdoing.

I have read with great interest your 2009 article
A Framework for Analyzing Influences and Outcomes of Mass Litigation Episodes in the United States | RAND (full pdf text here).

Relative to the subject of deterrence, the article, on pages 22 and 23, says that "general deterrence effects are very difficult to establish empirically." More fully, your article says:

Deterrence of behavior that imposes more risk of injury than is socially desirable is widely accepted, along with compensation, as one of the two fundamental social purposes of a civil liability system.24 The fundamental idea is that civil law—for example, tort law—introduces the possibility of paying damages for injuries and thereb yalters the cost-benefit calculus of potential defendants when making decisions that affect the injury risk to which they expose their customers (e.g., Cooter & Ulen 2000:chapter 8; Kaplow & Shavell 2002:section 5). 
General deterrence effects are very difficult to establish empirically for at least three reasons. First, many of the legal doctrines and procedures of main interest to policy makers—e.g., products liability—vary little across states; thus, estimating deterrence effects by comparing corporate decisions or safety levels across states is not likely to be feasible. Second, in the products context, a product that is marketed nationally generally has the same physical features and carries the same warnings in all states.25 Thus, such decisions are effectively made at the national level, presumably on the basis of an assessment of the overall or average liability climate nationally. Third, researchers cannot observe what potential defendants would have done if the legal rules had been different.26 Thus, specific examples of deterrence effects on particular MLEs would be speculative.
Various failures of deterrence are apparent, however. An important class of  deterrence failures is “under deterrence” namely, instances in which safety-enhancing actions were not taken that, with the benefit of hindsight, would have been socially advantageous (and also in a defendant’s interest). One example is provided by litigation involving hip and knee implants defectively manufactured by Sulzer (Journal of Law and Health 2001-2002). This MLE involved thousands of products-liability claims filed in the late 1990s, and resulted in a global, limited-funds settlement for approximately $1 billion in damages. Serious injuries, litigation, and compensation payments were the result of a manufacturing defect, namely failure by Sulzer (during a limited time period) to clean implants that had been contaminated by oil. Other examples include failure to adequately study injury risks in instances such as breast implants (Angell 1997:54-55) and MER/29 (Rheingold 1968).

I did not find in the article any separate mention of officer and employee individual liability as a means to deter corporate wrongdoing. Given your general view of the difficulty of establishing deterrent effects empirically, it is possible there is little research potential for investigating scientifically a differential deterrent effect of officer and employee individual liability, and there may be no meaningful research on the subject.

In any event, let me ask: Can you cite me any research literature on the subject of the deterrent effect on corporate behavior of imposing officer and employee individual liability?

Thank you very much.

Rob Shattuck

Sent: 5/3/2012 2:36:02 P.M. Central Daylight Time
Subj: Re: A Framework for Analyzing Influences and Outcomes of Mass Litigation Episodes


I know very little about the literature on the kinds of liability you are asking about (i.e., "officer and employee individual liability"). I do recall seeing work by Tom Baker (Penn law school) related to D&O insurance—and Tom does get into deterrence effects in some of his work--you might try him. I don't recall seeing anything on holding corporate employees liable, except that DOJ has brought criminal complaints against individuals (high-level—probably all were officers) at Purdue Pharma (a privately held company) about marketing of OxyContin.

Good luck with your ambitious project. Please send me whatever you write when appropriate.



Sent: 5/6/2012 8:58:51 A.M. Central Daylight Time

Subj: Re: A Framework for Analyzing Influences and Outcomes of Mass Litigation Epis...

Dear Dr. Garber,
Thank you very much for your quick reply.

My project is trying to draw in an array of significant actors, including lawmakers, regulators, judges, prosecutors, state attorneys general, plaintiffs' lawyers, corporate management, and ethics and compliance professionals.

Regardless of whether there is meaningful scientific research on the deterrence effect of imposing liability on responsible officers and employees for corporate wrongdoing, general knowledge about human nature is suggestive that consideration needs to be given to that, and policymakers and other actors will shape the law or take other action based on what their judgement tells them.

You referred to the Department of Justice. Three Wall Street Journal articles when I started my project last year were suggestive that the Obama administration was possibly shifting to targeting individuals. See this, this, and this.

Punishment inside the corporation of individual officers and employees has been incorporated in Section 8B2.1(b)(6) of the Federal Sentencing Guidelines for Organizations, which provides:
The organization 's compliance and ethics program shall be promoted and enforced consistently throughout the organization through (A) appropriate incentives to perform in accordance with the compliance and ethics program; and (B) appropriate disciplinary measures for engaging in criminal conduct and for failing to take reasonable steps to prevent or detect criminal conduct.
While the deterrence value of individual liability, from society's point of view, needs to be evaluated without other bias, some of the important actors are probably not bias-free. For more on this, see Interim project report. (I am sure your own studies have provided you much insight about the way biased self-interest can affect the consideration, evaluation and implementation of social policy and process.)

To my knowledge ethics organizations such as the Ethics & Compliance Officer Association and the Ethics Resource Center are unwilling to give attention to this subject. I know it is a hard topic to wrestle with. Your own article may contribute to a greater sense of the importance of my subject. Individual liability for corporate wrongdoing continues to be reported in the news. Last month, one Wall Street Journal article reported a "first" criminal case in the BP oil spill event against an engineer who was accused of deleting texts on flow rate, and another article, entitled "Weighing SEC's Crackdown on Fraud," reports that the SEC has charged more than 100 people and firms with fraud tied to the financial crisis, and that, of 74 cases filed against individuals, the SEC went after 55 chief executives. These articles can be found here. This all seems to cry out for thoughtful consideration by ethics and compliance professionals.

I hope I will learn more whether there is anything that the RAND ICJ or CCEG will pick up on here (or I will find they have already explored and written about the same).

I will include Professor Baker to receive a copy of this email and will follow up with him as you suggest.

Rob Shattuck

Sent: 5/6/2012 9:04:13 A.M. Central Daylight Time
Subj: Re: A Framework for Analyzing Influences and Outcomes of Mass Litigation Epis...

I am not interested in being involved with a project that calls itself "combatting plaintiffs lawyers."

Sent: 5/6/2012 9:18:22 A.M. Central Daylight Time
Subj: Re: A Framework for Analyzing Influences and Outcomes of Mass Litigation Epis...

Thank you very much for your quick reply, Professor Baker. If there is any critique you would like to make of anything I say in my blog, I will be pleased to post the same.


Rob Shattuck