Early last week, oral arguments were heard in the Fifth Circuit Court of Appeals on the appeal of the four Merrill Lynch executives who were convicted of wire fraud and conspiracy charges in November 2004 in the trial of the Enron-related case known as the Nigerian Barge case.
Reports from those who attended the oral argument indicate that it went well for the appellants, but it may have gone even better had counsel for the Merrill Four known about former Enron CFO Andy Fastow’s testimony from this past Thursday afternoon in the ongoing criminal trial of former key Enron executives Ken Lay and Jeff Skilling.
The Enron Task Force contended in the Nigerian Barge case that the Merrill Four were guilty of conspiring with Enron executives to mislead Enron investors in connection with Merrill’s purchase of a dividend stream attributable to an ownership interest in some power-generating barges moored off the coast of Nigeria. On a threshold basis, the Task Force’s case against the Merrill Four was bizarre because it was Enron, not Merrill, that may have improperly accounted for the transaction, although even that issue was never proven at trial. For its part, Merrill was simply buying a relatively small asset that Enron wanted to sell in Merrill’s ongoing effort to ingratiate itself to a potentially good customer of Merrill’s investment banking services.
The prosecution’s case against the Merrill Four rested almost entirely on the testimony of former Fastow henchmen, Michael Kopper and Ben Glisan, both of whom were deeply involved with Fastow in effectively embezzling money from Enron in connection with Fastow’s management of certain special purpose entities. Kopper and Glisan both testified on the key issue in the trial — i.e., that Fastow made during a December 1999 telephone call a legally unenforceable oral inducement to Bayly that Enron would either buy Merrill’s interest in the barges back or broker the interest to a third party, such as LJM2, an Enron SPE — despite the fact that neither Kopper nor Glisan participated in the telephone call. Inasmuch as Fastow’s oral inducement allegedly constituted a “hidden side deal” for Enron to “buy-back the barges,” the Task Force argued that Enron’s accounting of the transaction as a “true sale” was fraudulent and that the Merrill Four should have known that, so they were guilty of conspiracy.
Remarkably, the prosecution did not call either Fastow or anyone else who actually participated in the key December 1999 telephone call to testify during the trial of the Nigerian Barge case. Nevertheless, the Task Force represented to defense counsel for the Merrill Four that Fastow’s testimony in regard to the transaction was consistent with that of Kopper and Glisan. Based on that representation and the weakness of the prosecution’s case at trial generally, the defense team of the Merrill Four elected not to call Fastow as a witness during the trial. The jury convicted the Merrill Four, anyway.
With that backdrop, imagine the surprise of counsel for the Merrill Four when they heard about Fastow’s following testimony on cross-examination this past Thursday afternoon in the Lay-Skilling trial. After reading a portion of Kopper and Glisan’s testimony from the barge trial, Fastow testified as follows:

Q. Now, after having read through those pages [of Glisan and Kopper’s testimony], does that refresh your recollection at all about the events that transpired in December of ’99 concerning LJM[2] having been approached and what it did in response to that approach about these barges?
A. No, sir. They’re largely contradictory to my recollection of events.

Fastow went on to testify at some length on the barge transaction and contradicted key portions of both Kopper and Glisan’s testimony from the barge trial, such as the reason why LJM2 elected not to buy the interest in the barges at the time that Merrill bought the interest.
As noted earlier here (see also the thread here), this is not the first example of key testimony from prosecution witnesses in the Nigerian Barge trial being contradicted by testimony of prosecution witnesses in the Lay-Skilling trial. Meanwhile, four former Merrill Lynch executives sit in prison with their lives turned upside down based largely on testimony of prosecution witnesses that the Enron Task Force knew contradicted that of another key prosecution witness who the Task Force elected not to call.
The Department of Coercion, indeed.

The Andy Fastow Week of the criminal trial of former key Enron executives Ken Lay and Jeff Skilling drew to a quiet close on Thursday afternoon, which contrasted sharply with the crispness of his heavily-scripted direct examination and the combative opening cross-examination of Skilling lawyer, Daniel Petrocelli.

Thus, the corporate criminal trial of the decade is now through six weeks and the Enron Task Force’s case against Lay and Skilling continues to shrink before our eyes.

