After only one week of the defense’s case and the tenth week of trial, it has become clearer than ever that the Enron Task Force’s prosecution of former key Enron executives Ken Lay and Jeff Skilling has become the purest attempt to criminalize corporate agency costs of any prosecution since the bursting of the stock-market bubble of the late 1990’s.
After a friend of prosecution witness and former Enron investor relations chief Mark Koenig kicked off the defense case by testifying that Koenig had told her that he lied about wrongdoing at Enron in order to cop a plea deal with the Enron Task Force, the Lay-Skilling defense presented a series of former Enron executives who disputed the testimony of prosecution witnesses on a number of key prosecution allegations, including the following:
That Skilling authorized former Enron CFO Andy Fastow to operate Enron’s special purpose entities as parking lots for Enron’s underperforming assets while running roughshod over other Enron executives in negotiations;
That Enron had no internal controls regarding Fastow’s conflict of interest in managing certain of Enron’s SPE’s while acting as Enron’s chief financial officer;
That there was any wide-ranging criminal conspiracy within Enron;
That Skilling had misrespresented to the marketplace layoffs in Enron’s broadband unit as redeployments;
That Skilling had misrepresented to the marketplace the true purpose of a restructuring of Enron’s EES business unit and the nature of problems within that unit;
That former finance executives Fastow and Ben Glisan had ever informed Lay that the Dhabol Power Plant in India was highly overvalued; and
That Vinson & Elkins’ investigation into the allegations contained in Sherron Watkins’ memo was a sham by Lay to cover-up Enron’s shaky finances
Business decisions necessarily involve judgments over various possible alternatives, and the nature of business risk means that a number of those decisions will ultimately turn out badly, as certainly occurred at Enron.
But rather than allowing the civil justice system to sort out responsibility for such a loss, the Enron Task Force’s mindset is to criminalize the loss by appealing to the jurors’ hindsight bias and urging them to convict Lay and Skilling of making “the choice of seemingly riskier alternatives.”
As corporate law experts Stephen Bainbridge and Larry Ribstein have long maintained, shareholders deserve protection from theft, but not from risk taking, and it’s not clear that government prosecutors know — or even care about — the difference.
Thus, while the Task Force has properly obtained guilty pleas from Fastow, Glisan and the relative few of their cohorts who truly committed crimes by effectively embezzling money from Enron, the Task Force continues to spend an enormous amount of resources criminalizing business judgments that Lay, Skilling and others made in regard to Enron that simply do not involve the black-and-white circumstances of theft or embezzlement.
As a result, the Task Force has been forced to engage in a number of highly questionable tactics in order to attempt to pull off a win in such cases. The Task Force’s record in the three previous Enron-related prosecutions that have actually gone to trial — the Andersen case, the Enron Broadband case, and the unraveling Nigerian Barge case — reflects that even those dubious tactics cannot pull the wool over the specious nature of such prosecutions.
The cross-examination of former Enron general counsel James Derrick Thursday afternoon was a case in point.
Derrick — who is a quietly forceful, competent and genuinely nice man — made the following insight Thursday afternoon when Task Force prosecutor John Hueston accused him of trying to shield himself from civil liability by denying wrongdoing in connection with his involvement in retaining Vinson & Elkins to conduct the investigation into allegations contained in the Watkins’ memo:
A. I think it is fair for people to question [Derrick’s involvement in the decision to retain V&E], but the reason I haven’t admitted to [wrongdoing] is because I am personally confident that I have discharged, and did discharge, my obligation in good faith to the company. It’s perfectly proper to challenge my judgment, but in terms of whether I exercised it in good faith in a way that I thought was in the best interest of the company, I have no doubt that I did that. [. . .]
Q. Sir, it certainly helps you claim that you did everything proper by denying ever receiving a memo in that same time from your own internal legal counsel which would corroborate those Watkins allegations; right?
A. I think it serves my interest to tell the truth.
Derrick’s analysis is spot on. Sure, his and Lay’s decision to retain V&E to handle the investigation over the Watkins’ memo is subject to legitimate question. But there is little doubt that the decision was a reasonable business judgment that these two men made after careful consideration of the difficult circumstances and issues that their company faced at the time of the decision.
