Ideoblog

A former prosecutor looks at Enron and Bear

Writing in the WSJ, Robert Mintz, now gone over to the other side, says of the Bear hedge fund indictments,

[t]his is not Enron, where executives were charged and ultimately convicted of cooking the books* * * [L]ike all indictments, [it] benefits from the wisdom of 20/20 hindsight. We all know how the story ends, and it isn't pretty. But these two hedge fund managers were not alone in reaping huge profits for years from the subprime market. Nor were they alone in understanding the fundamentally risky nature of investments that relied so heavily on the misguided expectation of perpetual real estate appreciation. * * * Lying to the investing public is a serious breach that cannot be condoned if we are to maintain the integrity of our markets * * * But it is all too tempting for the government to ride in after a colossal collapse that many should have seen coming and look for someone to blame, when clearly there's plenty of blame to go around.

Ah, but it is Enron. 

Will Skilling walk?

Some commentators see this happening, via a Fifth Circuit decision that might be issued this week. See this Financial Week article (HT Sox First). 

Of course these sources see such a development with the standard media-conditioned trepidation.  But I first asked the title question two and a half years ago, before the conviction, and most recently in the wake of reports of prosecutorial misconduct (see Tom Kirkendall). 

The forthcoming decision will indicate whether a big part of Enron's enduring legacy is prosecutorial excess.

More on the WSJ's Enron coverage

Tom Kirkendall has more on WSJ’s John Emshwiller’s report on the Skilling appeal in the WSJ, which I analyzed on Sunday. Tom notes:

Even in the current article, Emshwiller is less than forthright in assessing what is truly going on in the Skilling appeal regarding the Fastow interview notes:

Normally, defense attorneys aren't allowed to see the raw notes of Federal Bureau of Investigation interviews with government witnesses. But Mr. Skilling's defense team, led by Daniel Petrocelli, sought them anyway, and the Fifth Circuit agreed to order the federal government to turn over the notes.

Emshwiller fails to explain that the Fifth Circuit granted the Skilling team's motion to obtain the raw notes because the Enron Task Force took the highly unusual step of providing the Lay-Skilling defense team a "composite summary" of the Form 302 ("302s") interview reports that federal agents prepared in connection with their interviews of former Enron CFO and chief Skilling accuser, Andrew Fastow. Those composites claimed that the Fastow interviews provided no exculpatory information for the Lay-Skilling defense, even though Fastow's later testimony at trial indicated all sorts of inconsistencies. In point of fact, the process of taking all the Fastow interview notes or draft 302s and creating a composite is offensive in that it allowed the prosecution to mask inconsistencies and changing stories that Fastow told investigators as he negotiated a better plea deal from the prosecutors over time. Likewise, the Task Force's apparent destruction of all drafts of the individual 302s of the Fastow interviews in connection with preparing the final composite is equally troubling. Traditionally, federal agents maintain their rough notes and destroy draft 302s. However, in regard to the Fastow interviews, what turned out to be the draft 302s were probably not "drafts" in the traditional sense. They were probably finished 302s that were deemed “drafts” when the Task Force prosecutors decided to prepare their highly unusual composite summary of the 302s.

This is important because it exposes the continuing slant in the WSJ’s coverage of the Enron trial. Without Tom’s analysis, a non-expert reader might conclude that the court was bending over backward to please Skilling’s high-priced lawyers – not what is actually the case, which is that the court’s extraordinary action indicates the potential presence of prosecutorial abuse.

As Tom concludes:

Regardless of what happens in the Skilling appeal, the WSJ has some deep soul-searching to do regarding its coverage of the aftermath of Enron's demise.

Update: Ellen Podgor has more on the Skilling argument tomorrow, focusing on the government's Fastow problem.

The WSJ shorts the Enron task force

Amid the WSJ’s John Emshwiller’s report on the Skilling appeal we read:

If the Skilling conviction is overturned, "all the guilty pleas obtained will be forgotten and the final grade of the Enron Task Force will likely be failure," says Jacob Frenkel, a former federal prosecutor now in private practice, referring to the Justice Department team that investigated Enron's 2001 collapse. . . . . The Enron Task Force was often described as the biggest criminal investigation ever done of a single corporation. It gained more than a dozen guilty pleas from former Enron officials including Mr. Fastow. But its record in court, the ultimate test of the strength of its cases, has been weak.

Of course none of this is new. These developments have been much better covered by Tom Kirkendall, e.g., here and here. I've been following along behind. The Economist was the first main stream source to pick up the story.

