Skilling's Appeal and Enron's Legacy
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"Oh yes, yes of course industrial dominance is a global problem, it sure is!" Jeff Skilling being interviewed on the crosswalk towards court during the Enron trial, by Stephan GM Tychon of the Netherlands -outside investigative and explanatory journalist with xxell.com, the only one to get Skilling answering his questions in the street. Friday, August 22, 2008 |
Brokerage firms reach auction rate securities agreement with regulators
Steve Czajkowski at 9:26 AM ET
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Today is a win for investors and a win for the market, and to date we’ve returned close to $50 billions back into the pockets of investors... At the heart of this investigation, is improving confidence for the investor and for the market, and today we’ve taken another giant step forward towards fulfilling this goal.The settlement also requires the banks to make payments to any investors who sold the securities for a loss, and require them to pay penalties in the amounts of $125 million for Merill Lynch, $22.5 million for Goldman Sachs, and $15 million for Deutsche Bank. This particular settlement is part of a larger investigation [press release] into 30 different firms which sold approximately $60 million in auction rate securities to retail investors. The Wall Street Journal has more. The New York Sun has additional coverage.
In 2006 Merill Lynch agreed [JURIST report] to pay $164 million to settle 23 class action lawsuits involving Merrill Lynch's research of online companies in the 1990s. Also in 2006, four former Merrill Lynch executives found guilty of charges connected with an Enron [corporate website; JURIST news archive] Nigerian barge scam, had their convictions overturned [opinion text, PDF; JURIST report] by the Fifth Circuit [official website]. Experts believe that due to the success of the former Merrill Lynch executives, the appeal [JURIST report] of former Enron CEO Jeffrey Skilling [Houston Chronicle profile] has a good chance of success. Skilling was convicted under the theory of "deprivation of honest services," which allows for the prosecution of those who enabled fraud but did not personally benefit from it.
Skilling's Appeal and Enron's Legacy
Regardless of the outcome—which very well may be favorable to Skilling—the question remains: Why didn't Enron's board pay more attention?
Nearly seven years after its collapse, Enron continues to fascinate those interested in the leadership and governance of companies.
The latest chapter of the Enron story opened on Apr. 2 at the Fifth Circuit Court of Appeals in New Orleans. Lawyers for former Chief Executive Officer Jeffrey Skilling argued that his 2006 conviction on 19 counts of fraud, conspiracy, insider trading, and lying to auditors—along with his 24-year prison sentence—should be overturned. Some four months later, a ruling by the appellate court on Skilling's appeal is near.
A great deal is at stake with the court's ruling. For Skilling, the judges' ruling will either seal his fate as a convicted criminal or open up possibilities for further vindication. (In the 2006 trial, nine of the ten insider-trading counts against him were dropped.) However, for the rest of us, the ruling will do much to define the true legacy of the Enron case.
If the appellate court overturns the lower court's conspiracy conviction, which is possible in light of recent precedent in similar conspiracy cases, such a partial decriminalization of Skilling's conduct will reopen discussions of what was the real offense committed by Skilling. The answer to this question is important because many of Skilling's allegedly fraudulent activities fall into what Owen D. Young—the founding chairman of RCA and NBC, and later chairman of GE (GE)—once called the "shadowed space" or "penumbra" between the clear light of doing right and wrongdoing, where the law is unclear and the spirit of the law is open to interpretation.
A close reading of the record suggests that much of Enron's behavior fell into this penumbra. But that same record also suggests that Skilling lost his way in this shadowed space by encouraging and tolerating aggressive gaming of accounting and SEC rules throughout that portion of the company where he had direct authority and accountability. Former SEC Commissioner Arthur Levitt made this savvy observation in the immediate aftermath of Enron's collapse, and this judgment looks as correct today as it did seven years ago. Since Enron is certainly not the only company to have engaged in such gaming, the important question raised by this marker case is how to rein in the kind of aggressive, but not incontestably illegal, gaming of society's rules that led to Enron's collapse.
