Lay-Skilling, Week Three

The glacial pace of the criminal trial of former key Enron executives Ken Lay and Jeff Skilling quickened this week, as former Enron Broadband CEO Ken Rice finished his testimony after not quite three days on the stand.

Although the mainstream media accounts of the trial continue to be generally favorable for the prosecution and, as such, the trial remains an extremely difficult one for the defense, my sense is that the biggest news after three weeks is that this trial is settling in to being a very difficult one for the prosecution.

The holes in the prosecution’s case are apparent after just two witnesses. The Task Force inexplicably spent almost three times longer with its first witness — Mark Koenig — than it did with Rice, which put the trial on its initial glacial pace.

Then, in an apparent reaction to that miscue, the prosecution seemingly hurried through Rice’s testimony, who is arguably the more important witness of the first two.

Moreover, much of the substance of the testimony of both witnesses was rather odd. Koenig claimed that he believed that Skilling and Lay misled the investment community in various ways, but he didn’t know the mechanics of how that was supposedly accomplished.

On the other hand, Rice asserted that Skilling misled the investment community on the prospects of Enron’s broadband unit, but he didn’t implicate Lay in any alleged wrongdoing at all.

Then, on cross-examination, Rice conceded that he believed Enron Broadband had great long-term potential, but that Skilling and he were involved in improperly hiding some of the unit’s short-term problems.

To make matters worse for the Task Force, the testimony of both men barely touched on a key element of the prosecution’s case — the alleged huge conspiracy within Enron to cover up the wrongdoing at the company.

Indeed, when the prosecution asked Rice on re-direct about whether he was involved in such a conspiracy, Rice replied unenthusiastically that “Mr. Skilling and I had misled investors on a number of occasions about the prospects of our business” at the broadband unit.

So much for the biggest conspiracy of all time.

But perhaps most importantly, both Koenig and Rice admitted during cross-examination that, despite testifying now that they were involved in lying about Enron to the investment community years ago, neither of them made any statement to Skilling, Lay or anyone else at the time of the supposed lies about the wrongdoing.

Similarly, neither of these key prosecution witnesses testified that either defendant ever once acknowledged telling a lie. That lack of evidence of fraudulent intent dovetails with the defense’s theory that Koenig and Rice are only now claiming that they were involved in wrongdoing to hedge their risk of long prison sentences under their plea deals with the prosecution.

That the prosecution had Rice dead to rights on illegal insider trading charges at the time he cut his plea deal also didn’t help his credibility, either.

So, after filing and publicizing a lengthy indictment against Lay and Skilling that asserts a wide array of alleged corporate crimes, the Task Force doesn’t want the jury to see that indictment (although the Lay-Skilling team does) and the Task Force’s case appears to have come down to a plain “pump and dump” case — Skilling and, to a lesser extent, Lay touted the failing company’s shares while selling their own (that Lay’s sales were forced under margin calls is a knawing problem with that theory that the Task Force has not even addressed, yet).

That theory of the case plays on “the presumption” in such cases — i.e., that Lay and Skilling are rich and Enron collapsed, so they must be guilty of something for failing to announce to the investing public that Enron was really just a highly-volatile trading company rather than the more stable logistics company that they contended Enron had become.

After three weeks of trial, it would not be surprising if some of the jurors are saying to themselves about that theory: “Is that all you’ve got?”

Finally, sometimes small things in big trials are the best indicators of problems.

Throughout the trial, Judge Lake has ordered the prosecution to advise the defense of its next five witnesses.

As late as yesterday evening, the prosecution still hadn’t even decided on its next five witnesses, and at least one of those witnesses — Koenig’s former aide, Paula Rieker — will likely be largely duplicative of Koenig’s earlier testimony.

That the prosecution is fumbling over the order of its witnesses at this early stage of the trial is a pretty darn good indication that this is not a prosecution team that is confident in its case.