Fastow’s testimony drew the largest crowds of trial spectators to date, who appeared to be drawn to Fastow’s appearance in much the same way many fans are drawn to NASCAR events to see the collisions.

Fastow really is a train-wreck of a witness, and his gaunt appearance on the stand dramatically contrasted with the ebullient nature of Petrocelli, who clearly has become a jury favorite during his entertaining cross-examinations of Task Force witnesses.

Normally, a defeated and somewhat pathetic person such as Fastow would tend to draw sympathy from the jury, but Fastow admitted to doing such despicable things that it is decidedly unclear whether even his repeated apologies could generate much juror empathy.

Even grizzled courthouse veterans were shaking their heads in disbelief over Fastow’s duplicity.

Fastow’s brazen conduct in regard to his wife Lea is a case in point.

During direct examination, Fastow played the part of a loving and protective husband in resolutely maintaining that his wife was innocent of the tax fraud charges for which she served a year in prison from mid-2004 through mid-2005.

However, during the electric opening moments of Petrocelli’s cross-examination, it became clear that Fastow had actually hung his wife out to dry while negotiating his own plea deal with the Task Force, and that his gaming of Lea’s fate almost certainly contributed to the fact that prosecutors did not believe Fastow’s eventual protestations of his wife’s innocence.

Incredibly, Fastow was apparently so insistent upon negotiating retention of a substantial net worth under his plea deal that he agreed that his and Lea’s plea deals would be “cross-collateralized” — i.e., if Fastow breaches his plea deal, then the Task Force can pursue additional charges against Lea!

Fastow’s testimony in regard to his hidden “Global Galactic” memo was almost as bizarre.

Fastow testified that the memo outlined a series of secret guaranties that former Enron chief accountant and former Lay-Skilling defendant Richard Causey had supposedly approved with Skilling’s alleged blessing.

However, Fastow admitted that he had never had Skilling approve the memo directly and that he destroyed the original of the memo soon after he was canned as Enron’s CFO. Only after Fastow had cut his plea deal with prosecutors and was attempting to negotiate a better deal for Lea did he come up with a copy of the memo, which Fastow testified that Lea fetched from a safe-deposit box.

However, even that part of Fastow’s story was put into question on Thursday when Petrocelli clearly surprised Fastow by showing him that Lea and her attorney — well-known Houston-based criminal defense attorney, Mike DeGeurin — had visited the safe-deposit several months earlier and apparently had either not found the copy of the memo in the box or decided not to bring it to Fastow’s attention at the time.

That bizarre revelation prompted Petrocelli to ask Fastow, “Mr. Degeurin wasn’t going to your safe deposit box to retrieve your wife’s jewelry, was he?”

So, although Fastow did implicate Skilling in “secret side deals” and undisclosed “bear hug” guaranties, and Lay in supposedly misrepresenting Enron’s financial condition after Skilling’s resignation, Fastow is such a despicable character that it remains decidedly unclear whether the prosecution gained much of anything with the jury from his testimony.

Likewise, it’s not a feather in the cap of the Task Force that prosecutors were forced to allow the jury to understand that even they thought the Task Force’s most-publicized witness to date was lying to them about his wife’s case at the same time while he was cooperating with them in regard to the Lay-Skilling case.

However, one thing is absolutely clear from Fastow’s testimony — the prosecution is likely going to have to put Causey on the witness stand to corroborate Fastow’s story on the Global Galactic memo or else the jury is going to sense a massive hole in the prosecution’s case.

Moreover, that is not the only problem in the prosecution’s case.

Through six weeks of its case, the prosecution still has not presented a substantive witness who has not testified under either a plea deal or a non-prosecution agreement. Although that approach is partly the result of the prosecution’s strategy in regard to freezing-out testimony that would be exculpatory for Lay and Skilling, the Task Force faces a substantial risk of jury skepticism regarding the prosecution’s case if the primary witnesses alleging wrongdoing are doing so under deals in which the are retaining large amounts of money and hedging the risk of a long prison sentence.

Perhaps sensing that dynamic, the prosecution plans to call a couple of witnesses next week — former Enron risk analyst Vince Kaminski and trading analyst David Port — who apparently will not be testifying under either a plea deal or a non-prosecution agreement with the Task Force.

Consequently, despite the enormous public relations advantage that the Enron Task Force enjoys in this case, my sense continues to be that the Task Force has big problems in making its case in court.

