Lay-Skilling, Week Fourteen

Week 14 of the corporate criminal case of the decade is in the books and the biggest news is that U.S. District Judge Sim Lake has issued an edict that he does not want the case to go beyond Week 16.

So, it presently looks as if the Lay-Skilling defense will wrap up its case-in-chief next early next week, the Enron Task Force will present a short rebuttal case, and then the reading of the jury charge and the closing arguments will begin on Monday, May 15th with the jury to get the case on Wednesday, May 17th.

So, yes, it does appear that this long slog is really coming come to an end.

The first part of Week 14 was the last chapter of the Ken Lay phase of the trial, and the cross-examination of Lay this week was not much different from last week’s.

Prosecutor John Hueston wasted little time addressing the actual business fraud charges against Lay, choosing again to spend far more time attempting to equate humiliation with guilt in hammering Lay over his personal financial affairs.

Although not particularly persuasive substantively, Hueston’s approach was at least consistent with the Task Force’s strategy of masking a fundamentally weak case through reliance on the real presumption that underlies the Task Force’s theory of the case — i.e., that Enron went bust and Lay and Skilling are rich, so Lay and Skilling must be guilty of some crime.

No corporate criminal trial in recent memory (perhaps ever) has had the extensive media coverage of the Lay-Skilling trial. Multiple blogs and major newspapers cover the trial daily, and the coverage is generally helpful in attempting to keep up with whatís going on in the trial.

However, just as the media coverage generally of Enron from the beginning has been overwhelmingly slanted against the company and its executives, the media coverage of the Lay-Skilling trial has not been particularly insightful in the depth of its analysis of the substance of the Task Forceís business fraud case against the two former executives.

Interestingly, a good dose of the vacuity that passes for analysis of the Lay-Skilling trial comes from the media’s various legal “experts,” some of whom have little or no experience in complex business cases and who appear to be competing with each other to have the most colorful comment of each day.

One such expert even pulled out the Watergate card this week by comparing Lay to the late former president, Richard Nixon.

Really penetrating analysis, eh?

Meanwhile, the media reported breathlessly this week on Hueston’s questioning of Lay regarding his relatively lavish lifestyle and use of Enron stock to pay his company line of credit while attempting to reassure employees and the market that Enron was still a fundamentally strong company.

During and after that testimony, the media covering the trial reached a virtually unanimous consensus that Lay and his defense team had performed poorly.

However, none of the media reports or legal experts raised a key fact relating to the Task Force’s focus on Lay’s personal finances — i.e., that the Task Force has not charged Lay with any crime relating to either his use of Enron stock to pay his company line of credit or his lavish lifestyle.

Sort of an important point, don’t you think?

In reality, the entire line of credit issue smacks of a red herring.

Lay traditionally took a substantial part of his compensation from Enron in stock, which was a good thing for both the company and him. As an accommodation to Lay, Enron’s board approved a line of credit — eventually reaching $7.5 million — that allowed Lay to monetize the stock efficiently by borrowing on the line and then repaying it with his Enron stock.

Each year, Lay and Enron complied with the requirement under S.E.C. rules and regulations to disclose Lay’s use of stock to pay the line.

That arrangement probably wouldn’t have made any difference in this trial except that Lay made what turned out to be a bad financial decision in regard to his personal financial affairs well before the time that the Task Force contends he was involved in wrongdoing at Enron.

Because his $300 million-plus net worth was almost entirely invested in Enron stock, Lay and his financial advisers decided that he should diversify his portfolio.

However, Lay continued to believe that Enron stock was the best value in his portfolio, so rather than selling the stock and using the proceeds to buy other securities, Lay borrowed $100 million from third party financial institutions, pledged his Enron stock as collateral and began buying other assets with the loan proceeds.

In so doing, Lay was exhibiting an optimism and confidence in the underlying value of Enron, a fact that the Task Force conveniently ignores in blithely alleging that Lay knew that Enron was a sinking ship.

