“International Co-operation in civil and criminal matters and ENRON-the British Chapter”

by

Sally Ramage

 

 

A country can request that a UK citizen be extradited to that country to stand trial for fraud and other criminal matters as long as the alleged offence is a crime in both countries and carries a prison sentence of more than one year.

It is now well known that the US-UK Extradition Treaty which was drafted to modernise and streamline the 1972 Extradition Treaty has still to be ratified by the US.

This 2003 Treaty as it stands causes the United States to derogate its obligations under Article 9 of the International Convention on Civil and Political Rights (ICCPR) and set aside the UN Refugees Protocol. The UK has, since 1988, set aside the United Nations refugee Protocol in line with Article 4 ICCPR which allows a state to derogate certain articles.

Since serious fraud is not synonymous with either terrorism or asylum, it follows that these derogations do NOT apply.  Serious fraud is an extraditable offence under the 2003 US-UK Extradition Treaty because it is punishable by imprisonment or other form of detention for more than one year in both countries.  In the UK, the offence of conspiracy to defraud is punishable by seven years imprisonment as a maximum sentence with no minimum stated sentence. An analysis of the UK’s Serious Fraud Office’s (SFO) trials over 5 years from 1998 to 2003 showed that the SFO used the charge of “conspiracy to defraud”, a common law offence in 60% of its cases with 46% of defendants penalised with 1 or 2 year prison sentences. Perhaps this leniency is the reason why the three British bankers being extradited for ENRON related fraud offences fought so vigorously for a UK trial.

The United States treats the offence of “conspiracy to defraud” prescriptively. [U.S.C.S 1349 and S 1350.] Also, Section 902 of the Sarbanes-Oxley Act, codified at 18 U.S.C. S 1349, provides a new offence for attempts and conspiracies to commit fraud, including securities fraud. The Sarbanes-Oxley Act 2002 specifically contains an attempt to commit fraud which the old laws under Title 18, United States Code, did not contain, although under pre-existing law even an unsuccessful attempt to commit wire fraud was a crime. This offence carries a 20 year prison sentence and a fine of $5 million. We can see the huge disparity in punishment for the same crime.

Furthermore, this new maximum penalty has been increased in the United States from 5 years to 20 years because of the Enron fraud and is part of the statutory increases to the fines and terms of imprisonment for a variety of white-collar offences. This 20 year maximum prison sentence moreover, can be increased to 30years on sentence plus one million dollar fine if the conspiracy affects a financial institution[1] as the Nat. West       Bank is. In the case of an individual    defrauded, the maximum sentence could be as much as 25 years plus a maximum fine. Furthermore, in the US criminal sentences are largely governed by the Sentencing Guidelines and prosecutors can simply include multiple counts in the indictment if the statutory maximum penalty falls below the potential sentencing guideline range. 

Moreover, as a result of the Sentencing Commission’s amendments in 2001, (before the US-UK Treaty), the Guidelines’ range for fraud offences involving large losses were already severe. In addition to these statutory increases in penalties, Sarbanes-Oxley Sections 805, 905 and 1104 directed the U.S. Sentencing Commission to review and amend the Sentencing Guidelines applicable to crimes involving securities, obstruction of justice offences, accounting fraud, and other related offences.  In doing so, the Commission is instructed to ensure that the Guidelines reflect “the serious nature of the offences”, the growing incidence of serious fraud offences, the “need to modify the sentencing guidelines and policy statements to deter, prevent and punish such offences” and the need for “aggressive and appropriate law enforcement action to prevent such offences”.[2] 

The case of United States v Muldrew, Giles Robert Hugh Darby and David John Bermington, conspiracy to defraud $7.3 million in transactions involving Enron Corp. has come to public notice because the three fought extradition to the US. The prosecution allege that, through a series of financial transactions, the three former bankers secretly invested in an Enron Special Purpose Entity (SPE), Southampton LP, and were able to siphon off $7.3 million that should have gone to their bank, Nat West.

The SPE is of particular importance to this massive fraud of creative accounting. To look profitable Enron had to minimize losses and volatility, accelerate profits and keep as much debt off its Balance Sheet in order to keep a good credit rating. So SPE’s were used to hedge certain investments.

As an example, Enron would transfer its own stock to an SPE in exchange for a note or cash[3].  It directly and indirectly guaranteed the value of the SPE.  The SPE would hedge the value of a particular investment on Enron’s balance Sheet, using the transferred Enron stock as the principle source of payment[4]. Because of its historically rising stock price, Enron judged the risk that it would have to pay on its guarantees as remote. So when Enron’s stock price fell unexpectedly, the SPE’s value also fell, triggering the Enron guarantees, which further reduced stock price, which triggered additional Enron guarantees[5].When Enron’s investment and stock price both fell, the SPE would lack sufficient assets to perform its hedge. This caused the SPE’s to breach the US’ 3% independent equity requirement for non-consolidation, and so the SPE’s debt became Enron’s debt on its Balance Sheet.