Although the Task Force is probably 75% through its case-in-chief, all of the Task Force’s substantive witnesses have initially lied to investigators for years until copping a plea in which they bargained for a reduced prison term and a substantial net worth in return for testifying against Lay and Skilling.

Virtually none of the testimony from Task Force witnesses has supported a key element of the prosecution’s case — the alleged huge conspiracy within Enron to cover up the wrongdoing at the company — and documentary evidence that corroborates the allegations of wrongdoing has been practically non-existent.

On the other hand, the Lay-Skilling defense has been able to submit mounds of documentary evidence that casts doubt on much of the allegations of wrongdoing by prosecution witnesses and the defense has not even begun what will almost certainly be a vigorous and well-orchestrated case-in-chief.

In short, this does not appear to be the stuff of a clear-cut winner for the prosecution.

As expected, the media is all over the well-scripted direct examination of former Enron CFO Andy Fastow, although some media sources are already questioning the credibility of some of Fastow’s direct testimony.

However, given the breadth of Fastow’s direct examination, the media has not yet focused on the absolutely bizarre testimony that Fastow gave yesterday on the sad case of his wife, Lea Fastow.

The Enron Task Force prosecuted Mrs. Fastow on tax fraud charges more harshly than normal — and she endured longer and harsher punishment (one year in prison) — because of her relationship to Mr. Fastow.

In that regard, Fastow filed an affidavit in his wife’s criminal case during 2003 in which he swore that “I never, and to my knowledge and belief, Michael Kopper never, agreed or conspired with Lea Fastow to commit the crimes alleged in Counts 1 and 2 of Lea’s indictment.”

The purpose of that affidavit was to support a motion requesting that Mrs. Fastow’s trial be put off until after Mr. Fastow’s criminal trial so that Mr. Fastow could testify on his wife’s behalf without waiving his Fifth Amendment privilege against self-incrimination, although Mr. Fastow’s affidavit comes pretty darn close to waiving it, at least in regard to the tax fraud charges.

U.S. District Judge David Hittner ultimately denied that motion and scheduled the case against Mrs. Fastow to trial, which prompted both Fastows to have their plea deals with the Enron Task Force approved in May, 2004.

By that time, Mr. Fastow had been cooperating with Task Force prosecutors for since at least January, 2004 and Mrs. Fastow had withdrawn from an earlier plea deal with prosecutors after Judge Hittner had rejected it. Judge Hittner proceeded to sentence Mrs. Fastow to a year in prison, which she has completed.

With that backdrop, Fastow attempted to explain during the early afternoon portion of his testimony yesterday the statements that he made in the affidavit that he filed in his wife’s criminal case. Apparently, Fastow contends that his affidavit was technically truthful because it says that he and Kopper did not conspire with Mrs. Fastow to commit tax fraud.

Left unsaid in the affidavit is that Fastow and Kopper did conspire with each other to commit tax fraud; they just didn’t include Mrs. Fastow in that conspiracy.

So, let’s get this straight.

While cooperating with Task Force prosecutors, Fastow tells prosecutors that his wife is innocent of the tax fraud charges. Either the Task Force prosecutors did not believe him and proceeded with the criminal case against Mrs. Fastow, anyway, or the Task Force prosecutors believed him and proceeded with the criminal case against Mrs. Fastow, anyway.

If the reason that the Task Force proceeded against Mrs. Fastow is that they didn’t believe Mr. Fastow, that certainly doesn’t say much for the credibility of one of the prosecution’s key witnesses in the case against Skilling and Lay.

On the other hand, if the prosecutors believed Mr. Fastow and proceeded with the criminal case against an innocent Mrs. Fastow, anyway, that is an egregious example of the type of prosecutorial misconduct that has plagued the Task Force’s entire investigation of the Enron scandal.

Cross-examination of Mr. Fastow is going to be very interesting.

