Corporate fraud: see, lawyers.

• Author: Koniak, Susan P.
• Position: Roundtable: The Lawyer's Responsibility to the Truth - Federalist Society 2002 Symposium on Law and Truth

1. INTRODUCTION II. LAWYERS, LIES AND MARKET-GATE III. THE LAW-FREE ZONE IV. LIES OR CONSEQUENCES V. CONCLUSION POSTSCRIPT: JANUARY 26, 2003 I. INTRODUCTION

   The accounting profession must bear a good deal of responsibility for the current wave of corporate scandals, as must those CEOs whose watchword was greed, lackadaisical directors, projections-for-hire investment analysts, banks selling methods designed to deceive, and institutional investors asleep at the switch. One set of villains, however, have managed thus far to float beneath the radar screen and thus escape the lion-sized portion of blame that should rightly be laid at their door: lawyers.

   The hidden dirty secret of corporate scandals is that without lawyers, few corporate scandals would exist and fewer still would succeed long enough to cause any significant damage. No reform directed at other groups or institutions that is enacted by Congress, the SEC, or any other body, private or public, will accomplish its intended result as long as lawyers are allowed to roam in a law-free zone where legal fees know no bounds and the bankruptcy of one firm's corporate client only provides more legal fees to another firm. Some racket: The client disintegrates with its lawyers' assistance and the lawyers need to pay back (at most) a token amount of the huge fees they reaped assisting the fraud that brought the client down. Even better: The lawyers get hired by a client, that some other law firm has helped bring down, to fight the SEC, the Justice Department, or creditors in bankruptcy. Perhaps they are hired by institutions victimized by another firm's client, as counsel, for example, to a creditors committee in a bankruptcy proceeding. Even more shocking: Lawyers can do all this with virtually no risk. There is no real prospect of criminal prosecution, SEC enforcement actions or discipline, or state bar sanctions. And best of all: This almost-to-good-to-be-true world that lawyers inhabit is all but impervious to change. As for everybody else? Well, they just have to live with the consequences, however painful those may be.

2. LAWYERS, LIES AND MARKET-GATE

   To take my assertions one at a time: Am I right that lawyers are responsible for much of the present travail? Take Enron. Vinson & Elkins, a prestigious Texas-based law firm, and other law firms representing Enron blessed many of the related-party transactions that played such a large role in Enron's demise. (1) I am certain that many of these transactions were fraudulent--meaning they violated civil and criminal law.

   Kirkland & Ellis, a prestigious Chicago-based firm, represented numerous Enron-related partnerships--entities with names like Raptor and Condor, names that all but screamed out, "Fraud is going on here." (2) They too blessed related-party transactions that I believe to be fraudulent. Kirkland & Ellis was surely not the only law firm to sign off on behalf of the entities and their big-time investors. Merrill Lynch, for example, marketed those partnerships to big-time investors based on documents that intimated the partnerships were great investments because partners would be privy to inside information concerning Enron. (3) Some set of lawyers and one or more firms had to have approved those marketing documents. To wit, representatives of Citigroup and J.P. Morgan, banks that also appear to have assisted Enron in its hell-bent quest to cook its books, testified before Congress that the shady and, again in my opinion, illegal transactions between the banks and Enron were approved by Citigroup's, J.P. Morgan's, and Enron's lawyers. (4) Further, the First Interim Report of Neal Batson (the court-appointed examiner for the Enron bankruptcy proceedings) makes clear that the accountants sought out and relied on the guidance of lawyers when trying to determine if certain transactions should be booked as sales or something else. (5) In fact, Enron had to provide Andersen with two legal opinions from its outside counsel in order for Andersen's accountants to sign off on the accounting treatment of the transactions. (6) This clearly suggests that these were not situations where, as many have claimed, lawyers were merely following the advice of the accountants, but rather it was the lawyers who made the accountants feel comfortable about the way some of the Enron transactions were to be booked.

   Before we go any further, a few definitions are in order. Fraud is, in plain English, lying to someone to get them to give you their stuff. Sometimes the lie is expressed out loud. Other times it is told by speaking and leaving out important information that the person with the "stuff" would certainly have wanted to consider before parting with that stuff. Consider the statement, "I have $40,000 in the bank," when spoken to a prospective lender. If you have written a check to another for $40,000 post-dated for the next day, you have lied by omitting important information.

