Companies do not always simply fall into insolvency because of bad business plans or unforeseen market trends. Sometimes they are pushed by accounting fraud, embezzlement or other crimes. From massively convoluted frauds at WorldCom and Enron to outrageously brazen schemes at companies such as Allou Healthcare, public companies can suffer traumatic financial injury from criminal conduct that significantly complicates the analysis of a debtor's assets and claims against it and creates a large number of interested parties that are competing for the same or similar information.
The Deputy Attorney General (DAG) stands at the crossroads of criminal, civil and policy decisions in the Department of Justice (DOJ). As, effectively, the Chief Operating Officer of the DOJ, the DAG ultimately supervises all U.S. Attorneys and all U.S. Trustees, as well as the Criminal and Civil Divisions and the DOJ's Office of Legislative Affairs.
The appointment of examiners in the Enron and WorldCom bankruptcies marked the beginning of a more assertive attitude toward a thorough investigation of a debtor's affairs where fraud played a central role in the debtor's insolvency. The Bankruptcy Code has long made available the appointment of an examiner to investigate the sources of the insolvency and legal claims for and against a chapter 11 debtor. In more serious cases, the Code also provides for the appointment of a chapter 11 trustee to assume the additional duties of managing the debtor's business. The recent amendment of 1104(e) of the Code makes it mandatory for a U.S. Trustee to file a motion for the appointment of a chapter 11 trustee "if there are reasonable grounds to suspect that current members of the governing body of the debtor, the debtor's chief executive or chief financial officer, or members of the governing body who selected the debtor's chief executive or chief financial officer, participated in actual fraud, dishonesty, or criminal conduct in the management of the debtor or the debtor's public financial reporting."
These developments ensure that in the future more bankruptcies will undergo the searching analysis of an examiner or trustee. In aid of ultimately producing important clarity and transparent justice, these developments also portend greater procedural complexity that will not only require a mastery of bankruptcy practice, but also a detailed knowledge of the inner workings of governmental investigations, as well as the interplay between the two.
Balancing Interests In WorldCom
The bankruptcy of telecommunications giant WorldCom in 2002 was the largest insolvency in American history, and it brought with it an unprecedented level of notoriety and public interest in the legal resolution on all fronts. A criminal prosecution and an SEC enforcement action, venued in the Southern District of New York, soon competed with the bankruptcy case conveniently located in the same district. Congress subpoenaed a number of the debtor's employees, and congressional investigators interviewed many other people. The SEC enforcement proceeding produced a "corporate monitor" that was appointed by and reported to the U.S. District Court for the Southern District of New York. The WorldCom corporate monitor was authorized to oversee the ongoing operations of the company.
In the midst of these developments, the U.S. Trustee sought the appointment of an examiner. The bankruptcy court complied, appointing former Attorney General Richard Thornburgh to the post. While an officer of the bankruptcy court, and ultimately responsible to the bankruptcy court to deliver his reports, the WorldCom examiner was directed to coordinate his actions with the DOJ, the SEC and the corporate monitor. As a practical matter, this required that two different arms of the DOJ, each with different missions and priorities - the prosecutors of the U.S. Attorney's Office and the bankruptcy supervisors of the U.S. Trustee's Office - to find a modus vivendi while juggling the needs of regulators, Congress and, of course, creditors and other interested parties.
The DOJ had to wrestle with the different interests and competencies of the various investigating agencies. Because the DOJ's primary mission is the enforcement of federal law with an emphasis on criminal enforcement where appropriate, the DAG decided that ensuring the success of the criminal investigation must come first, followed by assisting where possible (and certainly not hampering) the SEC's parallel regulatory investigation. Once these enforcement needs were fulfilled, the Office of the Deputy Attorney General (ODAG) encouraged its prosecutors and the SEC's investigators to support the examiner and the bankruptcy court in the effective resolution of the bankruptcy case. In addition, ODAG was mindful that it needed to assert the claims of the United States as a creditor and to provide necessary access to information for Congress.
ODAG met regularly with counterparts from the SEC's Division of Enforcement to both interface with the SEC's investigation and coordinate with the corporate monitor. Separately, ODAG met with congressional staff to broker their concerns over the subpoenaing of witnesses and documents in aid of Congress' inquiries.
ODAG developed ordering principles that provided a rough guide to the distribution of information among the many interested governmental parties. First, ODAG recognized that all parties had a legitimate claim to information for use in the various proceedings such that, to the extent that a witness or documentary evidence could be shared without endangering the investigations, they would be. Driving this analysis was the understanding that while the prosecutors were working diligently to build a criminal case against individuals, the SEC already had filed a civil case and the examiner was under an ongoing and pressing duty to file periodic reports with the bankruptcy court.
Second, ODAG reached an agreement with the SEC that the criminal prosecutors would have the first claim on information - that is, prosecutors could decide whether a given witness should be allowed to speak only to the criminal investigators, to the criminal investigators and the SEC, or to the examiner as well. Furthermore, the prosecutors could limit the scope of interviews by others by excluding particular topics. This required the ODAG to ensure, for example, that the examiner's reports did not contain information that would prematurely disclose information discovered by the criminal investigators that they were seeking to use to advance the criminal prosecutions. As a mutual accommodation, on several occasions the prosecutors and the SEC permitted the examiner to interview government witnesses on the condition that the examiner delay the publication of the information derived from these interviews until its release would no longer threaten to undermine the government investigations.