The answer points to three persistent tasks of corporate governance: the avoidance of perverse incentives for executives, the strengthening of board oversight, and the reinforcement of ethical discipline in the conduct of business affairs.
Enron's approach to compensation and incentives included many perverse features: It encouraged growth over profitability. It rewarded employees for closing commodity deals and power-generation projects without concrete evidence of their future profitability. It deepened a deadly addiction to pumping up the price of the stock through a variety of obfuscating maneuvers. It helped encourage a corporate culture that tolerated and sometimes encouraged deception. It created many opportunities for executives to reap enormous personal gains from gaming accounting and SEC rules.
If Enron-type breakdowns are to be avoided in the future, corporate boards need to keep in mind seven propositions—drawn directly from Enron's experience with perverse incentives—that collectively address the potentially perverse effects of turbocharged financial incentives.
• That awarding "up front" bonuses—before cash and profits flow from commercial endeavors—invites employees to maximize their short-term pecuniary interests while compromising the company's long-term interests.
• Systems of reward that ignore comparative measures of business performance vis-à-vis leading competitors often lead to overcompensation and lull executives into a false sense of security.
• Pay-for-performance systems that ignore rigorously applied subjective judgments often promote gaming behavior and otherwise provide insufficient direction to executives.
• Stock options that are not indexed to both the movement of capital markets and gains in the price of competitors' stock can give executives unearned windfalls for uncompetitive performance and promote unwarranted overconfidence.
• Awarding stock grants without restricting the amount and timing of their sales weakens their incentive effects, allows executives to benefit from short-term rises in stock price, and creates conflicts of interest for corporate insiders vis-à-vis ordinary shareholders.
• Pay-for-performance systems that lack provisions for rescinding bonuses if companies revise their past or expected performance invite people to lie and game the system.
• Turbocharged incentives require turbocharged controls.
Board Oversight
One of the mysteries in the Enron case is how Enron's board of directors failed on so many levels to detect or deter questionable applications of accounting principles and rules. It failed to question the wisdom of using its own stock to hedge merchant investments rather than contracts with bona fide counterparties. It failed to monitor the conflicts of interests that the board itself had approved involving Fastow's dual role as Enron's chief financial officer and the managing partner of several off-balance sheet partnerships that purchased assets from Enron. And it failed to see and react to many "red flags" indicating that Enron's economic performance and its public commitment to ethical values were deteriorating.
Enron had a distinguished board—all hand-picked by former Chairman Kenneth Lay. At least some directors understood the natural-gas and power-generation business. How many actually understood derivatives, derivatives trading, and derivatives accounting is not clear. What is clear, however, is that the effectiveness of Enron's board was diminished by the following factors: Skilling's and Lay's intolerance of dissent, an incestuous relationship between Arthur Andersen auditors and Enron, weaknesses in Enron's esteemed risk-management process, a notable lack of rigor in examining the use of off-balance sheet partnerships, group norms against criticizing Ken Lay, and outmoded board processes. This mix of factors was sufficiently toxic to put the corporation in mortal danger.
To deter further Enron-type breakdowns in board oversight, public companies need to consider four innovations:
• Expanding their cohort of directors to include retired executives and entrepreneurs, independent of age, who have the time to serve as truly focused directors;
• Increasing the level of director compensation to keep attractive directors and candidate directors from drifting to the profitable world of private equity or other less risky assignments;
• Requiring that a different degree of directors' wealth be at risk through meaningful investments in company shares to ensure they have interests totally aligned with those of shareholders;
• Completely separating the role of CEO and board chairman.
This last innovation is the most important one. It is simply contrary to human nature to expect total objectivity from a CEO regarding his or her performance. One cannot expect a CEO in the role of chairman to prepare the board to evaluate lapses and failures on his or her part, or on the part of his or her management.
