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Thursday, February 17, 2005

Scrushy, Ebbers, Tyco Trials Show Investors `Cry for Scalps'

Feb. 16 (Bloomberg) -- In 1992, Ollie Dean Couch, chief executive officer of Texas lender Couch Mortgage Co., was convicted of 16 counts of fraud and making false statements involving $45 million in home loans. He got a year in prison.

Now, former HealthSouth Corp. CEO Richard Scrushy, whose trial began last month, faces as many as 450 years behind bars on 58 charges, including fraud and money laundering. ``I wouldn't want to be a CEO in today's environment,'' says Joel Androphy, who was Couch's lawyer.

Scrushy is the first CEO tried under the Sarbanes-Oxley Act, passed by Congress in July 2002, which increased white-collar criminal fines and prison time as much as 10-fold. He leads an unprecedented parade this year of half a dozen CEOs and other top executives on trial, as the three largest U.S. stock exchanges still struggle to recover from the record $7.5 trillion decline in market value from March 2000 through September 2002.

``The aftermath of the bubble created so much pain for everybody that there was a hue and cry for scalps,'' says Steve Hoedt, 33, who manages 1.6 million Tyco International Ltd. shares at Cleveland-based National City Corp.

On trial are Scrushy, former WorldCom Inc. CEO Bernard Ebbers, and former Tyco CEO Dennis Kozlowski and his chief financial officer, Mark Swartz. They may be joined this year by former Enron Corp. Chairman Kenneth Lay. All are likely to face longer prison terms than executives in savings-and-loan and insider-trading scandals of the 1980s and 1990s, making investors such as Cecil Duke more secure in owning stocks.

``Instead of being slapped on the wrist, they need to serve some time in prison,'' says Duke, 69, a retired junior high- school football coach in Pleasant Grove, Alabama, who owns 5,900 HealthSouth shares. He is among investors suing the company in a federal securities-fraud case. ``This was going on for years before it boiled over. Now they're cleaning up their act.''

`Getting Involved'

Other investors who see a silver lining in the trials include Kevin Bannon, chief investment officer at New York-based Bank of New York Co., which manages $102 billion. He says the trials may build confidence.

``We went through the discovery of the scandals, the government getting involved and cleaning up a lot of governance issues,'' says Bannon, 52. `I think it's mostly behind us.''

Indictments were a buying opportunity to Ian Fields, who manages health-care investments at New York-based Exis Capital Management Inc., which bought 600,000 HealthSouth shares after Scrushy, 52, was indicted Nov. 4, 2003, and sold the stake as of Dec. 31, 2004. The shares had risen to $6.28 on Dec. 31, from a low of 8 cents on March 28, 2003. Fields sums up the negative effects of trials on his strategy in two words: ``No impact.''


More than 60 CEOs or presidents have been charged under federal law with corporate fraud in the past three years, according to the U.S. Justice Department. Among the executives charged since 2002 are former Adelphia Communications Corp. Chairman John Rigas, housewares-company founder Martha Stewart, and ImClone Systems Inc. founder Sam Waksal.

The simultaneous trials of CEOs are unprecedented in U.S. history, says Lawrence Mitchell, a law professor at George Washington University in Washington.

Those on trial may be victims of their own success, says Mitchell, 48. Until CEOs turned into celebrities after the Standard & Poor's 500 Index quadrupled in value in the 1990s, regulators were more likely to fine corporations accused of white- collar crimes, instead of seeking criminal convictions of individuals.

When Boeing Co. in 1982 faced 40 counts of covering up payments it had made to sell airplanes overseas, for instance, the company entered a guilty plea in federal court in the District of Columbia and paid $450,000 in fines.


After Chicago-based Boeing said in November 2003 it dangled a job before a U.S. Air Force official awarding a $23 billion contract, Congress killed the deal, CEO Phil Condit quit and federal prosecutors won guilty pleas from the two people involved: Darleen Druyun, a former Air Force acquisitions official; and former Boeing CFO Michael Sears.

Druyun is serving a nine-month sentence for violating federal conflict-of-interest laws. Sears is scheduled for sentencing this month. Condit wasn't charged.

