Competitive Intelligence

Bernie Ebbers Convicted, Ignorance Defense Weakened & JPMorgan Settles… for $2 Billion!

Even as Bernie Ebbers was convicted, the likelihood that the so-called "ignorance defense" likely to be used by CEOs like Richard Scrushy of HealthSouth and Ken Lay and Jeff Skilling of Enron, has been irrevocably undermined:

The conviction Tuesday of former WorldCom Inc. chief Bernard J. Ebbers for orchestrating an $11-billion accounting fraud could have deep repercussions for other disgraced executives who claim they were unaware of financial scams taking root beneath them.

A federal jury found Ebbers, 63, guilty of securities fraud, conspiracy and filing false documents with regulators. He was convicted on all nine counts that he faced. It was the government's biggest win yet in a string of victories against top corporate figures, including Silicon Valley financier Frank Quattrone and lifestyles entrepreneur Martha Stewart. He faces a possible prison term of more than 30 years.

There was little hard evidence against Ebbers — no smoking-gun e-mails or paper trails — and the defendant insisted the fraud was masterminded by Scott D. Sullivan, his onetime finance chief who became the federal government's star witness.

But it came down to this: Jurors couldn't see how the man who had built WorldCom from a small phone company in Clinton, Miss., to a global telecommunication colossus could not have known about the accounting scams that triggered the company's 2002 bankruptcy filing — the biggest in U.S. history.

"When you start a company … and you bring it up from nothing, it's hard to convince a jury that you are just too stupid to know what's going on," said Daniel J. Callahan, a veteran litigator. "This see-no-evil, hear-no-evil, speak-no-evil policy just doesn't fly."

Legal experts said the jury's decision boded poorly for toppled executives Kenneth L. Lay of Enron Corp. and Richard Scrushy of HealthSouth Corp., who are employing variations of the above-the-fray defense.

Lay faces trial in Houston in January on fraud and conspiracy counts stemming from Enron's 2001 collapse. Scrushy is on trial in Birmingham, Ala., for an alleged $2.7-billion fraud at HealthSouth.

"These guys are shaking in their boots now," said Andrew Genser, a white-collar criminal defense lawyer at Kirkland & Ellis in New York.

If anyone seemed poised to pull off the "know-nothing" defense, others said, it was Ebbers.

The former high school basketball coach and milkman twice flunked out of college. He disdained e-mail, denying prosecutors a weapon they had used effectively against Quattrone and others. And Ebbers almost never sold his WorldCom shares, testifying that he even had bought $5.3 million in stock a few weeks after he was forced to resign in 2002 under the cloud of a federal investigation.

In an interview, juror Aran Nulty said that the panel weighed the evidence carefully during eight days of deliberations, and did not rely on Sullivan's testimony alone.

The tipping point, she said, was the argument that Ebbers would have to know about WorldCom's troubles because of regular revenue statements and numerous other financial reports.

Ebbers's evasiveness and defensive posture on cross-examination left a lasting impression on jurors hearing his case - the jury clearly concluded that testimony of former chief financial officer Scott Sullivan, the prosecution's star witness, was more credible than that of Ebbers, even though jurors did not fully believe Sullivan either.

Meanwhile, all bets are off at JPMorgan, holding out for a possible acquittal, ended up swallowing a $2 billion settlement charge:

JPMorgan Chase & Co., the nation's second largest financial institution, has agreed to pay $2 billion to settle claims from investors who lost money in the collapse of WorldCom Inc.

It was the last major bank to reach a settlement in the class action suit, though other defendants remain.

The federal court supervising the case was told Wednesday that 11 former directors of WorldCom were close to reviving a deal in which they would pay millions of dollars to settle their part in the investor suit.

The JPMorgan Chase settlement came Wednesday, a day after WorldCom's former chief executive, Bernard Ebbers, was found guilty of fraud, conspiracy and false regulatory filings in the $11 billion accounting fraud at WorldCom. The company collapsed in 2002, but has since emerged from bankruptcy to operate under the name MCI Inc.

New York Comptroller Alan Hevesi, representing thousands of WorldCom investors as the court-appointed lead plaintiff, said that the more than a dozen banks and investment banks that have reached settlements have agreed to pay more than $6 billion -- a record in a securities class action case.

"I'm delighted that we are coming to closure," he told reporters. "This is a huge securities case. I think we've made a substantial recovery for the people that we represent."

In addition to JPMorgan Chase, two small investment banks also announced settlements Wednesday. Blaylock & Partners LP agreed to pay $573,000, and Utendahl Capital agreed to pay $234,000. Both are based in New York.

If the case goes to trial, jury selection will begin next week, the court said.

The remaining defendants, in addition to the 11 former directors, are auditing firm Arthur Andersen and former WorldCom board member Bert Roberts.

Judge Denise Cote gave preliminary approval on Wednesday to a number of settlements reached earlier with banks, including Bank of America Corp., which is headquartered in Charlotte, N.C.; Credit Suisse First Boston, a unit of the Zurich-based Credit Suisse Group, and Citigroup Inc.

"Let me give the court's congratulations to the settling parties," Cote said. "This case has been very hard-fought."

The banks were involved in the underwriting or sale of billions of dollars worth of bonds that WorldCom issued in 2000 and 2001.

Investors who purchased the securities argued that the financial institutions should have been aware of ongoing fraud at the company.

The settlement by JPMorgan Chase was second in size only to the $2.58 billion that Citigroup, the nation's largest financial institution, agreed to pay last May to settle its share of the case.

JPMorgan Chase last year rejected a settlement on the same terms as Citigroup, which would have required it to pay $1.37 billion. Hevesi said he considered the difference a "premium."

Crime never pays, eh? Let's hope the message comes across that screwing your shareholders is less profitable than it used to be...

- Arik