Public defender: Former Assistant U.S. Attorney provides an inside look on fraud prosecution.

Jeffrey Bornstein has a unique perspective on fraud. He served the U.S. Attorney's Office in San Francisco for 19 years, most recently as an assistant U.S. attorney, senior litigation counsel for the criminal division, white collar/securities fraud unit.

As an assistant U.S. attorney, Bornstein served as a trial lawyer specializing in white-collar criminal cases. He has tried more than 25 criminal and civil cases, including revenue recognition, insider trading and Ponzi schemes, and has worked on many others, such as market manipulation cases relating to California's energy crisis.

Now a partner with San Francisco law firm Kirkpatrick & Lockhart Nicholson Graham LLP, Bornstein concentrates on white-collar crime/criminal defense and securities enforcement.

CalCPA sat down with Bornstein to get his perspective on prosecuting fraud, the Enron trial, the effects of the Sarbanes-Oxley Act and how federal scrutiny of stock option backdating might play out.

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* Tell us about some of the high-profile cases you've helped prosecute.

There's a pending case against the former CFO of what was then Network Associates. Two other people have pled guilty--the former controller and another high-ranking finance executive. It's a revenue recognition case alleging that channel stuffing, side deals and other arrangements artificially inflated revenue.

I also prosecuted the former CFO and the CEO of Unify Corp. in a revenue recognition and insider trading case. It involved similar kinds of issues--side letters and side deals--relating to software sales.

I also prosecuted an ERISA health insurance fraud scheme. The defendant set up an entity that people could join to buy health insurance. He claimed that the insurance came from Lloyds of London, and a friend of his, an insurance broker, gave him a certificate showing what coverage from Lloyds would look like. But it was only a sample certificate; there was no real insurance. I thought that case was particularly egregious. It was very emotional to listen to some of the victims' testimony--they thought they had health insurance but found they were on the hook for their medical bills.

Another case involved an investment adviser and preacher in Napa County, who went to churches and talked to parishioners about investment strategy. He used his religious faith to connect with people. He convinced them to invest with him and basically just stole their money and used it for his own personal expenses. Some parishioners lost hundreds of thousands of dollars.

I also worked on a number of E-Rate cases involving fraud in a government-sponsored program to bring internet access to poor schools across the country. As a result of the investigation, two major corporations pled guilty to wire fraud and antitrust violations, and paid millions in fines and restitution. It was important not only locally for the San Francisco School District, but also for other districts that were taken advantage of.

Another prosecution involved Department of Housing and Urban Development properties.

There were some very large landlords in charge of some of these properties all around the country that were taking advantage of loopholes in the HUD program to line their own pockets. In addition to securing millions in fines and restitution, we were able to assist HUD in closing some of those loopholes.

* What was the trickiest fraud to uncover?

There were a couple of cases that were incredibly tricky. As an assistant U.S. attorney I was a generalist for many years before I started prosecuting white-collar crimes. So I prosecuted a lot of sophisticated drug crimes and other violent crimes. And working those cases helped me to become a better white-collar prosecutor.

In many respects, dealing with witnesses in white-collar cases is very similar to dealing with drug dealers or other folks involved in some criminal activity. It's the same level of denial, the same level of exaggeration of other people's roles or minimization of their role.

But there is one significant difference--in most white-collar cases, many people don't really think that they've done anything wrong. Many times I've had the impression that they were so convinced that they could actually pass a polygraph.

It's always been challenging, particularly for defense attorneys, to get their clients to understand what they're up against--and the fact that admitting you did something wrong might not be so bad, compared with going to trial. We've just seen that in the Enron cases, where the defendants spent something like $60 million on their defense, but now could be sentenced to lengthy prison terms. It seems like a very resounding victory for the government.

* What was the most egregious fraud--in terms of dollars--you've prosecuted?

That would be the California energy cases, where various companies and individuals are alleged to have manipulated the market, costing ratepayers in California hundreds of millions of dollars. The Reliant Energy case is still pending and may go to trial this year.

Many of the fraud cases have involved hundreds of thousands if not millions of dollars. The typical revenue recognition cases involve huge stock price declines, costing investors millions. In Unify, for instance, the company was de-listed and continues to struggle. Network Associates restated. It just depends on how you calculate the losses.

* How did cases end up on your desk?

Sometimes I'd get a call from FBI agents when they had particularly interesting cases. Sometimes there'd be a more formal case assignment process. At one point, I referred to myself as the office sanitation engineer because I would pick up cases that were going nowhere or were problematic. But I got some really good cases out of that.

Sometimes I would read the newspapers and see something that I thought needed the government's attention and then call the FBI myself and say, "Hey what about this?"

* A potential case would jump out at you from a newspaper article?

Many times the private bar is very aggressive, especially in the securities areas, so it was quite common for them to be ahead of the government in filing cases. They can file cases much quicker on the civil side because discovery largely happens after a complaint is filed, whereas generally, in a criminal case, we do it the other way around--an investigation needs to be completed before seeking an indictment.

* I'm a CPA, and the DOJ or FBI has just arrived at my doorstep, wanting to see my workpapers and interview me. What should I do? What's the worst thing I can do?

The worst thing is to just sit down and say, "Here are all my papers, what else do you want to know?"--and then start talking.

First of all, when you get that kind of request, you need to understand what's going on. Is it a formal request? Are you obligated to respond? Does the government think that you or your firm did anything wrong? Are you a witness, a subject, a target? Are there any issues involved in terms of the privacy of your clients? Is there something to protect you if you do start talking, like immunity?

The best practice is to have a plan in place for dealing with those kinds of inquiries. It's actually common these days for there to be some sort of SEC or NASD inquiry involving some aspect of an accounting firm's work. So, be prepared for these kinds of inquiries.