Unfortunately for Lay, the steady decline in Enron stock price during 2001 undermined the value of the Enron stock collateral for the $100 million in personal loans that he had used to diversify his portfolio.

Thus, as the collateral value fell and margin calls resulted, Lay used the most efficient facility at his disposal to repay about $70 million of debt in 2001 — i.e., the proceeds from draws on his company line of credit, which he repaid with his Enron stock.

Despite the straightforward nature of the Lay’s line of credit arrangement, the Task Force spent more time on Lay’s handling of it than any other subject during his cross-examination.

Hueston hammered Lay relentlessly over the fact that Lay did not disclose to Enron employees in late October, 2001 that he was using Enron stock to repay the line of credit, on one hand, while advising the employees at the same time that he was purchasing Enron stock and that the stock remained a good value, on the other.

Similarly, Hueston skewered Lay for his draw of a final $1 million on the line of credit roughly five days before Enron filed its bankruptcy case and Lay’s application of those proceeds to pay the remaining balance on the mortgage on his multi-million dollar homestead at the tony Huntington condominiums near River Oaks.

Although the Task Force has not charged Lay with any crime regarding his handling of the line of credit, Hueston repeatedly asserted that Lay’s conduct in regard to it reflects that he is a hypocrite who lacks credibility on other issues.

Lay’s eve-of-bankruptcy draw on the line of credit was clearly ill-advised, but the Task Force is simply wrong in its contention that Lay was largely dumping Enron stock at a time when he was advising employees and the market that it was a good value.

For example, in September, 2001, Lay accepted $10 million in cash and another $10 million in Enron stock when he agreed to step back into the CEO role after Skilling resigned, and Lay used the $10 million in cash to repay a portion of his margin loans.

In so doing, Lay effectively bought $10 million in Enron stock, meaning that Lay acquired over $20 million in Enron stock roughly a month before he made the statements to Enron employees of which the Task Force complains.

Consequently, even though Lay was also paying his line of credit with Enron stock at the same time, his acquisition of another $20 million in Enron stock is consistent with the optimistic view about Enron that Lay was communicating to employees and the public.

In its quest to demonize Lay, the Task Force simply ignores that salient fact.

In view of the Task Forceís emphasis on Lay’s handling of his line of credit, I suspect that the prosecution may attempt to morph Lay’s non-disclosure regarding his use of Enron stock to pay the line of credit into an alleged basis for either a wire fraud or securities fraud charge against Lay.

As noted above, there is nothing in the indictment about any of this being the basis of criminal charges against Lay, so it will be interesting to see how Judge Lake deals with that issue if the Task Force indeed seeks to make such a case to the jury.

However, the underlying weakness of the Task Force’s business fraud case against Lay and Skilling is perhaps best reflected by comparing the number of questions that the Task Force prosecutors asked Lay and Skilling over such titillating issues as PhotoFete and Lay’s handling of his personal finances (literally hundreds) versus the number of questions that the prosecution asked on such core business fraud issues as the alleged Global Galactic agreement and the alleged huge conspiracy at Enron (zero).

Just to underscore the weakness of the prosecution’s case on those points, the Task Force announced on Thursday that it was not going to call former Enron chief accountant and Lay-Skilling co-defendant Richard Causey as a rebuttal witness. So much for the Global Galactic and conspiracy issues.

Accordingly, at the Week 14 pole, the corporate criminal case of the decade appears to be boiling down to PhotoFete and whether Lay should have disclosed that he was using Enron stock to pay his company line of credit while he was touting Enron.

Despite the media’s fixation on Hueston’s hammering Lay regarding his personal finances, Lay actually acquitted himself reasonably well on cross-examination regarding the issues relating to the Task Force’s core business fraud charges.

Moreover, as most of the media fled the courtroom as Lay’s testimony on the lives of the rich and famous ended, a series of expert witnesses continued to poke holes in the foundation of the Task Force’s business fraud charges over the latter part of the week.