New York Attorney General Eliot Spitzer, who is running for governor in 2006, has focused public attention on corporate fraud, says Robert McGuire, a former New York police commissioner.

Spitzer Investigations

In October, Spitzer all but demanded the ouster of Jeffrey Greenberg, CEO of Marsh & McLennan Cos., after filing a complaint accusing the world's largest insurance brokerage of rigging bids and taking kickbacks from insurers.

Greenberg quit 11 days after Spitzer filed suit, saying at a press conference that Marsh should ``look long and hard'' at its management. New York-based Marsh & McLennan last month agreed to pay an $850 million fine to settle the case. Greenberg hasn't been charged. A former Marsh & McLennan managing director and two employees from New York-based American International Group Inc. pleaded guilty to Spitzer's charges of rigging bids.

``He has used all of the levers of his office to move into areas that really hadn't been investigated before,'' says McGuire, 68, now an independent attorney.

The result has been a competition among regulators that didn't exist in the 1990s, says Alan Bromberg, a securities law professor at Southern Methodist University in Dallas.

The SEC has responded with higher fines and more enforcement actions against individual directors. In 2003, for instance, WorldCom agreed to pay a record $750 million fine to settle fraud allegations. Just a year earlier, Stamford, Connecticut-based Xerox Corp.'s $10 million fine for inflating revenue had been the commission's largest.


The Sarbanes-Oxley Act strengthened the SEC's hand. The law allows the SEC to place fines in a fund to benefit the victims of corporate fraud -- shareholders, rather than the U.S. Treasury -- increasing the commission's incentive to seek large penalties that would help investors. By September 2004, the SEC had imposed 15 fines of more than $50 million, dwarfing the Xerox record, according to the SEC's Web site.

Until the law was passed, the commission had to show that officers or accountants were ``substantially unfit'' before seeking to bar them from serving on corporate boards. The law lowered that standard to ``unfit.''

In the fiscal year ended Sept. 30, 2004, the SEC sought to bar 161 officers and directors, quadruple the 38 in fiscal 2000. Among those who have accepted lifetime bans are former Xerox Chief Financial Officer Barry Romeril and former Tyco director Frank Walsh.

Prison Time

Under Chairman William Donaldson, the SEC has a $913 million budget in the fiscal year that ends Sept. 30, more than double the $438 million in the 2002 fiscal year. The agency has hired almost 1,000 new attorneys, accountants and compliance officials since 2002.

Congress passed the Sarbanes-Oxley Act a year after the collapse of Enron, which hid debt in off-the-books partnerships capitalized by its shares. When the shares fell, Enron had to reduce profit by $586 million and seek bankruptcy protection.

The law boosted the penalty for both wire and mail fraud to 20 years from five years. The penalty for knowingly making a false statement in a financial report rose to 20 years in prison and a $5 million fine, from 10 years and a $1 million fine. Corporations that file false statements can be fined as much as $25 million, up from $2.5 million. The law requires CEOs and CFOs to certify financial statements quarterly.

Threat of Incarceration

In the biggest executive settlement related to Enron, former CFO Andrew Fastow, 43, pleaded guilty to fraud charges in January 2004 and agreed to serve 10 years in prison and to forfeit $29 million in assets. He agreed to pay $23 million to settle SEC civil claims over hiding the debt.

Sarbanes-Oxley followed decades of tougher sentences. In 1984, more than half of all white-collar crime convictions resulted in probation, according to the U.S. Sentencing Commission. By 2002, more than 60 percent led to prison sentences.

The threat of incarceration has encouraged more defendants to fight cases rather than seek plea bargains, contributing to the increase in trials, says Androphy, a partner at the Houston- based law firm Berg & Androphy.

Fraud, the focus of the tougher sentencing regulations, is the most prevalent charge at the CEO trials this year. Ebbers, 63, is on trial in New York federal court on charges of leading accounting fraud. He faces one count each of securities fraud and conspiracy and seven counts of making false filings to the SEC. If convicted, he faces a maximum of 25 years in prison.

