So, week one of the Lay-Skilling trial is in the books. Let’s review what we’ve learned.
U.S. District Judge Sim Lake handles matters faster than the prosecutors and the defense attorneys do.
Opening arguments are too long.
The key evidentiary issue in the trial has not yet been addressed, but another court expressed interest in the issue.
Former Enron investor relations chief Mark Koenig thinks that he and Messrs. Lay and Skilling misled investors about Enron’s financial condition, but — over five years after doing so — he still cannot explain why he did it.
Sheila Jackson Lee knows where the cameras are (don’t miss Slampo’s comments on SJL), and could one or more of the trial participants end up on What Not to Wear?
As is usually the case, it’s difficult, if not downright impossible, to predict what effect all of this is having on the jurors.
But the prosecution has to be concerned about the glacial pace of the trial. The prosecution lost a similar trial last year after putting the jury to sleep during long stretches of the Enron Broadband trial.
Anticipating such problems in Lay-Skilling, the prosecution promised the jurors during opening argument that the trial would be about lying and not about boring financial matters.
Then, with its first witness, the prosecution proceeded to take a good part of the first two days of testimony going over boring financial matters, resulting in the prosecution failing to finish its direct examination of that first witness before the week concluded.
That is not the way to win friends on a jury.
This is not meant as a criticism of the Task Force prosecutors. Indeed, I suspect that they are among the best in the Justice Department for handling such trials.
Rather, this type of chloroforming slog is the inevitable result of criminalizing what amount to business judgments over which people can reasonably differ.
Justice would be much better served with the prosecution taking a third of the time that it took with Koenig and, instead, bringing to the witness stand every top-level former Enron executive to testify about how Enron’s management actually evaluated Enron’s finances and reported them to the public.
But if that were to occur, then the prosecution might lose the trial.
So, the prosecution effectively prevents those potentially more truth-revealing witnesses from testifying and spends an inordinate amount of time with a witness such as Koenig, who wasn’t even involved in the mechanics of how Enron’s management evaluated its finances.
As a result, rather than being allowed to handle the messy process of sorting out the truth, the jury gets a prosecution script of what it thinks the truth should be.
As we saw in the Enron Broadband trial, sometimes juries have a way of figuring such things out.
You have an interesting and informative blog, a good place for exchanging ideas.
You stated “this type of chloroforming slog is the inevitable result of criminalizing what amount to business judgments over which people can reasonably differ”.
As I recall Skilling has about eight charges which are for signing the 10-Q and 10-K forms which I don’t think fall into the category of “criminalizing what amount to business judgments”, I believe it has long been established in the law that it is a crime if one signs the forms 10-Q and 10-K indicating that the financial statements are materially correct when the person signing knows that the financial statements are not materially correct.
Would you consider lying to the investing public about material matters relating to the financial statements to be a criminal matter or only a civil matter.
The phrase “criminalizing what amount to business judgments” is pretty general, do you consider all of the charges against both Lay and Skilling to be criminalizing business judgments or just some.
Max, without hearing Skilling’s defense first, how can you conclude that there are “about eight charges which are for signing the 10-Q and 10-K forms which I don’t think fall into the category of ‘criminalizing what amount to business judgments'”?
I am reasonably confident that Skilling will have at least a colorable explanation for his belief that each 10-Q and 10-K that he signed were true and correct. Remember, Skilling did not sign those in a vacuum. They were approved by dozens of outside accountants, lawyers, and consultants, as well as Enron’s internal management team.
Tom,
I may not have been clear in getting my point across. My primary point concerns the general idea of ” ‘criminalizing what amount to business judgments” I was saying that “if” you were indicating that all of the charges against Lay and Skilling fell into the area of criminalizing business judgments that I did not think that from a general “criminal category” point of view that counts 14 through 20 of the indictment (which involve Skilling signing the 10-Q and 10-K statements) fell into the general category of “criminalizing business judgments”. I am not specifically talking about the guilt or innocence of Skilling on these counts, what I am talking about is whether acts of the type described in counts 14 through 20 should be described as “criminalizing what amount to business judgments” or whether they are acts that have been well defined in the law for many years as being a crime.
I would still be interested in knowing if you consider lying to the investing public about material matters relating to the financial statements of a public corporation to be a criminal matter or only a civil matter.
Max, yes, I think the counts to which you refer amount to criminalizing business judgments, and that the prosecution of such judgments is very bad public policy.
There is a big difference between prosecuting agency costs and prosecuting other crimes. Much of this has to do with the nature of the evidence involved, reasonable differences of opinion on business judgments, and the subtleties of dividing responsibility.
Larry Ribstein has analyzed the problem in the following manner. Suppose somebody lifts your wallet or strongarms you on the street. There is no question that is wrong and a crime. But what if the robber asks you first if they can borrow your wallet and then donít give it back on time? Or what if they ask your employee who is running the store for you if they can use your wallet? What if the “thief” is another employee who says the manager gave him the money as compensation?
