Editor’s Note: This is an extended version of the interview that appears in print in the September issue of CFO magazine.
After securing guilty verdicts against Enron’s top officials, U.S. Deputy Attorney General Paul J. McNulty told reporters: “It encourages us to continue to combat corruption wherever we find it.” So far, the Corporate Fraud Task Force, which the 48-year-old McNulty heads, has found it in plenty of places. The Task Force has won convictions against more than 200 executives, including 30 CFOs, in the past four years. In July, it opened a new frontier when the first federal charges for backdating stock options were levied against Brocade Communications Systems. McNulty has also voiced his intention to take on hedge funds and anything else that threatens the integrity of financial markets. “We are more than ever before in a situation where government has a duty to police the marketplace,” he insists.
The Securities and Exchange Commission is reportedly investigating some 60 companies for illegally backdating option grants. Are we seeing just the tip of the iceberg?
It’s clearly an area that is getting increased attention from federal regulators, investigators, and prosecutors. But we have to deal with it on a case-by-case basis and not charge until we have sufficient evidence. So this is an area of growing concern, but I don’t want to be specific about what kind of volume we’ll see.
The sums involved in backdating pale in comparison to the billions of dollars involved in the high-profile accounting-fraud cases. Can you really compare these cases?
You’re right. The numbers in the accounting-fraud scandals were enormous…. [But] regardless of the magnitude [in backdating cases], we’re seeing fraudulent conduct that undermines the [delivery of] truthful information. In time we’ll understand more about the scope of the conduct. But at this point, it’s the nature of the conduct itself that is really the principal focus.
Does it matter that many of the executives in these scandals didn’t profit from them?
That will affect how cases are charged and the direction the prosecution will take…. But the Corporate Fraud Task Force needs to be concerned about anything that undermines the integrity of the marketplace…. [There is still an issue] of who profits and who doesn’t. And in [backdating] cases, we see the potential for — and the reality of — significant harm.
Backdating cases aside, there has been a drop in the number of new charges and investigations opened this past year. Why?
First, there is a cyclical nature to these prosecutions. Sometimes there will be more cases because investigations get to the point where charges can be brought. Second, we have a limited number of resources. U.S. Attorneys Offices can become involved in large prosecutions that occupy the attention of corporate-fraud prosecutors and don’t allow for the opening of new cases. Finally, we’ve seen the message getting through regarding [better] corporate behavior. And [given that], it ought to be the goal of the law enforcement regulatory communities that our case numbers go down if we’re working just as hard. That would tell us that the instances of misconduct are going down as well.
In the Enron case, focusing the jury on the simplest part of the fraud seemed to work well. Is that your model?
I think it is. What we saw in Enron was the manifestation of efforts to encourage prosecutors to accomplish a few key things in these cases…. We need to streamline [the cases] because we want to keep them understandable for the jury. And we need to identify individuals who are involved but less culpable, and get them to cooperate — provide testimony against those who are more culpable. [Such focus means] that at the end of the day, we can look back and realize that there was a fair and thorough accountability for the scope of the criminal conduct.
The Thompson memo, which was written by your predecessor Larry Thompson, gives guidance on how the government should gain corporate cooperation in fraud cases. Recently, Judge Lewis A. Kaplan issued a sharp rebuke about some of the tactics used in the criminal case involving KPMG and tax shelters. Is that causing you to revise the memo at all?
The decision by the court in the Southern District of New York has not caused us to do anything with regard to the memo. We disagreed with the court’s decision, and we’ve been dealing with that case. [But] we have heard from a lot of different voices on the question of at least two issues in the Thompson memo: the issue of waiving attorney-client privilegeÂ and the question of denying or stopping the payment of attorney’s fees to subjects, targets, or defendants. We are listening to those concerns,Â and I’m not suggesting we anticipate a revision of the Thompson memo, but I’m not saying that we’re closed to that possibility. As we speak today, the Thompson memo is the policy of this department.
But didn’t the ruling specifically say that it was unconstitutional for the government to discourage companies from reimbursing the legal fees of their employees?
But that ruling doesn’t necessarily change the department’s policy,Â [nor] would it be the first time where a policy is in place that a particular federal judge objects to; where we have to deal with that litigation, but we don’t change our policy. If you look at what the Thompson memo says, it’s pretty straightforward. When it comes to charging a company, there’s a real possibility of bringing criminal charges against the corporation itself if senior officials have engaged in wrongdoing and the company benefited from that wrongdoingÂ . We didn’t make up that law. That’s what the law is. Now it would be interesting if we didn’t have any guidance on that. It would be interesting to know what the corporations and defense lawyers would be sayingÂ if we let every office make its own judgment as to whether or not to charge the company itself. The Thompson memo was an effort to try to guide that discretion.
What would you say to critics who argue that the government has been too aggressive in its efforts to get companies to cooperate?
I don’t accept that characterization. I’d say that the government has been aggressive in the way that taxpayers and investors expect us to be. We’re fulfilling the responsibility we have to guard their interests. That requires a certain amount of aggressiveness and energy. But I believe that the vast majority of prosecutors handle these considerations responsibly and work in a productive way with companies that want to cooperate. And I wonder sometimes if companies cooperate because they realize it is in the interest of the corporation to do so, and then complain later because it may be a more popular thing to do.
What about accusations that prosecutors have been unfair in pursuing waivers of attorney-client privilege?
There are some unique factors here…. Often the individuals who respond to the investigation are not the wrongdoers, but people who are trying to serve their company well. They’re willing to work with the government to hold the right people accountable. That’s why the discussion of waiving privilege even comes up…. And sometimes their only concern is [what] exposure it might create for lawsuits from the shareholders and whether waivers with regard to the government might result in waivers across the board. But a real willingness to work with the government is what we’ve seen in many cases. Now that by itself shows the unique nature of this type of law enforcement activity.
You recently said that the Task Force may investigate hedge funds. Why have you targeted them?
Because of the growth in that area and the fact that they are not regulated. [Those factors indicate] they might be susceptible to criminal conduct. It goes back to the question of the integrity of the marketplace…. The issue of regulation [of hedge funds] is a difficult one because of the recent court decision striking down the SEC’s ability to regulate this area. So the Task Force will discuss what direction we may want to go in in dealing with [the ruling].
Is prosecution one avenue that is open to you now that registration [of hedge funds with the SEC] seems to be closed?
Yes. [But] we wouldn’t pursue that course if we didn’t believe that there was a sufficient legal predicate for the criminal prosecution. So really it will be determined on what kind of specific cases emerge.
What else is on your radar screen?
Recently we’ve devoted more attention to the follow-through with deferred-prosecution agreements [with cooperating companies]. We’ve had a significant number of those agreements in recent years, and we need to make sure that the companies are following through on the conditions and the commitments that have been made.
Do you envision a time when the Task Force won’t be necessary?
No. The need to remain vigilant in this area is not going to go away. We see things emerging regularly that remind us that there are tremendous temptations in the area of business finance and that there will always be a certain percentage of people who will not resist the temptation to enrich themselves. If we signal that we are reducing our efforts, it could be very dangerous.