Enron, Tyco

Former Enron CEO Jeffrey Skilling, 51, may receive a prison term of as long as 325 years if convicted on 35 charges of fraud, conspiracy and insider trading at the Houston-based company. His one-time chief accounting officer, Richard Causey, 45, could get 265 years on 31 counts. Lay, 62, faces seven charges of fraud and conspiracy. All have asked for their trials, in Houston federal court, to begin this year.

In their retrial in New York state court, Kozlowski, 58, and Swartz, 44, are accused of taking $150 million in unauthorized bonuses. The two men face 31 counts of stock fraud, falsifying business records, grand larceny and conspiracy. The most serious charge carries a 25-year prison term.

John Rigas, founder of Greenwood Village, Colorado-based Adelphia, and his son Timothy Rigas were convicted of conspiracy and fraud in July for looting $3.2 billion from Adelphia and lying about its finances before the bankruptcy filing. John and Timothy Rigas both appealed their convictions. Another son, Michael Rigas, faces retrial on fraud charges after a jury was deadlocked on whether to convict him.

Martha Stewart Living

Scrutiny of Stewart, 63, wouldn't have been so intense a decade ago, says Christopher Bebel, who was an attorney in the SEC's Division of Enforcement in the 1980s and an assistant U.S. attorney in the 1990s.

Stewart, founder of New York-based Martha Stewart Living Omnimedia Inc., is serving a five-month sentence in a West Virginia prison for lying to government investigators about her trading of ImClone stock. She will complete her prison time next month. Stewart has appealed.

Waksal, 57, who tried to sell the stock after learning that regulators were about to reject a new cancer drug, pleaded guilty to insider trading and began serving a seven-year term in July 2003.

While the parade of trials has given such companies as HealthSouth and Tyco negative attention, it hasn't hurt some of those shares. Bermuda-based Tyco, the world's biggest provider of security systems, rose 90 percent to $33.90 on Feb. 14 from Kozlowski's indictment on Sept. 12, 2002.

Investment Opportunity

Among the biggest beneficiaries was Bill Miller, the only fund manager to beat the S&P 500 Index 14 years running. Miller's Baltimore-based Legg Mason Value Trust started adding Tyco shares that year and owned 34 million as of Sept. 30, his second-biggest holding. Miller declined to comment.

Shares of HealthSouth, a Birmingham, Alabama-based hospital operator, rose 12 percent to $5.70 on Feb. 14 from Sept. 29, when prosecutors said Scrushy, who founded the company as AmCare in 1984, had charges of perjury and obstruction of justice added to fraud in fabricating profit to meet earnings estimates. The board placed Scrushy on administrative leave on March 20, 2003.

Enron, by contrast, has been in bankruptcy while more than 20 former executives have been under indictment, according to the Justice Department. Enron shares were delisted by the New York Stock Exchange on Jan. 15, 2002.

`White-Collar Stage'

WorldCom filed for Chapter 11 bankruptcy protection in 2002. After winning court approval to exit bankruptcy in October 2003, the company listed new shares that began trading at $26.70. On Feb. 14 this year, they closed at $19.93.

The company officially exited bankruptcy in April 2004 as Ashburn, Virginia-based MCI Inc. Under Ebbers, the company had been based in Clinton, Mississippi. Verizon Communications Inc. said on Feb. 14 it agreed to buy MCI for $6.7 billion.

Even in this environment, prosecutors may still lose, says Charles Elson, head of the Center for Corporate Governance at the University of Delaware.

Kozlowski and Swartz's six-month trial ended in a mistrial in April. That month, federal jurors in Denver refused to convict four Qwest Communications International Inc. executives charged in connection with improper booking of a $33 million transaction.

Androphy, the lawyer who represented Couch, says public anger after the stock-market decline fueled a government emphasis on securities fraud. He said his client, who died in 1998, could have been sentenced to 10 years in prison under the new laws.

``Right now, you can rob a bank and be OK,'' says Androphy, the author of a textbook called ``White Collar Crime'' (Shepards/McGraw-Hill, 1992). ``We're in a securities fraud, white-collar stage right now. It will pass.''

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