S.E.C. v. Koenig

• Decision Date: 26 February 2009
• Docket Number: No. 08-1373.,08-1373.
• Parties: SECURITIES and EXCHANGE COMMISSION, Plaintiff-Appellee, v. James E. KOENIG, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

557 F.3d 736

SECURITIES and EXCHANGE COMMISSION, Plaintiff-Appellee, v. James E. KOENIG, Defendant-Appellant.

No. 08-1373.

United States Court of Appeals, Seventh Circuit.

Argued December 3, 2008.

Decided February 26, 2009.

John W. Avery (argued), Jacob H. Stillman, Securities and Exchange Commission, Office of the General Counsel, Washington, DC, Mary Keefe, Securities and Exchange Commission, Chicago, IL, for Plaintiff-Appellee.

Sarah R. Wolff, Reed Smith LLP, Chicago, IL, Donna M. Doblick (argued), Reed Smith LLP, Pittsburgh, PA, for Defendant-Appellant.

Before EASTERBROOK, Chief Judge, and MANION and WOOD, Circuit Judges.

EASTERBROOK, Chief Judge.

Waste Management, Inc., grew at an average annual rate of 26% from 1979 through 1991. When growth fell off, James Koenig, its Chief Financial Officer, decided to improve appearances. He devised several accounting strategies that a jury found to be fraudulent. The district judge imposed a civil penalty of about $2.1 million and ordered Koenig to disgorge the bonuses he received in 1992, 1994, and 1995 ($831,500, plus more than $1.2 million in prejudgment interest). Bonuses depended on Waste Management's profits. If its profits had been stated correctly, the judge concluded, Koenig would not have received these bonuses. The court also enjoined Koenig from again serving as a director or top manager of a public company.

The details of Koenig's strategies do not affect this appeal; he does not contend that the evidence was insufficient to support the verdict. But we mention two of the strategies to give a sense of what the trial was about.

Netting. One generally accepted accounting principle is that the results of unusual transactions must be reported separately from those of recurring events. Koenig violated this rule by netting recurring and non-recurring transactions. For example, in 1995 Waste Management made a profit of $160 million by transactions in shares of a company called ServiceMaster. Instead of reporting this $160 million as a one-time gain, Koenig used it to offset some operating expenses. The result was that the (stated) operating profits of Waste Management were improved by $160 million in 1995, implying to investors that in the absence of business reverses they could expect the same annual return in future years. Similar netting was performed for other one-time transactions.

Basketing and bundling. Another generally accepted accounting principle is that, when a project subject to depreciation winds up sooner than expected, the remaining cost must be written off. Suppose Waste Management invested $50 million in a landfill with an expected life of 20 years, and charged $2.5 million in depreciation annually against that asset. If Waste Management closed the landfill early (say, after 10 years), a capital value of $25 million would remain and, under GAAP, should be taken as an immediate loss. Koenig instead transferred the remaining depreciation to other landfills, a process he called "basketing" (when the loss stemmed from inability to maintain a waste-disposal permit) and "bundling" (when some other reason led to early closure). In our example, by transferring the depreciation Waste Management was able to report a profit $25 million higher than appropriate in the year of the landfill's closure. Ongoing depreciation would cause Waste Management to report lower profits in future years, but if other landfills closed in the interim that reduction could be postponed. Koenig's practice of "basketing and bundling" thus overstated current profits while burying in the corporate books items that were bound to reduce future profits, to investors' surprise.

In October 1997 Waste Management issued a press release declaring that its financial statements were unreliable and that its projections of future earnings were being rescinded. The value of Waste Management's common stock lost $3 billion, far more than any estimate of the accounting errors. This was in part because, as we have emphasized, items of income that investors had expected to continue vanished, so Waste Management was revealing that future profits as well as current profits would be reduced. And investors likely feared that worse was to come. The latter fear proved unwarranted. When Waste Management issued a formal restatement of its accounts in February 1998, showing no more bad news, its stock price rose (though not to the level before the disclosures of October 1997). In the restatement, Waste Management took a charge of approximately $1.1 billion for the years 1992-96. Of this, $361 million was attributable to netting and $198 million to basketing and bundling. Koenig argued at trial that his accounting devices, if dodgy, were not fraudulent. He attributed the restatement and stock price slump to new management's decision to "take an earnings bath"—to make the results of its predecessors look bad, so that the new team's performance would look better by comparison. The jury concluded, however, that the fault lay with Koenig rather than with the new management. Koenig presents on appeal six principal arguments, some with subparts. We do not discuss them all but shall cover the main themes.