And I know it will sound cliche, but talk to your lawyer. People need to be aware that even if you're served with a grand jury subpoena, there's usually time to respond. You can be compelled to produce documents immediately only if the agents have obtained search warrants or what is called a forthwith subpoena. But even then, you still don't need to make any oral statements.

* What is the scope of securities or corporate fraud in the United States? Who is most harmed?

If you look at the number of cases--both SEC and even prosecutions--they probably number in the hundreds per year. It's a small percentage of all public companies. But there are egregious things that become newsworthy, whether it's an Enron type of situation or now what we're seeing with the options backdating probe.

Even in the options backdating inquiry, what are we talking about, maybe a couple dozen companies? Now, does that mean that's as far as it goes? Many believe that the practice was much more widespread.

* So, you believe this backdating probe might have legs?

It's significant because you're talking about some very reputable companies. You're talking about executives that are alleged to have made millions of dollars based on the differential in dates.

The most interesting thing about options backdating is it may be a historical problem as opposed to a current problem. A lot of the cases are talking about the late-1990s, prior to 2002 when the rules changed about filing Form 4s, which basically made it much harder to fudge on those dates.

* Is the statute of limitations open on that?

That's going to be a very interesting question on these cases: whether or not the government is going to be able to prove, assuming that there is improper conduct, that it occurred in the last five years. But there are a number of different arguments that I'm sure the government will try to advance to get it within the statute.

* What are some red flags that get the government's attention in terms of securities fraud?

Certainly greed is a huge issue, where you see people making money at other people's expense; insider trading, for instance, and other sorts of self-dealing. Arrogance seems to go hand in hand with greed. False document cases where there are two sets of records--the "official" books and things that are off-book. And then there are side agreements.

Side agreements, in the government's mind, are bad, yet there may be a legitimate business purpose for them. The issue is: what's their purpose, are they disclosed and to whom, and is the true purpose something other than what's disclosed? False statements or material omissions in statements made to an auditor or accountant also are extremely important to the government.

When a company restates, the government thinks, "What's that all about?" Or when high-level corporate officers resign or are fired and it's coupled with some sort of a disclosure by the company of some impropriety--that's also likely to trigger the government's interest.

* What is the most common form of securities fraud?

I would guess insider trading. The second would be revenue recognition cases where people were so worried about making the numbers that they would do more than cut corners and take chances--they would push it beyond any rhyme or reason.

It's like what we saw in the Enron case, where various public statements and disclosures were just false. Executives that try to fool shareholders by false or misleading disclosures are particularly at risk.

* Could a fraud on the scale of Enron happen again?

It won't be the same kind of fraud, but I absolutely think it could happen again.

Business executives are under enormous pressure and are highly motivated to make their numbers. Sometimes there's a fine line between being an aggressive businessman and crossing that line. Sometimes that line gets blurry. It may be that you had good intentions in the sense of you were simply trying to keep the company afloat, but if the conduct is deceptive, that's still fraud.

For example, I don't know whether this options backdating situation is going to have legs or not, but there are a lot of public companies receiving subpoenas. A significant number of people already have lost their jobs over this; a number of companies are in the process of restating and some already have restated. I don't know to what extent shareholders have lost value as a result of these activities.

So when you ask, "Is Enron likely to happen again?" yes, but there will be a different set of circumstances.

* Do you believe that SOX has improved the government's ability to prosecute fraud?

There have been very few prosecutions that I'm aware of that are particularly focused on Sarbanes-Oxley violations. But it has made corporations more transparent and re-empowered auditors to be much more vigilant, which is a good thing.

Also, for most companies, SOX has reinvigorated their internal code of ethics and internal oversight and the concept of doing the right thing. It has put those people that share those values in more visible control of the internal processes of a company.

And I think all of those are important and beneficial because no matter how comprehensive our laws are, there's always a way around them.

So it's a cultural thing. If you can get people to want to do the right thing, to value ethical behavior and disclosure--and we're starting to see that more and more--that I think is the real benefit of SOX.

The problem is we're in a period where decision-makers are afraid to act decisively for fear they may be second-guessed, or prosecuted, or at the very least, sued by the SEC or shareholders. So companies are conducting very costly internal investigations--it's difficult to determine that an act is immaterial without a thorough evaluation. If you've got a whistleblower or an anonymous complaint, you have to take some action on it.

SOX has become problematic for smaller companies, because many of the rules were designed for bigger companies. Spending time and money on compliance is a huge undertaking for smaller companies. Certainly an enlightened CEO or board of directors understands that spending what looks like a lot of money on compliance in the short run may save the company significantly in the long run. All it takes is one SEC or U.S. Attorney investigation to make it extremely expensive.

And if you can prevent that by putting in good procedures upfront you may be better off. But that's very difficult when you're a smaller business; it's a very hard sell. What may be best practices for a national or international corporation may not work for a smaller company where it's much more personal and resources are stretched.

So I think we need to digest some of these issues, but I don't know that exempting small businesses from the internal control requirement is the answer. There needs to be some recognition of the cost and benefits and the realities of conducting business in a small company so we can develop a more workable framework.

And the other problem is that you end up with a checklist. People just check things off--OK, I've done this, done that. But that's not what Congress intended and what most shareholders expect. Which goes back to where we started: that most companies want to do the right thing and most people in business want to do the right thing. And I think the benefit of SOX is re-empowering those people.

Jeffrey Bornstein was interviewed by Jerry Ascierto, CalCPA's managing editor. You can reach Bornstein at [e-mail]. You can reach Ascierto at [e-mail].