Today, a full 94% of the Standard & Poor's 500-stock index companies now have nonexecutive chairs or "lead" directors that coordinate the work of all independent directors, up from 36% in 2003. But the lead director solution is not adequate. Without a truly independent board chair who controls the recruitment and tenure of directors, sets the board's agenda, selects the information that flows to the board, and oversees the process of evaluating CEO performance, directors will be unable to shift the power environment of the board so that they no longer see themselves as employees of the chairman and CEO.
Ethical Discipline
What Skilling and Lay failed to understand as leaders is that compliance with espoused ethical and legal standards is an organizational achievement. Or, to put it put slightly differently, despite the values and ethical guidelines published in Enron's Code of Ethics (available as a collectible on eBay (EBAY)), it was unreasonable to expect that a single individual at Enron, no matter how well-endowed with principled judgment, could be expected to remain untouched by dereliction or excessive gaming of accounting rules without positive, organized support. Skilling and Lay failed to provide that support.
Whatever the espoused intentions of Enron's leaders, the organization's commitment to the qualitative aspects of individual and group performance (such the protection of corporate integrity and reputation, respectful behavior, truth telling, legal compliance, and a host of other possible social goals) began to break down under pressures to maintain its meager profitability. This breakdown was hastened by Enron's turbocharged incentives, which offered executives enormous bonuses tied to estimated future profits and a very generous stock-option plan that paid out richly as Enron's stock became increasingly overvalued.
Creating an environment that supports ethical discipline requires precisely what Enron lacked in its governance practices:
• Sustained attention to the qualitative objectives and ethical standards of the organization;
• Balanced incentives that reward and penalize results other than economic performance;
• Systematic audits of decisions made by key executives in areas where the rules are ambiguous (as in structured finance transactions) and the risks to reputation high (as in opaque financial reporting); and
• Continuous monitoring of senior executives for evidence of what sociologist Philip Selznick has identified as two major sources of leadership failure—personal opportunism and utopianism.
Personal opportunism involves the pursuit of immediate, short-term individual advantage while ignoring considerations of principle and long-term consequence. In the end, unchecked personal opportunism and greed ruined Enron.
Utopianism enables leaders to avoid hard choices by a flight to abstractions. In Enron's case, the overgeneralization of purpose—at first, to be the best energy company in the world and, next, to be the best corporation in the world—provided few business-specific decision criteria for Enron executives. In their absence, personal preference tended to replace decision-making based upon the espoused ideals and distinctive competences of the company. In short, the utopianism of Enron's leaders created an environment where personal opportunism ran rampant.
Along the way Enron lost track of its ideals. This loss of ideals reveals the most important lessons of the Enron story—that financial success without an ethical foundation leads to disaster and that the governance of public companies requires relentless attention by elected directors to the ethical discipline of executives who are accountable to them.
Malcolm S. Salter is the James J Hill Professor, Emeritus, at the Graduate School of Business Administration Harvard University. From 1967 to 2006, Malcolm Salter was a member of the Harvard Business School faculty where, most recently, he served as a Senior Associate Dean. His latest book, Innovation Corrupted (Harvard University Press, 2008) is about the collapse of Enron. From 1986 to 2006 Professor Salter was president of Mars & Co., an international strategy-consulting firm. Professor Salter is a graduate of Harvard University where he received his AB, MBA, and DBA degrees.
- Posted on Monday, August 4, 2008
Enron setbacks could hurt other white-collar prosecutions
By Marisa Taylor | McClatchy Newspapers
WASHINGTON — Almost seven years after the energy giant Enron collapsed, a series of court decisions has opened the door to new trials for some of the convicted corporate executives and threatened to hobble the Justice Department's efforts to pursue future corporate-fraud cases.
In the wake of the scandal, prosecutors pursued executives for covering up the company's financial bleeding and unloading millions of dollars in stock. The Bush administration was under pressure to hold the company's executives accountable for what at the time represented the largest bankruptcy in U.S. history. More than 4,000 Enron employees lost their jobs, and investors lost billions.