Wrongness in these situations turns on the contracts and relationships among the various parties. Proof depends on who said what to whom. Can we rely on what the witnesses say about this? What if the prosecutor tells the employee who is minding the store that he will get off if he spills the beans on the “thief”?
In regard to prosecution of corporate agency costs, most people do not understand just how flexible corporate accounting can be, particularly in regard to trading and structured finance, which was a large part of Enron’s business. At Enron, the auditors and some of the executives who furnished its inital October, 2001 restatement had produced the very reports they were revising. Enron operated in dozens of countries and conducted tens of millions of transactions every year. Restatements in such a complex world are not extraordinary, for reasons — such as honest mistakes — that are not criminal in nature. Merely adjusting the amount of earnings set aside for loss reserves — a judgment call based on guesses about what damage the future holds — can make a world of difference.
Accountants’ views on such matters may differ widely, but one or the other conclusion does not necessarily imply intent to defraud. Indeed, accounting is a profession well known among its insiders for its uncertainties and ambiguities. Thus, when the outside auditors of American companies and the companies’ executives sign off on a financial report, they don’t claim infallibility.
Having said that, there is nothing wrong with punishing outright lying to investors. But as the evidence unfolds in Lay-Skilling, I am confident that it will be far from clear that Messrs. Lay and Skilling were lying about anything. And, even if they had not been prosecuted, they would have still been held responsible for Enron’s demise through the civil justice system. Such lawsuits arenít ideal (lawyers probably make too much money in them), but they are far superior to unleashing the daunting power of the state on a few select executives to criminalize merely questionable business conduct. At least the civil lawsuits can distribute responsibility among all the actors involved, including the directors who approved some of the policies that led to Enron’s downfall. Unless, that is, the shareholders contracted to indemnify the directors against such liability in the first place, which brings us back to addressing the threshold issue of whether this is wrong.
This apparent irrationality tends to reflect the true underlying rationale for criminalizing business judgments. Prosecution of corporate agency costs is not really about about good corporate governance or deterring criminal conduct at all. Rather, it is about resentment — disliking persons such as Lay and Skilling for having achieved a fortune and believing that their good fortune is undeserved. The resenter wants to lower the envied person to his level. That is a common element in such prosecutions as Lay-Skilling, Martha Stewart, and Michael Milken, despite the superficial difference of the offenses being prosecuted.
The supposed social payoff of such prosecutions is deterrence, but my sense is that the true crooks in the corporate world will keep engaging in wrongdoing while the legitimate executives will become increasingly relunctant to take risks that generate productive economic benefits for shareholders and communites. That is not to say that say that Kozlowski’s conduct in taking unapproved compensation from Tyco is worth encouraging, but the criminal case against, say, Michael Milken was completely different, and it’s not clear to me that ambitious prosecutors know — or even care about — the difference.
Tom,
Thanks for one of the few reasoned and informative discussions of the whole Enron case that I have seen. I agree with some of the things that you have said and others I disagree with. I’m going to give my overall view on all of this, if it’s too long, let me know and I’ll make several posts instead of one size fits all.
My feeling all along (regarding whether Lay can be convicted of a crime, not whether he is guilty or not) has been that Lay may have a pretty strong case depending on what kind of evidence the prosecution has. I think a big part of Lay’s defense is going to be that “I had the very best experts in the country look at all of these transactions and they all assured me that everything was all right, these experts were one of the world’s leading CPA firms, Arthur Andersen and one of the country’s leading law firms Vinson & Elkins, our Enron in-house accounting and legal departments consisting of some of the best CPA’s and lawyers in the country all reviewed these transactions and said that they were OK”. Lay will say, “what more could I do, I am not a CPA, I am not a lawyer, I got the very best people in the world to review all of this and they told me it was OK”. He will then point to 15 years of the Arthur Andersen “opinions” on the Enron financial statements where Andersen gave a “clean” opinion on the Enron financial statements right up through the year ended 12/31/00 and then the quarterly SEC 10-Q filings for the quarters ended 3/31/01 and 6/30/01 where Andersen signed off on these statements.
As strangely as it may seem, these highly questionable deals were all run by the “experts” and approved by the “experts”, it is not like Lay, Skilling and Fastow had all of these deals hidden in some desk drawer and they met at midnight to discuss how to sneak these deals by everybody. I think without a doubt the “intention” of all of these deals was to hide crucial information from the stockholders and investing public, but the “vehicles” used (SPE’s, partnerships, etc.) are legal and are generally accepted in the world of large corporations. Many, many large corporations use SPE’s that move debt off of their balance sheet, and for other purposes, and I feel sure that Lay’s legal team is going to bring in some very high level experts to testify and name some very well known companies that have used SPE’s in their business operations.