Whether management makes such judgments correctly is a fundamental risk of business ownership, and criminalizing that risk — through the prism of hindsight bias — will simply make executives in the future less likely to take the risks necessary to build wealth and create jobs while not deterring in the slightest the Fastows of the world from embezzling money.
How all of this is affecting the Lay-Skilling jury remains decidedly unclear. As Professor Bainbridge pointed out earlier in the week, the betting markets are lining up in favor of conviction, which mirrors public opinion that is conditioned by the mainstream media’s presumption in such cases — i.e., that Enron melted down and, thus, Lay and Skilling must be guilty of something as a result.
Although most of the reporters attending the trial each day are providing reasonably objective analysis, that hardly makes a dent in the societal bias against anything having to do with Enron. Heck, the business columnist for Lay and Skilling’s hometown newspaper has rarely missed a day during the trial in which he does not call for the conviction of the two men.
Nevertheless, my sense remains that the dynamics in play in the Lay-Skilling courtroom indicate that the outcome is not as certain as conventional wisdom suggests.
This week, the defense witnesses have presented an interesting contrast to the prosecution witnesses of the previous nine weeks. Inasmuch as virtually all of the key prosecution witnesses had cut plea deals with the Task Force in return for their testimony against Lay and Skilling, their testimony came after many hours of preparation with prosecutors. In contrast, almost all of the defense witnesses this week had either met only briefly or not at all with the Lay-Skilling team before testifying.
The result was testimony that was not as prepared as that of the prosecution witnesses, but maybe just more credible to the jury than the heavily-scripted testimony of the prosecution’s plea-bargaining witnesses.
Similarly, the Task Force’s cross-examination of the defense witnesses has seemed mostly off-target.
For example, during cross-examination of Max Hendrick, a Vinson & Elkins partner involved in the investigation of the allegations in the Watkins memo, a Task Force prosecutor attempted to impeach the testimony of Hendrick with the hearsay statement of an unindicted co-conspirator, even though the statement was exculpatory with regard to the unindicted co-conspirator being involved at all in the alleged conspiracy at Enron.
That not-so-subtle point went unreported in the mainstream media accounts of the trial, but it nevertheless highlighted perhaps the biggest injustice of all of the Enron-related prosecutions — the Task Force tactic of effectively precluding key witnesses with exculpatory testimony from testifying for the Lay-Skilling defense.
Likewise, the Task Force’s cross-examination of Derrick on Thursday afternoon was questionable, at best. During direct examination earlier in the day, Derrick had recounted conversations with Skilling on how they both valued the importance of family and how burdensome Enron executive jobs were on their them.
Derrick — who did not prepare his testimony with the Lay-Skilling team before taking the stand — then expressed appreciation to Skilling and Enron for allowing him to take an extended 1991 vacation trip rafting down the Colorado River with his only son, who died unexpectedly several years ago. “I’ll be forever grateful,” stated Derrick from the stand regarding Skilling’s kindness. An observer of the morning session told me later that the jury’s attention was riveted on Derrick during that part of his testimony.
Then, in the afternoon session (which I was able to attend), Task Force prosecutor Hueston attacked — with an accusatory tone in his voice — Derrick’s credibility and integrity.
Never changing his quiet and patient demeanor in the face of Hueston’s misguided tone of cross-examination, Derrick politely but firmly refused to give Hueston an inch and, by the end of the day, appeared to have Hueston flustered.
After the morning’s testimony about Derrick and his son, my sense in the courtroom was that the jury — which is predominantly female — was not appreciating the style of Hueston’s cross-examination toward Derrick one bit. Sometimes such seemingly small incidents in long trials end up making a big difference in the way jurors ultimately frame the issues.
Derrick returns to testify on Monday for a short time before Skilling takes the stand, probably around mid-morning.
Thus, Week Eleven of the corporate criminal case of the decade will be the Jeff Skilling Week, as the former Enron CEO will probably be on the stand for the entire week and probably a portion of the following week.