But it’s news that lead Enron reporter Emshwiller is finally coming around. In fact, Emshwiller even echoes a line taken by Tom K in noting that “some have argued that the collapse stemmed from miscalculations and misfortunes, not crimes. Mr. Skilling testified to that effect before Congress in 2002.” See Tom’s post on Enron as the forerunner of Bear – the quick collapse of a trust-based business – exactly what Skilling said years ago. The Economist later worked this angle.

So we’re seeing the mainstream media following rather than leading the blogs. This is not so surprising given the biases and conflicts that can infect any news source. In this case, as Tom K discussed long ago, Emshwiller had a particularly large investment in Enron's being a massive fraud -- the Gerald Loeb award for covering Enron, followed by a best-seller on Enron.  Emshwiller had almost as much of his career invested in Enron as David Duncan had. That's why we need blogs.

So after years of prodding by, among others, Skilling’s lawyers and Tom Kirkendall, it looks like the story is finally starting to change. The language quoted above from Emshwiller’s story sounds a bit like ground-preparation. Watch for the hounds of the press to turn full on against the Enron prosecutors if Skilling gets a new trial or reversal for prosecutorial misconduct. It's not going to be about losing one case.  It's going to be about the basic flaws in the Task Force, which was determined to get Lay and Skilling at all costs. Maybe Emshwiller already has a sequel in the works.

But as with Spitzer’s questionable conduct as prosecutor and governor, it’s too bad the press didn't catch on sooner.

More on the Nifonging of Enron

Tom Kirkendall posts on and links a motion in the Nigerian Barge case that shows that misconduct by the Enron task force is rippling beyond what we’ve seen in the Skilling and Law prosecution. This is getting pretty ugly.

More on the cloud over the Enron prosecution

Finally somebody in the mainstream press gets it –The Economist, on the Enron appeal, sounding a lot like Tom Kirkendall and me (e.g., here and here).  Regarding the Fastow notes:

Mr Skilling’s defence team allege serious prosecutorial misconduct of the sort that ought to result in Mr Skilling’s conviction being overturned, with no possibility of a retrial. Brady v Maryland held that the government had to provide the defence all favourable evidence. That is because the government has “substantial resources and considerable other advantages” over defendants and the “system reposes great trust in the prosecutor to place the ends of justice above the goal of merely securing a conviction.” * * *

And regarding putting Enron in the perspective of recent events:

For many people, the mere fact of Enron’s collapse is evidence that Mr Skilling and his old mentor and boss, Ken Lay. . . presided over a fraudulent house of cards. Yet Mr Skilling has always argued that Enron’s collapse largely resulted from a loss of trust in the firm by its financial-market counterparties, who engaged in the equivalent of a bank run. Certainly, the amounts of money involved in the specific frauds identified at Enron were small compared to the amount of shareholder value that was ultimately destroyed when it plunged into bankruptcy. Yet recent events in the financial markets add some weight to Mr Skilling’s story—though nobody is (yet) alleging the sort of fraudulent behaviour on Wall Street that apparently took place at Enron.

* * * Although it can do nothing for Mr Lay, the fate of Bear Stearns illustrates how fast quickly a firm’s prospects can go from promising to non-existent when counterparties lose confidence in it.

The Economist discusses eery similarities between Enron and Bear Stearns arising in the Fastow notes controversy:

As Enron entered its death spiral, Mr Lay held a meeting to reassure employees that the firm was still in good shape, and that its “liquidity was strong”. The composite [notes] suggested that Mr Fastow “felt [Mr Lay’s comment] was an overstatement” stemming from Mr Lay’s need to “increase public confidence” in the firm. The original FBI notes say that Mr Fastow thought the comment “fair”. The jury found Mr Lay guilty of fraud at least partly because it believed the government’s allegations that Mr Lay knew such bullish statements were false . . .

The article compares Lay's statements with those of Bear Stearns CEO Alan Schwartz (“we don’t see any pressure on our liquidity, let alone a liquidity crisis”).

As for the quote from Brady that the prosecutor should "place the ends of justice above the goal of merely securing a conviction," Enron prosecutor John Hueston's article, Behind the Scenes of the Enron Trial: Creating the Decisive Moments, 44 American Criminal Law Review 197 (2007), which plays a starring role in the Skilling brief, suggests strongly that that is precisely what Hueston and his colleagues were not doing. The article discusses in detail what Hueston calls the "shortcomings" in his case. But the prosecutors apparently didn't feel they had the luxury of not going full steam ahead anyway. Everybody had condemned Lay and Skilling, so they had to make the case, hell or high water.