8 thoughts on “Lay-Skilling, Week Three

  1. Tom,

    Alan Murray in his 2/15/06 article in the Wall Street Journal indicated his disgust with the Lay/Skilling lawyers
    claiming Enron’s collapse was merely the result of bad press and market panic, Murray stated “Right. And Jesse James just wanted a small business loan”.

    Murray raised an interesting point, he stated that he thought if Lay and Skilling were judged by a jury of their real peers, the CEOs of other big public companies, that these CEOs would understand exactly how far out of line Enron’s actions were and they would throw the book at Lay and Skilling.

    I do think a jury of CEOs of other large public companies would probably have a hard time buying Mike Ramsey’s and Dan Petrocelli’s opening arguments to the jury that [Enron’s fall], “….. 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” (courtesy of Mr. Ramsey) and “[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” (per Mr. Petrocelli).
    My guess is that there would be a few laughs coming from those CEOs when they heard these “the dog ate my homework” alibis.

    I think the defense position that “Jesse James just wanted a small business loan” is much stonger then the Lay/Skilling position of “market panic and that rascally Andy Fastow”.

  2. Max, for the utter hyprocrisy of Murray’s stance, take a look at this earlier post.
    As for Murray’s observation that a CEO-jury would convict Lay and Skilling, I’d be willing to bet that Hank and Jeffrey Greenberg would not be as quick to convict as Murray suggests.

  3. Tom, to use a lawyerly term let’s “stipulate” that no indicted (or possibly soon to be indicted) or convicted CEOs would be included in that CEO jury – just good old red blooded, honest as the day is long, All American captains of industry would be on the CEO jury.

    I think the Lay/Skilling defense team would have trouble with this CEO jury and I think they may have trouble with the current “real” jury in convincing them that the “market panic/ run on the bank theory and Andy Fastow alone” brought down Enron.

    Your referenced 12/24/05 article talks about the more “nuanced” view that Enron was a tremendously innovative firm and engaged in structured finance and other financing transactions that had literally never been attempted before, and certainly never on the scale that Enron generated them – I think you will find a lot of people will agree that the transactions that Enron were engaged in had never been done before and never on a scale that Enron did them, where the disagreement comes in is that most people feel that the transactions were fraudulent (probably why they had never been done before and on such a massive scale), and were orchestrated not by just Mr. Fastow and “his henchmen”, but by the then Enron CEO (Lay) and COO (Skilling).

    Professor Culp is certainly well credentialed and I assume offers some scholarly insights into the world of structured finance and alternative risk transfer as well as the theory of futures, forwards, options and swaps. But the view may be a little different in the real world, where billions of dollars are changing hands, and where on June 30, 2001 Enron’s financial statements show a stockholders’ equity of $11.7 billion and in a July 12, 2001 conference call with analysts Jeff Skilling announces that “Enron is in solid shape” and .”Very, very strong performance in all sectors,” and then five months later on December 2, 2001 the stockholders’ equity of 11.7 billion is now worthless and the stockholders have lost everything they have invested in the company. In this world, the stockholders and just about everyone else who does not have a “nuanced” view of this monumental catastrophe, feels very strongly that Enron and it’s executives have been engaged not in “innovative” financial activities but rather in massive fraudulent activities.

    In my opinion Enron did not fall because of “market panic” or “a run on the bank” or some “lone activities” by Andy Fastow, Enron fell because it had billions of dollars of “real” liabilities in excess of billions of dollars of “worthless” assets, Enron’s stockholders’ equity at 6/30/01 was no where near $11.7 billion, and it was no where near the $11.4 billion stockholders’ equity shown on the financial statements for the year ended 12/31/00.

    I think the idea that a “market panic” or “run on the bank” caused Enron’s downfall is going to be a hard sell for the defense. Dynegy made an offer to acquire Enron in November 2001, but when Dynegy got into the details of Enron’s balance sheet they saw that Enron had billions of dollars of liabilities in excess of billions of dollars of worthless assets and they knew that Enron was beyond saving. Dynegy had the cash backing of Chevron/Texaco, a run on the bank or market panic was of no real concern to Dynegy, but billions of dollars of liabilities in excess of worthless assets is what quashed the deal.

