Lerach, S-corps & the Savvy Guy Syndrome

by Kurt Schulzke on February 11, 2008

Today, attorney William Lerach was sentenced to two years in the federal pen for obstructing justice and making false statements. He once won a $7 billion judgment against Enron for . . . (drum roll) making false statements. It’s a classic example of what I call the “savvy guy syndrome,” a behavioral disorder in which an individual or a group follows the lead of so-called “savvy guys” right over the edge of legal or ethical cliffs.

W Lerach leaves court

Lerach (Mario Anzuoni/Reuters/Landov pic, above) and his partners — who were seen at the time as very savvy guys — schemed with so-called “professional plaintiffs” who agreed to testify in lawsuits brought by the firm in exchange for a share of the legal fees.

You’ll know the savvy guy when you see him. He drives an expensive car, drops expensive names, wears Armani everything, dines at the best restaurants, takes vacations in exotic locales and makes sure that everyone hears about it. Over a period of two decades, Lerach’s firm of savvy guys won $216 million in over 150 cases, paying out $11 million to its so-called “clients”. The perpetrators were apparently motivated by greed and the desire to look better than competitors in the securities class-action business. It was a fool’s bargain.

The Lerach case and my earlier post on Scientific-Atlanta brought to mind a host of savvy-guy discussions over the years with clients, business partners and students. In the S-A case, the Supreme Court assumed for decision-making purposes that Scientific-Atlanta and Motorola had conspired with Charter Communications to help Charter fabricate sales transactions and revenue. This was supposedly necessary to meet the expectations of financial analysts which, in turn, propped up Charter’s financial ratios and stock price. Expectations of analysts — in or outside the company — often trigger fraudulent behavior.

One responsibility of a corporate counsel is to help the client steer clear of ethical hazards. Often, the hazards are disguised as organizational habits or standard operating procedures. Others come dressed up as whatever my friend does because her lawyer or accountant told her it was OK. Sometimes, it’s pressure from analysts or the head office. Whatever the motivation, the results are distressingly predictable.

Not infrequently a client — current or prospective — will call with a story about a friend or relative whose attorney or CPA has this almost magical mojo with the IRS and uses a brilliant technique to save taxes. The pitch concludes with something like, “Can I use it on my tax return this year?”

A perennial favorite in this genre is abusing a solo-owner S-corporation by calling all of the company profits “distributions” thereby escaping FICA or SE tax. “Why can’t I use S-corporation profit distributions to reduce my salary and avoid paying FICA taxes?” Because it’s against the law.

In some cases, an S-corporation owner can legally reduce the FICA tax burden with this technique, but in many cases, the legal tax savings are too small to justify the added cost and hassle of the S-corporation. What is clearly illegal is rerouting all of your company profits into S-corporation distributions to eliminate FICA taxes. Yet, many people do it because they have savvy friends who got away with it last year and their advisors can’t or won’t say “no.”

No matter what your legal question — booking fake revenue, taking deductions that aren’t yours, or hiding S-corp income — your best bet is to get objective advice from independent advisors with the knowledge and integrity to tell you where the lines are in the sand and the courage to “good-bye” if you insist on crossing them. Otherwise, you can easily end up just like William Lerach and his clients, staring through steel bars. These days, you’ll be lucky if it’s only for two years.

Lerach’s sentencing judge, Judge Walter, was apparently unimpressed by a long list of letters from all the king’s horses and all the king’s men trying to get this Humpty-Dumpty a lighter sentence. Memo ht: Dan Levine at LegalPad.