Corporate Investigations & White Collar

As the student loan scandal widens, it seems that most colleges and universities will have to examine and modify any existing internal policies that outline appropriate conduct between employees and outside service providers.

In both New Jersey and New York, news is unfolding of possible inappropriate practices of college and university employees accepting perks ranging from stock options, the use of vacation homes, trips, as well as cash provided by loan industry representatives in an effort to become one of the institution’s preferred lenders for prospective students.

More than 90% of all students have some form of student loan, and more than 80% utilize the private lenders recommended by the university. Since these loans are for the most part subsidized by the government, there is little risk of non-payment to the lenders, in fact student loans are not even dischargable in bankruptcy.

Colleges and universities must now face the reality that in spite of their enlightened existence, they too are subject to conflicts of interest, as well as possible civil and even criminal liability.


New Jersey’s Attorney General, Zulima Farber, is under investigation for coming to the scene of her boyfriend’s traffic stop.  The matter in question is whether or not her boyfriend received special treatment because Farber was there.  Scott Unger, a Shareholder in the Litigation Group, commented on the situation for the Associated Press.

You can read the story here.

Today’s Trenton Times reports on Mercer County College (MCC) President Robert Rose’s meeting with the school’s board of trustees. The board is investigating financial practices at the school. Kevin Hart, Chair of the Firm’s Corporate Investigation and White Collar group, attended this meeting with his client Rose. After the closed door meeting both Rose and Hart spoke to the press and expressed their optimism that Rose will soon return to his position at the college.

Today’s Star Ledger reports on Tyco International’s disclosure to regulators that it hired outside counsel to review whether one of its business units violated the Foreign Corrupt Practices Act by making improper payments to foreign officials. The Foreign Corrupt Practices Act has a self reporting provision which requires companies to act as their own monitor and alert regulators when perceived improper practices are discovered. In this particular case, Tyco reported the results of its review to the Justice Department and the Securities and Exchange Commission.

This situation is a good example of a circumstance where it is important for an organization to bring in independent counsel who can objectively investigate alleged infractions.

A turf war seems to have erupted between United States Attorney Christopher Christie and State law enforcement officials such as Attorney General Peter Harvey and Monmouth County Prosecutor John Kaye. One has to ask if the strife between these powerful officials is hindering the effective prosecution of corrupt public officials, or is it just another “black eye” for New Jersey.

To some degree tension has always existed between the various offices. However this tension was usually relieved by the relationships that existed between the U.S. Attorney and various State officials. There was also an unwritten rule governing the prosecution of different types of Criminal activity. As a result, a cordial relationship between these offices existed for many years which was kept alive by the movement of career law enforcement officials between the Federal and State agencies. Yet today we see that the era of civility is officially over, its end marked when new leaders with political connections, and more importantly political aspirations, assumed control of the two offices.

Christopher Christie had plenty of political connections and very limited law enforcement credentials when he was appointed. He quickly realized that to further his political ambitions he needed to be noticed, and no type of case generates publicity like political corruption. Christie sent a clear message to his office to develop corruption cases. Meanwhile on the State’s side, beginning with the appointment of Peter Veniero as Attorney General and continued with the appointment of Peter Harvey, the State Attorney General has been more concerned with protecting the Governor’s reputation than eliminating corruption.

Christie does have an advantage over the State Attorney General in that he does not have a Governor to protect, and can therefore commence corruption investigations without alienating people to whom his boss owes favors. Attorney General Harvey on the other hand has had to stand by and watch the numerous faus paux of his former boss, Jim McGreevey.

Christie has won the corruption fight hands down. He has brought case after case against public officials both enhancing his name recognition among Republican partisans and embarrassing the Democratic public officials who he has primarily targeted. The turf war has now escalated with the recent Indictments by Christie of what seems 50% of the public officials in Monmouth County. In doing so Christie has now stepped on the toes of a more formidable opponent Monmouth county Prosecutor John Kaye.