ODAG also agreed on behalf of both the U.S. Attorney and the U.S. Trustee that the SEC would have the second claim on all information and the right to protect its civil enforcement action against the premature disclosure of information through the examiner. Thus, where the SEC had developed information in support of its parallel but separate investigation, it would enjoy the same rights of priority that the criminal prosecutors had vis-a-vis the examiner.
Finally, ODAG was continuously sensitive to the need to tread a careful line with regard to the exchange of information between the examiner and the prosecutors. The strict limitations of grand jury secrecy prevented the disclosure to the examiner of information developed through criminal subpoenas. That included not only grand jury testimony, but subpoenaed documents as well as any information directly derived from testimony or documents.
On the other side, ODAG was concerned that the transmission of information from the examiner to the prosecutors would spur the allegation that the examiner acted as an agent of the prosecutors. Had the prosecutors provided information to the examiner or directed the examiner as to his inquiries, a criminal defendant might argue that information produced to the examiner, whether via interview or writings, was somehow improperly obtained through a deceptive use of civil process or insufficiently disclosed pursuant to 18 U.S.C. §3500. Moreover, that perception would have undermined the independence of the examiner, whose first duty was to the bankruptcy court. In combination, these perceptions could have impeded the examiner's investigation by chilling witnesses who might have otherwise been forthcoming with the examiner. ODAG addressed this concern by personally managing the ground rules for contact between the examiner and the prosecutors, serving as a filter and buffer between parties who needed to cooperate but who also required some degree of separation.
The Examiner's Role In The Context Of A Government Investigation
The WorldCom and Enron bankruptcies provide significant insight as to what an examiner can do in the context of a large commercial bankruptcy with significant criminal and regulatory investigations. First and foremost, the examiner is charged with the responsibility to "investigate the acts, conduct, assets, liabilities and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan." Furthermore, the examiner must prepare a report covering "any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity in the management of the affairs of the debtor, or to a cause of action available to the estate.
Second, an examiner must operate with the skill of a diplomat. While they are invested with the authority of the bankruptcy court, they must still contend with other parties often aggressively competing for the same information. An examiner must understand who those other parties are, what they want and what tools they can apply to accomplish their objectives. Because an examiner is in a procedurally weaker position than the government investigative agencies, an examiner must adapt his or her investigation to the realities of the circumstances of the case to successfully complete their mission.
Prosecutors And Other Investigators
The most powerful among the investigating parties are the prosecutors. A prosecutor's primary responsibility is to seek punishment for criminal acts, such as securities fraud or embezzlement that can harm businesses and deepen the woes of failing companies. In this process, prosecutors also will seek redress for fraud victims - creditors and shareholders alike - but not necessarily subject to the priorities established in the Code.
Prosecutors need information to build their criminal cases, and the law equips them with powerful tools to both obtain the required information as well as protect such information from disclosure to potential defendants and other interested parties. The threat of prosecution can induce the debtor and individuals with knowledge of the suspected fraud to supply prosecutors with information that may be withheld from other interested parties in the initial phases of a bankruptcy case. Finally, prosecutors can seek and most often receive - even before an indictment is issued - a court order staying proceedings in any other action to the extent that such proceedings may interfere with the criminal investigation.
Following closely behind the prosecutors are the SEC and other regulators - including the CFTC, FCC, FERC and state regulatory authorities. These regulators have significant independent power over businesses and associated individuals. For example, most federal regulators can issue administrative subpoenas for testimony under oath and can require the production of documents on pain of fines or sanctions including debarment from conducting business with the U.S. Government. Regulators often operate in tandem with prosecutors, although they shrink from complete parallelism for reasons including grand jury secrecy and the desire to maintain regulatory independence. Subject to the automatic stay provisions of the Code, regulators often enjoy the power to bring enforcement proceedings against a debtor that proceeds separately from the bankruptcy case and may be filed in a different district. Moreover, because regulators operate with civil, rather than criminal, enforcement power, their burden of proof at trial is lower and their scope of scrutiny may be broader than that of the prosecutors.
Congress has evinced its interest in fraud-provoked bankruptcies. Subsequent to the bankruptcy filings by WorldCom and Enron, congressional investigators sought to interview employees and former employees of those companies. Congressional committees issued subpoenas for public testimony and the production of documents. Congress' role in these matters is self-defined. While it may develop new legislation, its retrospective inquiry seeking information about suspected fraud competes with prosecutors, regulators and all other interested parties that are seeking the same or similar information.
The fraudulent nature of the contemporary mega-bankruptcies and the recent revision to the Code requiring U.S. Trustees to move for the appointment of a chapter 11 trustee in cases of suspected fraud, coupled with the principle of seeking examiners in appropriate cases, will produce an increasing number of bankruptcies that attract the searching analysis of an independent review - in addition to any prosecutorial or regulatory investigation. That trend requires practitioners in the financial restructuring arena to remain aware of the possibility of the appointment of a trustee or examiner and to be sensitive to the dynamic of parallel, if not competing, investigations. If the federal government continues to juggle these enforcement priorities wisely, it can produce markedly positive results for creditors and shareholders as well as the public at large.