When it comes to corporate scandal, place blame where it’s due


“Boss, that suit looks great on you.” CEOs used to smile when hearing that; lately, though, the CEOs aren’t grinning — especially when they hear it from New York Attorney General Eliot Spitzer (HLS ‘84) and the boys at the S.E.C.

Last week, Wall Street’s worst nightmares filed some of their most deeply-impacting lawsuits in recent months. But while some of them — the S.E.C.’s criminal and civil actions against Enron Chief Financial Officer Andrew Fastow — threaten to bring to justice a man who spearheaded an effort to defraud market players of ludicrous sums of money, one of them — Spitzer’s suit against a number of tech CEOs — at least threatens to crash down upon parties without a showing of actual moral culpability.

The documents uncovered throughout the various Enron and Arthur Andersen investigations detailed a near-Gordian Knot of managerial ignorance — intentional and unintentional alike. The knot, once unraveled, displayed a board of directors that looked past a staggering list of off-balance sheet entities and ineffective managers, management more effective in lining its own pockets than creating value sufficient to justify the stock price, and auditors who approved off-the-books ventures that were questionable in light of accounting standards (let alone any standard of “ethics”), that reveled in its ignorance then as much as it does in finger-pointing now. The one party who is utterly unable to claim ignorance in these matters is Fastow, who, in the words of the criminal complaint, “took advantage of [his] simultaneous influence over Enron’s business operations and the SPEs as a means secretly and unlawfully to generate millions of dollars for [himself] and others.”

Whether or not the Fastow prosecution leads to subsequent prosecutions of CEOs Lay, Skilling, or any other related parties, champions of market accountability can cheer the indictment of Fastow, which stands as a reminder that the S.E.C., under the watch of the oft-maligned Harvey Pitt, is not finished in its quest to bring corporate malefactors to justice.

The Fastow indictment stands in stark contrast to the recent lawsuit filed by Spitzer against the executives of five major telecoms. All five defendants are charged with “misstat[ing] or omi[tting] material facts regarding the sale of securities to the public.” In each case, the executives received shares of “hot IPO stocks” from Salomon Smith Barney, implicitly (though never explicitly) in return for subsequent work with SSB’s investment banking arm. Moreover, SSB researcher Jack Grubman supplied the market with inflated evaluations of the defendants’ respective firms in this quid pro quo. Because investors were misinformed by the defendants’ failure to disclose their relationship with the investment bank researchers, Spitzer seeks, among other damages, restitution in the amount of $28 million in profits from the IPO stocks and $1.5 billion in profits from the executives’ sale of stock in their own companies.

Sixteen pages of the 29-page complaint detail the relationship between SSB’s research and I-bank divisions as well as the inappropriately high ratings awarded by Grubman to the companies in question. All in all, it would be a marvelous indictment of the seemingly indefensible Grubman … except that it’s not an indictment of Grubman. Despite pages and pages of detailed explanations of Grubman and SSB’s fraudulent acts, Spitzer fails to offer a single explicit example of conscious fraud perpetrated by the defendants.

Spitzer is not light on implication of such. Throwing about assertions that “[T]he executives who received the hot IPO shares were in a position to determine or influence their company’s [other contractual engagements with SSB],” or that, for example “Ebbers’ (and the other defendants) receipt of IPO shares predated (the companies’) retention of SSB for banking services,” the implication is clear: The IPO distributions caused the subsequent business.

But, in sharp contrast to his depiction of Grubman, Spitzer does not explicitly charge the defendants with malicious acts (although he assured 60 Minutes this Sunday that the complaint is not exhaustive). Indeed, under New York’s Martin Act, one of the statutes under which the defendants are charged, the proving of actual intent to defraud is not necessary. Spitzer need only prove by a preponderance of evidence that the defendants withheld the information and that the information was material to market perception of the value of the stocks.

That’s the essential difference between last week’s lawsuits: While the S.E.C. suits bring to justice someone who appears to have consciously robbed shareholders, the Spitzer suit, while viable under New York law, may extract over $1.5 billion from defendants even if it is shown that they did not act out of malice against the shareholders. That does not render the prosecution inappropriate under the law, but it does leave the public to ask: Will we be satisfied when we have punished those who declared war on our 401(k)s and mutual funds, or will we send the weight of the state crashing down upon those who might have acted wrongly — despite a lack of hard evidence to prove it? The law may empower the public to extract the gains from these CEOs, but at what point do we lose the moral high ground?

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