Kaye, the longest tenured county Prosecutor has long had a reputation as a hardliner on things such as drug prosecutions. In fact Kaye has developed a reputation that there is much less crime in his county because of his ruthless prosecution of one and all. Imagine his displeasure when he found out that Christie had imported from Florida an out of control cooperating witness who seemed to offer bribes to every public official he could find. The prospect of this occurring in Kaye’s County, much less without his approval caused the two principles to engage in a very public dispute. Christie claims that Kaye sabotaged the federal investigation by calling in some of the targets for questioning. Kaye claims that Christie refused to advise his office of the investigation of public officials within his county. Christie has now subpoenaed Kaye, and Kaye not only threatening to subpoena Christie, but is attempting to go over his head by appealing directly to the Justice Department with his complaints.

The bad blood between Christie and Kaye has now reached a fever pitch. Last week, The Star Ledger reported that Kaye’s support is quickly eroding. Senator John Adler, chairman of the Judiciary Committee, along with Senators Tom Kean and Ellen Karcher, are all calling for Kaye’s immediate removal. Even acting Governor Richard Codey has said that he will not reappoint Kaye when his term expires in four months, and he may demand Kaye’s resignation sooner. Christie’s corruption prosecutions have scored him points with the power elite while Kaye’s twenty-two year history of writing his own rules regarding law enforcement in Monmouth County has left him isolated and targeted for removal from office.

When all is said and done, the drama playing out in New Jersey is all about politics, and the loser once again are the citizens of New Jersey.

Kevin Hart, Chair of the Firm’s Corporate Investigation & White Collar Group, was interviewed by WNBC News New York regarding Acting New Jersey Governor Richard Codey’s appointment of Mary Jane Cooper to the position of Inspector General for the State.

The Inspector General of New Jersey will be charged with ferreting out fraud and wasteful spending at all levels of government.

You can read more about this story here.

United States v. Booker

The United States Supreme Court on Wednesday January 12, 2005 rendered the long awaited decision regarding the constitutionality of the U.S. Sentencing Guidelines (Guidelines). In an interesting decision, two separate groups of Justices essentially rendered two opinions in the one case, the first determining that the Guidelines violate the Sixth Amendment, to the extent that they allow judicial rather than jury fact finding to form the basis for the sentence, and the second determining that the Guidelines can continue to be used, as long as they are advisory rather than mandatory.

The background for this decision relates back to the June 2004 decision in Blakely v. Washington, where the Court in a groundbreaking opinion held that Washington State’s Guidelines violated the Sixth Amendment guarantee of a trial by jury in criminal cases. Washington’s guidelines allowed judges rather than juries to make certain findings of fact that increased an offender’s sentence. The Court held that a judge may impose a sentence solely on the basis of facts reflected in the jury verdict or admitted by the defendant.

The U.S. Sentencing Guidelines, like Washington State’s allow judicial fact finding to play a role in determining the sentence. After, Blakely the federal courts were immediately faced with the prospect that the Guidelines also violated the Sixth Amendment, thus raising the thorny question of whether all sentences determined under the Guidelines were unconstitutional. Thankfully, the Court granted quick review of two cases that raised the issue, Booker and United States v. Fanfan.

As was set forth above, not surprisingly, a majority of the Court composed of Justices Stevens, Scalia, Souter, Thomas and Ginsburg found the same Sixth Amendment violation that they found in Blakely. The reasoning followed the Scalia opinion in Blakely, by holding that “Any fact which is necessary to support a sentence exceeding the maximum authorized by the facts established by a plea of guilty or a jury verdict must be admitted by the defendant or proved to a jury beyond a reasonable doubt.”

In practical terms, a defendant appears for sentencing after having either pled guilty, or having been convicted by a jury. In entering a guilty plea, the defendant must allocute under oath the facts that establish th defendant’s guilt. Likewise a jury must make findings of fact, at a minimum, facts necessary to establish that the legal elements of the crime were proven. Fast forwarding to sentencing, the Guideline sentencing range requires a finding as to the “criminal history category” and “offense level”. Particularly, with the offense level, the sentencing Judge is required to make factual findings that are often beyond the proven facts including evidence that would not be admissible at trial.

