The Divide: American Injustice in the Age of the Wealth Gap

by Matt Taibbi

  Rehnquist insisted that the state needed to offer a higher burden of proof: that the mere fact that Andersen had shredded two tons of documents in the Enron case was not enough, and that prosecutors had to show “consciousness of wrongdoing” as well. (What did they think they were doing with all that shredding? Cleaning?)

  Six months after that court ruling, the Justice Department heaved a big sigh of regret and made a great show of dropping the case. “The government has determined that it is in the interests of justice not to re-prosecute Andersen,” federal prosecutors wrote in November 2005.

  This would be one of the first of a series of decisions not to retry high-profile corruption cases. Whereas before the state had kept coming and coming, Jason Voorhees–like, after corrupt companies, after Arthur Andersen it started to lose its appetite for battle.

  Subsequently, in both the financial and the mainstream press, it became gospel that the experience of Arthur Andersen proved that such prosecutions of otherwise functioning companies are inappropriate. “There was an initial outbreak of moral condemnation after Enron and the bubble burst,” Larry E. Ribstein, a corporate law professor at the University of Illinois, told The Washington Post. “That was a time for people to take a deep breath. Instead, a lot of these things were rushed into prosecution, and now we’re seeing the fallout.”

  Academics piled on, writing paper after paper about the misguidedness and impropriety of the Andersen prosecution. There were critics in Congress, critics in the media, critics from the big law firms in New York and Washington. No 28,000 jobs lost were ever mourned as much as the 28,000 jobs lost in the Andersen case.

  Thereafter, the government began to think differently about prosecuting big companies. No matter how big the crime, the new thing was to think about the possible endgame first. And the worst possible endgame became the starting point for all future “to charge or not to charge” discussions. “From that point forward,” says Eliot Spitzer, “every time one of these things came up, someone always brought up Arthur Andersen.”

  During this whole time, at the end of the Bush years, Eric Holder was in private practice at Covington & Burling, a major corporate defense firm based in Washington, D.C. The firm’s clients at the time included four of the biggest banks in the world: JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, in addition to Freddie Mac and a little-known mortgage-registration company called MERS.

  In the cozy confines of C&B, Holder seemed to experience, if not a change in heart exactly, a change in perspective. His 1999 memo, though ignored by the Bush administration on the Collateral Consequences score, had survived and become unintentionally important policy (the way a joke becomes unintentionally funny) in other arenas.

  In particular, his 1999 memo was used as the basis for a 2003 memo written by a Bush administration official, deputy attorney general Larry Thompson. Thompson was something of a hero to young prosecutors in the Justice Department, an old-school law-and-order type who backed his troops in battle. “He had our backs” is how one former federal prosecutor put it. His new “Thompson memo” repeated the Holder guidelines under which companies could get (or lose) credit for cooperation, depending upon whether they waived attorney-client privilege.

  The Thompson version was more explicit and aggressive, but the root concept was the same as Holder’s. Unfortunately, some of Holder’s bad ideas survived in the memo along with the good ones.

  This would have a major impact on one of the biggest corruption cases of the early 2000s, the KPMG tax-shelter case. KPMG, a Netherlands-based firm that even today is one of the “big four” global auditing companies, along with such titans as Ernst & Young and PricewaterhouseCoopers, was accused of serially selling bogus tax shelters to extremely wealthy clients, depriving the IRS, and by extension other regular, cough-it-up-every-April taxpayers, of at least $2.5 billion.

  The government had KPMG dead to rights in the case. Before the state had even made a decision on whether to indict it, the company preemptively surrendered a little, like an octopus releasing ink, issuing a statement saying that it took responsibility for the “unlawful conduct by former KPMG partners.”

  As in the case of Arthur Andersen, there was a bit of a human-shield defense going on here, as the government was implored to consider the consequences of indicting the firm and wiping out 18,000 jobs.

  The Washington Post even came out with a house editorial entitled “Don’t Destroy KPMG,” in which it begged the Bush Justice Department to spare the thousands of jobs. “It’s hard to see the good that could come of indicting KPMG as a firm,” the paper wrote, adding, “KPMG has forced out the partners responsible for the problem and is apparently prepared to cooperate in prosecutions of individuals—which would have far greater deterrent value than a corporate indictment.”

  That made sense to just about everyone, and so unlike Arthur Andersen, KPMG was not criminally indicted and instead got a deferred prosecution deal, to go with $456 million in penalties. And as is not common practice today, authorities in 2005 launched those criminal indictments of KPMG’s individuals, hauling in nineteen former executives on broad-ranging tax fraud conspiracy charges, including several former partners.

  But there was a crazy catch with the case. As one exasperated investigator explains it, many of the KPMG executives had clauses in their employment contracts guaranteeing that in the event of a problem, the firm would pay their legal fees. But KPMG, in order to get credit for fully cooperating, had to stiff its former execs on the legal fee question. It turned out that at a meeting back in February 2004, the federal prosecutor in the case, Justin Weddle, had told KPMG executives that if the company planned on paying its employees’ legal fees, the state would “look at that under a microscope.”