    The same goes for all of the other companies in the Fortune top 50, if Enron had been this great company that Mike Ramsey and Dan Petrocelli make it out to be, companies would have been lined up around the block trying to buy Enron, but as it turned out they all realized that Enron had billions of dollars of “real” liabilities in excess of billions of dollars of worthless assets and not one of them wanted to acquire Enron..

    I don’t think that the theoretical jury of CEOs would have any trouble understanding that at all – and I believe that the “real” Enron jury (who Jeff Skilling might say “just don’t get it”) will “get it”.

  4. Max, as with Drexel and Continental Illinois almost 20 years ago, Enron’s fate was sealed when the credit markets lost confidence in the company. Although Fastow’s criminal acts certainly had much to do with that loss of confidence, the run on Enron’s bank that ensued does not mean that Lay, Skilling or anyone else at Enron outside of Fastow’s relatively small circle and Rice’s insider trading was engaged in criminal wrongdoing.
    Enron was similar to a bank or brokerage house because Enron’s largest business was in natural gas contracts. Inasmuch as Enron created the long-term natural gas market, Enron became the market maker for such contracts and, thus, offered to buy or sell long-term natural gas contracts in that market.
    That raises an important attribute of Enron’s business that led to its downfall — Enron was a party to every transaction in its trading business. Therefore, buyers and sellers did not contract with each other, but with Enron. Thus, every company that conducted trading business with Enron had credit exposure to Enron and, as a result, a big part of the value placed on a contract depended on Enron’s creditworthiness. This exposure is greater in long-term contracts, particularly for buyers who prepaid some or all of the contract.
    Consequently, as the revelations of Enron’s accounting problems began to emerge in late 2001, buyers of such contracts from Enron began to bid lower — the value of a contract fell with the increased risk. On the other hand, sellers of contracts began to demand a higher price from Enron because of the increased risk that the contract might not be fully consummated. Moreover, the foregoing process was not limited to Enron’s natural gas trading market. It also occurred in regard to the numerous other markets that Enron had created. Almost overnight, Enron’s profit margins in its trading business diminished dramatically or disappeared completely, and that process ultimately led to the implosion of Enron’s trading markets.
    There is no question that you are correct that Enron’s poor cap X investments had become a drag on the company’s earnings and stock price. But my sense is that the market had already taken those bad investments into consideration well before Fastow’s shenanigans with the SPE’s came to light.
    Accordingly, the bad cap X investments and the heavy debt load alone would not likely have brought down Enron. But the breach of trust in the marketplace caused a dramatic decline in Enron’s hugely profitable trading business and that, in my view, is what sealed the fate of Enron into bankruptcy.
    Enron’s collapse into bankruptcy was unfortunate, and employees such as Fastow who effectively embezzled money from the company should be prosecuted. But that’s not what Lay and Skilling are being prosecuted for. They are being prosecuted for making difficult business judgments, and it’s a very small step from that type of prosecution to criminalizing similar difficult judgments that are made daily in virtually any reasonably-sized business. I, for one, am not comfortable with ambitious prosecutors being able — or willing — to tell the difference between merely difficult business judgments, on one hand, and criminal ones, on the other.

  5. Tom — Criminal prosecution may be overkill, but so too is your effort to paint them as misunderstood business titans. Accepting the “market panic” explanation, as I think you acknowledge, this was not a random and unforseeable event–Enron did business in ways that made it particularly susceptible to panics and particualrly incapable of surviving them. Was this fairly disclosed to investors?

  6. I am not convinced that Enron conducted business in a significantly riskier manner than similarly-situated companies. However, even if the company was far riskier than other such companies, remember that its disclosures to investors were vetted and approved by scores of outside accountants, consultants, and lawyers, most of whom had far more information and a better understanding of the specific matters upon which they were providing advice to Enron than Lay and Skilling had. It’s an unfortunate and dangerous trend to extend criminal liability to business executives for the company disclosures made under such circumstances.

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