Enron Broadband Services Primer

What Was EBS?

Enron Broadband Services, or EBS, was Enron’s internet group. But Enron wasn’t making pretty websites. The objective of EBS was to deliver high-bandwidth applications to consumers. EBS did this with the Enron Intelligent Network, which was constituted with distributed servers (like any network), Enron’s own fiber distribution, and a special embedded software intelligence, called the Enron Broadband Operating System (BOS). Together, the EIN and BOS was a powerful application capable of delivering rich media – something nobody else was doing at the time.

In 1999, obtaining tv-quality video on computer screens was the zenith of technology. It seemed that every technology and entertainment company believed that it could be done, but actually doing it was proving to be a much more complex task than one imagines now from the comforts and sophistication of 2009.

To understand EBS, one should understand Rex Shelby and Scott Yeager.

The Shoulders of Giants

Scott Yeager was Senior Vice President for Business Development, Sales and Marketing at EBS and it has been said that he was the person who dreamed up the idea of getting Enron into Broadband. In order to get them there, however, they had to find somebody who was up to the huge engineering challenge.

During closing arguments of his trial, prosecutors snidely referred to Rex Shelby as “the technology man.” Perhaps they didn’t even know how correct they were.

Rex Shelby was (and, I suppose, is) an entrepreneur, not an executive like the others. Jeff Skilling, Ken Rice, and Joe Hirko had decades of experience at large public companies, while Shelby had been busy with his own company for the previous six years.

Modulus developed distributed communications middleware. InterAgent was the messaging middleware that routed information through networks – and it was this piece of the software that Enron found particularly valuable. In late 1998, Enron made an offer for Modulus. Rex Shelby accepted, then Shelby went to work for Enron as Senior Vice President of Engineering and Operations for EBS.

The End of EBS

When the company collapsed, EBS was an immediate (and easy) target. It was true that many millions of dollars had been poured into EBS and that EBS wasn’t making any money. That is a fact. But it was not unexpected. Jeff Skilling said many times that EBS was a start-up company, and that it wasn’t scheduled to make money for several years. The fact it had not yet broken even was not indicative of fraud or even failure; it just had not been allowed to grow into maturity.

After the collapse of Enron Corp., the executives at EBS were some of the very first to be indicted – and ironically they are still fighting their cases long after many have completed their sentences and moved on with their lives.

The Prosecution

On August 15, 2002, Rex Shelby was at home when the FBI knocked on his door. According to an affidavit filed in connection with his case, he asked the agents if he was in trouble in some way or if there was any reason he was being singled out for questioning. The agents replied that he was “simply one of many people being questioned as a part of a general fact-gathering effort.” In addition, the agents said there was “nothing special” about EBS, but that they were gathering information about all the Enron businesses.

Shelby spent approximately three hours speaking to the agents, attempting to bring them up to speed on the BOS. At one point they asked him why “things didn’t work.” He replied that if the “things” they referred to meant the network and software, they did indeed work. He also emphasized that “working” for network and software is not a “0/1 proposition.” He explained to the agents that the software was constantly being improved and expanded.

After the agents left, Mr. Shelby contacted a friend, and the friend told him that agents had also been to his house, and that they had told him that that Shelby was a person of special interest to the government because they were looking into fraud at EBS and that the fraud “had Shelby’s name written all over it.”

This, combined with the agent’s lack of understanding about the technology, prompted Shelby to contact another friend, an attorney. The attorney called John Kroger, the prosecutor, and offered up to Kroger a “whiteboard session” to teach the technology to Kroger. Kroger refused. According to another affidavit, Kroger stated that he did not need any further investigation [into the technology] because he had already made up his mind.

When Mr. Shelby retained an attorney, he offered again to speak to John Kroger to discuss the technology, and again his offer was declined.

Kroger not only refused to learn about the technology from the engineers who built it, he chose to ignore the huge quantity of EBS technical documents available to him because he couldn’t understand them. Instead, as he revealed in his book about the prosecution of EBS, Kroger chose to rely on witnesses whose participation he could coerce and whose testimony he could shape.

The fact that the government made no credible attempt to preserve the only tangible evidence in this case, the actual EBS software and hardware, is unconscionable. The government managed to preserve certain secondary evidence, such as emails, but made no effort to stop the dismantling and sell of the primary evidence, the EBS technology. As an analogy, consider a situation in which a prosecutor accuses someone of damaging an automobile but then stands idly by while the vehicle is dismantled and disposed of before trial — such a fiasco would be thrown out of court. But in the EBS case, the trial was allowed to proceed.

