Executives find reputations don't return after criminal charges dropped

David Pinkerton had just left his 8-year-old twins at his in-laws' home in Morristown, N.J., when he learned he was no longer a suspected felon.

Pinkerton's lawyer called to say that the U.S. prosecutors who had charged the former American International Group managing director with bribery, which could have led to a decade in prison, had dropped the case. The relief was so great that day in July 2008 that the 6- foot-2-inch-tall executive, who had fought the stress of the 31-month-long ordeal with intense gym workouts, broke down and cried.

David Stockman, a former U.S. budget director, lived under the shadow of a fraud indictment for two years before prosecutors dropped the charges without explanation or apology.

"They wrecked my reputation, my business career," Stockman, 63, says. "I don't know how you compensate for that."

Stockman and Pinkerton are among a growing number of executives in recent years who have been indicted on charges of corporate crimes then later see them dropped. From 2006 to 2008, the most recent period available, U.S. prosecutors dismissed charges against 42 such defendants for which the most serious charge was securities fraud. That's more than twice the 20 dismissals in the previous three years, according to the Federal Justice Statistics Resource Center.

The collapse of so many cases is surprising, legal experts say, because U.S. prosecutors are expected to have thoroughly investigated the facts and law before asking a grand jury to bring charges.

At least five indictments were returned — and then dropped — by the U.S. Attorney's Office in Manhattan, which oversees Wall Street.

"This strikes me as very unusual," says Duke University law professor Samuel Buell, a former prosecutor who brought fraud cases stemming from the collapse of Enron. "These are some of the best prosecutors in the Justice Department."

The increasing number of dismissals may signify that the transactions in some corporate cases have become so intricate that even top prosecutors have trouble mastering them, Buell says.

The phenomenon may become more widespread as investigators sift through the wreckage of the global financial crisis. Criminal investigators have probed Lehman Brothers, which filed for bankruptcy in 2008; Countrywide Financial, which Bank of America acquired that year; and AIG, which got $182 billion in the U.S. bailout, according to people familiar with the probes.

If indictments stem from the collapse, Peter Henning, a former Justice Department fraud prosecutor, says he doubts they'll focus on sophisticated transactions involving mortgage- backed securities.

"Those are very tough cases to prove," says Henning, who now teaches at Wayne State University Law School in Detroit, citing the acquittals in November of former Bear Stearns hedge-fund managers Ralph Cioffi and Matthew Tannin on fraud charges. Instead, prosecutors will look for clear instances where executives lied about company finances, he says.

Yusill Scribner, a spokeswoman for U.S. Attorney Preet Bharara in New York, who took office after the Manhattan dismissals, declined to comment.

Rules change

A dismissal may result when the evidence or law changes or because prosecutors make a tactical or even a compassionate decision, says Bruce Green, a professor at Fordham University School of Law.

"It should only be necessary in the rarest of circumstances," says Michael Garcia, who was U.S. attorney in Manhattan from September 2005 to November 2008. "But the circumstances arise."

"My own view would be, 'How come we didn't think of this before we indicted the case?' " he says.

Though exonerated defendants may sue for fees, there is no legal provision for repairing a damaged reputation.

"Somebody made an allegation that I did something improper, and everything got thrown under the bus," Pinkerton, 49, says. "One day, 100 people around the world want to talk to you. The next, your BlackBerry goes silent and you have three friends."

For a public figure such as Stockman, the impact was magnified. Television cameras rolled at a packed news conference on March 26, 2007, as Garcia announced the indictment of the former director of the Office of Management and Budget under President Reagan.

Flanked by investigators, Garcia said Stockman had lied in regulatory filings and defrauded investors of $1.35 billion in a scheme to raise capital and save Collins & Aikman, the Southfield, Mich.-based auto-parts maker of which he was chairman, from bankruptcy.

Stockman's private-equity firm, Heartland Industrial Partners, paid $260 million for the parts maker in 2001 and snapped up other auto-supply companies in a bid to create the dominant supplier of fabric, consoles and other components for automakers. Four years later, in May 2005, Collins & Aikman, with more than $1 billion in debt, filed for bankruptcy as Ford Motor and General Motors slashed production.

