This post earlier in the week on the appeal of the Merrill Lynch defendants in the Enron-related Nigerian Barge case generated quite a bit of traffic and some interesting responses from around the blogosphere.

First, Larry Ribstein complimented the post as an example of how blogs provide a valuable Hayekian information source, a subject on which Larry has written extensively. Subsequently, Vic Fleischer over at the Conglomerate blog excoriated Larry for “fawning” over my post, and then goes on to criticize the post.

That prompted Larry to post this response to Vic’s post, then Vic commented on Larry’s response, and others commented on both Vic and Larry’s posts. I encourage everyone interested in the government’s criminalization of business to read all of the above for a lively discussion of the issues relating to that policy. This type of give-and-take is one of the blessings of the blogosphere.

But what is particularly interesting to me is Vic’s approach to the subject. I do not know Vic, but I have read his posts on Conglemerate and he is an insightful fellow, and his professional pedigree appears to be developing in a quite solid manner. So, Vic is a reasonably sophisticated fellow in regard to the financial and legal issues that are involved in Nigerian Barge case.

Despite that sophistication, Vic harshly criticizes my post based on a combination of misinformation and misinterpretation. Although this is partially explained by the fact that I have had more access to the detailed information relating to the Nigerian Barge case than Vic, I have nevertheless found over the past several years that Vic’s reaction is not particularly unusual with regard to virtually anything having to do Enron.

As perhaps best reflected by the mildly entertaining but shallow Enron documentary, even intelligent lawyers have a difficult time analyzing Enron-related matters dispassionately. This is unfortunate because Enron represents precisely the type of difficult case for which the legal profession has a special responsibility not to allow public animus toward merely unpopular people to overwhelm justice and the rule of law.

Larry Ribstein notes in his response to Vic’s post the similar circumstances that surrounded the case of Michael Milken back in the late 1980’s, and Daniel Fischel examines how public perceptions overwhelmed the rule of law in his fine book about the prosecution of Milken, Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution (HarperCollins 1995). The same dynamic is at play nowadays in regard to Enron.

Vic relies on misinformation from the beginning of his post:

The basic facts are that Enron “sold” some barges to Merrill Lynch. That is, Enron recognized a “sale” for accounting purposes. Enron could not formally guarantee that they would buy back the barges, but promised to find a third party buyer within six months. From an economic standpoint, the so-called sale starts to look like a loan.

First, Enron did not sell barges to Merrill Lynch. Rather, in a sophisticated transaction (regardless of whether one characterizes it as structured finance), Merrill acquired from Enron common stock in a company that was the parent company of another company that owned the barges. In so doing, Merrill acquired the right to a dividend stream, the source of which was revenue generated by unsecured contracts for the use of the barges.

Moreover, contrary to Vic’s suggestion, the transaction was quite risky for Merrill. Heck, Fastow’s buddy in crime, Michael Kopper, declined to allow the LJM2 partnership to enter into the transaction at the time that Merrill did because of the unsecured nature of the source of the revenue stream (Kopper subsequently allowed LJM2 to buy Merrill’s interest when the deal was improved with security for those underlying contracts). The deal involved extensive documentation and common hedging characteristics, such as political risk and other types of insurance.

Now, Vic could not be expected to know all of that because he has not had an opportunity to review the documentation on the deal. But despite that lack of rather basic information, Vic has no problem in characterizing a complicated and risky transaction as a rather simple deal, and then making the remarkable leap that “the so-called sale starts to look like a loan.”

Vic goes on in his post to observe the following:

I agree that it’s not a slam dunk criminal case. The appeal has a real shot at success, and I’m not at all sure the government made its case. But that’s no reason to lionize the defendants.

Well, I’m not sure that characterizing the Merrill defendants as “decent men” is the same as lionizing them, but let’s not quibble about that detail. The fact of the matter is that each of the Merrill defendants — as reflected in the elaborate reports filed by both the government and the defendants in connection with their sentencings — had never been in any type of trouble whatsoever before the Nigerian Barge case, and each of them had outstanding personal and professional reputations.

Again, I don’t expect Vic to know that because he does not have access to that information. But what is it about Enron — resentment of wealth? Enron’s hard-nosed business reputation? investment loss? high profile business failure? — that would prompt an otherwise reasonable person to take offense at calling men decent who have never been in a lick of trouble?

Vic goes on:

The deal stinks. It reeks. In no way is this deal an “ordinary structured finance transaction,” as Kirkendall claims.