The article offers interesting insights into how the case was constructed. Hueston discusses how he searched for "a means of creating a sense of excitement in the jury; a way to entice them to join us on a journey through the evidence, into a world normally foreclosed to them." Then he found the answer – in Tom Waits, of all people [though I'm not sure Hueston knows this]:

Thanks to a two-week postponement of the trial following the guilty plea of Richard Causey, Enron's former Chief Accounting Officer and the third defendant in the original prosecution, I was able to see the documentary film “The Smartest Guys in the Room.” It was here that I found the sense of mystery and drama I wanted to convey to the jury: in the film's opening sequence, set to a soundtrack of tolling chimes, a camera swung around and over the now-darkened Enron towers in downtown Houston. As the cameras moved, a voice muttered, “What's he building in there ... what the hell is he building in there?”

Meanwhile, I'm constructing a "narrative" for the prosecutorial misconduct case: Prosecutors desperate for a conviction, their careers turning on the outcome, have a key witness, Andy Fastow. The problem is, the guy has, in Hueston's words, a "heartstopping history of self-dealing." Obviously the government couldn't afford any additional shadow on Fastow's credibility. Yet in the government interviews it seems his story got more negative on the defendants over time. Could be a big problem for Fastow on the witness stand, as the defense sought on cross to show he was changing his story to suit his jailers. Could the prosecutors afford to give these notes to the defense? Why not just turn over a summary?  By the time the truth came out (if it ever did) they could do a dance about how the differences were inconsequential.

The government is saying the differences are inconsequential. So why, then, didn't they produce the notes as repeatedly requested, rather than summarizing them?  I think those prosecutors have some explaining to do.

The cloud over the Enron prosecution

I noted a couple of days ago that there was a big problem brewing in the Enron trial, with the specter of possible prosecutorial misconduct regarding the prosecution's destruction of exculpatory evidence in Andy Fastow's government interviews. Today, Tom Kirkendall drops the other shoe, discussing the now unsealed defense supplemental brief: As Tom says:

The brief reveals suppression of exculpatory evidence by the Enron Task Force of a massive scale. The entire brief is devastating to the Task Force's prosecution of Skilling and the late Enron chairman, Ken Lay. * * *

The implications of this brief reach far beyond the Skilling appeal. For example, the already-reeling prosecution of the four Merrill Lynch bankers in the Enron-related Nigerian Barge case would appear to be over -- the prosecution in that case not only withheld exculpatory evidence, but put on incriminating testimony from former Enron treasurer Ben Glisan that directly contradicted the exculpatory evidence that Fastow provided to Task Force prosecutors during his interviews. Other Enron-related criminal cases -- as well as plea bargains -- could well be affected.

For a taste of what the brief shows, consider this summary of evidence relating to the "global galactic" document, which Fastow says summarizes what Skilling purportedly knew about the Enron fraud. Skilling didn't see this document, but Fastow testified that he discussed its contents with Skilling. Yet the authenticity of the document was questionable, as I discussed at the time. Now consider this from the recently filed Enron brief (citations to the record omitted):

Task Force prosecutors called the “Global Galactic” document “three pages of lies” and the “most incriminating document” in Skilling’s entire case. At trial, Fastow testified Skilling knew about Global Galactic because Fastow “confirmed” it with him during a spring 2001 meeting. Skilling denied knowing anything about Global Galactic. To bolster Fastow’s testimony and impeach Skilling’s, the Task Force introduced a set of handwritten “talking points” that Fastow said he prepared in anticipation of his meeting with Skilling. At trial, Fastow swore he “went over” the talking points with Skilling, including the crucial point “Confirmation of Global Galactic list.” In closing, the Task Force relied heavily on this document to corroborate Fastow’s testimony that he discussed Global Galactic with Skilling.

The raw notes of Fastow’s interviews directly impeach Fastow’s testimony and the Task Force’s closing arguments. When shown and asked about the talking-points document in his pre-trial interview, Fastow told the Task Force he “doesn’t think [he] discussed list w/ JS.” This obviously exculpatory statement was not included in the Task Force’s “composite” Fastow 302s given to Skilling. Nor was it included in the “Fastow Binders” the Task Force assembled for the district court’s in camera review of the raw notes. It is not possible that this omission was inadvertent. Fastow’s statement is one of the most important pieces of evidence provided during all his countless hours of interviews. Moreover, in preparing both the composite 302s and Fastow binders, the Task Force extracted and included other—relatively inconsequential—statements from the same interview date and even the same page of notes. The Task Force’s exclusion of this critical piece of evidence for over three years is inexcusable and, on its own, warrants a complete reversal of Skilling’s convictions and other substantial relief.

The defense's 100 page brief asks for dismissal of the case against Skilling, not merely a mistrial.

I'm still waiting for this to capture the attention of the press, which had been so riveted on Fastow's testimony at the trial.