   Not all untruths are lies. A lie is an untruth spoken when one knows it is an untruth or when one asserts something as true when one has no idea whether the statement is true or not. Consider the statement, "I did not eat a salad last Wednesday." I have no idea what I ate last Wednesday. So, the assertion is a lie, at least if it tuns out later that I did eat a salad and maybe whether or not I ate a salad. Finally, an often over-looked point, one need not know what is true to know what is false. Consider the statement, "I ate chicken last Wednesday." I know that is false because I never eat chicken. It is irrelevant that I have not a clue what I did eat last Wednesday.

   I said I was certain that many of Enron's related party transactions were fraudulent. Why? The partnerships were buying assets from Enron and making trades with Enron that Enron was financing. This made it seem as if Enron was generating profits that it was not (a lie). This also made it seem as if Enron had protected itself from potential losses from risky assets and trades (another lie)--risks it was not transferring to the related-entities , given because Enron was promising the investors in those entities a profit, no matter what happened. These lies were told to get people to buy Enron's stock at inflated values--values driven by financial statements that included these lies, thus projecting an intentionally false picture of Enron's financial condition. They were, in other words, lies to get people to give up their stuff.

   Moreover, some, if not all of the so-called "related entities," did not qualify to buy anything from Enron because they did not meet the requirements that would have made it legitimate to book these transactions as sales between Enron and an arms-length trading partner, which is how Enron booked them. Some of the related party transactions seemed to have failed the base requirement that at least three percent of the investment made by the "special purpose entity" ("SPE") be from sources other than Enron. Furthermore, most, if not all, of the SPEs that arguably met the three-percent minimum were nonetheless obviously not engaging in "arms length trades" with Enron--the trades that a truly independent party would entertain. The SPEs were controlled by Enron's CFO, who "supervised" the agents who were supposed to be negotiating on Enron's behalf with the SPEs, entities in which their boss had a huge financial stake. In short, it was Enron CFO Andrew Fastow's will (used in service of his interests) that was manifest on both sides of the "negotiation." All in all, these transactions were more like an eyelash-length, than an arms-length, negotiation. Thus, not only were those buying Enron's stock "defrauded" by Enron, Fastow's partnerships, and knowledgeable principals of both, some of the investors in the related-entities were defrauded too (i.e., told a lie that the entities were qualified to trade with Enron, when many, if not all, were not). (7)

   Marketing the partnerships as investments, Merrill Lynch emphasized to would-be investors in these partnerships that the major investor and controlling partner was Enron's CFO, a person uniquely situated to make would-be investors in these partnerships (set up to trade with Enron) sure, steady, and substantial profits. This was a selling point because as Enron's CFO, Fastow had a front-row seat at Enron's planning sessions and understood the company's strategy and financial state as only a person with access to all of Enron's inside information would. Trading on inside information is both a civil and criminal wrong. Again, the lawyers approving Merrill Lynch's marketing strategy seemed not to notice or care about this none-too-subtle suggestion that inside information would be the key to the partnerships' future success.

   J.P. Morgan, Citigroup and other major banks engaged in what they call "structured financing" with Enron. (8) It worked like this: The banks would enter into contracts to buy a commodity from entity A at X price some time in the future, say within the next year or two. Entity A (and each bank had its own A) would contract to buy that commodity from Enron for X price (or X plus some take for entity A) within the same period of time. Enron, in turn, would agree to buy the commodity from the banks for X + Y price within that period of time. Y was some percentage of X that turns out to be what one might expect the interest rate to be, if Enron were borrowing X from the banks.

   Notice the circle. The commodity in Enron's possession at the start is (at least on paper) to be transferred to A, which in turn will "deliver" the commodity to its sponsoring bank. Then the bank will "deliver" the commodity back to Enron. In the end, the commodity ends up where it started, with Enron. Indeed, the commodity never has to leave Enron's possession except on paper. In the meantime, the money, which is the bank's money at the beginning, moved from the bank to A (ostensibly as a "prepayment" for the commodity) and...