September 11 Changed Everything
The prosecution of Enron, for our purposes today, begins on September 11, 2001. On September 11, 2001, those of us on the East Coast who witnessed firsthand the terror attacks were horrified beyond anything we had ever experienced in our lifetimes. The impact was felt all across the United States and indeed the world, but seeing the devastation up close was a truly soul-shattering experience.
The Passion of the FBI
For law enforcement personnel, it was felt on two levels (or more.) Certainly as an institution, the FBI felt they had failed; they did not admit it publicly but several FBI agents that I know admitted as much to me. There was a sense of defeat, of embarrassment, and of course, plain old horror at what had happened. Additionally, several federal law enforcement agents were killed in the attacks, and as we all know, they do tend to protect their own.
Who Was Minding The Country?
From September 11, 2001 to December 2, 2001, our entire national conscience was on September 11. Fighting the war in Afghanistan, learning about al Qaeda, setting up the TSA, learning about GITMO, watching news reports night after night about Kabul and the Northern Alliance and what Real Muslims were. Though Enron had been experiencing difficulty for several weeks by December 2, very little attention was paid to it. At that time, most stocks were down. Most companies were struggling in the aftermath of the terror attacks. It would have been difficult for the average person who was not necessarily focused on Enron to determine that anything was wrong at all.
On December 2, 2001, Enron declared bankruptcy. Immediately a firestorm of activity broke out in Houston, Washington, DC and New York City. I recall very specifically being in my friend’s condo and looking up and seeing Ken Lay on the news. I remember thinking, “Oh… Houston….” And then I saw what the report was about. It’s true that I loved Enron even back then. I loved the people who worked there, loved the leadership, loved the company and the products and the services. Yet when I saw it on the news, it barely made an impression because my mind was occupied by other things. So unless you were invested in the company, or had some other compelling reason to care, you just didn’t. There were too many other things happening.
Task Force Formed
George W. Bush, for reasons that will remain his own until he writes a memoir, made the executive decision to form a task force to investigate the collapse of a single company. This was unprecedented.
Just as I do not believe that Enron hired people who were latent criminals, I do not believe that the Department of Justice is staffed with jerks who are gratified by the prosecution of innocent people. I believe most of the agents who work for the DOJ are motivated to do good work and are instilled with a sense of decency and justice. But the government staffed the ETF with Mafia prosecutors who had little white collar criminal experience. They knew nothing about business, nothing about businessmen, and nothing about how to actually investigate an alleged white collar criminal offense. With a perfect storm of personalities, interests, motivations and (lack of) knowledge, the Task Force would ultimately become what they hated.
The first indictments handed down in the Enron case were Arthur Andersen. Since the government already assumed there was malfeasance afoot, it was easy to blame the auditors for everything that had gone wrong. Arthur Andersen lost their accounting license, and thus they could not do business and quickly collapsed. Their convictions were appealed to the Supreme Court. The Supreme Court overturned the convictions by unanimous accord. But the company was already gone. It was vindicated but destroyed.
Enron Broadband Services In The Crosshairs
Enron Broadband Services was the low-hanging fruit of the Enron prosecutions so it was not surprising that they were the first inside Enron to be indicted by the government. (A primer on EBS can be found here.) EBS was not making money – but that was by design. They were a very young startup company inside a huge company and they were not scheduled to make money for years. In fact, they were scheduled to lose about $160 million in 2002. Because they were a cost-center, and not making money, it was easy to criticize them.
John Kroger, the Broadband prosecutor, wanted to be “the first on the boards”, so he rushed an indictment so he could beat the other ETF teams to the punch.
Project Braveheart was a partnership between Enron and Blockbuster. The two individuals indicted on charges related to this project were Kevin Howard and Michael Krautz. Kevin Howard was Enron Broadband Services CFO. Michael Krautz was EBS senior accounting director.
Enron set up a partnership with an Oregon company called nCube and another partnership called Thunderbird (The majority shareholder in privately held nCube was Larry Ellison, chairman and CEO of Oracle). The government alleged that Enron arranged a phony sale of the venture to another partnership called Hawaii 125-0 that Enron Broadband had created with Canadian Imperial Bank of Commerce. Enron then booked the sale of the venture – $111 million – on their books.
The government claimed it was illegal because none of the partnerships were really separate from Enron, (i.e., the equity was never really at risk) even though the partnerships contributed the necessary three percent of capital to make it a legitimate deal. The government claims that there was a Secret Side Deal – the same exact allegation against Fastow and Skilling – which is telling. (The deal with CIBC was alleged to have a secret side deal with Fastow as well.)
The indictment against Kevin Howard says that Howard promised nCube that it would receive its original investment plus $100,000 to $200,000 in return. If indeed it was uttered at all, this could have been puffery. But if it was illegal, why didn’t Larry Ellison – an experienced businessman – cry foul? Howard’s convictions were overturned.
Michael Krautz was acquitted.
The Broadband Three
The three other Broadband executives swept up in the Enron purge were Joe Hirko, Scott Yeager, and Rex Shelby – referred to here as the Broadband Three. These three were not alleged to have participated in Project Braveheart. They were alleged to have lied to analysts at a 2000 analyst conference in order to inflate the price of the stock.
Joe Hirko pleaded in October 2008. Scott Yeager’s appeal is pending before the Supreme Court. Rex Shelby’s retrial is suspended until the Supreme Court rules on Scott Yeager’s appeal.
The next transaction under attack was the Nigerian Barge transaction. It was a tiny, insignificant deal between Enron and Merrill Lynch. The fact the government even bothered with this $12 million speck shows just how desperate they were. Yet they found it, and decided they could build something out of it. Of all the thousands of deals that were done at Enron, the best they could find was this. It boggles the mind.
The government used plea deals to entice Enron executives to turn on one another. While this strategy is not uncommon, it does tend to truncate justice for the sake of expediency. When a person is offered the opportunity to save his own skin if he puts another in prison for a few years, well, that deal can look pretty tempting.
The Government used them ruthlessly in the Enron cases. Out of 34 defendants, 18 pleaded guilty.
I believe the government was in a terrible fix after 9/11. Unlike Osama bin Laden, Jeff Skilling and Dr. Lay were not hiding in caves in Afghanistan. They were a four-hour plane ride away, in Houston, Texas. I believe that most of the Enron convictions via plea deals were aimed at getting Jeff Skilling and Dr. Lay.
It pains me to say this now, but with the benefit of hindsight, I can see that Jeff Skilling was never going free. The full force of the United States government was pushing for punishment, for “scalps”, as John Kroger called them. He and Dr. Lay were scapegoats. The other Enron defendants might have had an honest chance – doubtful in Houston, but maybe – but Jeff Skilling and Dr. Lay were going to prison no matter what.
In 2001, the government wanted to reassure the public that, in America, a large corporation just could not go bankrupt by normal means (as companies do every day), but instead worked hard to prop up the idea that large corporations can only go bankrupt by criminal activity (a preposterous concept on the face of it). As a result, the government never tried to understand the real problems that had plagued Enron but simply decided that scalps were necessary to mollify the shareholders and public. In his book, Kroger stated that the ETF was “under pressure to get scalps quickly.”
Also, Enron was a victim of an ever more negative view of big business in America. Businessmen had become the villains in books and movies. So the government had the support of a non-skeptical public and a non-investigative press in demonizing Enron executives. It had the classic circumstances that make witch hunts possible. Lay and Skilling were the big scalps, and no amount of collateral damage and no amount of wasted money would stop the Enron Task Force.