He follows that up with the following observation contained in a comment to Larry’s response to his post:

The transaction was not a typical or ordinary transaction, and calling it “bad finance” still understates the case. Fraud is fraud. Maybe they shouldn’t go to jail over it, but it’s not crazy to think maybe they should.

With nothing more than a flawed understanding of the deal, Vic now asserts that the Nigerian Barge transaction is a fraud. Was it a typical transaction that any number of public companies use to manage the timing of income? Absolutely, and Vic is much more naive than I think he is if he believes that such is not the case.

Was it a typical transaction for Merrill Lynch? No, and Merrill readily admitted that. But simply because a transaction is unusual for a firm does not make it questionable, much less criminal.

Was it a reasonable business decision for Merrill to invest and potentially lose $7 million in order to maintain and perhaps improve a relationship with the seventh largest public company in the United States, a relationship that was worth $40 million annually to Merrill?

Absolutely, and anyone who suggests that such a decision is even close to criminal conduct risks indicting major sectors of the American economy. Shoot, many large law firms commonly write-off fees, cover expenses and make investments with clients in order to maintain or enhance relationships.

Despite all that, Vic deems the question of whether the Merrill defendants are guilty of a crime a close call. If that is the case, then every businessperson involved in reasonably complicated business transactions in the U.S. better add a criminal defense attorney to their personal legal staff immediately.

In my over 25 years of specializing in defending complex business transactions, which includes advising dozens of criminal defense attorneys in regard to defending complex business transactions in white collar prosecutions, the Nigerian Barge case is the weakest white collar criminal prosecution that I have seen, and certainly the most egregious example of the government using “shoddy merchandise” and suppressing evidence to criminalize what, at worst, is a risky business deal.

If the Nigerian Barge transaction had involved Merrill Lynch and — rather than Enron — a debtor-company that was unknown to the general public, the Justice Department would have never pursued this prosecution.

Vic continues:

In an ordinary structured finance transaction, substantial economic risk is shifted away from the seller. I don’t think that happened here, and it’s the shifting of economic risk that justifies the accounting treatment.

Again, without fully understanding the transaction, Vic blithely concludes that there was no substantial shifting of economic risk in the Nigerian Barge transaction.

What would have happened if the barges would have sunk to the bottom of the Atlantic Ocean while Merrill owned them? Is that enough risk?

Frankly, that Merrill took on the substantial risk of ownership is clear from the answer to the following simple question: What would Merrill have been legally entitled to recover from Enron if Enron had not fulfilled Fastow’s alleged oral promise either to broker a sale of the interest to a third party or buy it back itself?

Answer: Zilch. Under the contract between the parties, both Merrill and Enron confirmed that any prior oral representations (i.e., Fastow’s promises) not contained in the deal documents were null and void, and that neither party relied on them in entering into the transaction. This is a standard contractual provision in such deals. But Vic still concludes that Merrill took on no substantial economic risk in the transaction because of Fastow’s unenforceable promise.

In a comment, Vic continues his disparagement of the deal:

The evidence suggests, to me, that Fastow promised to buy back the barges, that Merrill Lynch expected him to buy back the barges and did the deal based on that representation, and that Fastow (through LJM) in fact bought back the barges. The phone call is not the only piece of evidence.

Vic’s downplaying of the Fastow conference call belies the fact that the call was the crux of the government’s case during the trial and final arguments. Similarly, Vic’s assertion that Fastow “promised to buy back the barges” and that “Fastow (through LJM) in fact bought back the barges” falls into the same blurring of the transaction that the government engaged in at trial and to which the Merrill defendants now object on appeal.

Inasmuch as LJM2 was a third party, its purchase of Merrill’s interest did not render Enron’s accounting of the gain from the transaction improper, and the government conceded that during the case.

However, as the Merrill defendants point out on appeal, that did not stop the government from suggesting to the jury repeatedly during the trial that LJM2’s purchase of Merrill’s interest was somehow compelling evidence that a crime occurred and that a criminal conspiracy existed.

Vic goes on in his comment:

I noticed, for example, that one of Merrill’s memos noted “reputational risk” as a risk factor in the deal. You don’t do that with a plain vanilla financing.

Now, this may not add up to a criminal conviction. I have a lot of sympathy for the defendants here — drawing the line between planning and fraud is hard. If I were on the jury, I might vote to acquit, and the 5th Circuit has a tough case. But we should not pretend that the transaction was perfectly legal or run of the mill. It wasn’t, even in the pre-2001 era.