For example, I was able to sit in for a couple of hours during Wednesday afternoonís testimony as Skilling accounting expert Walter K. Rush schooled Task Force chief Sean Berkowitz — who does not let a disadvantage in specialized knowledge deter him from lengthy cross-examination — on the validity of Enron’s accounting for its reserves and the resegmentation of the EES retail unit.

Rush was clear and convincing, and explained application of relevant accounting principles to the jury in a clearer manner than any witness to date. Berkowitz was no match for him.

How all of this is going over with the jury is anyone’s guess.

Could a jury convict either or both of the defendants based on such a weak case? Sure, it happens all the time.

However, Skilling and Lay have presented — under extraordinarily adverse circumstances — a compelling defense that they were not involved in any criminal wrongdoing at Enron and that the company’s failure was, at worst, the result of business misjudgments, such as maintaining too low a credit rating and too much leverage for a company with a huge trading operation to endure the post-bubble and post-9/11 market’s reaction to the negative Fastow/Kopper-fraud disclosures during the fall of 2001.

Can a jury immersed in anti-Enron publicity for the past five years see through beguiling theories of massive frauds, conspiracies and high lifestyles to grasp that simple truth?

That’s the key question still to be answered in Houston as the corporate criminal case of the decade enters its final two weeks.

10 thoughts on “Lay-Skilling, Week Fourteen

  1. Opening Bell: 5.5.06

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  2. Can a jury immersed in anti-Enron publicity for the past five years see through beguiling theories of massive frauds, conspiracies and high lifestyles to grasp that simple truth?
    Sad to say..but they sure can, one need only look to the Nigerian Barge Trial and wrongful convictions of those men. A public vendetta of sorts, especially in Houston.

  3. Tom,
    I have to disagree with your opinion that Mr. Lay represented himself well. Most jurors are going to be biased or resentful of any boss or CEO. As Mr. Lay tried to forcefully explain himself, he came across as controlling- a trait most regular joe’s really dislike in most bosses. Also, his memory left him at conveniently inopportune (sp?)times. I have no idea if the character witnesses helped or hurt Mr. Lay.
    The other problem both Mr. Lay has is that the company collapsed under his watch. Most jurors are going to assume someone should have caught Mr. Fastow earlier, and assume that since his embezzlement continued, somehow the SPE’s illegally (or unethically) benefitted Mr. Lay and Mr. Skilling. It would have been nice if there were witnesses who could detail other companies that used SPE’s in their accounting (if SPE’s are such a good idea, someone else is currently using them. That evidence may have been deemed inadmissable or strongly discouraged by the Task Force)
    Although the prosecution has not mentioned the Global Galactic agreement or the conspiracy, the prosecution has damaged the credibility of Mr. Lay and Mr. Skilling. I came into this trial assuming they were guilty; I have tried to keep an open mind. I know they were guilty of some bad judgement, but not of a conspiracy. The whole 114 co-conspirator list does stack the deck against the defense.
    I should get back to work. Thanks for your insight.
    BTW- you and Loren Steffy should have an online chat.