As predicted yesterday, the media frenzy over former Enron CFO Andy Fastow’s testimony relegated the previous Enron Task Force witness — former Enron Broadband chief operating officer Kevin Hannon — to obscurity rather quickly. However, before leaving the stand, the final moments of Hannon’s testimony yesterday reminded me that a lawyer should always be extra-careful about what to ask the witness during re-direct examination.
As noted here, one of the Enron Task Force’s main themes last week during the testimony of former Enron Energy Services executive David Delainey and a couple of other witnesses was that Skilling engineered a reorganization of the Enron Energy Services (“EES”) unit in a manner that hid trading losses of that unit underneath the blanket of high profits being generated by Enron’s top-flight trading unit, Enron Wholesale. During cross-examination, Skilling’s lawyers challenged Delainey and the others by suggesting that the true purpose of the reorganization was simply business efficiency — to combine EES’ poorly-performing trading operation with the better trading expertise of the Wholesale unit. Delainey, in particular, generally contested that defense contention during cross-examination.
Which leads us to the following exchange between Task Force prosecutor Cliff Stricklin and Hannon during redirect examination yesterday:

Q. And what did [Enron Wholesale CEO] Mr. Whalley, first of all, remind the jury who Mr. Whalley was at the time?
A. He was the CEO of Wholesale.
Q. And what did Mr. Whalley tell you about the rationale for Mr. Skilling moving EES into Wholesale?
A. He said he had met with Dave Delainey, who was depressed over the state of the EES business and he said we had to do something. I didn’t want Dave to quit, so we made the argument to Arthur Andersen that we should move the risk folks [from EES] into Wholesale.
Q. And why?
A. To improve the operation of EES [was] my impression.

Mr. Stricklin quickly moved on to another line of questioning, but it’s hard to downplay testimony of a prosecution witness that directly contradicts a major theme of the testimony of the prosecution’s previous witness.
Be careful what you ask on re-direct.

Former Enron Broadband chief operating officer Kevin Hannon will finish his testimony today in the trial of former key Enron executives Ken Lay and Jeff Skilling. Most likely, with the testimony of former Enron CFO Andy Fastow to follow, Hannon’s testimony will quickly fade into obscurity.
However, the nature of the media reporting on Hannon’s testimony from last Thursday afternoon got me to thinking. The prosecution went for a cheap score with Hannon by eliciting from him that Skilling had supposedly admitted during a May 2001 meeting with a group of other Enron executives that “they’re on to us” after a small analyst firm had produced a research note critical of some Enron transactions. Most of the media covering the trial (representative examples: NY Times and Houston Chronicle) seized on Hannon’s statement as gripping testimony that could prove to be highly probative in the government’s case against Skilling.
Well, maybe so, but doesn’t Hannon’s testimony really undermine the government’s case? The report that supposedly prompted Skilling’s remark was based on negative information about Enron that the company had made available to the efficient securities market. The report was not even a particularly novel analysis of Enron, given that it came a couple of months after Peter Elkind and Bethany McLean’s much-bantered Fortune article that suggested that Enron stock was overpriced. Despite the negative inference that Hannon attributed to Skilling’s alleged comment, it’s at least just as likely that Skilling — if he made the statement at all — was making light of the report to a group of company executives while emphasizing that his more optimistic opinion of the same information should also be made known to the markets.
But more importantly, how does the Enron Task Force square the report’s negative evaluation based upon information that Enron disclosed to the efficient securities markets with its core allegation that Skilling withheld such information from the markets?
Call it the risk of going for the cheap score. The prosecution went for testimony that seemed damaging to Skilling on its face, but in substance is counterproductive to the prosecution’s case. By the time Skilling lawyer Mark Holscher had elicited from Hannon on cross-examination yesterday that previous anti-Skilling witness David Delainey had also attended the meeting and heard Skilling’s supposed dramatic admission, but somehow failed to recall it in his testimony last week, it would not be surprising if the jury is, might we say, skeptical of Hannon’s testimony about Skilling’s statement and of the prosecution’s motive in eliciting it.
All of which just reinforces that Lay and Skilling will never win their case in the court of public opinion. But they still just might win it in court.