Unlike many white collar business defendants, Skilling is anxious to tell his side of the story, and I expect his testimony will be a fascinating look into the conflicting considerations and pressures that surrounded the process of making tough business judgments for a huge company that was often involved in taking cutting-edge risks.
From a business law standpoint, it doesn’t get much more interesting than that, so stay tuned.
Opening Bell: 4.7.06
Senate Deal on Immigration Falters (NYT) Things were looking good when we went to bed last night, but disputes over parliamentary procedure (the bedrock of democracy) threaten to delay the vote until after the Spring recess, “…raising the possibility…
What’s going on at Enron?
Only the jury really knows who’s winning. But for the second best source, I’d go with Tom Kirkendall. Tom’s been tracking the dynamics in play in the Lay-Skilling courtroom on a day to day basis. He applies real expertise in
Tom,
I enjoy your blog and appreciate the commentary about the prosecution keeping the defendants from properly presenting their case. I have a question. V&E did what appears to me a very cursory investigation into Enron’s financials, finding nothing important. The company went bankrupt 2 months later, partly because of a billion dollar write down. V&E did not talk to Lay or Skilling and did not get into many details with Fastow or Glisan. Can Mr. Hedrick claim that V&E did an adequate investigation into Ms. Watkins’ claims?
one more note, as a doctor, I really get hosed by hindsight bias (“How can you let my 95 year old mother die- She had been OK for 95 years?!?!”)
Kenneth, thanks for the kind words.
You are correct that, in retrospect, the V&E investigation appears to have been inadequate. However, let’s look at it given the circumstances that Lay and Derrick were facing at the time.
Skilling had just quit and the market had been hammering Enron’s stock for quite some time. Although the allegations in her memo were serious, Watkins was not an expert in accounting and her allegations regarding fraudulent accounting at Enron had little support within Enron’s management team.
On the other hand, if there was substance to her allegations, then a long investigation — which would have been necessary had Enron hired a law firm and accounting firm that was unfamilar with Enron’s operations — may well have left Enron in worse condition than it would have been had V&E been able to uncover evidence of wrongdoing quickly and Lay could have quickly acted on it. Moreover, V&E interviewed all of the Enron executives who Watkins specifically identified in her memo and, while some of them expressed reservations about Fastow’s conflict of interest, none of them supported Watkins’ amateurish (she was not an expert accountant) accounting analysis regarding Enron’s SPE deals. Inasmuch as Fastow had by that time resigned his position with the SPE’s, V&E concluded that the conflict issue was no longer an issue going forward.
And remember, Derrick and Hendrick were both clear in their testimony that the investigation was preliminary in nature — had they found evidence of wrongdoing, Derrick testified yesterday that it was his and Lay’s intent to follow up with the Enron board to initiate a more thorough investigation. Finally, given the nature of such information, Lay and Derrick knew that it was likely that the allegations in Watkins’ memo would filter into the marketplace, so they definitely wanted to have a quick investigation done in order to combat negative information in the marketplace if, in fact, there was no substance to the charges or, if there was substance to them, they could assure the market that they were being investigated.
Again, with the benefit of 20-20 hindsight, the wiser choice for Lay and Derrick would have been to hire independent counsel and accountants to review the allegations in the Watkins memo. However, I can’t say that Lay and Derrick’s decision was unreasonable under the circumstances that they were confronting, and I am aware of no meaningful evidence that either of these men were acting other than with the utmost good faith in discharging their duties in what they thought was the best interests of the company and its shareholders.
Finally, remember that the billion dollar writedown at the end of 2001 Q3 did not bring Enron down. Heck, AIG’s write down under similar circumstances last year was over $1.5 billion and it did not go out of business. What put Enron under was an overall loss of confidence in the investor and credit markets that was the convergence of many factors, including the write-down, the impact of 9/11, concern over the company’s ability to fund its trading operation, the revelations of Fastow’s effective embezzlement using the SPE’s and other factors. There is no question that AIG’s dire situation last year was helped enormously by the market’s knowledge of what happened to Enron and Arthur Andersen. Indeed, if the timing of the two companies problems had been switched, my bet is that AIG would have been the company that melted down and Enron the one that survived.