Although I’m glad Vic toned down his initial harsh comments toward the Merrill defendants in this comment, his off-hand reference to Merrill’s acknowledgement of “reputational risk” as an indication of wrongdoing is a painful stretch.

Reputational risk is an important consideration for any transaction that is done at year end, and management would be heavily criticized for not considering such a risk. Moreover, reputational risk was merely one of at least ten other risks that Merrill management identified and reviewed internally in considering whether to enter into the barge transaction. The existence of such risks — and Merrill’s consideration of them — underscores the mistaken nature of Vic’s contention that risk was not transferred from Enron to Merrill.

But Vic’s biggest doozy is the following:

Kirkendall really goes over the top at the end of the post, explaining:

For as Thomas More reminds us, if the courts do not stand up for justice and the rule of law in such cases, “do you really think you could stand upright in the winds [of abusive state power] that would blow then?”

The implicit comparison of the Merrill defendants to a Man For All Seasons makes me want to barf.

My apologies for prompting that barfing reaction, Vic, but that barf was not the result of any “implicit comparison” that I made. Rather, it was the result of Vic’s misinterpretation of the point that I made by using Sir Thomas’ statement.

Rather than comparing the barge defendants to Sir Thomas, my point was to contrast Sir Thomas’ wisdom with the government’s dubious decision to use its enormous power to bring a flimsy prosecution against four innocent men based on suppression of evidence and appealing to the jury’s resentment of Enron.

The context of Sir Thomas’ statement was a debate with several family members. Sir Thomas’ wife, daughter, and future son-in-law (Will Roper) were urging Sir Thomas — as England’s Lord Chancellor — to arrest and prosecute Sir Thomas’ student, Richard Rich, who had decided to leave Sir Thomas’ tutelage in a huff over Thomas’ refusal to grant him a political appointment.

Although Rich had not committed a crime, it was clear to everyone that the conniving Rich would betray Sir Thomas in the future. So, Sir Thomas’ family beseeches him and Sir Thomas engages Roper in the following passage to make his point:

Wife: “Arrest him!”

Sir Thomas: “For what?”

Wife: “He’s dangerous!”

Roper: “For all we know he’s a spy!”

Daughter: “Father, that man is bad!”

Sir Thomas: “There’s no law against that!”

Roper: “But there is, God’s law!”

Sir Thomas: “Then let God arrest him!”

Wife: “While you talk he’s gone!”

Sir Thomas: “And go he should, if he were the Devil himself, until he broke the law!”

Roper: “So, now you give the Devil the benefit of law!”

Sir Thomas: “Yes! What would you do? Cut a great road through the law to get after the Devil?”

Roper: “Why, yes! I’d cut down every law in England to do that!”

Sir Thomas: “Oh? And when the last law was down, and the Devil turned ’round on you, where would you hide, Roper, the laws all being flat? This country is planted thick with laws, from coast to coast, Man’s laws, not God’s! And if you cut them down — and you’re just the man to do it, Roper! — do you really think you could stand upright in the winds that would blow then?”

“Yes,” Sir Thomas concludes. “I’d give the Devil the benefit of law, for my own safety’s sake!”

In short, even relatively wealthy business executives who had the misfortune of being involved in a business transaction with a societal pariah are entitled to the protection of the rule of law in the face of the overwhelming power of government. Not only for their protection, but for ours.

Update: As usual, Larry Ribstein has additional perceptive observations on these issues.

Update II: And Vic responds with a more thorough analysis here.

I want to digest Vic’s post before deciding whether to extend this debate because the issues have already been well-defined and we all have day jobs.

But I do want to make one point regarding Vic’s speculation that LJM2 was not a really a third party purchaser of Merrill’s interest.

As you would expect, the prosecution examined that issue thoroughly before trial because it would have made the prosecution’s case easier in many respects against the Merrill defendants if it could have simply contended that LJM2’s purchase of Merrill’s interest was the same as an Enron buy back.

Despite that incentive, the government concluded that LJM2 was a seperate entity with different ownership from Enron, and the government conceded that fact well before trial.

Thus, the government did not contend during the trial that Fastow’s involvement with LJM2 made it one and the same as Enron or that LJM2’s purchase of Merrill’s interest was equivalent to an Enron buy back. However, that pre-trial concession did not stop the prosecution from blurring that very issue during the heat of trial, which is why the Merrill defendants are raising that as an issue on appeal.