The second part of the Court’s holding dealt with whether the Guidelines by virtue of the Sixth Amendment problem are null and void. The Court’s answer was surprisingly, no. This answer was given by a different majority comprised of Justices Breyer (a former Chairman of the Sentencing Commission), Rehnquist, O’Connor, Kennedy, and Ginsburg (the one common denominator). This majority sought to determine whether Congress would have intended the Guidelines be defunct, or would it have intended that a partially altered set of Guidelines continue to be in effect.

The Court believed that Congress would have intended the Guidelines to survive in a way that allowed them to comply with the Sixth Amendment. That was accomplished by the Court determining that the Guidelines now become advisory rather than mandatory. Thus the Guidelines help judges choose an appropriate sentence between a statutory maximum and minimum, but no longer dictate the result. Therefore judges must consider the Guidelines, but are not bound to follow them. This is an outcome that few predicted. In fact Justice Stevens noted in his dissent from the second holding, “Neither the Government, nor the respondents, nor any of the numerous amici (friends of the court) has suggested [this].”

The guidelines were intended to create uniformity, certainty and parity in sentencing. Put simply, they were meant to ensure that similarly situated defendants were treated more or less alike. Prior to the Guidelines, the result depended on the particular judge that imposed sentence. The Guidelines by constraining judicial discretion were designed to change that by making sentencing a matter of rational decision making, not just the luck of the draw as to the sentencing judge.

Now that the guidelines are merely advisory, it will be interesting to see if they will continue to serve their purpose. Will judges feel constrained to apply them or will they ignore them. An educated guess is that most judges will continue to follow the guidelines except in those special cases were a judge feels strongly enough to depart from the guidelines, and set forth the reasons for the departure.

The most likely beneficiaries of the new Guideline approach will be those charged with white collar offenses. White collar defendants prior to the Guidelines generally stood a better chance of avoiding jail time. Under the Guidelines the discretion of the sentencing judge was taken away, forcing many judges to impose sentences of incarceration in white collar cases based upon the application of the Guidelines. With that discretion being returned, it will be interesting to see if sentencing judges become more willing to consider non custodial type sentences for first time white collar offenders.

The ball has been passed squarely into the lap of Congress to decide whether a new sentencing system needs to be developed. It will be interesting to see what happens next.

Most small businesses struggle in their formative years due to difficulties associated with obtaining sufficient working capital. Assuming that you have cleared that hurdle, your business should move forward and begin to grow. Internal control systems generally take time to refine and are usually behind other systems in terms of development. In fact, the faster you are expanding the more likely that internal control systems are neglected. Without dedicated, loyal, and honest employees, you would probably not be able to grow in the first instance.

Statistics have shown that thefts by employees from their employers account for losses of approximately $40 Billion a year. That number is staggering when you consider that it is larger than the Gross National Product of some Third World Nations. No matter what type of business you are in, you are not immune. Professional practices, service companies, banks, and manufacturing companies are all equally susceptible to this universal problem.

Initially, before conducting any internal audit or investigation, you should be mindful of your employees’ right to privacy. Courts have shown a great willingness to protect an employee’s privacy from invasion by their employer. Therefore any employer must be cautious not to offend the sensibilities of their employees. If an employee suspects that he/she is being placed under scrutiny company moral may be adversely affected, leading to more serious labor troubles.

People that embezzle from their employers do not fit any one mold that can be easily identified. Experience has shown that dishonest employees are as diverse as the schemes that they originate. For example, I have seen acts that involved false bank accounts, false bank records, false billing statements, false receivable records, and even false computer records. However there exist some similarities in these various schemes.

One common theme is that the employee is almost always highly trusted and otherwise dependable. This employee usually has delegated authority and supervisory responsibilities. If it is any consolation, a dishonest employee normally has a great incentive to insure that the business is successful, because the more successful the business, the greater the opportunity to continue a scheme. Often the employee has two reasons for making sure that neither third parties nor other employees gain an advantage in their business dealings. First, the dishonest employee wants to be the only person taking advantage of the company. Second, such aggressive protection of the business’ interests usually does not go unnoticed by Management, which can lead to more responsibility and less scrutiny of their activities.

