Circle of Greed

by Patrick Dillon

  “Yes,” Torkelsen answered.

  Raising his voice to be certain to be heard, Lerach then asked: “And your testimony was taken in that regard to overcome the objections of Arthur Andersen and these other defendants who tried to scuttle the settlement, isn’t that right?”

  In unison, the defense lawyers leaped to their feet, raising a chorus of objections. The jury also tensed.

  “The objection is sustained to that question,” Judge Irving said quickly.

  Red-faced, Lerach spun and stormed back toward the plaintiffs’ table, hurling his notes to the floor as he sat, uttering, “Let’s go to the football game.”

  COURT RESUMED AT NINE FIFTY A.M. on January 5, 1988. Without the jury present, Stuart L. Kadison—a World War II veteran, Stanford law graduate, venerated trial lawyer, and the lead attorney representing Arthur Andersen—approached the bench. “Even if it should not please the court,” he began, “on behalf of my client, Arthur Andersen and Company, I move for a mistrial by reason of deliberate misconduct of counsel [Lerach] for the class plaintiffs in the presence of the jury, shortly before the close of proceedings on Wednesday, December 30, 1987.”

  Lerach’s question of Torkelsen “assumed a falsehood,” Kadison maintained—namely, that Arthur Andersen had attempted to derail the previous Nucorp settlement. Moreover, the assertion could have had no other purpose than to bias the jury. “The jury reacted, both visibly and audibly,” Kadison noted. “It was probably the most dramatic moment of the trial. After the court sustained the objection … the jury observed Mr. Lerach storm back to the counsel table, throw his notes on the floor, and subside … Mr. Lerach’s misconduct was conscious, it was deliberate, and it was calculated to inflame and prejudice the jury against the defendants, and our client in particular.”

  Kadison wasn’t asking the judge to rein in Lerach—he was asking him to throw out the case or at least reprimand Lerach in front of the jury.

  “At some point there has to be a limit to amateurish and infantile behavior in the presence of the jury,” Kadison continued. “I think the damages done in terms of prejudice to our client are beyond repair and certainly was in no way our fault.”

  Even if the judge disagreed, Kadison added, he should read a cautionary statement to the jury unbinding the defendants to the previous settlement. The judge affirmed this point and informed the defense lawyers that he was inclined to rule against the motion. However, he added: “I do intend on saying something to the jury.”

  Lerach did not object.

  Following that the judge called a recess. In the elevator Lerach pushed his way into a crowd that included Kadison. He addressed his opponent, senior to him by nearly three decades, for all to hear: “Kadison, this case is going to bring an ignominious end to your mediocre career!” He knew immediately that the remark would eventually cost him—just not how much.

  When court resumed at 10:35 A.M. on January 5, Judge Irving bade the jurors a happy New Year, and the plaintiffs called a new witness. His name was Fred Hervey, then seventy-nine years old. The jury learned that he was from El Paso, Texas, where he had twice been mayor. During the Depression, Hervey—who had dropped out of high school to support his family—and his brother opened a drive-in root beer stand and also sold tamales, beans, pies, and other food cooked by their mother. In 1936 he opened a second store. After serving in the U.S. Navy during World War II, Hervey returned home and opened three more restaurants, a supermarket, and a radio station. In 1951 he ran for Congress but lost. Nonetheless, Fortune magazine recognized him in a list of young men who had proved that America was still a land of unlimited opportunities. Six years later he expanded his restaurants and supermarket into what would eventually become the nation’s second-largest convenience store chain—Circle K Corp.—with fifteen hundred outlets in fifteen states. In September 1980 Circle K purchased one million shares of Nucorp stock for $23.5 million, borrowing the whole amount to invest in Nucorp’s oil-drilling efforts. Further questions, which Lerach had to repeat because of Hervey’s hearing difficulties, showed that Circle K reflected on its books as assets a 10 percent interest in a Nucorp heavy oil–drilling project that Lerach and Torkelsen had already derided, in South Texas’s sand tar pits. At the same time Hervey was elected to serve on Nucorp’s board of directors. Hervey then recounted joining Nucorp’s CEO Richard Burns in a hotel room for a meeting with the president of Mercantile Bank, which, along with defendant Continental Bank, held Nucorp’s line of credit. According to his testimony, Hervey was still considering investing in Nucorp; Burns suggested to the Mercantile president that he loan Hervey the money to make the deal.