Oral argument takes place today at the Fifth Circuit Court of Appeals in New Orleans in the appeals of Dan Bayly, Robert Furst, James Brown and William Fuhs, the former Merrill Lynch executives who were convicted of wire fraud and conspiracy charges in November 2004 in the trial of the Enron-related case known as the Nigerian Barge case.
The plight of the Merrill Four in the Nigerian Barge case is a case study in the dubious nature of the government’s criminalization of business in the post-Enron era (for a thorough discussion of that subject, begin here). In the barge case, the Task Force took a finance transaction between Enron and Merrill Lynch and criminalized it through a brazen web of distortion, suppression of key testimony, inadmissible hearsay, opposition to the defense’s jury instruction on the key issue in the case and prosecutorial misconduct. In short, the Task Force effectively prosecuted the Merrill Four for doing their jobs in connection with the firm’s purchase of a dividend stream for which Enron, not Merrill, may have improperly accounted, although even that issue was never proven at trial.
Then, to make matters worse, the Task Force at trial played on the jury’s hindsight bias and presented to the panel a fictional screenplay of the underlying transaction while effectively effectively preventing the Merrill Four from presenting exculpatory testimony and evidence that contradicted the Task Force’s fictional account. The Task Force is deploying precisely the same deplorable tactics in the ongoing trial of former key Enron executives Ken Lay and Jeff Skilling.
Interestingly, part of the key testimony that the Task Force has elicited to date during the Lay-Skilling trial contradicts an important part of the testimony that it presented in convicting the Merrill Four during the Nigerian Barge trial. In Lay-Skilling, the Task Force had former Enron investor relations chief Mark Koenig testify that he learned on January 14, 2000 — just days before Enron was scheduled to publish its fourth-quarter 1999 financial statement — that earnings were likely to be 30 cents a share, a penny below the 31 cents a share that had been forecast on Wall Street. Koenig then testified that he alerted Enron’s CFO, Richard Causey, that the company would miss its forecast and that, on January 17 — the day before the earnings report was scheduled to be publicly released — he saw a draft memo saying that the company would earn 31 cents a share. On Jan. 19, the day after the earnings release, Koenig testified that he discussed the sudden change with Lay, who seemed surprised and allegedly observed to Koenig that “he went to bed and we were at 30 cents and, when he woke up, we were at 31 cents.”
In contrast, during the barge trial, the Task Force elicited extensive testimony and contended during closing argument that Enron’s motivation to arrange the barge transaction with Merrill Lynch in December 1999 was to help Enron hit its earnings target of 31 cents per share, not the 30 cent-per-share target that Koenig in his Lay-Skilling testimony suggested was the company’s true target until just days before the January 18 earnings release. Thus, the Task Force’s evidence in the barge trial that Enron’s earnings target in December 1999 was 31 cents per share directly contradicts Koenig’s testimony in Lay-Skilling that the company increased its earnings target by a penny-per-share just days before the January 18, 2000 earnings release.
So it goes in the wacky world of criminalizing corporate agency costs.
Meanwhile, Alexei Barrionuevo and Kurt Eichenwald of the NY Times provide this article today in which they summarize the testimony to date in the Lay-Skilling trial and observe that this week’s star witness — demonized former Enron CFO Andy Fastow — may end up being just another witness in the trial.

The pace of the Enron Task Force’s legacy case against former key Enron executives Ken Lay and Jeff Skilling continued to pick up pace during its fifth week, but that quicker pace is highlighting an unusual aspect of the trial — that is, the Task Force’s case appears to be shrinking dramatically before our very eyes.

After years of a highly-publicized propaganda campaign against anything having to do with Enron, after bludgeoning plea bargains from over a dozen former Enron executives, after alleging the biggest criminal conspiracy in the history of federal prosecutions, and after issuing a 66-page indictment against Lay and Skilling that is so far afield from what is going on in court that the prosecutors don’t want the jury to see it, the Task Force’s case is coming down to a complex jumble that relies heavily on innuendo and requires the jury to connect the dots of amorphous points that the Task Force is hoping will be enough to convict Lay and Skilling.

This week’s testimony was a case in point. The Task Force’s main theme was that Enron was so successful in making money in its trading operations that it allowed Lay and Skilling to soft-pedal to the investing public the losses that Enron was incurring in a couple parts of its business.

Mind you, the Task Force is not suggesting that Lay or Skilling was involved in approving fraudulent accounting; rather, the Task Force alleges that Skilling engineered a reorganization of an Enron business unit in a manner that hid losses of the poorly-operating unit underneath the blanket of high profits of Enron’s trading unit.

