A Sweeping Ruling May Emerge From Trial of Keating

As jury selection continues, the judge in the criminal trial of Charles H. Keating Jr. has to make a crucial decision that will likely break new legal ground and could affect top executives in companies throughout California.

It is an issue headed almost certainly for appeal.

Los Angeles Superior Court Judge Lance A. Ito must determine what level of awareness Keating had to have in order for the law to hold him criminally liable for the actions of employees in selling his company’s risky bonds.

The defense asserts that prosecutors must show a link between Keating’s actions and the sale of 20 bonds to purchasers named in the state court indictment. Prosecutors contend that no such link need be made between Keating and the actions of sales people at the Southern California branches of the company’s main subsidiary, Lincoln Savings & Loan.

“The deeper I get into this, the more perplexed I become,” Ito admitted to lawyers during a recent court hearing in the first criminal trial stemming from the collapse of Irvine-based Lincoln.

As chairman of Lincoln’s parent company, American Continental Corp., until a year ago, the outspoken Keating, 67, became the leading symbol for excesses blamed for the debacle in the industry.

The Phoenix company went bankrupt and the S&L; failed in April, 1989, wiping out thousands of small investors who bought more than $250 million in American Continental bonds at Lincoln branches and elsewhere.

The investors, especially elderly Lincoln depositors who bought their bonds at the S&L;, contend that they were misled with assurances that they were buying safe, low-risk investments and that the company was financially sound.

While Keating faces a wide-ranging federal investigation and some two dozen civil lawsuits over the collapse of his empire, the state indictment returned last September focuses narrowly on allegations of fraud in the sale of bonds through Lincoln offices, accusing Keating of making material misstatements and omissions in the sale of the bonds.

The indictment is based on state securities laws that ostensibly permit convictions of top officers for criminal actions of subordinates regardless of whether the officers knew what the employees were doing and regardless of whether anyone intended to violate any laws.

While such notions are commonly used in civil lawsuits, they have been limited in criminal law to public welfare areas--such as food processing and drug manufacturing--where great damage can be done.

Ito, however, has ruled that to subject Keating to the maximum penalty of 10 years in prison, prosecutors must show some knowledge or intent or willful action on Keating’s part to help defraud investors. In effect, Keating would be tried as someone who aids and abets his employees in violating securities laws.

But Ito hasn’t decided yet exactly what level of knowledge or intent Keating must have had to be found guilty.

“There is a certain vagueness in California law about this,” acknowledged William Hodgman, the deputy Los Angeles district attorney leading the prosecution team.

At one extreme, prosecutors argue that Keating could be found guilty as long as he intended to make certain statements about American Continental bonds regardless of whether he knew that they were misleading or violated state law and regardless of whether he knew that his sales force was misleading bond buyers.

Such a standard would subject corporate executives to possible criminal charges for any routine business decision, defense attorneys contend.

At the other extreme, defense attorneys argue that Keating could be found guilty only if he intended that false and misleading information be used to persuade Lincoln depositors to buy the bonds.

But that standard would let corporate executives escape criminal liability for almost any actions their employees take, prosecutors say.

Ito has said he doesn’t like either extreme. He’s also said he is “not happy” with other proposed theories of liability that both prosecutors and defense attorneys have made. So, he said, he will do his own research and will announce his decision before jury selection is completed, which isn’t expected for about two weeks at the earliest.