1. Although all of Koenig's misconduct occurred before January 1997, when he stepped down as Waste Management's CFO, the SEC did not file its complaint until March 26, 2002. The statute of limitations is five years, see 28 U.S.C. § 2462, and Koenig argues that the demand for civil penalties is untimely. But the district court concluded that the SEC had not discovered the fraud until October 1997, and that the claim accrued only then.

Koenig maintains that claims under federal law accrue when the violations occur, not when agencies learn about them. Section 2462 gives a federal agency five years "from the date when the claim first accrued" to seek a fine, forfeiture, or other penalty. In United States v. Kubrick, 444 U.S. 111, 100 S.Ct. 352, 62 L.Ed.2d 259 (1979), the Justices read a statute with the same reference to the claim's accrual to start the clock when the plaintiff knows both loss and causation—in other words, when the wrong is discovered. (Kubrick added that a would-be plaintiff need not know that the injury is a legal wrong; only the injury and its cause, and not potential for a legal remedy, need be discovered.) The district court treated Kubrick and similar decisions as establishing a norm that federal statutes of limitations do not begin to run until the claim has been discovered. This is a common view, see Rotella v. Wood, 528 U.S. 549, 555, 120 S.Ct. 1075, 145 L.Ed.2d 1047 (2000), but the Supreme Court pointedly remarked in TRW, Inc. v. Andrews, 534 U.S. 19, 27, 122 S.Ct. 441, 151 L.Ed.2d 339 (2001), that "we have not adopted that position as our own." TRW concludes that some periods of limitations start with discovery and others not, with the difference depending on each provision's text, context, and history.

According to Koenig, § 2462 is one of those that starts with the wrong rather than with the wrong's discovery. And that position has support in other circuits, which have traced the language of § 2462 back to 1839, long before the "discovery rule" was invented. See 3M Co. v. Browner, 17 F.3d 1453, 1462 (D.C.Cir.1994) (collecting cases). See also TRW, 534 U.S. at 36-38, 122 S.Ct. 441 (Scalia, J., concurring) (discussing the nineteenth century's understanding of a claim's accrual).

We need not decide when a "claim accrues" for the purpose of § 2462 generally, because the nineteenth century recognized a special rule for fraud, a concealed wrong. See, e.g., Bailey v. Glover, 88 U.S. (21 Wall.) 342, 22 L.Ed. 636 (1874); Holmberg v. Armbrecht, 327 U.S. 392, 66 S.Ct. 582, 90 L.Ed. 743 (1946). These days the doctrine is apt to be called equitable tolling, see Cada v. Baxter Healthcare Corp., 920 F.2d 446 (7th Cir.1990). Whether a court says that a claim for fraud accrues only on its discovery (more precisely, when it could have been discovered by a person exercising reasonable diligence) or instead says that the claim accrues with the wrong, but that the statute of limitations is tolled until the fraud's discovery, is unimportant in practice. Either way, a victim of fraud has the full time from the date that the wrong came to light, or would have done had diligence been employed. And the United States is entitled to the benefit of this rule even when it sues to enforce laws that protect the citizenry from fraud, but is not itself a victim. Exploration Co. v. United States, 247 U.S. 435, 38 S.Ct. 571, 62 L.Ed. 1200 (1918).

Koenig's accounting maneuvers did not come to public attention until October 1997; although the press release did not convey their particulars, it put the SEC on notice of the need for inquiry. Koenig does not contend that a diligent SEC should have nosed things out earlier. His maneuvers fooled Waste Management's outside accountant (Arthur Andersen), which knew a great deal more than the SEC about the firm's finances. Arthur Andersen had detected some of Koenig's stratagems and notified Waste Management that, unless they were discontinued, it could not certify the financial statements. Koenig promised to change his ways but reneged, and Arthur Andersen's accounting team did not notice.

The overstated profits fooled professional investors and analysts too; that's why the stock's price fell when the news came out. If a formal announcement (whether by press release or restatement of earnings) did not cause much movement in the stock's price, then there would be room for an argument that the news either must have been out already or could have been found by reasonable inquiry. Cf. Flamm v. Eberstadt, 814 F.2d 1169 (7th Cir.1987) (discussing the "truth-on-the-market doctrine"); Asher v. Baxter International Inc., 377 F.3d 727 (7th Cir.2004) (same). But information about Koenig's misleading accounting practices did not come out until October 1997, so the SEC's...