However, legal experts said the government's recent setbacks in court raised troubling questions about how federal prosecutors handled the high-profile cases and suggested that the Justice Department could face serious obstacles in other white-collar investigations:
- In one defeat for the Enron prosecutors, the usually divided Supreme Court in 2005 unanimously overturned the conviction of Enron accounting firm Arthur Andersen after the justices found that the trial judge had instructed the jury improperly.
- In another case, four former executives from Enron's Internet subsidiary, Enron Broadband Services, are getting another trial after a federal jury acquitted them on some charges and deadlocked on the rest. The group was accused of exaggerating the firm's technology capabilities in order to inflate stock prices and cash out. One former executive was acquitted in the original trial.
- Three Merrill Lynch executives are being retried after the 5th U.S. Circuit Court of Appeals reversed most of their convictions. They're accused of helping to inflate Enron's earnings by arranging a fraudulent sale to their company of three electricity-generating barges off the coast of Nigeria. A jury acquitted a fourth executive, and the conviction of a fifth was thrown out because of a lack of evidence.
- Finally, prosecutors are under fire in the conviction of former Enron Chief Executive Officer Jeffrey Skilling because of allegations that they withheld evidence that could have cleared him. A federal appeals court also tossed out a legal approach that the prosecutors used, giving Skilling and future defendants new ammunition to challenge their convictions.
Prosecutors secured 18 guilty pleas, but the legacy of the entire Enron investigation is at stake in Skilling's appeal and the 5th Circuit's ruling in the Merrill Lynch case gives Skilling a realistic shot at overturning at least part of his conviction, experts said.
"Skilling is kind of the linchpin," said Peter J. Henning, a Wayne State University law professor and a former Securities and Exchange Commission attorney. "If his conviction stands, the Enron prosecutions were a success. If it doesn't, prosecutors will have a hard time convincing the public that they took the right approach."
In its 2006 ruling in the Merrill Lynch case, the 5th Circuit struck down the government's reliance on the so-called "honest services" theory, which allows prosecutors to pursue suspects who enabled fraud but didn't profit from it directly, a common allegation in corporate scandals.
Prosecutors still rely on the theory despite the ruling, Justice Department spokesman Peter Carr said, "but it's clear that the law is evolving in this area."
"Whenever a court rules — as the 5th Circuit did regarding this issue — we listen to that ruling," he said.
Skilling, who's serving a 24-year prison sentence, is awaiting the outcome of his appeal before the 5th Circuit. A jury convicted him of 19 counts of conspiracy, insider trading and lying to auditors. Kenneth Lay, Enron's former chairman of the board, also was convicted, but he died of a heart attack before he could be sentenced.
Defense attorneys contend that prosecutors responded to the public outcry over the Enron scandal by bringing unwarranted charges, taking shortcuts and relying on unorthodox tactics to win convictions.
"I've never seen such egregious misconduct by any prosecutor," said Sidney Powell, a former federal prosecutor who represents one of the defendants. She's filed a misconduct complaint against Matthew Friedrich, a former Enron prosecutor who now heads the Justice Department's Criminal Division.
The defense attorneys cite newly released FBI notes of interviews with former Enron Chief Financial Officer Andrew Fastow, a key government witness in the Enron cases.
Prosecutors are required to turn over to the defense FBI summaries of interviews of testifying witnesses such as Fastow. But throughout the Skilling trial, prosecutors declined to hand over the usual FBI summaries of the hundreds of hours of interviews with Fastow. Instead, they provided what defense attorneys called "summaries of summaries." Agents destroyed the original summaries.
Since the 5th Circuit ordered the Justice Department to turn over the full FBI notes to the defense, Skilling's lawyers contend that they've found dozens of facts in the documents that could have cleared their client.
The Justice Department declined to comment on the allegations of misconduct.
In court papers, department lawyers have said that defense attorneys received all the evidence to which they were entitled. The Justice lawyers called an attempt by several defense attorneys to dismiss charges because of alleged misconduct "stunning" and "an attempt at character assassination" despite "the paucity of evidence to support the claims." If small details weren't divulged, the department lawyers said, the new information wasn't sufficient to clear the defendants.
