Saturday, July 28, 2007

US Dropped Enron-Like Fraud Probe

By Marisa Taylor
McClatchy Newspapers

Monday 23 July 2007

Prosecutor who built case against Virginia insurer was replaced.

Two years into a fraud investigation, veteran federal prosecutor David Maguire told colleagues he'd uncovered one of the biggest cases of his career.

Maguire described crimes "far worse" than those of Arthur Andersen, the accounting giant that collapsed in the wake of the Enron scandal. Among those in his sights: executives from a subsidiary of Berkshire Hathaway, the investment empire overseen by billionaire Warren Buffett.

In May 2006, he felt strongly enough about his case that he prepared a draft indictment accusing executives from a Virginia insurer, Reciprocal of America, of concocting a series of secret deals to hide its losses from regulators. Although he didn't name anyone from Berkshire Hathaway's subsidiary, he described the company as a participant in the scheme.

But Maguire never brought those charges.

Months after preparing the draft, he was removed as the lead prosecutor on the case and reassigned.

His replacement, a prosecutor who hadn't been involved in the case until then, soon announced that the Berkshire Hathaway subsidiary, General Reinsurance, would not be indicted. By April of this year, the entire investigation, which the Justice Department once hailed as one of the largest insurance-fraud cases in Virginia history, had fizzled.

Former employees and policyholders of the Richmond-based insurer were astounded. Why had the Justice Department spent upward of $2 million to investigate the case only to decline to prosecute? Maguire and his team of investigators had secured two related guilty pleas, interviewed dozens of witnesses and gathered 7,000 boxes of documents.

At the Justice Department, some whispered that Maguire and his team had overreached and had been knocked down. Others heard that the government needed resources for terrorism investigations.

Lawyers for the two companies had another explanation: Prosecutors realized they didn't have evidence of a crime.

"It was a black and white decision," said Stanley Twardy Jr., one of General Reinsurance's attorneys and a former U.S. attorney. "They just called it like they saw it."

But Tom Gober, a certified fraud examiner who worked on the case, thought investigators had gathered plenty of evidence.

Gober, a government-contracted investigator, concluded that the Justice Department had buckled under pressure from defense lawyers. Shortly before Maguire was removed, his supervisors were urging him to drop the case against General Reinsurance, Gober said.

Gober's suspicions were fanned by allegations of politicization in the Justice Department after nine U.S. attorneys were fired. He took his complaints to the Office of Professional Responsibility, which investigates Justice Department misconduct. That investigation is under way.

"It just stinks," he said. "You don't come in out of nowhere and in no time kill three years of sophisticated effort."

Maguire and officials with the U.S. attorney's office and the FBI in Virginia declined to respond to questions about the decision.

Justice Department spokesman Bryan Sierra said he wouldn't comment, either.

Internal documents obtained by McClatchy Newspapers show that Justice Department lawyers in Washington had become locked in an intense debate with Maguire over the case until he was removed from it.

Five years after Enron collapsed and tough measures aimed at white-collar crime were enacted, federal officials struggled with questions of corporate accountability: Who should be held responsible when fraud leads to a company's demise? How far should federal prosecutors go in pursuing corporate suspects? In the Reciprocal of America case, the fallout was clear.

More than 80,000 lawyers, doctors and hospitals in 30 states lost their malpractice coverage. As they couldn't expect new insurers to cover them for past cases, some who were sued have claimed losses of hundreds of millions of dollars.

A Company Under Siege

A team of state insurance auditors arrived at Reciprocal of America's headquarters in January 2003 to launch their investigation. They shepherded the company's 300 employees into a conference room and locked the doors.

Suspicious accounting activity had been detected. The company and its subsidiaries were being shut down for the duration of the investigation.

Federal agents soon expressed interest in joining the case.

The auditors had found troubling numbers.

Insurance companies are supposed to avoid insolvency by socking away vast surpluses collected from policyholders' premiums and passing risk to giant reinsurance counterparts such as General Reinsurance.

Reciprocal's surplus began to erode in the late 1990s, when medical malpractice awards shot up. Desperate to pump up the surplus, the company's executives asked General Reinsurance to assume millions more in risk.

The Berkshire subsidiary agreed, according to documents from both companies. General Reinsurance, known as "Gen Re," treated the unusual transactions as "side" or "unenforceable" or "handshake" deals. Executives referred to one deal as an "off balance sheet loan," according to internal documents.

Maguire included details of the deals in his draft indictment as part of the alleged accounting-fraud scheme designed to help Reciprocal inflate its surplus and hide its losses from regulators.

Regulators and FBI agents sifted through thousands of e-mails and memos. The trail led straight to Reciprocal President Kenneth Patterson and his executive vice president, Carolyn Hudgins.

Investigators found evidence that the pair had manipulated the company's accounting records to conceal losses and urged the pair to admit their guilt.

In February 2005, Patterson and Hudgins pleaded guilty to felony fraud charges. They agreed to cooperate with investigators. But agents soon became frustrated with the pair because they didn't appear to be divulging much detail. Corporate fraud cases are hard enough to prosecute because of their complexity. Without testimony from convincing cooperators, the case could be difficult to sell to a jury.

A federal judge sentenced Patterson to 12 years in prison and Hudgins to five years. Both declined requests for interviews.

That spring, Justice Department lawyers in Washington began to voice skepticism about proceeding against General Reinsurance. They pointed out that some of the evidence, which dated to the late 1990s, might be too old. They also warned that an indictment could hurt a major corporation unnecessarily.

"The bottom line has always been what do we want to do with Gen Re," Joshua Hochberg, the Justice Department's then chief of the fraud section, wrote to Maguire. "Indicting the company would have enormous collateral consequences."

Hochberg, who's no longer with the Justice Department, declined to comment.

Maguire pushed back, arguing that his team had plenty of evidence showing a pattern of fraud over more than 15 years.

"Gen Re has been a public menace for a long time," he wrote colleagues. "Their 'I'm not my brother's keeper' attitude has enabled them to make millions by 'aiding and abetting' bad guys."

At the very least, Maguire argued, the department should impose a fine of up to $600 million. "If they balk, they should know that we are more than ready to indict Gen Re," he wrote.

Some Setbacks

While General Reinsurance attorneys acknowledged their clients might have entered into "handshake deals" with Reciprocal, they described them as harmless and the industry norm.

Ronald Olson, an attorney for General Reinsurance and a director on Berkshire Hathaway's board, argued that his client was a victim of Reciprocal's fraud. After Reciprocal collapsed, General Reinsurance lost millions, he said. It later banned "side" deals as a bad business practice.

"There was no knowledge at Gen Re that people at Reciprocal of America were hiding information from regulators or auditors," Olson said.

FBI agents urged Maguire in May 2005 to proceed at least with an indictment against John William Crews, Reciprocal's general counsel, who'd co-founded the company in 1977, according to internal documents.

Maguire and the agents believed that Crews had participated in many of the meetings with General Reinsurance and had received memos and e-mails about the firms' relationship.

Crews and his law firm also had collected more than $63 million in legal fees from Reciprocal of America and its subsidiaries, documents show.

Within months, Maguire was removed from the Reciprocal of America case.

His replacement, Assistant U.S. Attorney Michael Gill, quickly set a new tone. In his first meeting with the team last fall, he called General Reinsurance's lawyers to tell them that no case would be brought against their clients in regard to Reciprocal.

Gill decided this spring not to indict Crews, either.

Crews' lawyer, J. Jonathan Schraub, said his client wasn't indicted because he didn't do anything illegal. "There are many reams of allegations," Schraub said. "None of them are valid."


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