Another common characteristic is that the dishonest employee will generally work long sometimes irregular hours. Typically they will arrive early or stay late when few other employees are present. This permits an opportunity to act without co-workers observing their actions. This employee will frequently not take their vacation or spend long periods away from the business. Extended absences result in a greater chance of detection.

Another popular misconception is that you are protected if your company books are routinely audited or reviewed by your accountant, or bookkeeper. However, an essential part of any embezzlement scheme is a method of preventing detection. No one engages in criminal activity if they think that they will be caught. The initial temptation to embezzle is usually associated with a determination of how easy it would be to accomplish, without being detected. In most business situations, a competent employee can design a scheme that would not likely be noticed. Your accountant may, unwittingly, contribute to the development of a scheme by specifying what records are needed for the audit. A predictable audit, either in terms of timing, or the documents to be reviewed, will not necessarily be a deterrent.

Additionally, the employee very often has supervisory control over the company’s payables, receivables, and banking relations. Since this is an area where revenue transfers in and out of the company, special scrutiny is required.

Even employees for whom special allowances have been made are capable of embezzling from their employer. Many employers are shocked to learn the identity of a dishonest employee when an embezzlement is discovered. Often I have heard an employer lament that this was an exceptional individual who received special favors or treatment due to their status as a loyal and trusted employee. In many of these cases, regardless of the size of the loss, employers are more distressed by feelings of betrayal then the actual loss suffered.

The local police while being very helpful may not recover what has been taken. If the money involved is a sizable amount, then jurisdiction probably rests with the county prosecutors office. Due to the fact that a Civil action can be brought against the dishonest employee, authorities may not be as helpful as expected. A far more effective response is to retain either an attorney or accountant that specializes in this area. Note that once funds have been embezzled, the likelihood of recovery diminishes very quickly. The typical dishonest employee does not invest the proceeds in conservative investments. Rather the money may be indulged on luxuries that would not normally be afforded by the employee on their normal salary. For this reason it is imperative that quick action be taken to locate whatever assets can be frozen in order to maximize any recovery.

Other significant issues exist with respect to the termination of the employee. A confrontation should be avoided until sufficient information has been developed, otherwise there is the possibility of a wrongful discharge suit being filed by the employee.

In closing it is important to stress that not all employees are dishonest, and this article is not intended to imply that all companies have a problem but merely to suggest that the company be sensitive to the issue and prepared to deal with the problem should it arise.

Yesterday, Kevin Hart, Chair of the Firm’s Corporate Investigation and White Collar Group, was interviewed by WNBC News New York regarding Acting New Jersey Governor Richard Codey’s executive order creating the position of Inspector General for the State. The new Inspector General’s mission will be to “ferret out fraud and wasteful spending at all levels of government”.

An Associate Press article regarding the executive order can be read here.

The New Jersey Supreme Court in a recent decision in E. Dickerson & Son, Inc. v. Ernst & Young, LLP, 179NJ500 (2004), dealt a significant blow to third parties seeking damages from accounting firms for negligence. Dickerson provided the New Jersey Supreme Court with its first opportunity to interpret New Jersey’s accountants liability statute, N.J.S.A. 2A:53A-25, which was enacted for the purpose of overruling the New Jersey Supreme Court decision in H. Rosenblum, Inc. v. Adler, 93 NJ 324 (1983). The Rosenblum decision greatly expanded the scope of accountant liability by adopting a “foreseeability” standard for cases involving accountant negligence. Rosenblum placed New Jersey law in direct conflict with the position taken by the New York Court of Appeals in the seminal case of Ultramares Corp. v. Touche Niven & Co. 255N.Y.170 (1931), which position was followed by the vast majority of other jurisdictions. The Uitramares decision rejected negligence claims brought by third parties due to the lack of privity of contract between the plaintiff and the accountants. The New York Rule has long stood for the proposition that a plaintiff’s failure to allege privity or in the alternative a nexus between it and the accountant was fatal to any negligence claim against the accountant.