"To be clear, we vigorously oppose the defendant's every accusation of prosecutorial misconduct," the lawyers wrote in response to Powell's allegations.
Some former prosecutors say that the Enron investigation suffered from a perennial problem at the Justice Department. When regulators fail to detect or prevent corporate malfeasance, prosecutors and investigators find themselves under pressure to pursue rich, powerful and resourceful suspects with complex charges that are difficult to explain to juries. Even if they win convictions, when the crisis blows over they're on the defensive for lacking sufficient evidence or acting too aggressively.
John Kroger, who oversaw one of the Enron indictments in question, has described a pressure-cooker atmosphere in which the Bush administration "was motivated to get some scalps quickly."
"The Bush team knew that if it failed to move aggressively on Enron, there would be a huge political price to pay," he wrote in his new book, "Convictions: A Prosecutor's Battle Against Mafia Killers, Drug Kingpins and Enron Thieves."
Defense attorneys have seized on passages in Kroger's book to support their contentions. For example, unlike in other corporate fraud cases, Kroger wrote, he and other prosecutors didn't delve into the millions of company documents to prove their cases.
"The Enron business records were so voluminous and hard to decode we thought it could take years to determine what evidence was relevant," he wrote.
At one point, he calculated that if prosecutors had tried to analyze each of Enron's 3,500 potentially fraudulent financial transactions, "it would take the six of us more than a decade."
In an interview with McClatchy, Kroger denied that prosecutors had responded to the pressure by pushing weak cases.
"We tried as hard as we could to do a thoughtful and conscientious job in a very difficult case," said Kroger, who's now running as a Democrat for Oregon attorney general.
Several former prosecutors assigned to the task force that oversaw the investigation dismissed the defense lawyers' criticism as a routine part of the appeals process when defense attorneys try to clear their clients.
And even if defense lawyers convince a court that misconduct occurred, their clients still could be guilty of crimes. In dismissing the charges against the Merrill Lynch executives, the 5th Circuit said that its opinion "should not be read to suggest that no dishonest, fraudulent, wrongful or criminal act has occurred."
When Justice Department spokesman Peter Carr was asked about the department's view of the investigation's success, he replied: "The book is not finished, as many of these issues continue to work their way through the courts."
There are signs, however, that the Justice Department already is taking a different tack. Prosecutors are relying frequently on deferred prosecutions, which allow corporations to pay fines but avoid indictments.
In a separate development, Attorney General Michael Mukasey announced in June that he wouldn't create an Enron-like task force to oversee the investigation into the sub-prime mortgage crisis. Although he said he made that decision because he thought that individual U.S. attorneys could handle the job, some suspect that the Justice Department is trying to avoid a repeat of the sprawling Enron investigation.
"They're trying to avoid being attacked for what some may call the excesses of the Enron and other earlier corporate-fraud matters," said Roma Theus, a former federal prosecutor who's now a defense attorney. "The government was very aggressive, and they may have gone too far in their prosecution theories."
No matter what the outcome, former Enron prosecutor Kroger predicted, the public would demand the same forceful action after the next "boom and bust cycle."
"We see this cycle repeated over and over again," Kroger said. "We regulate very loosely, then we have a crisis and we react strongly. Then, we grow complacent again."
McClatchy Newspapers 2008
Enron setbacks cast pall on cases
Posted on Sunday, August 10, 2008
WASHINGTON — Almost seven years after the energy giant Enron Corp. collapsed, a series of court decisions has opened the door to new trials for some of the convicted corporate executives and threatened to hobble the Justice Department’s efforts to pursue future corporate-fraud cases.
In the wake of the scandal, prosecutors pursued executives for covering up the Houstonbased company’s financial bleeding and unloading millions of dollars in stock. The Bush administration was under pressure to hold the company’s executives accountable for what at the time represented the largest bankruptcy in U. S. history. More than 4, 000 Enron employees lost their jobs, and investors lost billions.
