For the past couple of years, I have tried to carve out a piece of the "overcriminalization of corporate law" debate by pointing out that the same set of facts that leads to a corporate conviction leads to a dismissal of a civil lawsuit under securities fraud doctrines.  I explored this theory in The Undercivilization of Corporate Law, but regretted that this theory rarely plays itself out.  When there are parallel prosecutions and civil lawsuits, the plaintiffs usually wait for the conviction, and then use the conviction as leverage, a la Enron.  However, for some reason, this theory is playing itself out now in the Refco drama involving Joseph Collins, a partner at the law firm of Mayer Brown, which represented Refco before and during its 2004 LBO by Thomas H. Lee Partners and its 2005 IPO. 

The Refco scandal is even more brazen than more celebrated ones of this decade:  CEO of company hides massive losses with round-trip loans to affiliates, then sells 57 percent of shares in an LBO.  LBO firm, quickly after LBO decides to sell in fast-track IPO, even though it denies ever finding out about the fraud while running the company with its own officers.  Weeks after IPO, the fraud is discovered, CEO is arrested, company files bankruptcy.  CEO is serving 16 years in jail, and other insiders are cooperating.  Collins, outside counsel to Refco for 10 years, is indicted.  Collins is the only outside attorney indicted in any of this decade's scandals.  Lucky guy.  (Full story here, in the American Lawyer.)  And, not surprisingly, Collins and Mayer Brown were added to the shareholder lawsuit against Refco.

I cannot say that I am happy to find a case that fits in with my article's theory, but here is one.  In March, Collins and Mayer Brown were dismissed form the shareholder lawsuit for securities fraud in the Southern District of New York.  This week, Collins' criminal trial began in the Southern District.  If there is enough evidence to proceed against Collins for a criminal trial, then why isn't he subject to a shareholder suit?  Given the ordinary paradigm of evidentiary burdens being less in a civil trial and higher in a criminal trial (remember O.J.?), how can this be?

The easy answer is Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994), the Private Securities Litigation Reform Act of 1995 (15 U.S.C. s. 78u-4(b)) and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. __, 128 S. Ct. 761 (2008).  After Central Bank, only primary actors may be defendants in an action under Section 10(b) of the Securities Exchange Act of 1934.  The PSLRA then increased the pleading requirements for primary actors, so not only must an actor be a primary participant in the fraud, but the plaintiffs must be able to allege with particularity the elements of the crime as they relate to the participant, i.e., scienter.  Then, Stoneridge went on to hold (in a case where scienter as to the "third-party" participants could be inferred easily) that the plaintiffs did not "rely" on the statements of the third-party participants, which were detailed in documents that formed financial statements but were not themselves disclosed.  So, third parties that knowingly helped an issuer pump up financials by artificially inflating revenues, complete with documents from the contract parties meant to dupe the auditors, could not be held liable in a 10b-5 action because the plaintiffs didn't see those documents.  Thus, these counterparties were mere aiders and abetters, and not subject to private civil lawsuits.

In his opinion and order granting the motion to dismiss of Mayer Brown and Collins, Judge Lynch acknowledges that there was no way that Collins and the other attorneys could have drafted either the LBO offering memorandum, the registration statement for the related bond offering, or the registration statement for the IPO offering without knowing them to be false, given their involvement in 17 rounds of affiliate loan documentation.  Here, these false statements were made to the public, in publicly disseminated documents.  However, Judge Lynch ordered that because these statements were not attributed directly to Collins and Mayer Brown, these defendants were as remote to the investors as the defendants in Stoneridge.  Even though these documents identified Mayer Brown as issuer counsel, their name appearing once does not create an inference that investors knew that the firm was involved in making the false statements in the documents.  Attorneys everywhere should breathe a sigh of relief; under this analysis, securities attorneys that aren't otherwise directors or officers are fairly well insulated from civil suit.

But not from criminal prosecution, which brings us back to Mr. Collins, whose indictment is here.  This disconnect between civil and criminal prosecutions could signal either a Type I error, in which Collins may be falsely found to be guilty of securities fraud, or a Type II error, in which Collins may be falsely found to be not civilly liable for securities fraud.  I don't know enough about the facts to say which is happening.  Or, it could be that regulators have made a decision that there are certain types of fraud that we will pursue criminally or civilly only in an SEC prosecution, but we do not want private litigation in that area.  I think then we need to have a longer conversation on why we want to protect certain defendants from the vagaries of private litigation but not from the all-out hell of criminal prosecution.

As my criminal law professor Michael Tigar once said (to paraphrase):  Corporal punishment is unconstitutional because its cruel and unusual, but capital punishment is not.  Most criminals, however, would choose the former over the latter.

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