While the Price of Asserting Innocence is High, Pleading Guilty is Lucrative

Alexei Barrionuevo, who has been doing a fine job covering the day-to-day developments in the Lay-Skilling trial for the New York Times, and his Times colleague Kurt Eichenwald — who has written the best overall book on the Enron scandal, Conspiracy of Fools (Broadway 2005) — collaborated on this article in today’s Sunday Times that addresses one of the more troubling aspects of the government policy of criminalizing corporate agency costs — the exorbitant cost of a defense to charges in such a case.

The article lucidly points out that Ken Lay — who at one time was worth about half-a-billion dollars and now is almost broke — has paid or dedicated about $10 million to his defense team, which is on top of another $20 million that his lawyers were paid from Enron’s D&O insurance policies before the proceeds of those policies were locked up in connection with the Enron independent directors’ settlement in the Enron class action securities litigation last year.

Inasmuch as Lay’s co-defendant, Jeff Skilling, has reportedly paid over twice as much out of his pocket than Lay to his defense team and presumably received about as much of the insurance proceeds as Lay, an estimate of $70 million in defense costs for the case is certainly well within the ballpark of accuracy.

And as enormous as the defense expenditures have been, you can bet that the cost of the prosecution is much higher.

So, what are we to make of this extraordinary expenditure of resources?

My sense is that it is a stark reflection of the folly of engaging in the the type of criminalization of corporate agency costs — which is legalese for the prosecution of merely questionable business decisions — that has been a large part of the Enron Task Force’s largely ineffective trials to date in the Enron-related cases.

While the Task Force has properly obtained plea bargains from former Enron CFO Andrew Fastow and the relative few of his cohorts who effectively embezzled money from Enron, the Task Force prosecutors have not limited themselves to such clear cases of theft and fraud.

Rather, the Task Force has spent an enormous amount of time and resources criminalizing business decisions that simply do not involve the black-and-white circumstances of theft.

Indeed, these types of business decisions involve judgments over various possible alternatives, a number of which — given the nature of business risk — will turn out badly and result in a loss for the company.

As Stephen Bainbridge points out in this insightful TCS Daily column, hindsight bias of juries with regard to such bad outcomes results in penalizing beneficial risk-taking rather than punishing true criminal conduct.

Many judges and most lay juries usually have only a minimal understanding of the nature of business risk-taking and, therefore, improperly conclude that a bad result from a business decision had a high probability of occurring (and, thus, should have been prevented by the decision-maker) simply because the bad result occurred.

Consequently, juries are generally biased in favor of finding criminal liability against a business executive under such circumstances even if, at the time the business judgment was made, the probability of the bad result was reasonably low and hedging the risk of the bad result was too expensive. Professor Bainbridge explains the counterproductive effects of this syndrome:

[T]here is a substantial risk that juries will be unable to distinguish between competent and negligent management because bad outcomes often will be regarded, [viewed with 20-20 hindsight], as having been foreseeable and, therefore, preventable. . . . If liability results from bad outcomes, without regard to the [looking forward] quality of the decision and/or the decisionmaking process, however, managers will be discouraged from taking risks.

If it is true that lack of gumption is the single largest source of agency costs, as somebody once said, rational shareholders will disfavor liability rules discouraging risk-taking, as Judge Ralph Winter opined in Joy v. North:

[B]ecause potential profit often corresponds to the potential risk, it is very much in the interest of shareholders that the law not create incentives for overly cautious corporate decisions. . . . Shareholders can reduce the volatility of risk by diversifying their holdings. In the case of the diversified shareholder, the seemingly more risky alternatives may well be the best choice since great losses in some stocks will over time be offset by even greater gains in others. . . . A rule which penalizes the choice of seemingly riskier alternatives thus may not be in the interest of shareholders generally.Hence, when juries review the merits of even bad corporate governance, they run the risk of effectively penalizing “the choice of seemingly riskier alternatives.”

