Middelhoff Verdict Sending a Message to Corporate Wrongdoers

The harsh sentence handed down to Thomas Middelhoff heralds a new era. German judges and prosecutors are no longer prepared to go easy on corporate wrongdoing.
From courtroom to the clink.

He felt a sense of foreboding, calling his trial an “apocalyptic dream,” but on Friday, Thomas Middelhoff woke up to a far worse reality. A regional court in Essen found the former Arcandor chief executive guilty of breach of trust and tax evasion. The penalty was three years imprisonment and immediate arrest as he was considered a flight risk.

Mr. Middelhoff is now trying to secure his release, which might happen if he surrenders his passport and agrees to always report his whereabouts or posts bail. But Handelsblatt has learned that the creditors to whom Mr. Middelhoff owes millions are keeping a close eye on any money he puts up for bail. A source within the creditors’ camp said, “According to our estimates, the bail would have to be set at half a million. If Middelhoff pays it, we'll claim it.” In addtion to Arcandor’s insolvency administrator Hans-Gerd Jauch, many of Mr. Middelhoff's old partners are also demanding money.

In general there was surprise at the spectacular outcome of the trial against Mr. Middelhoff, which was closely followed by Germany’s business lawyers.

“Being placed under arrest before the verdict was legally applicable is a very harsh course of action,” said Heiner Hugger, compliance expert and partner in the Frankfurt-based global law firm Clifford Chance. A majority of experts on criminal law consider the verdict harsh.

Stephan Spehl, a partner at Baker & McKenzie in Frankfurt, said, “The severity of the verdict was thoroughly unexpected.”

While the 61-year old Mr. Middelhoff fights for his release, fears over who might be next are growing in Germany’s executive suites. Will corporate powerhouses soon be facing tough sentences in the courts on a regular basis?

It’s clear things are changing. Every case is different, but it is not only Jürgen Fitschen, co-chief executive at Deutsche Bank and his predecessor Josef Ackermann, who will soon be appearing in court. Mr. Hugger sees the Essen court’s decision as a signal, not only for future criminal proceedings against company executives but for the way things are done in German companies.

The verdict has the effect of sending a message, not only for future criminal proceedings against executives, but also for companies’ compliance practice. Heiner Hugger, Compliance expert

A series of high-profile German executives have stood trial over the past few years, but whether it was Formula One legend Bernie Ecclestone or Heinrich von Pierer, the former CEO of Siemens, state prosecutors and judges have often been content to halt the proceedings with a fine due to “minor guilt” or to honor an early confession with a reduced sentence. Multi-year prison sentences remained the exception, creating the impression of “buy-your-freedom” justice.

Mr. Middelhoff and his lawyers apparently expected similar treatment with, at most, the imposition of a suspended sentence. His wife, Cornelie, shocked by the outcome of the trial, broke down in tears in the courtroom. Seldom has a business leader been so severely punished for mixing professional duties with private interests.

It appears Mr. Middelhoff's hardline defense played a role. He never admitted to anything, or saw any justification for the charges against him and declared in his closing plea, “I am not conscious of any wrongdoing.” Judge Jörg Schmitt, on the other hand, was of the opinion that Mr. Middelhoff was not being honest, perhaps not even with himself. The judge was outraged that despite having a company apartment in Düsseldorf and a chauffer-driven company car, Mr. Middelhoff preferred to fly to work from his home in Bielefield via helicopter. The result was three years behind bars and a fine of a half-million euro.

This is a new direction for German courts.

“The verdict has the effect of sending a message, not only for future criminal proceedings against executives, but also for companies’ compliance practice,” said the compliance expert Mr. Hugger, adding courts are increasingly taking a more critical look at manager liability.

Karl-Jörg Xylander of the law firm White & Case said compliance cases are now being more intensively prosecuted. He sees the Middelhoff verdict dovetailing with the ongoing debate over executive pay and equity of distribution.