Reviewing the case

After appearing in court in March 2007 to deny fraud charges that could have brought him two decades in prison, the gray-haired Stockman retreated to his home in Greenwich, Conn.

Hunched over company documents, Stockman spent weeks reviewing the rebate transactions and accounting at the heart of the case. Then he penned a 31-page memo to his lawyers outlining how he had tried to rescue his company.

"The prospect of the guillotine tends to focus the mind," says a now-relaxed Stockman, in jeans and a white baseball cap, from the office where scores of binders filled with company documents still line his bookshelves.

He insisted that his attorneys seek to convince prosecutors that they were wrong. Stockman helped lead dozens of lawyers, paralegals, accountants and investigators through 15 million documents that the government turned over.

"I was naive enough not to understand how bad the odds were," says Stockman, a former Harvard Divinity School student and U.S. congressman.

After more than a year of research, Stockman's attorneys produced a 221-page report backed by 647 footnotes and 47 binders of documents. Evidence was overwhelming that he was innocent, the report said, adding that prosecutors hadn't done their homework and had relied too heavily on an internal probe done by Davis Polk & Wardwell, the law firm that guided Collins & Aikman after its 2005 collapse.

"The government gave far too much credit to private counsel's unfounded conclusions," the report said. "Much of the documentary evidence most directly relevant to this case appears not to have been reviewed at all — by anyone — prior to Mr. Stockman's indictment."

The report, financed by Stockman's indemnification policies, argued that Collins & Aikman was never in jeopardy of violating loan covenants and that the accounting issues in the case were ambiguous.

The defense found documents indicating that outside auditors knew of deals prosecutors said Stockman hid, transcripts of conference calls showing that Stockman never made statements attributed to him and records demonstrating that lenders weren't deceived about collateral.

"We found a lot of these," Stockman says. "You'd find these nuggets everywhere, but it was a 15 million-page swamp."

Stockman's defense delivered the report to prosecutors on Oct. 20, 2008. On Jan. 9, 2009, the government released a brief statement saying it had dropped the case against Stockman "in the interests of justice." By then, the lead prosecutor had left for private practice.

Elkan Abramowitz, Stockman's lawyer, says the case underscores a wider issue. Lawyers for companies that come under government scrutiny have discovered that corporations won't be prosecuted if they deliver to authorities evidence against top executives, and sometimes they find crimes where there are none, he says.

"There is almost an institutional bias to find and expose criminality," he says.

Davis Polk partner Dennis Glazer defends his firm's confidential probe and refuses to characterize its findings.

Today, Stockman's anger is palpable. He leans forward, his voice urgent.

"I think the prosecutors involved in this should be personally liable," says Stockman, who paid a total of $7.2 million to settle lawsuits by investors and the Securities and Exchange Commission without admitting or denying liability.

Seven other Collins & Aikman employees, including four who pleaded guilty, also won dismissals.

Azerbaijan oil deal

An indictment is devastating, AIG managing director Pinkerton says. His ordeal began with his decision to invest a fraction of the private-equity and hedge-fund money he managed for AIG in an oil deal in Azerbaijan in 1998.

"It wasn't a bet-the-house," says Pinkerton, who then managed about $6 billion. "It was $15 million."

The deal had potential, Pinkerton thought. Clayton Lewis, who oversaw an AIG investment at New York-based hedge-fund firm Omega Advisors, was investing $126 million in a bid to buy state assets in the Caspian Sea nation and suggested AIG join.

Pinkerton says his due diligence showed the possibility for big gains: Investors might see a 1,000 percent return if Azerbaijan sold part of its hobbled oil industry. There was also risk: Not only might Azerbaijan choose not to sell the company; media reports said the deal's promoter, Viktor Kozeny, had stolen assets from public companies in the Czech Republic.

Pinkerton signed on, believing that Omega was a solid partner and that an oil investment was a good hedge against inflation. Kozeny denies stealing assets.