In sum, shareholders deserve protection from theft, but not from risk taking, . . . Unfortunately, it’s not clear that prosecutors know the difference — or even care.

Meanwhile, the flipside of the high-cost of asserting innocence is the financial pressure to plead guilty, which is underscored by the motion that former Lay-Skilling co-defendant Richard Causey filed late last week.

As a result of his plea deal, Causey in his motion requests (with the Enron Task Force’s approval) that U.S. District Judge Sim Lake release several million dollars of property to Causey that the government had previously frozen and not allowed Causey to use (except to pay some living expenses) while he was defending himself from the government’s charges.

Thus, the first three substantive prosecution witnesses in the Lay-Skilling trial were each able to preserve a significant net worth by copping a plea deal with the Task Force.

While some speculate that Causey’s decision to plead guilty was the result of a personal revelation of wrongdoing, Causey’s motion and other circumstantial evidence reflects that the true reasons for that decision are far more nuanced and troubling.

6 thoughts on “While the Price of Asserting Innocence is High, Pleading Guilty is Lucrative

  1. Tom K. —
    Another fascinating post. Thank you for the information and the links.
    It strikes me that the Enron broadband trial was a prime example of federal prosecutors attempting to punish legitimate and, according to essentially all the witnesses, well-conceived risk taking. In that trial, the government attacked not only financial decisions, but technology decisions as well.
    In the Enron broadband trial, the programmers who actually developed the technology in question testified that it worked exactly as described in public statements. However, the prosecutors then attacked the technology by trying to make the case that it did not create a commercial bonanza for the broadband unit within the first year of its release (even though the defendants never claimed that it would or did).
    The following words, which appeared back in June 2003 in an article about the Enron broadband indictment, written by Eichenwald and Markoff for the NY Times, sum up the logical result of state attacks on technology risk-taking:
    “If they succeed in convicting the Enron developers,” said an executive at a major computer hardware manufacturer who was never employed by Enron but who had direct knowledge of its systems, “anyone in Silicon Valley can be sent to jail.”

  2. TK,
    what a red herring. as you very well know, the Enron indictment has absolutely nothing to do with risk taking. Enron took all sorts of stupid risks; losses on investments such as water plants in India and Brazil ran to more than $15 billion in a very few years.
    What the Enron indictment is about is that, after taking risks that turned out badly, no one at Enron wanted to be honest in telling anyone about how stupid the actions of the company had been.
    Contrast, for a moment, an honest business man like Warren Buffett and Lay/Skilling. Read one of WB’s shareholder letters. He writes clearly and honestly about his failures, but that doesn’t stop him from getting up the next morning and trying all over again.
    As for the costs of defense, proportionately, defense of a white collar case takes less of a family’s wealth than defense of a drug case does for a poor person, but I forget, you believe the legal system is solely concerned with the comforts of the elite.

  3. Moe, I do not recall Mr. Buffett providing much disclosure of General Re’s participation in the allegedly illegal (according to Mr. Spitzer, anyway) finite insurance transactions that almost brought AIG down, at least before AIG and Buffett served up to prosecutors a few General Re execs and the man who was mostly responsible for providing significant wealth to both AIG and Berkshire shareholders (Hank Greenberg).
    As for your assertion that I believe “the legal system is solely concerned with the comforts of the elite,” that statement is without basis and you know it. Frankly, that type of nonsense undermines the substance of your position on the issues that are being addressed.

  4. nonsense undermines the substance of your position
    I don’t recall TK, Skilling or Lay being concerned about the federal criminal justice system until after Skilling and Lay had defrauded millions of people and left thousands of Enron employees in the streets with empty pockets

  5. Revisiting Arthur Anderson’s Death Sentance

    The firm of Arthur Anderson was put to death by government prosecutors. Unlike human beings, Anderson was killed without ever receiving a trial, and was dead long before any appeal was mounted. Many a media tear have been shed for

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