  KPMG promptly responded by sending letters out to its employees, explaining that it had “no obligation” to pay fees but would do so provided the employees cooperated with the government. Even in that case, they would cap fees at $400,000.

  Years later a high-ranking Justice Department official would cringe to recall that episode. “We want everyone to have good lawyers. So why do that?” the official said. “That was just fucking stupid. The whole idea is stupid. It put everything at risk.”

  It sure did. Shortly after the Feds strong-armed KPMG on the legal fee issue, a district judge named Lewis Kaplan tossed the indictments of thirteen of the individuals on Sixth Amendment grounds, that is, that the defendants had essentially been denied counsel. Kaplan raged in particular against the Thompson memo, blasting the Justice Department for way overstepping its prosecutorial bounds.

  Noting with undisguised anguish that the indictment “charges serious crimes” that “should have been decided on the merits,” Kaplan ripped Thompson & Co. for going too far. He didn’t mention Holder and didn’t seem even to be aware of him. In fact, in his ruling, Kaplan cited a key section of what he thought was Thompson’s memo, which read as follows—the emphasis here is Kaplan’s:

  Thus, while cases will differ depending on the circumstances, a corporation’s promise of support to culpable employees and agents, either through the advancing of attorneys fees … or through providing information to the employees about the government’s investigation … may be considered by the prosecutor in weighing the extent and value of a corporation’s cooperation.

  This was exactly Holder’s language, but Judge Kaplan laid it all at Thompson’s feet. “The Court well understands,” he wrote, “that prosecutors can and should be aggressive in pursuit of the public interest.” But in this case, the Department of Justice

  deliberately or callously prevented many of these defendants from obtaining funds for their defense as they lawfully would have absent the government’s interference.… This is intolerable in a society that holds itself out to the world as a paragon of justice.

  A Second Circuit court later somberly upheld Kaplan’s savage ruling. This left the Justice Department—still covered in the nine-egg omelet that was the Suprem
e Court’s self-righteous flipping of the Andersen case—facing another barrage of incoming egg.

  Having gone after two of the world’s biggest accounting firms, both of which were clearly guilty of major systemic infractions, the Justice Department ended up completely overturned in one case and partially overturned and torn a new one by an angry judge in another.

  Furiously, the attorney general’s office quickly got to work tearing up the relevant portions of the Holder and Thompson memos, replacing them with new memos. The first one was written in 2006 by a deputy AG (or DAG) named Paul McNulty, and the second one in 2008 by another DAG, Mark Filip. The new rules more clearly defined what companies could get “cooperation credit” for and tossed out the whole concept of giving credit for anything but disclosing information.

  And here’s the punch line in all this: when the Thompson memo was overturned, an enterprising reporter from The Wall Street Journal named Peter Lattman traced the Thompson memo back to Holder and found the now-privately-practicing attorney at his new cozy home at Covington & Burling.

  Asked about all the hoopla, Holder expressed two things. The first was a chuckling appreciation that his name had miraculously been left out of it all, that all that judicial ire that could have been directed toward his memo had instead been lobbed at Thompson’s. “And I’m sure Larry [Thompson is] glad today that there’s now a McNulty memo and he doesn’t have to be reading about the Thompson memo all the time,” Holder quipped.

  Lattman, who now writes for The New York Times, remembers that Holder wasn’t troubled at all by his call. “It was a jocular conversation,” he recalls.

  The second thing Holder expressed to Lattman was a kind of new appreciation for the point of view of the big company facing federal investigation. He told the reporter that his memo had been misinterpreted, that it had never been intended to force companies to waive privilege, that it had been intended only as a positive thing—you know, if a company waived, that was something you could consider as a plus.

  Being on the business end of those policies now, defending such companies, he saw how tough they could be. “Today, it’s maddening,” he complained. “You’ll go into a prosecutor’s office … and fifteen minutes into our first meeting they say, ‘Are you going to waive?’ ”

  Holder, in other words, had gone from helping the State Department secure cooperation from corporate defendants using the white-collar equivalent of thumbscrews all the way to the other side of the argument as a highly paid corporate flack, whining that his own ideas were unsustainable intrusions upon commercial privacy.

  Such flip-flops are so common among this type of lawyer that most finance-sector observers scarcely even raise an eyebrow at them. “You’ll have a guy who as a prosecutor was tossing everyone in jail,” laughs one Wall Street reporter, “and six months later he’s a partner at some firm, and it’s almost like he thinks insider trading should be legal.”

  Holder was and is exactly that kind of character. But when he would return to government years later, the flip-flops would stop. Even as attorney general, he would remain a corporate lawyer at heart.

  In his capacity as a private defense lawyer, however, Holder was not yet in position to push the doctrine of Collateral Consequences in the federal Justice Department. All the same, it seemed like someone in power was reading his memo.

  In 2004, before the Supreme Court killed the Andersen case, the federal government had made sparing use of such tools as deferred prosecution agreements and nonprosecution agreements, deals that allowed companies to stay in business without taking a criminal charge.

  There were only five such deals in 2004. In 2005, after Andersen, the number jumped to twenty. By 2006 the number of DPAs and NPAs combined jumped to twenty-one. By 2007, as the next great era of corporate scandal in American history—the great mortgage-backed securities scam of the 2000s—was beginning to spill into public view, the number of DPA/NPA deals jumped to an incredible forty-one.