According to the Task Force, the hiding of these losses, along with over-reserving to hide excess profits of the trading unit, allowed Skilling — and presumably Lay, although he was almost an afterthought this week — to misrepresent Enron as a stable logistics company than a more volatile trading company, which the Task Force contends would not have been as highly valued in the marketplace.

Thus, the prosecution of Lay and Skilling is shaping up as the purest prosecution of corporate agency costs in the post-Enron era.

The underlying message of this prosecution is that an executive of any publicly-owned corporation better disclose every bit of bad news about their company or risk prosecution — under the sharp lens of hindsight bias — for misleading the investing public about the true health of the company. If the Task Force’s approach is successful against Lay and Skilling, one would wonder why any executive of a publicly-owned corporation would risk saying anything to analysts and the investing public other than “go read the financial statements in our regulatory filings. It’s all there.”

Amidst this muddle, the Task Force continues to show clear signs of desperation.

One such sign is that the Task Force continues to fumble about in regard to the order of its witnesses, a problem that drew the rare ire of the remarkably patient Judge Lake early this week.

Moreover, the Task Force continues to rely heavily on testimony from witnesses who are testifying under cooperation agreements with the Task Force under which the witnesses hedged the risk of a long prison term and the loss of millions in return for their testimony.

Is the jury really going to believe that the biggest corporate conspiracy in history was hidden from everyone except the relative few Enron executives who have copped pleas or entered into non-prosecution agreements?

An even bigger problem for the Task Force is that the testimony of the cooperating witnesses has been all over the map in regard to their conduct.

Mark Koenig testified that he lied a few times while touting Enron. Paula Rieker testified that others lied, but she did not — she only “overstretched” a few times. This week’s star prosecution witness, former Enron Energy Services executive David Delainey, testified that he lied all the time. Wes Colwell, a former Enron trading unit accountant, incredibly testified that he was involved at Enron in defrauding Tom Bauer, a former Andersen accountant with whom Colwell is now in business!

Meanwhile, there is no documentary evidence that any of these cooperating witnesses thought they were lying at the time of the alleged crimes and no meaningful evidence that they even told anyone that they thought they were lying.

Meanwhile, the defense has introduced on cross-examination large amounts of documentary and video evidence that the cooperating witnesses appeared to be working hard under difficult conditions to help Enron’s cause.

Is the jury going to believe that all of these witnesses were such good liars? And, if so, will the jury believe that they were lying then or lying now on the stand?

Seemingly sensing this dynamic, the Task Force elicited testimony at the end of the week from its latest cooperating witness — former Enron Broadband executive Kevin Hannon — that Hannon had actually participated in a meeting with Skilling, Lay and others in May 2001 in which Skilling supposedly admitted that an analyst’s report at the time had finally figured out his elaborate fraud on the market.

Testimony for the week closed with Hannon still under direct examination from the prosecution, so no cross-examination has occurred. But just how likely is it that such a significant meeting took place and Skilling made such incriminating statements, and yet none of the half-dozen previous former Enron executives who have testified during the trial were told about it by either Hannon or any other participant in such meeting? Stay tuned on that issue.

Consistent with the shrinking nature of the prosecution’s case, the Task Force announced this week that it is over halfway through with putting on its case in chief and expects to be through presenting its case by the end of this month. Inasmuch as the Task Force originally estimated that it would take 36 days (i.e., nine weeks) to put on its case, assuming an equal amount of time on cross-examination to that spend on direct.

Even though the Task Force took more time than was necessary or advisable with its initial witness Koenig and cross-examination has been taking far longer than direct, the Task Force is now over halfway through presenting its case. That’s another indication that the Task Force is literally adjusting its theory of the case “on the fly” during the trial, and that it has concluded that it cannot prove the vast majority of what it alleged in its charging documents against Lay and Skilling.

Next week should be particularly interesting as demonized former Enron CFO Andy Fastow — the architect of Enron’s special purpose entities or “SPE’s” — takes the stand after Hannon.

Fastow was a notoriously volatile fellow — at least to subordinates — while at Enron, and it will be interesting to see whether his demeanor has changed since he copped a plea deal with prosecutors back in early 2004.

On the other hand, the Task Force’s case to date has wandered away from the SPE’s, so there is a decent chance that a difficult-to-control Fastow could end up being a not-so-important witness in the ever-changing big scheme of this corporate criminal case of the decade.