  4. Tom,
    Thanks for your excellent analysis.
    I was surprised that in the description of Enron’s meltdown, the defense didn’t use some of the information from the Enron Bankruptcy Reports to substantiate their “run on the bank” theory.
    The Bankruptcy Examiners Batson & Goldin reviewed not only Enron & Enron’s SPEs but the numerous banks. Those banks signed documents saying they were “investing” in Enron’s SPEs when in reality they accepted Fastow’s oral promises of repayment & properly recorded the same transactions on their own books as loans. Not having any loan agreements naturally made the banks nervous about their ability to enforce repayment from Enron’s SPEs. Therefore the Bankruptcy Examiners found widespread documentation of the fraud in loan committee agendas, minutes of loan committee meetings, e-mails, etc. and these were quoted in the Bankruptcy Examiners Reports.
    A review of these quotes yields 3 themes consistent at the various banks, 2 of which help the defense:
    1) The banks knew that Fastow didn’t want to sign loan agreements because if Andersen knew that the “investments” were really nothing other than loans, Andersen would require Enron to use different accounting.
    2) The banks were dealing with Fastow. The names of Lay, Skilling & Causey were not mentioned in the banks’ documentation. In fact, at Barclays, bankers worried about how they would collect if Fastow were fired.
    3) As would be normal in any loan situation, the banks wanted to know about Enron’s existing debt before increasing Enron’s debt limit. Each bank knew that they were helping Enron disguise debt and they knew that others were, too. So they tried to estimate how much disguised debt was outstanding in total before they would authorize disguising more. One banker at Royal Bank of Scotland worried that if there were some sort of shock to the market, Enron might crater & the bank’s part in the fraud would be exposed. He wasn’t sure the huge fees were worth the risk. But the disguised loan was subsequently approved.
    Given this detailed info on the thinking at the various banks, it is easy to see why Enron’s cash dried up. When the Chewco/JEDI fraud was exposed & Andersen withdrew its opinion & notified the Justice Dept. & SEC, the banks were on the horns of a dilemma. Should they extend credit as would be normal if Chewco/JEDI were the only fraud? Or should they deny credit, knowing that Chewco/JEDI was only the tip of the iceberg? Most denied credit.
    So the “run on the bank” theory applies not only to the fact that energy trades will dry up unless they are assured you deliver the goods. The same theory applies to the fact that the banks dried up with reference to Enron because the banks knew more about Fastow’s frauds than possibly Lay, Skilling & Causey.

  5. Mary, during pre-trial proceedings, Judge Lake ruled that the contents of the Powers, Batson and Golden reports were inadmissible in the Lay-Skilling trial. In my view, it was the correct decision and supports my view that the conclusions contained in those reports must be viewed with a large grain of salt.
    The conclusions of each reports are questionable because of the motivations and the incentives behind them. For example, the Powers report reflected the motivation and incentive of the Enron board to blame management and, in so doing, deflect critical scrutiny of the board’s own inadequacies. As a result, the Powers report delivered harsh judgments of Enron’s management, but largely ignored the fact that the SPE vehicles were vetted by the Enron board, particularly Pug Winokur, who actually was involved in structuring the Raptor model. Of course, none of that familiarity with the structures is any evidence that the board or anyone else knew of Fastow’s embezzlement and fraud in regard to them, and that’s one of the reasons why Judge Lake did not allow the prosecution use them in the Lay-Skilling trial.
    Similarly, Batson’s incentives and motivations in preparing his report have been among the least examined issues in the Enron case. Batson had a strong commercial interest to condemn the accounting of the SPE’s because he was lobbying to bring the independent entities created in connection with those vehicles into the Enron estate for the benefit of his constituency (i.e., Enron’s creditors). In the meantime, Batson was using his dubious findings regarding the SPE’s as one of the primary reasons that he justififying his $100 million fee in the Enron chapter 11 case.
    In reality, Batson’s claims to date have not stood up well under the scrutiny of objective legal proceedings. For example, note this post regarding the civil case brought against JP Morgan in London over Enron’s derivative pre-pay transactions and structures. The London court’s judgment is a reasoned and damning indictment of Batson’s hatchet job regarding those transactions in his report.
    Consequently, be careful in relying too much on the Batson and Golden reports. As reflected by the paltry evidence that the Task Force has mounted during the Lay-Skilling trial regarding alleged fraud in the structuring of the SPE’s, it’s not at all clear that the conclusions contained in the Powers, Batson and Golden reports along those lines would stand up under the test of truly objective analysis.

  6. Tom,
    Points well taken. I was referring to the source documents quoted in the reports, not the conclusions drawn.

  7. The Lay/Skilling defense finished by blowing big holes in the prosecutions case.

    I guess nobody noticed.

    It was the ìexpertsî that did it, forcing attention to mundane facts rather than exciting things like girlfriends and Photofete.