Middelhoff-2-others

 

Fear must be making the rounds among executives currently awaiting their judgment. In Cologne, for example, where the former management team at the private bank Sal. Oppenheim is to face legal proceedings in the regional court. Like Mr. Middelhoff, they are accused of mixing private and professional interests. Newspapers have reported prosecutors will demand the ex-bankers serve terms of three- to four-and-a-half years in prison.

The severity of the verdict against Mr. Middelhoff also should concern executives at Deutsche Bank, where co-chief executive Jürgen Fitschen and other senior managers of Germany's largest bank may soon stand trial. They are accused of lying in the legal dispute with the media mogul Leo Kirch and his heirs in an effort to fend off compensation claims.

The bank ended the Kirch trial in February with a settlement of over €925 million, or $1,158 million, but in August state prosecutors filed charges of attempted fraud against Mr. Fitschen and the former top executives Rolf-E. Breuer, Josef Ackermann, Clemens Börsig and Tessen von Heydebreck. The decision on whether or not to proceed to trial will be made in the coming week by the Munich-based judge, Peter Noll.

The Middelhoff case also could sting other high-profile executives at Arcandor, because in the eyes of the court, the supervisory board failed to carry out their duties. The court is taking a particularly critical look at the role played by the company's former supervisory board chairman, Hero Brahms.

“The monitoring of flight activities was a farce,” said Mr. Schmitt, noting Mr. Brahms only kept an eye on company flights. How, then, was he supposed to monitor private flights?

Additionally, Mr. Brahms was responsible for Mr. Middelhoff's contract. When auditors were critical in 2006 about the lack of contractual regulations on the use of chartered airplanes by Mr. Middelhoff, minutes of a meeting of the supervisory board show Mr. Brahms declared use of private jets for business had been verbally agreed upon during contract negotiations. It had simply not been included in the written contract by mistake, he said.

Multi-year prison sentences have remained the exception, creating the impression of 'buy-your-freedom' justice.

Mr. Schmitt sees this as an attempt by Mr. Brahms to protect himself. “We are convinced that there never was such an agreement,” he said. “Brahms lied to cover up that it had never been discussed.” Mr. Brahms refused to appear as a witness in the Middelhoff trial because state prosecutors were also investigating him in the Arcandor case.

How far outside the range of previous sentences the Middelhoff verdict lies is revealed by a look at past rulings.

Munich state prosecutors had accused the 84-year old Briton Bernie Ecclestone of bribing Gerhard Gribkowsky, the former executive at the BayernLB bank. Mr. Ecclestone, however, accused Mr. Gribkowsky of extorting him. Mr. Ecclestone ended the legal proceedings last August by paying a record sum of €75 million ($93.94 million). Mr. Gribkowsky, on the other hand, was found guilty of taking bribes and tax evasion and sentenced to eight-and-a-half years imprisonment. The lengthy prison sentence is one of the few exceptions among verdicts in recent years.

Several BayernLB executives also got off easy. They were charged with breach of trust and accepting bribes in the takeover of the Austrian bank Hypo Alpe Adria. Among the accused were the former head of the bank, Werner Schmidt, and the present general manager of the Association of German Banks, Michael Kemmer. Mr. Schmidt was sentenced to one-and-one-half years on probation and a fine of €100,000. Mr. Kemmer ended the court proceedings by paying €20,000.

Top executives in the Siemens bribery scandal also emerged relatively unscathed when it could not be proven that the ex-chairman, Heinrich von Pierer, and his board were involved in the system of slush funds.

Trial proceedings against former board members have normally ended with the paying of a fine or the conviction of lower level executives. But Mr. Middelhoff can no longer hope to “buy himself free.” The only way he can avoid a prison term is if he successfully appeals.

 

Axel Höpner, Robert Landgraf, Kerstin Leitel, and Christoph Schlautman contributed to this article. Massimo Bognanni is an investigative reporter at Handelsblatt and closely followed the Middelhoff trial. Andreas Dörnfelder is a business reporter for Handelsblatt. To contact the authors: [email protected]; [email protected].