  It’s important to explain that the government has always had many tools at its disposal for dealing with corporate crime. In every case, the issue was always how far the state wanted to push things. One method was to gather a ton of evidence against an entire industry, gather all the major players into a room, and simply demand widespread structural changes. This was how then–New York attorney general Spitzer had done it in his so-called Global Settlement, in which virtually the entire investment banking industry was very publicly hauled behind the woodshed and forced not only to pay fines but to make significant structural changes in the way it handled IPOs and produced financial analyses.

  A key feature of the Spitzer settlement was the way the evidence was laid out openly so that the public could see the companies’ internal communications. At Lehman Brothers, for example, analysts admitted to giving cushy ratings to companies in exchange for more investment banking business, not caring if ordinary investors who were not in on the game got screwed. In another example, an analyst joked about giving an overenthusiastic rating to a company called Razorfish. “Well, ratings and price targets are fairly meaningless anyway,” he wrote. “But yes, the ‘little guy’ who isn’t smart about the nuances may get misled, such is the nature of my business.”

  Dumping all this out in public not only had a definite shaming angle, it also provided fodder for private litigators, who were now privy to industry behavior. Federal prosecutors would sometimes achieve the same end by filing a complaint as soon as they had evidence, instead of rushing into an agreement with the target firm, essentially telling a story to the public that had a kind of jurisprudential value all its own—it put the truth out.

  In another approach, if the state wanted to fully clean house, it could work corporate crime cases just like narcotics or racketeering cases, starting by charging small players and working their way up the chain. This had been the government’s approach in the savings and loan crisis, when the state started with the littlest of fish and worked its way up to criminally charging whales like Charles Keating of Lincoln Savings and David Paul of CenTrust Savings Bank. “That’s how they did it back then,” says a New York City police investigator who has worked on major bank cases. “In the S&L thing, they started at the branch manager level and just rolled their way up.”

  Deferred prosecution agreements and nonprosecution agreements represent a third course. Companies pay fines and enter into nominally restrictive agreements, but they also frequently are allowed to settle without admitting wrongdoing, which essentially shields them from private litigation. If the Spitzer approach was aimed at changing the behavior and the S&L approach was aimed at sending a powerful political message, the NPA/DPA route represents a more collegial process in which the state and the targeted company work together to disgorge its criminal liability in a way that typically keeps everybody out of jail and also helps keep the target firm out of civil court. In many of these agreements, the evidence is kept mostly secret. These agreements sometimes have a less adversarial feel than the cops-and-robbers approaches of Spitzer, Robert Morgenthau, and the S&L prosecutors. They often read like agreements hashed out in friendly meetings by like-minded legal colleagues from similar cultural backgrounds, which is often exactly what they are.

  It’s important to note that this isn’t always the case. The deferred prosecution agreement is sometimes a harsher strategy than, say, extracting a plea deal from a company. In a plea, the courts are in charge of monitoring compliance with the deal. In a DPA, it’s the prosecutor—the person who really cared enough to go after the dirty company to begin with—who gets to be the watchdog of the deal.

  But even the DPA began to fall out of favor, sort of, just as a fresh-faced politician from Illinois named Barack Obama was taking the national political scene by storm. After his election, state and federal prosecutors took their next great evolutionary step in the dispensation of white-collar justice. From abandoning criminal prosecutions in favor of deferred prosecutions and nonprosecution agreements, the state now bega
n to emphasize fines as a new means of settling with white-collar criminals.

  In 2008, when the state handed out twenty-five NPA/DPA deals, a grand total of $289 million in fines was collected. Over the course of the next three years, the number of nonprosecution agreements held mostly steady, but the amount of fines collected increased more than tenfold. In 2009 the state collected $5.312 billion in settlements. In 2010 it was $4.682 billion. In 2011 it was $3.013 billion.

  By then, two things had happened. One is that America had exploded in the biggest white-collar crime wave in its history. The other is that Eric Holder had rejoined the Justice Department, this time as Barack Obama’s attorney general.

  Holder was in office for four long years before anyone at Justice said anything out loud about Collateral Consequences.

  But even before the phrase hit the public’s ears, a close observer of the situation could tell that the new regime was vigorously employing some kind of new policy—he or she may not have known it had anything to do with a memo written in 1999, but it was clear enough that something very different was going on.

  As the biggest Wall Street companies screamed their way through one criminal scandal after another without facing corporate indictments or even criminal indictments against individuals, it was obvious that the nation’s law enforcement officials had undergone some kind of radical transformation. Crime after heinous crime was being committed, and nobody was getting arrested.

  There had to be a plan here, a conscious strategy. But what?

  That plan ended up being Collateral Consequences. But it wasn’t as though it was a conspiracy all along, a secret plan to give get-out-of-jail-free passes to the nation’s biggest corporate offenders.

  No, it was more like the Holder Justice Department got there by accident, through sheer incompetence, timorousness, and oversensitivity to bad press. It arrived, organically as it were, at a policy of utter regulatory surrender.