An Act To Regulate The Use Of Deferred And Non-Prosecution Agreements

An increasing number of criminal investigations involving business organizations are resolved with non-prosecution or deferred prosecution agreements. Consider, for example, the increasing numbers of Foreign Corrupt Practice Act cases. While many of these case end with prosecutions as to individuals, those involving business organizations are frequently resolved with either a non-prosecution or deferred prosecution agreement. The difference between the two types of agreements is significant. At the same time, there is little doubt that from the organization’s prospective, either agreement is preferable to the consequences which can follow from an indictment.

In view of the increasing use of these agreements, legislation has been introduced in the U.S. House of Representatives to regulate the use of the agreements. The proposed legislation, H.R. 6492, titled Accountability in Deferred Prosecution Act of 2008, is being co-sponsored by Representatives Pascrell, Pallone, Sanches and Conyers.

The Act has three key sections. Section 4 requires the Attorney General to issue written guidelines for the use of the two types of agreements to promote uniformity. Accordingly, the guidelines would: define when and why it would be appropriate to enter into a non-prosecution agreement, rather than a deferred prosecution agreement; identify the terms and conditions which should be included in an agreement; identify the circumstances in which an independent monitor is warranted; define the process by which DOJ decides that the organization has successfully satisfied the terms of the agreement; and describe what constitutes cooperation, if any, that might be required under the agreement with respect to on-going criminal prosecutions.

Another section of the Act focuses on judicial oversight. Section 7 would require that the government file each deferred prosecution agreement in the appropriate District Court. The Act specifies that “the court shall approve the agreement if the court determines the agreement is consistent with the guidelines for such agreements and is in the interests of justice.” In addition, the parties to the agreement and any independent monitor would be required to submit quarterly reports to the court.

Finally, Section 8 of the Act would require public disclosure of the terms of the agreement. Each agreement would be available on a public website of the Department of Justice. Overall, the proposed legislation seeks to provide uniformity and add transparency to the use of deferred prosecution agreements and non-prosecution agreements.

Notes On A Financial Fraud — A Non-Professional Is Barred From Practice

The SEC filed a settled financial fraud case on Tuesday which differed from many of its others. According to the complaint, the years-long fraud by a former division CFO not only materially overstated the financial performance of the company, but was reflected in a series of handwritten notes the man left behind. In resolving the case the former CFO, who is not alleged to be an accounting professional, consented to a bar from practice before the Commission, a remedy usually reserved for professionals. The former CFO also agreed to pay disgorgement of part of his salary, although there is no allegation that his compensation was tied directly to the financial performance of the company or his division. SEC v. Hirth, Case No. 08 CV 13139 (E.D. Mich. Filed July 22, 2008).

Scott Hirth was the CFO of the Information and Learning Division of ProQuest Company. From 2001 through the first three quarters of 2005, Mr. Hirth directed the entry of unsupportable manual journal entries at the end of months and quarters. These entries were made in four key areas: prepaid royalty, deferred revenue, prepaid commissions and accrued royalty payable. The bogus entries were timed to the closing of the books for the period.

Mr. Hirth’s baseless entries caused the company to overstate its pre-tax income by about $129.9 million over the period. The company overstated pretax income by as much as 43.5% in one year during the scheme. Eventually, the company admitted flawed internal controls and restated its financial statements.

As the scheme progressed Mr. Hirth took steps to cover it up, according to the Complaint. For example, in one year he used a “hide” function on a spread sheet program to conceal false entries. He also lied to the auditors.

Despite the cover up Mr. Hirth virtually admitted his wrongdoing in a series of handwritten notes which almost suggest a desire to get caught. Included in the notes were statements such as:

• “how can we be audit proof and make fin. #s this year. ENRON and Worldcom”

• “Once past audit prob [problem or probably] no sweat on jail”

• “What if caught — Blame the query and old systems and get fired. Key is all else clean.”

The motivation for this scheme, according to the complaint, was advancement in the company and financial gain. From 2000-2005 Mr. Hirth’s salary increased from $200,000 to $300,000. He also received unspecified bonuses. There is no allegation that the raises or bonuses were tied directly to the financial performance of the division in which Mr. Hirth was employed or to the company in general. Yet, to settle the action Mr. Hirth consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions and an order requiring him to pay disgorgement of over $233,000 and a civil penalty in excess of $54,000.

Likewise, there is no allegation that Mr. Hirth is an accounting professional. Yet, the relief included a bar from practice before the Commission, in addition to an officer and director bar. While there is no doubt that serving as a CFO and participating in the preparation of filings is practicing before the Commission, bars from practice before the agency are more typically reserved for professionals. The company, also named as a defendant, consented to a books, records and internal controls injunction.