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The SEC is referring more accounting-fraud cases to federal prosecutors. Wrongdoers could face stiff prison sentences--without parole.
Tim Reason, CFO Magazine
September 1, 2000
Cosmo Corigliano will likely wake up behind bars this month as a result of his role in inflating the earnings of CUC International Inc.--misstatements that came to light after CUC merged with HFS Inc. in 1997 to form Cendant Corp. The 40-year-old former CFO pleaded guilty to two counts of fraud in June. Corigliano, who appears to be cooperating with the government in its pursuit of his former boss, Walter Forbes, faces as much as a 10-year sentence without parole. And two of Corigliano's former colleagues, Anne Pember, CUC's controller, and Casper Sabatino, the CUC accountant in charge of external reporting, each pleaded guilty to one count of fraud and face 5-year sentences. All three will find out their fate this month.
What's striking about the CUC fraud is not just that a former CFO will probably wind up behind bars, but that it was the Securities and Exchange Commission that called in criminal prosecutors--as the agency did in January 1999 in another case, involving Canadian theatrical producer Livent Inc. Livent's former CFO, Maria Messina, is awaiting sentencing after pleading guilty to one count of filing fraudulent financial statements. According to the U.S. Attorney's Office, she could receive five years in prison.
The SEC, it seems, is fed up with screaming headlines and crashing market caps caused by earnings management that crosses over what chairman Arthur Levitt calls "the gray area between legitimacy and outright fraud." In a speech last December to the American Institute of Certified Public Accountants, Richard Walker, director of the SEC's Division of Enforcement, warned, "We are moving toward turning the 'numbers game' into a game of Monopoly--that is, you cook the books and you will go directly to jail without passing Go."
That, say officials, means the SEC is referring more of its cases to the U.S. Attorney's Office for criminal prosecution. "The amount of criminal referrals is up in general and certainly up with regards to financial fraud and Internet fraud," says David M. Levine, senior adviser to the director of enforcement at the SEC. "These are our two top priorities now." Indeed, last May the SEC created a financial fraud task force, composed of 10 attorneys and three accountants.
Citing pressure to make numbers and keep analysts and shareholders happy is no defense against individual criminal prosecution, warns Levine. "We are not a fan of the 'good soldier' defense," he says. "Behind every fraud we believe there are one or more persons calling the shots, and we try to ascribe individual liability." As proof, he notes that in 94 financial fraud cases brought last year by the SEC, only 3 did not name individuals.
Most of those cases were not referred for criminal prosecution, but the U.S. Attorney's Office seems eager to tackle any cases the SEC sends its way. "Financial fraud cases are being warmly received by criminal prosecutors," claims Levine.
The Giuliani Factor
That wasn't always the case, according to Philip Feigin, who recently joined the Denver law firm of Rothgerber Johnson & Lyons LLP after 20 years as a state securities regulator in Colorado and Wisconsin. "In 197980, the mood among my colleagues was that you simply could not get a prosecutor to take a white- collar case at the federal or state level," says Feigin. "They were too complicated, they took too long, and judges never sentenced white-collar crooks to jail even if you convicted them."
Times change. According to a study last fall in the ABA Journal, about one of every two convicted white-collar criminals was put behind bars between 1993 and 1997. Feigin credits former U.S. Attorney Rudolph Giuliani, who launched a political career in the wake of his prosecution of Michael Milken, for proving that white-collar crime does pay--for federal prosecutors with political ambitions.
But while prosecutors are now willing--even eager--to pursue white-collar crimes, it's not clear yet whether there is any bite behind the SEC's bark. Statistics on SEC referrals to the U.S. Attorney's Office are available only through 1998, the same year that Levitt announced the agency's new focus on reporting fraud during a speech at New York University. That data shows the number of criminal referrals actually falling from 1992 to 1998, from 23 cases to 9. However, the same data shows average prison sentences resulting from SEC referrals growing longer, from 10 months in 1992 to 49 months in 1998. There are too few sentences to draw statistically significant conclusions, but the numbers seem to support Levine's contention that frauds are growing in size, involving larger companies.
"Historically, many of the cases that we brought involved smaller issuers like ZZZZ Best," notes Levine, referring to the carpet-cleaning company that defrauded investors in the 1980s. "But now you see the Cendants of the world. You are starting to see larger issuers involved in these cases."
That doesn't mean smaller issuers are slipping through the net. Consider the case of Patrick R. Bennett, former CFO of Bennett Funding Group, who fleeced more than 10,000 investors of at least $600 million in what law enforcement officials say was the largest pyramid scheme in U.S. history. Bennett was sentenced in June to 30 years in prison.
Granted, Bennett was no ordinary CFO. "He was the alter ego of that entity," comments attorney Scott Magargee of the Philadelphia-based law firm Cozen and O'Connor, a specialist in white-collar-crime defense. "It was his personality that brought [in] the investors."
30 Years To Life
But white-collar defense attorneys say Bennett's sentence-- one of the longest ever in a case of fraud--raises troubling issues for finance executives who come under criminal investigation. Bennett's long prison term was dictated by the U.S. Sentencing Commission's guidelines. Put into effect in 1987, the guidelines are a complex set of formulas intended to standardize federal sentences based on the types of crimes committed and, in the case of white-collar crime, the amount of money involved.
"Many lawyers have compared the U.S. sentencing guidelines to the IRS tax code in its complexity," notes Maureen Rowley, chief federal defender for the Eastern District of Pennsylvania. One thing is clear: the guidelines make jail far more likely for white-collar offenders, says Rowley.
