After three years from Enron Corp.’s demise into bankruptcy, dozens of indictments and plea bargains, and an unprecendented government and media campaign to demonize former Enron executives, the first criminal trial against former Enron executives will begin Monday in Houston before U.S. District Judge Ewing Werlein in the case that has been dubbed “the Nigerian Barge case.” Here are earlier posts about this case.
The trial is about a relatively small Enron deal with Merrill Lynch & Co. involving three electricity-producing barges off Nigeria’s coast. But the outcome of the trial is likely to have much larger implications on the government’s other Enron-related criminal prosecutions and future prosecutions of investment bankers and corporate executives generally.
Two former midlevel Enron executives and four former Merrill executives face conspiracy and fraud charges. One of those charged is Merrill’s former head of investment banking, Daniel Bayly, the highest-ranking securities industry figure to be criminally charged in the corporate scandals that emerged after the stock market bubble burst earlier this decade.
The government contends that Enron’s 1999 sale to Merrill Lynch of an interest in the barges was a sham that and that the energy company improperly booked about $12 million in pretax profit as a result of the deal.
Merrill Lynch got into the barge deal because it was trying accomodate Enron, with which it wanted to do more business. As 1999 came to a close, Enron wanted to sell an interest quickly in the barges and book the profit in the fourth quarter. Such end-of-the-quarter deals are routine at big companies. So, Enron turned to Merrill, which concedes that it invested $7 million in the deal as a favor to Enron. As an inducement to make an investment that it would not make but for accomodating a valued corporate custormer, former Enron CFO Andrew Fastow orally represented to the Merrill executives that Enron would either buy or broker a sale of the barge interest the following year for a nice profit to Merrill.
Mr. Fastow’s oral inducement is the key fact in the case. If that promise was truly a part of the deal, then Merrill’s investment was never truly at risk, the transaction was not a “true sale,” and Enron’s booking of the $12 million in profit from the transaction was illegal. On the other hand, if Mr. Fastow’s oral representation was simply encouragement to a relunctant investor to do the deal and Enron had no legally enforceable obligation to repurchase or broker a deal for the interest in the barges the following year, then Enron’s booking of the transaction was entirely proper and no crime occurred.
So, Merrill decided to buy the interest in the barges and the deal closed in the fourth quarter of 1999. The parties entered into typical deal documents for such a transaction that specifically provide that neither party relied on any prior oral representations in entering into the transaction, that any such prior oral representations are void, and that the parties are relying solely on the written representations contained in the deal documents in entering into the deal. Mr. Fastow’s oral inducement to Merrill during the prior negotiations was not included in the deal documents, which were approved by both Merrill and Enron’s lawyers.
Nevertheless, in mid-2000, Mr. Fastow followed through on his oral promise by arranging for Merrill to sell its barge interest at a profit to one of the off-balance partnerships that Mr. Fastow operated and partly owned. As a result, the government contends that the Merrill purchase was never a legitimate transaction because of Mr. Fastow’s oral guarantee that Merrill would not lose any money. With Merrill never at risk, the government argues that no true sale actually occurred and, thus, Enron’s booking of the earnings from the deal was fraudulent.
After Mr. Fastow pleaded guilty to committing crimes at Enron and agreed to cooperate with prosecutors earlier this year, you would expect that the government would make him their star witness in the barge trial. However, the government has indicated that it does not even plan to call Mr. Fastow to testify in the upcoming trial. Rather, the government’s primary evidence of the alleged sham nature of the deal appears to be the “nervousness” that Merrill executives openly expressed about the deal in emails both before and after the transaction was consummated. The government interprets that nervousness as evidence that the Merrill executives knew that the deal was a sham and that they could be caught participating in a fraud with Enron.
However, there is a much more reasonable interpretation of Merrill’s nervousness regarding the deal — that is, that they really were nervous about the business risk of the deal, not because they thought it was a sham and a fraud, but because they knew that they could not rely on Mr. Fastow’s unenforceable oral assurance that Enron would broker a sale of the barges the following year. Accordingly, they were understandably concerned they might be making a bad investment that would result in Merrill having to hold the barges for a long time rather than the short term they preferred.
Stated another way, the Merrill executives were nervous because they knew that this was a real deal in which the deal documents controlled the rights of the parties, and that Mr. Fastow’s oral assurances to get them out of the investment could not be enforced if Enron failed to live up to them.
Under normal circumstances, it is highly unlikely that the government would have even pursued an indictment in a case of such marginal criminal liability. Inasmuch as the written deal documents would have dispostively undermined any attempt by Merrill Lynch to enforce through the civil justice system Mr. Fastow’s oral promise for Enron to repurchase or broker a deal for the barges, how does the government expect to prove beyond a reasonable doubt that such an unenforceable promise was really a part of the deal?
But Enron has become such a corporate pariah in American culture that nothing is normal that has anything to do with Enron. The barge trial will test the extent to which the pool of potential jurors in Houston has been tainted by Enron’s collapse. Given the extraordinary media coverage — much of which has been fueled by governmental officials’ public statements — private polls that the barge defendants’ defense attorneys have conducted reflect that over 75% of the jury pool would not be impartial in deciding a criminal case against a former Enron executive.
Thus, rather than using prosecutorial discretion to pass on prosecuting a case of dubious merit, the government in the barge case continues to pursue convictions because it knows that the public bias against Enron — partly stoked by the governmental officials’ derogatory public statements about Enron — gives it a good chance of obtaining convictions, anyway.
Moreover, the barge case took another twist recently after the U.S. Supreme Court’s recent decision in Blakely v. Washington (prior posts here), which held that the state of Washington’s sentencing laws were unconstitutional because they only allowed judges, not juries, to consider factors that increased sentences. Some legal experts have speculated that the decision calls the Constitutionality of federal sentencing guidelines into question for the same reason.
As a result of the Blakely decision, Enron prosecutors re-indicted the barge defendants to include new allegations that the barge deal caused market loss of more than $80 million, an allegation that can add years to a sentence under existing federal guidelines.
Not explained in the new indictment is how the Nigerian Barge deal — which was a relatively small transaction involving about $12 million in allegedly illegal profit for Merrill Lynch — could have caused $80 million in market loss. In fact, neither Enron nor Merrill Lynch lost a dime on the transaction, and the allegedly questionable accounting on the deal was not even discovered until well after Enron had filed bankruptcy and its equity value had already become worthless. During his distinguished legal career as a defense attorney before becoming a federal judge, Judge Werlein often defended corporate clients against dubious damage claims. It will be interesting to watch how he deals with the government’s equally questionable market loss allegations in this case.
Thus, watch this trial closely. If the criminal justice system works properly and the trial results in either a judge-directed or jury acquittal, then hopefully such a result will prompt the government to concentrate on its clearer cases of fraudulent conduct against former Enron officials and wrap up the investigation in reasonably short order. But if the government obtains convictions in this remarkably weak case, then the government will understandably believe that it can obtain a conviction against virtually any person having anything to do with Enron, and many others will come into the government’s sights for indictment.
Although it’s hard to emphathize with former Enron executives, Martha Stewart or Frank Quattrone, we should all be concerned about the increasingly common abuse of the criminal justice system that is disguised in popular prosecutions of unpopular corporate executives. For if we allow the government to abuse its power against unpopular defendants, it is a small step for the government to use that same power against you and me.
Meanwhile, here are the Houston Chronicleand NY Times stories on the barge trial and this Washington Post article speculates that recent plea bargains of former Enron executives have improved the government’s chances of obtaining convictions agaisnt former Enron chairman and CEO Kenneth Lay and former COO and CEO Jeffrey Skilling.