    Reporters predictably found this testimony intolerable and abandoned their posts to the point Iíve found no source for what Mr. Arnold had to say. But Mr. Rush was quite enough. He blew off Delaineyís testimony on the grounds that Enronís transfer of EES losses to wholesale was perfectly proper. Separately, he blew off Paula Reiker, Mark Konig, and Wes Cowell on the quarterly earnings business about pennies on the earnings inidicating that such things happened at all companies in the rush to report. (Something by the way those two could not have readily known since they worked only at one company, Enron, at such a high level.)

    Mr. Rush was rather unequivocal. If heís right, theyíre wrong, or at least their testimony is pretty worthless. Nothing they described is untoward according to Mr. Rush. Nor did his testimony provide much wiggle room. Surely one would expect that Mr. Rush is going to get on the stand and try to make any pig look as pretty as possible on behalf of his client. But he went way beyond that. He even came up will a brilliant metaphor for those who donít think the jury can understand accounting: pennies in the pockets, while pointing out the losses were in fact intracompany losses. (Its like you have two pennies in each pocket and transfer one from one pocket to the other, you still have 4 pennies.) So the jury has to decide whether to credit him or the other witnesses. Iíll opine below on the credibility issue, but assuming for the moment heís neutralized these witnesses, what is the prosecution left with in terms of testimony?

    Well Fastow and Rice.

    I believe that if one accepts Andyís story as opposed to Jeffís, Jeff is done. The most critical testimony is that related to the Global Galactic agreement for which Andy claims to have documentary proof that confirms Jeffís participation in the fraudulent guarantees offered to the equity holders, i.e. Andy and his friends. So how does the jury balance the credibility of these, both of whom have an extreme self interest in the story the put forth, Andy to come through on his not yet consummated deal with the prosecution, and Skilling to avoid jail? I think itís transparently obvious that Causey, the alleged intermediary in Andyís deal with Skilling will not corroborate Andyís stuff. Otherwise heíd be on the stand for the prosecution putting the final nail in Jeffís coffin. I donít buy this idea that heís dangerous for both sides. At this point the prosecution knows what heís going to say and the defense doesnít. This means itís very safe for the prosecution to call him for the limited purpose of corroborating Fastow, and even if, which I doubt, the defense can use this to claw into other matters, Skilling is still dead. The defense at this point, however, has no idea what Causey might say. He could go against everything he told them when he was a codefendant. Even if heís called for the limited purpose of refuting Andy, they donít know what heís going to say because of course his incentive to lie has been reversed 180 degrees.

    If Causey wonít corroborate Andy on GG, then one must conclude that in all likelihood Andy is lying and has forged the GG. Not a certainty, but the more likely conclusion. In fact, if Causey is not corroborating, I bet the prosecution is pretty unhappy with Andy for having led them down the path.

    Again, I was impressed with Riceís testimony and thought it was big trouble for Jeff. But again we find that a critical document, the Analystís Meeting Presentation, allegedly modified with lies at Jeffís direction according to Rice, was dated after the meeting. Shades of the Broadband trial: Rice being caught for the second time lying about lying. And then they attempt to reconstruct him with an earlier dated version of the same document that mysteriously appears on his, Riceís home computer, which it could not physically be on. Rice is coming back, so maybe there is some explanation that staunches this bleeding wound, but right now, I donít see how one can avoid being be very skeptical of what Mr. Rice has to say.

    Finally, Iíll opine as to credibility of the ìexpertsî vs the Enron folks.

    There are two factors that might give one pause per accepting the Enron folkís version of events. First, they have an obvious incentive to please the prosecution to diminish potential jail sentences. And letís be clear about the nature of their criminal liability. In each case they have done what the prosecution deems to be insider trading. This ranges from almost trivial (Reiker) to flamboyant (Rice). This alleged criminality is entirely separate from the charges against Skilling and Lay and is totally independent of the conspiracy in which they all were alleged to be criminally engaged. So these folks arenít necessarily going to jail because the weight of evidence forced to admit they were coconspirators, but rather because of things they did entirely on their own and they have every incentive to please the prosecution to reduce the effect on them of what they did do. Admitting to the alleged conspiracy costs them nothing: theyíre going to jail for other things, the only relevant question is how long.