  “And it was a surprise when the president of the bank said: ‘We would be glad to loan Fred Hervey all the money’?” Lerach asked.

  “That’s right. And I said: ‘Well, don’t you think maybe I’ll put up six million and you’ll only put up seventeen million?’ And he said, ‘No, you’re going great places with Dick Burns,’” Hervey continued in his nasal, West Texas twang: “‘You just take all of that money because you are going to need it, and you’re going to put it to real good use. You and Dick Burns are going to make history.’”

  With Circle K’s attorney Charles “Chuck” Dick listening intently, Lerach then walked Hervey back through the company’s financial quarterly reports for the year leading up to the purchase, showing him charts plotting a steady decline in Circle K’s earnings until the final quarter of 1981, when the company factored its investment in Nucorp and the energy company’s stated record earnings into its own earnings report, showing improved results. On December 15 of the same year—1981—Circle K sold 1.25 million shares to the public at between $11.62 and $14.50 per share, raising some $15 million. Lerach also elicited an admission from Hervey that Circle K had dumped its previous auditors and hired Arthur Andersen—on Richard Burns’s recommendation.

  Hervey explained that, to his thinking, there was logic to this move. He had been told that Arthur Andersen had more expertise in gas and oil accounting. And since Circle K would be backing Nucorp’s drilling ventures, it made sense to share accountants anyway. This observation inspired a response from Lerach: “Mr. Hervey, isn’t it a fact that in order for Circle K to pick up a part of Nucorp’s earnings and include them in Circle K’s earnings via the equity method, that Circle K had to, in fact, demonstrate that it had significant influence over Nucorp’s operating and financial policies?”

  “Well, I don’t know what you mean by ‘demonstrate,’” Hervey replied. “They just merely had to do what the auditors said, ‘You have to do it this way.’” At the defense table, Chuck Dick, the Circle K attorney, took notes but did not object.

  Lerach wanted this to be indelible with the jury: “And, in fact, and in truth, Circle K did have significant influence over Nucorp’s operating policies and financial policies—and that’s why it could use the equity method.”

  Hervey thought about it and answered: “We just had—we had—we just carried out what the auditors said, ‘Here’s what you have to do.’”

  Digging deeper, Lerach cited a 1981 Arthur Andersen internal document and asked Hervey to vouch for a memo that said: “Circle K could demonstrate ‘significant influence’ over Nucorp’s operating and financial policies because Fred [Hervey] would go on the Nucorp board of directors and executive committee. With his election to the executive committee, he would represent one vote out of four on that committee.”

  Even more potentially damaging was Hervey’s admission that he had been warned of Richard Burns’s insider selling before his previous company plunged into bankruptcy and that he had not done a credit check on his new business partner. With a growing inventory of expensive oil-recovery equipment pressing the company’s bottom line, Hervey also conceded attending a meeting when the board discussed canceling or deferring taking delivery of the equipment “to fight for time,” because “there is no question we had an inventory problem.” Yet, Hervey acknowledged, this problem was not disclosed on the c
ompany’s September 1981 prospectus.

  “Now, isn’t it a fact that shortly after that information came to your attention, that you learned that management at Nucorp Supply had been cooking the books?” Lerach asked.

  “No,” Hervey answered hesitantly. “The ‘cooking the books’ statement was heard by me in the hallway of the offices of Nucorp by David Tenwick, a co director of Nucorp, and an outside director of Circle K, and I asked David—Mr. Tenwick, I said, ‘What do you mean by cooking the books?’ And he said to me: ‘We found that some of the sales of one month were put over into the sales of a succeeding month, which distorted the picture somewhat.’ It was at that point that I said to him, ‘Well, now, that’s not—that is inconsequential. Why would you …’ He said: ‘Well, as far as I’m concerned, it was inconsequential, but I think we had to put a stop, to make sure that the sales went into the right month.’ And I said, ‘Well, you have solved—you have corrected the problem?’ He said, ‘I have.’”