Mr Fastow  was the SPE principal and when the SPE’s thrived he received massive compensation[6], mostly without Board approval. This was an ingenious fraud only because the value of Enron’s stock became embedded in the value of the SPE; when stock prices rose, SPE’s value rose but when the unexpected stock price collapse came; the guarantees were called in and could not be met. Such abuse of SPE’s raised fundamental questions about the legitimacy of structured finance transactions, of which securitization transactions constitute the bulk.  In a typical securitization transaction, a company transfers rights to payment from income-producing financial assets, such as accounts receivable, loans or lease rentals, to an SPE.  The SPE in turn issues securities to capital market investors and uses the proceeds of the issuance to pay for the financial assets. The investors are repaid from collections of the financial assets. They buy securities based on their assessments of the value of the financial assets.[7]

In general, the global hedge fund industry is intensely secretive.[8]A recent survey of the industry revealed that the sector is rapidly expanding. It is estimated that there possibly may be 12000 hedge funds investing more than$7 trillion in the world’s financial markets by 2008. Research has revealed that up to 1999, one could receive 30% returns, very lucrative indeed. Then most hedge funds tried to emulate the best and today, hedge funds’ returns arte less than 2%.in this $1000 billion industry. .The Chairman of the US Federal Reserve describes hedge funds as the shock absorbers of the financial markets.[9]  The corporate finance world is very complex and securitization is not normally a way for a company to obtain lower-cost financing through disintermediation.  But securitization does avoid the mark-up charged by a middleman of funds and it enables a company to raise funds cheaply based on an allocation of risks that are assessed by parties having the most expertise. The difference between normal securitization and Enron’s manipulation of SPEs is that Enron had high risk that stock prices could fall and that its asset values could fall

So the structured transactions have dubious   economic value as in most

Securitization deals, the receivables are sold to SPEs with minimal recourse, so the SPE and its investor take the economic risks of collection and once the deal is closed nothing can happen to cause the risk allocation to be subsequently reversed.

The evidence requirements of Article 8 of the Treaty have been fulfilled because the allegations were made by guilty parties to the Enron fraud and the alleged transactions did take place. The dual criminality of the offence is positive as it is punishable in both countries by at least 1 year imprisonment.  It even qualifies for the requirements of the European Arrest Warrant as it provides a “description of the circumstances in which the offence was committed, including the time, place and degree of participation in the offence by the requested person”. In any case, the European Arrest Warrant has been in force since January 2004.  The UK government cannot refuse extradition because the death penalty does not apply to wire fraud. The UK cannot now derogate from the new extradition obligation because the event is not political, just criminal.

The time that the charge has already stood is over 3 ½ years or 42 months (June 2002 to July 2006).  One other possibility is for these three bankers to be extradited to a third country, say in Europe, and especially to Switzerland, which has a Mutual Assistance Treaty with the US and any hidden transactions can be found.

In theory, the UK’s Proceeds of Crimes Act can be used to seize the disputed profits gained by the three British Bankers charged with US wire fraud because the profits relate directly to the offence charged. Section 88 provides that such monies be forfeited and dealt with in such a manner as the court deems fit. When the UK-US Extradition Treaty became law, it implemented the EU Framework Decision on a European Arrest Warrant.

The 2003 Treaty complies with the UK’s Statute of Limitations because limitations do not apply to criminal offences. The Extradition Treaty 2003 does not change the evidentiary requirements for extradition from the United Kingdom to the US but the requirements are lowered from a “prima facie” standard to a “probable cause” standard. Therefore there is nothing to stop the provisional arrest of the three men for extradition.

This is indeed a strange case as the three ex-bankers were formally charged by the U.S. Department of Justice with wire fraud in June 2002. The UK-US Extradition Treaty was ratified by the UK government in May 2003, signed by the U.S Attorney General on 31st March 2003, and implements the EU-US Treaty on extradition signed in Washington on 25th June 2003 and in force in January 2004. So technically, the Nat West ex-bankers can be extradited without the new UK-US Treaty because The United Kingdom already had an arrangement for mutual assistance with United States in criminal matters. This was on entirely general criminal matters and applied to assistance in respect of proceedings related to criminal matters, including any measure or step taken in connection with an investigation or the prosecution of criminal offences, including the freezing, seizure or forfeiture of the proceeds and instrumentalities of crime, and the imposition of fines related to a criminal prosecution[10]. This Treaty permitted oral requests later confirmed in writing.[11]

The three defendants appealed against the extradition.  This appeal was not heard until 28 September 2004 (27 months after being charged). On 15th October, the English court recommended that the three be sent to Texas, US, for trial. Although the three argued for a UK trial, it is not a ‘forum conviens’ for jurisdiction because all of the discoveries, the principle place of business, the other defendants, are in the US. Enron is a US company under US law.

To date many in the ENRON case have pleaded guilty and the accountants Anderson gave $60 million as restitution, Citigroup bank gave $300 million and the Canadian Imperial Bank $80 million, totalling $440 million; they pleaded guilty and paid up and this indicates the basis on which the 3 bankers should be extradited for Fraud.

Meryl Lynch agreed to pay nearly 30 million dollars for its part in the ENRON fiasco but this was not until the ex-CEO, guilty Ken Lay, had died on July5th, 2006.

ENDS

 

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[1] There are new guidelines for such serious fraud and now a Chief Finance Officer of a Fortune 500 company, say, could receive a prison sentence of 30 years to life, with no possibility of parole, even if this was a first offence.

[2] See Sarbanes-Oxley Act 2002, ss 905 and 1104.

[3] Powers Report, page 13...

[4] This hedging was used in virtually all Enron’s SPE transactions.

[5] Powers Report pages 41-2.

[6] But even if he had board approval, performance-based compensation tied to a list of goals such as return on equity, cost of capital and so on, make the goals vulnerable to manipulation. Today the SEC has new rules on asset backed securities

[7] Schwarcz. S. L, (1994), “The alchemy of asset securitization”, Stanford Journal of Business and Finance.

[8] Irving.R, (2004), “Hedge fund aspirations may have to be trimmed”, Times Newspaper, 8th November, 2004.

[9] Cole.R, (2004), “Transparency is needed for hedge funds”, Times Newspaper, 10th November 2004.

[10] Article 19(3) (e) UK-US Full Mutual Assistance Treaty.

[11] Article 4(1) UK-US Full Mutual Assistance Treaty.