One other thought. my late father, a longtime professor of medicine, was also a critic of hindsight bias in medical cases. However, almost all those cases — except in extreme ones — involve hindsight bias in a civil setting. Lay and Skilling face that same problem with regard to the Enron civil litigation, but they are also facing the daunting prospect of having that bias manipulated by the government to take away their personal freedom. That is a use of power that should get all of our attention.
Do you think it would have helped if Mr. Lay had availed himself to the Mr. Hendrick? No one saw Enron’s collapse coming, but a more thourough investigation may have alerted Enron’s leadership of the problems they did not see.
Kenneth, once Lay and Derrick handed the investigation over to V&E, any attempt by Lay to intercede in investigation ran the risk of being perceived, within the prism of hindsight bias, of interfering with the investigation. Thus, Lay and Derrick did the right thing in not attempting to direct V&E’s handling of the investigation, although it may not have been the best decision to hire the firm in the first place.
Theoretically, if you take the case to counsel other than V&E, then it might take too much time to get the new counsel up to speed on what the transactions are–you would be spending a bunch of money and time just trying to explain your business. In this alternative history, then would they to be at blame for not finishing the investigation fast enough, given the time frame of what happened from the time of investigation to the time of collapse? Corporate clients don’t have much patience waiting for attorneys to spin their wheels on stuff-they want answers right away (and maybe fries and a chocolate shake).
In-house counsel deal all the time with corporate ethics stuff–some of it legit and some of it crackpot and some of it where bright well-meaning people completely misunderstood stuff.
It gets extra difficult in that intersection between legal things and accounting things because the lawyers only want to sign off on the lawyering of the deal and the accounting people only want to sign off on the accounting parts of the deal.
No one saw Enron’s collapse coming . . .
right, Fastow wasn’t pulling out cash, Skilling didn’t quit, cut and run with $200 million, there were weapons of mass destruction, we are winning the war in Iraq (it will be over in 2 weeks), and as S.Tracey as Judge Hayward says in Judgment at Nuremberg, “not one German knew?”
it is amazing the depths to which the authoritarian personality with drag any decent society.
V&E was hired to cover-up, was a willing explicit participant in a cover-up. Judge the book by its contents–within days the result of the investigation was a direct attempt to fire the employee
Moe,
You predicted the collapse of Enron? When did you come to that conclusion? What date will GM go down?
I don’t think too many people saw a complete collapse.
Moe –
After additional facts came to light, Enron undertook a complete investigation overseen by Dean Powers in October – over a month before the bankruptcy filing in December. How do you reconcile that with your “VE cover up”?
Joe,
The Powers Report was itself fatally flawed. Its stated mission was to conduct an “independent investigation and review of transactions between Enron and certain related parties” — ie, Enron’s SPEs.
The Report of the Special Committee (the Powers Report) blames Andersen. Despite detailed discussion of fraud within Enron’s SPEs, nothing in the report mentions that Andersen was never the auditor of these SPEs. This is despite the fact that the report cites Andersen’s engagement letter listing Andersen audit responsibilities for Enron but not Chewco or LJM, the focus of the investigation. In three months of study, is it possible that no one on the Special Committee was able to correctly identify the auditors of the SPEs from either the audit opinions or the engagement letters for the years under investigation?
The Powers Report states that “although Andersen reviewed the [Chewco] transaction at the time it occurred, we do not know what information the firm (Andersen) received or what advice it provided.” The only relevant facts regarding the quality of an audit are (1) the information sought by the auditor, and (2) the information received by the auditor. By their own admission, Dean Powers and the Special Committee did not have the relevant facts necessary to reach a valid conclusion regarding Andersen because those facts can only be determined by a knowledgeable and comprehensive examination of the audit workpapers.
In summary, the Powers Report has two fatal flaws: (1) it omits the material fact that Andersen was never hired to audit Enron’s SPEs, and (2) its conclusions regarding Andersen’s audit are without foundation because none of the relevant facts were examined.
Innocent until proven guilty is what our Nation is based on…My Dad,Russell was an honest,honorable man who respected Ken and his wife…we wish them strength to see this through..