Transactions authorized

The transaction was one of hundreds that Pinkerton authorized over the years. A University of Delaware graduate who later got a degree at night from Brooklyn Law School, Pinkerton joined AIG in 1985 in a $19,000-a-year underwriting job and eventually became its first U.S. employee devoted to hedge funds and private equity. He rose through the ranks overseeing AIG's investments in Blackstone Group LP, Carlyle Group and others.

"My blood ran blue with AIG," Pinkerton says.

"He was a guy who you knew could handle bigger and bigger investments," says Edward Matthews, who was AIG's vice chairman until 2005. "He grew into the position."

The Azerbaijan deal collapsed in 1999 when Azeri leaders didn't sell the company. AIG and Omega sued Kozeny, claiming he had pocketed their investment. Kozeny denied that and said AIG and Omega should be barred from suing because they had joined him in a plot to bribe Azeri leaders, in violation of U.S. anti- bribery laws. Kozeny also took his allegations to U.S. prosecutors, who launched a probe.

Lewis later pleaded guilty in Manhattan to charges of investing with Kozeny after learning of the bribery scheme. Seeking leniency, he cooperated with prosecutors and, according to court records, claimed Pinkerton knew of the payoffs.

On Oct. 4, 2005, Pinkerton's lawyer summoned him home from Switzerland, where he was visiting a client. Pinkerton surrendered to the Federal Bureau of Investigation two days later and was jailed for hours in a Manhattan federal court holding pen.

"There's a process," Pinkerton says. "It's really about trying to shred your dignity, putting you in a jail cell and letting you sit."

Pinkerton's life slowly fell apart. In December 2005, AIG placed him on leave without pay. Living off savings, Pinkerton immersed himself in his defense, only to grow frustrated at the glacial pace. He curtailed his daily contact with his lawyers.

Meanwhile, lawyer Barry Berke worked to prove Pinkerton's innocence. The co-chief of the white-collar practice at Kramer Levin Naftalis & Frankel in New York, Berke gathered evidence showing that Pinkerton's due diligence was genuine, including assurances about Kozeny that a top AIG executive had gotten from another investor in the deal.

Berke learned that Pinkerton had heard Azeri officials seeking U.S. investors at a conference in Washington, D.C. Colleagues of Pinkerton's agreed to testify that Lewis had said the deal was legitimate.

Berke concluded that prosecutors had misinterpreted notes found in AIG files. For instance, a mention that Azerbaijan's president was involved in the deal meant only that he supervised the asset sale, not that he had been bribed, Berke says.

Berke says prosecutors didn't probe deeply enough before filing charges. "The government often views the case with blinders on."

The indemnification policy that paid Berke also financed a defense investigative team at Nardello & Co., which turned its sights on Lewis.

Investigators hired by Berke traveled to Australia, Azerbaijan, Hawaii and Seattle, following leads that Lewis was more involved in the scheme than he had claimed. They also uncovered documents indicating that Lewis had wrested control of an Australian pearl farm from its owners, which could be used to attack his credibility at a trial.

"The government doesn't do the same sort of background investigation of witnesses," says Dan Nardello, a Manhattan federal prosecutor from 1987 to 1994 and principal of the New York-based international investigative firm.

R. Scott Thompson, Lewis's lawyer, says Nardello got facts wrong about the pearl farm and his client's role in the bribes.

"They took a grain of truth and stretched it," says Thompson, of Lowenstein Sandler PC in Roseland, N.J. In a lawsuit that was settled in May, Omega accused Lewis of hiding the bribery scheme from the firm.

Prosecutors, meanwhile, disclosed that Lewis had told Pinkerton that Omega had investigated Kozeny's arrangement with Azeri officials and concluded it wouldn't run afoul of anti-bribery laws.

On July 1, 2008, after nearly a year of discussions, the government dropped the charges. Mark Mendelsohn, who was deputy fraud chief in the Justice Department, which brought the charges, declined to comment. Another investor, Frederic Bourke, was convicted of bribery conspiracy last year. He's appealing.

Pinkerton is working to build the asset-management firm he launched after his arrest, Pinkerton Capital Management.

"I got a lot of feedback from people," he says. "They said, 'That could have been me.' "