Mark Morze, the financial brains behind the ZZZZ Best fraud, knows he was lucky he was caught, convicted, and sentenced when he was- -after the guidelines were written, but before they were widely applied. "In my heart, I know I was fortunate," he says. That's because he was paroled after serving only four years and four months of his eight-year term. The new guidelines abolished parole. "Federal sentences are [now] real-time sentences," says Rowley.
For Bennett, that means staying in jail until he is almost 80, says his attorney, Michael D. Pinnisi, who has filed an appeal. "Effectively, that's a life sentence," says Pinnisi. "A first-time, nonviolent, white-collar offender gets life in the form of a 30-year sentence."
There's another aspect of the sentencing guidelines, evident in Bennett's sentence, that several defense attorneys call "frightening." When calculating the length of the sentence, the judge included charges of mail fraud and securities fraud, even though two juries were unable to reach verdicts on those charges. "Because of how the sentencing guidelines are structured," explains Rowley, "a person can be sentenced to many more years in jail based on conduct for which a jury said that person was not guilty."
This "relevant conduct" concept allows judges to base sentences on all charges brought against a defendant--whether or not the jury agreed. Although the Supreme Court upheld the concept in previous rulings, a relatively obscure ruling this June in the case of Apprendi v. New Jersey ultimately may require juries to be involved in determining the aggravating factors that result in increased sentences.
Also controversial is the application of money-laundering statutes to white-collar crimes. Such statutes were designed to prosecute people trying to clean up money from large-scale drug operations, says attorney Magargee, but they are increasingly being applied in cases of economic crime. A money-laundering charge carries heavy penalties, notes Magargee, "and then you are in a situation where the risk is so tremendous that you have to think seriously about whether you can even try the case, from a defense perspective."
Shades Of Gray
So are CFOs risking jail every time their quarterly earnings hit the Street? Not really. But when it comes to financial reporting and accounting, defense attorneys and prosecutors see different shades of gray. "What is creative bookkeeping versus cooking the books? " asks Magargee. "There is a gray area there. With the dot-com world taking over, the gray is only going to get bigger."
Former securities regulator Feigin and the SEC's Levine say that intent is a major test of whether to pursue prosecution, and someone who misinterprets a fuzzy accounting rule is unlikely to be prosecuted. "Accounting literature can be very complex," says Levine. "But in the cases that we refer to the criminal authorities, it is pretty clear that these are people who were deliberately and knowingly cooking the books." Adds Feigin, "In most cases of white- collar crime you have all the intent in the world. There has never been a fraud of passion."
Both sides agree, however, that there are plenty of reasons for financial executives to be constantly on guard against fraud, even if they have no personal involvement. "People do run for cover when the government comes knocking," says Magargee. "Somebody who has been an ally may very well provide information to the government that is devastating. And it may or may not be the truth."
Morze notes that the FBI and the Justice Department suspected that many of the people he duped during the ZZZZ Best scam--including prominent auditors and investment bankers--were actually co- conspirators. "Look how easily I could have lied and said they were on my payroll," he says.
Once a fraud is exposed, says Morze, the fraudster quickly disappears. "But if you are near the fraud, you are stained," he adds. "If your choice [of defense] is that you were a co- conspirator or just stupid, you have to choose the stupid defense. And if you take the stupid defense, you have to pray the guy who really did it doesn't lie."
Ti m Reason is a staff writer at CFO.
SITTING ON CFO ROW
CFOs who served time, are behind bars now, or are awaiting sentencing.
|Paul F. Polishan||Leslie Fay||Scheduled to be sentenced October 23||Faces 115 years|
|Edward Creevy||Donnkenny||Awaiting sentencing||Faces 5 years|
|Maria Messina||Livent||Awaiting sentencing||Faces 5 years|
|Cosmo Corigliano||CUC International (Cendant)||Scheduled to be sentenced this month||Faces 10 years|
|Donald Bender||Bennett New Car Alternative|
At press time, scheduled to be sentenced August 25
|Sealed plea agreement keeps potential sentence unknown|
|Jack Randall Foster||SSM Healthcare's managed-care unit||June 2000||7 years, 3 months|
|Patrick R. Bennett||Bennett Funding Group||June 2000||30 years|
|James M. Murphy||Centennial Technologies||May 2000||1 year, 3 months of community confinement and 3 years of supervised release|
|William P. Sullivan||Lumivision||January 2000||10 years|
|George Brodzki||Bernard Food Industries||January 2000||6 years|
|Jan R. Kirk||Ferrofluidics||November 1999||5 years, 3 months|
|Keith E. Gottschalk||BroMenn Healthcare||November 1999||1 year, 6 months|
|Steven Henke||California Micro Devices||December 1998||2 years, 8 months|
|Jerry Weissman||Empire Blue Cross Blue Shield||September 1998||1 year, 6 months|
|John McAndris||A.R. Baron||June 1998||5 to 15 years|
|Harry R. Carboni||Cableco||June 1998||1 year, 3 months|
|Jeffrey Klop||National Grocers Association||April 1998||5 years, suspended, and 15 years probation|
|Stefan Solvell||Astra USA||February 1998|
2 years probation, the first 3 months under house arrest wearing electronic monitoring device
|C. Steven Bolen||Financial News Network||September 1997||1 year, 6 months (plus 2 years supervised release)|
|Barry Rosenfield||Star Clippers||July 1994|
2 years, plus 6 months in a controlled release program and 10 years probation
|Patrick J. Schleibaum||Miniscribe||June 1994||2 years|
|Patrick Finn||Phar-Mor||November 1993||2 years, 9 months|
Sources: U.S. Attorney's Offices, the New York Times, the Wall Street Journal, other news reports.