    Second, it is a well-known psychological fact that a person, who is under the control of another who has dire power over him or her, has a strong tendency to buy into that personís point of view. Applying that hypothesis to this situation, life becomes much easier for the witnesses if they start to accept wholeheartedly the prosecution theory, even if they might have found it preposterous had not the prosecution had such power over them. ìTeachersî with near life and death power may have reeducated them. (BTW it would be relatively easy to test this: ask similarly situated people at Enron not subject to independent insider trading prosecution whether they thought there was a conspiracy. Iíll bet a dollar to a donut theyíd say no in the overwhelming majority.)

    Compare these incentives and influences to those impinging on the ìexperts.î The experts first of all are volunteers in this. They didnít have to do it. Of course theyíre getting paid, and paid outsized amounts. The press loves to seize on this with the implication their testimony is bought and paid for, but logically these circumstances cut another way. These guys are obviously well off. Half a million or a million to them is not what it is to the guy on the street. Further theyíve put 6 months to a year of their professional lives into this, no small thing. From a strictly pecuniary point of view, if they, in this trial, are viewed as putting forward wholly or largely wrong testimony to serve a clientís end, their usefulness in the future to other clients will be reduced. So will their fees. Additionally these guys have a professional standing among their peers that they value in addition to fees. That standing is not, as might a lawyerís standing, raised by getting a guilty client off on false premises (or getting an innocent man convicted). Such a result would instead lower their reputation. Their standing would be raised mostly be being right under difficult circumstances or with a difficult analysis.

    The witnesses against Skilling/Lay, on the other hand have little interest in their courtroom standing beyond this case. Iím very sure none of them want to go through something like this again. So if later it becomes clear they shaded the truth against Lay and Skilling, they might have a pang of guilt, but they will have served less time. The basic incentives to weigh are saving jail time against mere money, albeit a pretty nice amount.

    Under these circumstances, I think itís logical to find the experts the more credible.

    But what of the prosecutionís overarching conspiracy charge? Itís first up in the indictments.

    I thought it was preposterous when I first heard it. Little has emerged to change my opinion. No overt act furthering the conspiracy has been attached to Lay or Skilling. The idea that a conspiracy involving 130 people could be kept secret for five years seems silly. What was the mechanism by which the conspiracy was communicated and maintained? Lay and Skilling are not mob bosses. They didnít have people ìwhackedî for ratting on them. Among other things, many people within the top 130 executives left during that period of time (as youíd expect of any company). What was to keep them from ratting out the scheme?

    There were surely overarching conspiracies at Enron. Virtually everyone at the company was engaged in a conspiracy to increase earnings, mark to market or otherwise, and worked very hard at it. But this conspiracy was far from unspoken: it was broadcast every day. There was also a conspiracy to inform the investing public about Enronís success, and to put that in the best light permissible under the rules. If this is what the prosecution means by conspiracy, then theyíve got it. Of course they could also accuse virtually everyone in a public company of the same thing.

    Of course all this doesnít mean Skilling and Lay are innocent, or even not guilty. The prosecution simply has chosen not to dig into the details of why Enron went down and link that to possible and complex wrongdoing by the two. Allegedly the prosecution has not gone into such things for fear of confusing the jury. But this choice has left them with a shadow puppet trial in which we see some flat images moving around that might signify something but do not see the reality itself. Deeply buried in the finance and accounting details of Enronís downfall, there are some questionable acts on the part of Skilling and even Lay. Maybe theyíve got a very good explanation for these. But weíll never know because the prosecution never dug into it.

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  9. Tom, Lay shot himself in the foot worse than you can imagine. As Loren Steffy put it, it doesn’t matter what happens here. It’s the 18th the Lay dreads. Lay cost me my retirement. Plain and simple. Lay also has a date with the IRS. They are always years behind their man. They are the vultures that pick the bones. The Bank Fraud will get him.

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