  Lerach moved into Circle K’s investment in Nucorp’s oil exploration and steered Hervey into telling the jury that the lack of drilling performance became a concern—at one point returning about $145,000 on a $5 million investment.

  The Circle K chairman conceded that he tried to get out of the drilling investment because it was “too big a risk, too big a gamble.” He conceded that Nucorp agreed to refund the investment with commensurate shares of stock valued at $20 per share provided that Circle K purchased 150,000 shares of Nucorp stock at that price. Lerach then produced documents that Hervey recognized showing that the Nucorp shares Circle K agreed to purchase would have traded before the public offering just a month later.

  However, according to Circle K documents and Hervey’s testimony, Circle K dropped out of the stock purchase because the price of Nucorp stock was already starting to drop. Instead it announced it would purchase three million shares of Nucorp stock on the open market—as prices had fallen below $20 a share. The move was twofold: Circle K was hedging its bets, but by making a purchase in the open market, Circle K, Nucorp’s largest investor, was sending a message to prospective investors that it still had confidence in Nucorp.

  “Now if Nucorp stock continued to go down and down, it was going to have the impact of requiring Circle K to write off that investment on its books, wasn’t it?” Lerach asked.

  Hervey was quick to answer: “Well, yes. If you’ve got stock in a company and it goes broke, you’re going to lose—you’re going to lose your investment.”

  Circle K’s qualms about the drilling operation, and Nucorp’s repurchase of Circle K’s share of that operation did go through, but were not disclosed on the public offering prospectus. This, Lerach was trying to demonstrate, constituted fraud on the part of Nucorp and Circle K, with help from the other defendants—a fraud that was perpetrated on uninformed investors.

  “We should not have invested—we shouldn’t have gotten mixed up with Nucorp anyway,” Hervey said, “and whenever we got mixed up with Nucorp, I’ll guarantee you we had to pay and pay through—pay through the nose.”

  This concession was a major point for the plaintiffs, or so it seemed. But (and this wasn’t clear until later) something was happening in the jury box. Maybe it dated to Lerach’s exhibition before the New Year’s break. Maybe it was Hervey’s life story or his age, or simply his candor. Yet somewhere along the line Lerach had succeeded in turning Hervey into a sympathetic figure.

  One onlooker picked up on the subtle turning of the tide. His name was Patrick Coughlin. He was a thirty-two-year-old assistant U.S. Attorney in San Diego, who specialized in criminal prosecutions of white-collar crimes. He was solidly built, with curly hair and a slightly lopsided mouth that turned down from right to left, giving him a tough-guy appearance more resembling the football player he’d been at Santa Clara University. After graduating from law school at the relatively obscure Golden Gate University, he joined the U.S. Attorney’s office in Washington, D.C. There he prosecuted felony crimes, including one of the largest RICO cases in U.S. history, as well as an infamous oil fraud that had, as part of its complexities, a murder-for-hire element. In the nation’s capital Coughlin earned a reputation for being a fearless and dogged prosecutor, and after four years he was transferred to San Diego. At the time of the Nucorp trial Coughlin had found himself between cases. He was tiring of government prosecution work, and starting to dream of making more than his $45,000 government salary. He had mentioned his interest in private practice to a friend who recommended he do some diligence on Milberg Weiss Lerach, a firm where his fierceness and penchant for hard work might be a good match. So he made himself at home in Judge Irving’s courtroom, paying particular attention to his prospective boss Bill Lerach.

  “I was impressed with his preparation, particularly in a complex trial such as this,” he remembered two decades later—just after his name replaced Lerach’s on the door announcing him as head of the firm Lerach had once ruled. “I was also struck that he did not play well to the jury. He played well to the judge, to his opponents, to the witnesses, although he could be heavy-handed in front of the jury. But I noticed he never looked at the jurors. If they think you are ignoring them, they can turn on you.”