However, legal experts said the government’s setbacks in court raised troubling questions about how federal prosecutors handled the high-profile cases and suggested that the Justice Department could face serious obstacles in other white-collar investigations: In one defeat for the Enron prosecutors, the usually divided Supreme Court in 2005 unanimously overturned the conviction of Enron accounting firm Arthur Andersen after the justices found that the trial judge had instructed the jury improperly.
In another case, four former executives from Enron’s Internet subsidiary, Enron Broadband Services, are getting another trial after a federal jury acquitted them on some charges and deadlocked on the rest. The group was accused of exaggerating the firm’s technology capabilities in order to inflate stock prices and cash out. One former executive was acquitted in the original trial.
Three Merrill Lynch executives are being retried after the 5 th U. S. Circuit Court of Appeals reversed most of their convictions. They’re accused of helping to inflate Enron’s earnings by arranging a fraudulent sale to their company of three electricity-generating barges off the coast of Nigeria. A jury acquitted a fourth executive, and the conviction of a fifth was thrown out because of a lack of evidence.
Finally, prosecutors are under fire in the conviction of former Enron Chief Executive Officer Jeffrey Skilling because of allegations that they withheld evidence that could have cleared him. A federal appeals court also tossed out a legal approach that the prosecutors used, giving Skilling and future defendants new ammunition to challenge their convictions.
Prosecutors secured 18 guilty pleas, but the legacy of the entire Enron investigation is at stake in Skilling’s appeal, and the 5 th Circuit’s ruling in the Merrill Lynch case gives Skilling a realistic shot at overturning at least part of his conviction, experts said.
“Skilling is kind of the linchpin,” said Peter J. Henning, a Wayne State University law professor and a former Securities and Exchange Commission attorney. “If his conviction stands, the Enron prosecutions were a success. If it doesn’t, prosecutors will have a hard time convincing the public that they took the right approach.” In its 2006 ruling in the Merrill Lynch case, the 5 th Circuit struck down the government’s reliance on the so-called “honest services” theory, which allows prosecutors to pursue suspects who enabled fraud but didn’t profit from it directly, a common allegation in corporate scandals.
Prosecutors still rely on the theory despite the ruling, Justice Department spokesman Peter Carr said, “but it’s clear that the law is evolving in this area.” “Whenever a court rules — as the 5 th Circuit did regarding this issue — we listen to that ruling,” he said.
Skilling, who’s serving a 24-year prison sentence, is awaiting the outcome of his appeal before the 5 th Circuit. A jury convicted him of 19 counts of conspiracy, insider trading and lying to auditors. Kenneth Lay, Enron’s former chairman of the board, also was convicted, but he died before he could be sentenced.
Defense attorneys contend that prosecutors responded to the public outcry over the Enron scandal by bringing unwarranted charges, taking shortcuts and relying on unorthodox tactics to win convictions.
“I’ve never seen such egregious misconduct by any prosecutor,” said Sidney Powell, a former federal prosecutor who represents one of the defendants. She’s filed a misconduct complaint against Matthew Friedrich, a former Enron prosecutor who now heads the Justice Department’s Criminal Division.
The defense attorneys cite newly released FBI notes of interviews with former Enron Chief Financial Officer Andrew Fastow, a key government witness in the Enron cases.
Prosecutors are required to turn over FBI summaries of interviews of testifying witnesses such as Fastow. But throughout the Skilling trial, prosecutors declined to hand over the usual FBI summaries of the hundreds of hours of interviews with Fastow. Instead, they provided what defense attorneys called “summaries of summaries.” Agents destroyed the original summaries.
Since the 5 th Circuit ordered the Justice Department to turn over the full FBI notes to the defense, Skilling’s lawyers contend that they’ve found dozens of facts in the documents that could have cleared their client.
The Justice Department declined to comment on the allegations of misconduct.
In court papers, department lawyers have said that defense attorneys received all the evidence to which they were entitled.
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