The New Jersey Supreme Court in Rosenblum rejected the New York Rule and allowed a recovery without a lack of privity, by finding that an independent auditor owes a duty to all parties who the auditor could reasonably foresee would be recipients of and rely upon from the financial statements prepared.

The Rosenblum decision has generally not been followed by other jurisdictions. Many of these jurisdictions have adopted a middle ground which is embodied in the Restatement (Second) of Torts 552, which limits accountant’s liability for negligence for losses to (a) the person or one of a limited group of persons, for whose benefit and guidance the accountant intends to supply the information or knows that the client intends to supply it, and (b) through reliance on it in a transaction that the accountant intends the information to influence or knows the recipient so intends or in a substantially similar transaction.

In 1994 The New Jersey Legislature passed the accountants liability statute (N.J.S.A. 2A:53A-25 which limits accountants liability for negligence, and effectively overruled Rosenblum. The statute adopted the New York Rule and was for the most part based upon a model statute promoted by the American Institute of Certified Public Accountants.

The Dickerson case represented the New Jersey Supreme Court’s first opportunity to interpret the New Jersey Accountants Liability Statute. The facts in Dickerson were that the plaintiffs were corporations who were owned and operated supermarkets that were members and shareholders of Twin County Grocers, Inc., a corporation functioning as a cooperative of supermarkets for marketing and purchasing purposes. Twin County filed a bankruptcy petition after it was discovered that its upper management had engaged in an ongoing scheme to misappropriate funds and defraud the Twin County members. The plaintiffs’ claimed that Ernst and Young negligently performed several annual audits at Twin County, by failing to discover the ongoing fraud. The plaintiffs first sued Ernst and Young for negligence and other related claims. These claims were dismissed by the Trial Court and the Appellate Division affirmed that decision. Undaunted the plaintiffs applied for Certification to the New Jersey Supreme Court. Before the Supreme Court, the plaintiffs argued that the Court should construe the statute broadly so as to deem Twin County Grocers Ernst and Young’s “clients.”

This argument would have given the Court an opportunity to minimize the Statute’s effect. However, the Court declined the invitation. The Court held that Twin County’s cooperative purpose leant it no special status and consequently the plaintiffs were indistinguishable from any other shareholder of an accountant’s corporate client. As such, they were required to satisfy requirements for third parties to bring a negligence claim, which the court held they did not do.

In denying the plaintiff’s negligence claims, the Court did shed light on how a potential plaintiff might satisfy the statute’s requirement. This may prove indispensable to potential claimants seeking to protect themselves from potential losses attributable to accountant negligence. The guidelines set forth in the Dickerson decision were as follows. First a non party to the contract must demonstrate that the auditor knew at the time of the engagement (1) that its report would be given to the claimant in connection with a specified transaction, and (2) that the claimant intended to rely upon the report. This follows the New York Rule and the New York Rule line of cases. The plaintiff must demonstrate that the accountant knew from the inception of the transaction that his or her services were rendered either wholly or in part for the benefit of another. In order to satisfy the second requirement it must be shown some “linkage” between the accountant and the third party claimant. The linkage requirement could be satisfied if the plaintiff secures an engagement letter or another understanding to that effect. This may create an obstacle to any such suit being brought as it is highly unlikely that an engagement letter would be provided to a third party. The only way to satisfy these requirements would be for the plaintiff to show that (1) the accountant knew that the results of the audit would be transmitted to the plaintiffs for use in a specific transaction and with that purpose known to it (2) the auditor conducted the audit.

An interesting question was raised whether or not shareholders of a corporation , who is the client, might recover by way of a derivative action brought on behalf of the client corporation. In the Dickerson case this was not available to the plaintiffs due to the fact that the bankruptcy proceeding had already occurred. However, it does appear that if shareholders of the corporate client were to bring such a derivative claim on behalf of a client that they would be able to bring such an action.

In closing, while the New Jersey Supreme Court in Dickerson has left the door open to some third party plaintiffs, it has closed the door to many other potential clients. As a result, going forward third party lawsuits against accountants for negligence may constitute the exception rather than the rule.