The government claimed that the software didn’t exist, and that defendants Rex Shelby, Joe Hirko, and Scott Yeager had lied about the capabilities to inflate the stock price. The defendants did manage to track down some of the software which the government claimed did not exist. At one point in the first trial, the defense had the programmer on the stand who actually wrote some of the key software. When the defense attorney, Ed Tomko, tried to get the actual software code admitted into evidence, the prosecution objected, saying the code was “not relevant”. When the judge asked Tomko why he wanted the jury to see the code, he answered “Because it exists, Your Honor.” Incredibly, the judge sided with the prosecution, saying that “the jury would not understand the code” (even though the defense had the creator of the code on the stand prepared to carefully walk the jurors through it). It boggles the mind to think that a judge would tolerate meaningless hearsay testimony from people who never touched the actual software, but would refuse to allow the actual code to be put into evidence with the author of the code on the stand!

Post-Trial

The trial resulted in a confounding verdict of numerous acquittals and numerous hung counts. The government re-indicted the Broadband Three on the hung counts. Scott Yeager was re-indicted on thirteen insider trading counts. Yeager appealed, and in March 2008, a three-judge panel of the Fifth Circuit ruled that Gilmore was correct in refusing to dismiss the counts. Yeager then appealed to the Supreme Court and was granted writ of certiorari. Yeager’s oral arguments before the Supreme Court will be in early March, and a decision will be handed down by June.

Meanwhile, on October 15, 2008, Joe Hirko pleaded guilty and accepted a prison term not to exceed sixteen months.

Rex Shelby’s petition to the Supreme Court was denied, but any clarification of the law in Yeager’s case will be applicable to Shelby’s case.

Double Jeopardy and Collateral Estoppel

The issues are much different at the Supreme Court than the lower courts. Scott Yeager is arguing that he can not be retried because the issues of fact that were decided at his first trial can not be considered again because double jeopardy would apply. The case hinges on Ashe a 1969 case, in which six poker players were robbed in a private residence. Ashe was accused of robbing one of the men. He was found not guilty in court. The prosecutors then accused him of robbing one of the other poker players. Ashe claimed that because the facts of the case had been heard in his first trial, and decided upon by a jury when they issued their Not Guilty verdict, a second prosecution would violate the Double Jeopardy Clause of the Fifth Amendment. The Supreme Court agreed and thus under the doctrine of collateral estoppel, the government was constitutionally foreclosed from relitigating that issue in another trial.

The comparison to Yeager is striking. Mr. Yeager asserts that because he was acquitted of conspiracy, wire fraud, and security fraud counts, the same facts that were considered under those counts can not be re-considered for the pending hung counts against him. Though it will not be considered by the Supreme Court, there is also a logical inconsistency that should be addressed: he could not have committed insider trading since the jury already decided he didn’t commit fraud. If there was no fraud, there was no inside information for him to trade on.

Likewise for Rex Shelby, who had a different mix of acquittals (some insider trading counts) and some hung counts; the issues at trial had already been decided and thus they can not be prosecuted again.

Effects on Other Enron Cases

EBS was like a precursor to everything that happened to Jeff Skilling and Dr. Lay. The Enron Task Force used all the same strong-arm tactics, all the same misconduct, just ratcheted it up another octave perhaps for Skilling and Lay. The EBS defendants did a better job perhaps of catching the prosecutors with their pants down — the prosecutors were just incredibly ignorant of the core EBS technology subject matter (which begs the question of how can you indict someone if you don’t even understand the subject).

As far as I know, no unindicted co-conspirators defied the government to provide defense testimony for Skilling and Lay. In the EBS trial, two very brave men named Larry Ciscon and Mark Palmer (not the same Mark Palmer, the VP of Communications at Corporate), both unindicted co-conspirators, did defy the government, and their testimony was crucial to the outcome. This makes you wonder what would have happened to Skilling if others have been as brave and principled as Ciscon and Palmer.

Conclusion

Enron Broadband Services employees were not in the business of creating or selling vaporware. Many of them have gone on to create new software companies. Those who were ensnared in the government’s claws are not guilty of anything more than being businessmen. The fact that the government could not obtain even one single conviction out of over one hundred counts divided among Shelby, Yeager and Hirko indicates just how weak, legally, the case was. But it was also weak morally. The software did exist and was functioning though it was constantly being expanded and improved. The government was misguided at best to pursue the Broadband Three.

The men of EBS have been pursued for six years. One of the pivotal events of the case – the January 20, 2000 analyst conference where Rex Shelby and Joe Hirko allegedly lied about the capabilities of the software – was nearly a decade ago. If for no other reason, the government should simply put this aside because there are so many bigger fish to fry.

It is time for the government to admit it made an error in prosecuting the Broadband executives. Rex Shelby and Scott Yeager deserve more than our support; they deserve an apology from the government. It is time for these men to return to their real lives and their families and friends who miss them while they are at war, fighting for their freedom.

For other Enron Primers, please see:

The Nigerian Barge Primer

West Coast Trading Strategy Primers:
Get Shorty

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Wheel Out

Fat Boy

Ricochet