Chronicle business columnist Loren Steffy responds to this weekend post on the high price of asserting innocence and hindsight bias in prosecutions of corporate agency costs by urging us to remember the supposed lies that Ken Lay and Jeff Skilling told in regard to Enron.
Steffy is a talented writer and has consistently pulled no punches in expressing his belief that Lay and Skilling are guilty, although his guilty verdict at this point in the trial is a bit difficult to square with this prior column. In fact, Steffy’s blog post reminded me of this funny story about one of my experiences on jury duty. Still, I admire Steffy’s honest stance more than the disingenuous positions taken by some in the media, who cloak an anti-Lay-Skilling bias with a transparent jacket of objectivity.
In the Lay-Skilling trial, the prosecution is only through about a third to 40% of its case in chief. Four out of the five substantive prosecution witnesses to date have testified under agreements with the prosecution in which they hedged the risk of a long prison sentence and loss of virtually all of their net worth in return for their testimony against Lay and Skilling. Moreover, the prosecution’s case to date bears little resemblance to the highly-publicized indictment and related charge pleadings against Lay and Skilling, and the prosecution has gone to great lengths to chill witnesses from testifying who have potentially exculpatory testimony for Lay and Skilling. Meanwhile, Lay and Skilling patiently wait for the opportunity to tell their side of the story.
Against that backdrop, Steffy has already decided that Lay and Skilling are guilty. That’s his perogative, but I prefer to view Lay and Skilling as innocent until the entire story is told and the prosecution has proven — beyond a reasonable doubt — that these men are guilty of a crime.

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.

Peter Lattman — whose WSJ Law Blog has quickly become essential daily reading on business law matters — points us to this Corporate Crime Reporter article on former Enron Task Force director Andrew Weissmann, who is leaving the Justice Department for a position in the white collar criminal defense section of Jenner & Block.

As this Mary Morrison article explains in detail, Weissmann’s dubious decision to prosecute American accounting icon Arthur Andersen out of business over the firm’s work for Enron was an egregious breach of prosecutorial discretion. In the Corporate Crime Reporter article, Weissman is asked about his decision to prosecute Andersen:

Weissmann defends the prosecution of Andersen against a growing consensus in the defense bar that the firm should not have been prosecuted.

“The company through its choices had given the Department of Justice an ‘all or nothing’ ultimatum,” Weissmann said. “People need to remember that Andersen had been offered a deferred prosecution agreement and rejected it.”

He believes that as a result of the Andersen prosecution, more and more corporations are jumping at deferred and non-prosecution agreements when offered.

“One of the fallouts from Andersen is that corporations are much more willing to say yes to deferred prosecution agreements, because they can see what happened to Andersen,” Weissmann said. “What major corporation is now going to gamble that the Justice Department is going to go away and issue a declination? That’s one of the reasons you are seeing a dramatic rise in deferred prosecution agreements and non-prosecution agreements.”

H’mm, let’s break this reasoning down.

An improper prosecution that cost people and communities in the U.S. over 30,000 jobs was really Andersen’s fault because the firm didn’t agree to a deferred prosecution agreement in regard to crimes that the firm did not commit.

Besides, despite the cost of thousands of jobs and millions of dollars in retirement benefits, the improper prosecution was still justified because it achieved the better good of scaring other companies into selling out their employees and copping deferred prosecution agreements.

That such appalling reasoning goes unchallenged in the article is a daunting sign of our times.

Prosecution of business crimes has become a game of roulette for prosecutors such as Weissmann, who play on an ugly cauldron of public cynicism, resentment, and tolerance for abusive use of governmental power to prosecute the unpopular business executive of the moment.

When the frightening loss of thousands of jobs and the destruction of careers and families is glibly rationalized by a former high governmental official as merely a tolerable cost of the use of the state’s awesome prosecutorial power for the better good of society, we are well on our way to a time when, as Sir Thomas warns us, we will not be able to “stand upright in the winds” of abusive state power that will blow then.

And what about the criminalization of business mindset that Weissmann reflects?

Ayn Rand summed it up well with regard to her observation about socialism (courtesy of Bryan Caplan):

[T]he truth about their souls is worse than the obscene excuse you have allowed them, the excuse that the end justifies the means and that the horrors they practice are means to nobler ends. The truth is that those horrors are their ends.