  ON MONDAY MORNING, MARCH 15, 1988, the fifty-ninth day of the trial, Jim Goldman, the Arthur Andersen defense attorney, called as a witness Daniel R. Fischel, a thirty-eight-year-old professor of law and business at the University of Chicago, who specialized in teaching corporate finance and economic analysis of the law. At Goldman’s urging, Fischel, a slight, intense-looking man with wavy hair and wearing what appeared to be a fixed grin, told the court that he was a principal in the corporate finance and securities area of a company called Lexecon, a ten-year-old Chicago-based consulting firm specializing in the application of economics to an array of legal and business problems. Its clients included Ford, General Motors, General Electric, and Sears Roebuck. Among the more than sixty employees, Fischel added, were two Nobel Prize winners in economics.

  Following Goldman’s guidance, Fischel explained that he had studied at the University of Chicago Law School under Richard A. Posner, a brilliant, prolific, and controversial legal thinker and writer credited with being one of the early proponents of a doctrine called the “economic analysis of law.” Adherents to the “law and economics movement,” as it is also known, apply economic theories as a way of ascertaining which legal rules and precedents are economically efficient—and likely to survive. It’s a pragmatist school of thought, which taken to its ultimate logical conclusion holds that in certain cases willingly breaching contracts makes more economic sense than honoring them.

  Bill Lerach was unimpressed with Posner and had even a lower opinion of Fischel. As far as he was concerned, both men hid behind esoteric theories to defend the likes of Michael Milken and Charles Keating at a time when those men were doing real damage—not theoretical harm—to working Americans who were looking for an honest return on their investments. Lerach’s contempt for these Chicago professors was on display as he rose to his feet from the plaintiffs’ table, objecting to the very mention of Posner’s name by Fischel. It was irrelevant, Lerach said. As events would unfold, both Fischel and Posner became very relevant—to Lerach’s detriment. Judge Irving overruled the objection, and Fischel continued, telling the jury he had graduated first in his class and later clerked for Justice Potter Stewart of the U.S. Supreme Court. Lerach was not physically violent by nature, but as he listened to Fischel rattle off his bona fides, he thought to himself—and later said aloud to David Gold—“Someday I’m going to wipe that grin right off that little shit’s face.”

  Over Lerach’s objection, Fischel also told the court that Milberg Weiss had filed a Supreme Court brief listing several of his published articles, including the “fraud on the market” theory that Lerach’s firm had developed, in a table of authorities, citing his expertise in the functioning of securities markets. Further, Fischel recounted being invited to consult for the Securities an
d Exchange Commission and the New York Stock Exchange, and being asked by William Proxmire, chairman of the Senate Banking Committee, to testify before Congress on issues related to shareholder rights.

  As Lerach had done with John Torkelsen, Goldman urged his own expert witness to expound on the extent of his preparation for the Nucorp case, including the review of SEC filings, quarterly and annual reports, press releases, analysts’ reports, and trading information, as well as materials on the oil and gas industry. He mentioned that he had read the transcripts of the previous witnesses, including Torkelsen’s testimony on behalf of the plaintiffs.

  “As a result of your review of those documents and other documents, have you come to some opinions?” Goldman asked.

  “Yes, I have,” Fischel answered.

  Sensing impending objections, Judge Irving called a recess. Outside of the jury’s presence he asked Goldman to outline what Fischel was prepared to say. “He is here to testify about, among other things, the nature of risks associated with investing in stocks and other securities, and in particular Nucorp’s securities, and how those risks explain movements of stocks in general and movements in Nucorp’s securities in particular,” Goldman told the judge. “The plaintiffs have tried to prove that the alleged fraud explains all or substantially all of the movement in the price of Nucorp’s securities. We feel we’re entitled to prove that that isn’t correct.”

  Judge Irving was skeptical. “Frankly, Mr. Goldman, I have some difficulty understanding how, whether this stock was speculative or not, it has any relevance to any issue in this case,” he said. “But let me hear further from Mr. Lerach.”

  “He admits the man is going to testify about the riskiness of investing generally,” Lerach told the judge. “That can’t have anything to do with this case … If this witness gets into this and they try to imply to the jury that somehow they [plaintiffs] are a bunch of plungers who ought to suffer, they are without recompense, you’re going to have to deal with that very dramatically and sternly.”