It may come down to a matter of “intention” and then “evidence”; were these transactions done willfully to deceive the investing public about the financial condition of Enron or was there a “legitimate” business purpose for these “deals”. If there is proof of the criminal intention to deceive the investing public, then the prosecution may have a key point to hammer home to the jury, but if there is no hard evidence to show that their intent was to “fool” anybody, then the defense team is going to say, “look these are generally accepted business practices that are done by many large corporations, Enron was just doing what “everybody else was doing”, there was no evil intent here”. One of the things that I have wondered about all along is that Andy Fastow must have known that if all of this came crashing down that he was going to be the fall guy and was going to take the biggest hit, I just wonder if at some time he may have secretly taped any meetings with Lay and Skilling that discussed “manipulating” the financial statements – assuming that any meeting ever took place. If Fastow or someone else, possibly Causey, has some “hard evidence” then Lay may have some big problems., but lacking hard evidence, it may get down to a “he said, she said” case involving “confessed criminals” and Lay, how the jury will go on that I don’t think anyone knows.
I have made posts relating to these issues on the Chronicle blog regarding the following and I will just repeat them here rather than include a link to the Chronicle postings.
Regarding the prosecution:
One of the cornerstones of the defense is going to be that Enron (i.e. Lay and Skilling) were only doing what everybody else in the business “Big Leagues” was doing and such activities are routine and commonplace and “everybody does it”.
Many of the activities undertaken by Enron were also done by other large corporations, such as using Special Purpose Entities to move assets and liabilities off the balance sheet, the use of mark-to-market accounting etc. The hurdle for the prosecution is going to be to convince the jury that at some point Enron, using perfectly legal vehicles, crossed the line and moved over onto the criminal side of things. To use a rather simple example to get across the point, it is like you are moving down the freeway in your car at 50 miles per hour, you and everybody else is moving along at a pretty fast clip, but it is all legal since the speed limit is 65 MPH, you decide to move up to 55 MPH, still you and lots of other folks are doing this and everything is OK, you move up to 60 MPH and then 65 MPH, same thing everything is OK, then you decide to move up to 70 MPH and then there’s trouble, you go through the radar and the cop pulls you over and you have broken the law and you get a ticket. At some point something that was basically legal crossed over the line and became illegal.
This is what the prosecution is going to have to demonstrate in order to get a conviction of either Lay or Skilling. They are going to have to show that, yes, Lay and Skilling were driving the Enron car down the freeway just like lots and lots of other “business cars” but at some point Lay and Skilling stepped on the gas and took the Enron car way, way beyond the speed limit, while the other business cars stayed below the speed limit.
Whether the prosecution can get that point across remains to be seen, they were not able to get it across in the first Broadband trial, even though the president of Broadband had already pleaded guilty.
Regarding the defense
In the opening statements to the jury:
” [Mike] Ramsey closed by outlining his reasons that Enron fell, saying it didn’t happen because of wrongdoing by Lay or Jeff Skilling, but rather by a market panic set in motion by revelations of financial chicanery by then-CFO Andrew Fastow”.
Mr. Petrocelli stated “[Lay and Skilling] were well informed and that they knew the company was sound and successful. But Enron was the victim of an immediate, punishing drain on its liquidity from its trading partners, who drained it of cash”.
Enron was not a “sound and successful” company in the latter part of 2001, and it’s astonishing fall into bankruptcy in a matter of 7 weeks from October 16, 2001 to December 2, 2001 is evidence of that, and the fall into bankruptcy was not caused by “market panic set in motion by revelations of financial chicanery by then-CFO Andrew Fastow” as Mr. Ramsey stated, or as Mr. Petrocelli puts it, a “punishing drain on its liquidity from its trading partners, who drained it of cash”, the so called “run on the bank” theory. The fall of Enron was caused by there being billions of dollars of “real” liabilities in excess of billions of dollars of “worthless” assets, and this disastrous state of affairs in December 2001 was the result of several years of manipulating financial information of Enron to make it appear to be a successful and financially sound company when in fact it was moving toward financial disaster, which occurred on December 2, 2001.
You could have a “run on the bank” or a “market panic” involving Microsoft tomorrow and the government could “put them out of business tomorrow” and Microsoft would pay off all of their liabilities and have billions left over to distribute to the stockholders in liquidation because Microsoft has “real” assets to pay off “real” liabilities.
I think one of the key rebuttals to the “run on the bank” or a “market panic” theories is that Dynegy initially made an offer to acquire Enron and it looked like it was a done deal, but after Dynegy got into the details of Enron’s balance sheet they backed out of the deal because they knew that Enron’s liabilities were enormously in excess of their assets. A “run on the bank” or “market panic” was of no real concern to Dynegy, because they had the cash backing of Chevron/Texaco behind them, they would have had plenty of cash to “make it” in the short run until they got Enron turned around, but as Dynegy saw, Enron was beyond saving.
If indeed Enron was a “sound and successful” company as Mr Petrocelli describes it, that only had a “run on the bank” or a “market panic” problem, the other members of the Fortune top 50 companies would have been lined up around the block to try and buy Enron, but as it turns out none of them had any interest in buying Enron, because Enron’s main problem was not a “run on the bank” problem but the main problem was that Enron had billions of dollars of “real” liabilities that were in excess of billions of dollars of “worthless” assets.
Tom, one other thing, could you give an explanation of “corporate agency costs” – too “lawyeresque” :>)
Max, sorry about the prolix use of corporate agency costs. That term simply means the costs attributable to deficient corporate governance.