What does the Enron cert denial mean?

The Supremes denied cert in the Enron case. So what does this mean? Unfortunately, the WSJ’s report presents a somewhat misleading picture.

First, the article says that the decision “underscor[es] the sweep of last week's decision limiting the liability of companies that help other corporations commit fraud.” Actually, that’s far from clear. As I wrote last week, here and here, Stoneridge left potentially exposed parties like lawyers, accountants and investment banks that are closer to securities fraud than the Stoneridge defendants. The cert denial is a win for the specific defendants in Enron, but leaves the general issue in limbo.

Second, the WSJ quotes NYU’s Jennifer Arlen as saying that “[t]he Supreme Court all along has defined securities fraud as being the public statements that the firm made to its shareholders” and that “private plaintiffs can only go against people who participated directly in making those statements," not those "who lay the groundwork for being able to make those statements."

But that’s not clear either. Indeed, one of the few things the Court did clarify in Stoneridge is that mere conduct can trigger securities liability. Here’s what the Court said:

The Court of Appeals concluded petitioner had not alleged that respondents engaged in a deceptive act within the reach of the §10(b) private right of action, noting that only misstatements, omissions by one who has a duty to disclose, and manipulative trading practices . . . are deceptive within the meaning of the rule. . . . If this conclusion were read to suggest there must be a specific oral or written statement before there could be liability under §10(b) or Rule 10b–5, it would be erroneous. Conduct itself can be deceptive, as respondents concede.

This conduct might include misleading structures on which plaintiffs relied.

So the Enron cert denial leaves scheme liability battered but still alive. Someday, when securities fraud litigation is more politically palatable, the Court might pull this theory from the rubble of Stoneridge.

Stoneridge and the Enron zombie

I had hoped and predicted that the Court would take cert on Enron in order to ensure that “secondary civil liability under 10b-5 is really dead, and stays dead, rather than wandering in scheme liability form like some terrifying zombie.”

Unfortunately one of the things Stoneridge did not do is destroy the zombie – that is, it did not settle what would happen under the facts of Enron, which involve more central participants in securities transactions than in Stoneridge, as I noted in my post of yesterday.

The WSJ Blog reminds us today that this is of more than just academic interest. As the Justices

discuss whether they should hear the Enron class-action in light of their Stoneridge ruling this week… . .

In a brief filed yesterday, lead plaintiffs’ lawyer Coughlin Stoia said ”this court’s decision in Stoneridge demonstrates critical differences between Enron and Stoneridge — differences that warrant a grant” of certiorari. “Enron is, at its core, a case about financial fraud, executed by financial professionals targeting investors,” said the brief. The court should “clarify when financial professionals may be liable for deliberately misleading investors.”

The problem is that the Stoneridge reliance test does not easily permit clarification that the liability doesn't exist. In other words, I fear that the zombie is going keep walking. The worst case scenario is that the Court may bring it back to life, though I seriously doubt that given the policy considerations articulated in the opinion.

Enron unravels

Enron has gone through several incarnations. It first entered the public view as a shining star in business. Then its sudden collapse made it a classic symbol of business excess.  It reemerged as a shining star of business prosecutions, with prosecutors, journalists and filmmakers hyping the criminal prosecutions and the Enron Task Force just as Lay and Skilling had hyped Enron. 

At the peak of the Task Force's activities we had Enron: The Smartest Guys in the Room. The film was co-written by one of the book's authors, Peter Elkind, and featured monologues by journalists Elkind and his co-author Bethany McLean as well as "whistleblower" Sherron Watkins (here's a less hagiographic portrayal) and trial lawyer Bill Lerach, among others. The movie stacks its case with Michael-Moore-type juxtaposition of images, crafty lighting and camera angles, and an aggressive sound track that highlights the hyping of Enron with rock, and then its downfall with dirge. Never do we catch a hint of the Enron defendants' side of the story.

Tom Kirkendall now reminds us that the Enron Task Force bubble is popping just as its target did.  Consider:

• The conviction of Enron Broadband executive Kevin Howard has been thrown out.
• The Nigerian Barge defendants' conviction has been thrown out.  Defendants Bayly and Furst have been granted an interlocutory appeal of the denial of their motion to dismiss the government's attempt to retry them. [The film, in a long sequence on the Nigerian Barge case, presented the prosecution's factually questionable theory that the transaction was a sham sale as fact.]
• Jeff Skilling's defense team is currently attempting to determine through notes of FBI and Task Force interviews whether prosecutors withheld exculpatory evidence or got Andy Fastow (whose credibility has always been in doubt) to change his story over time. If so, that alone could justify a reversal of Skilling's conviction, though there are other possible grounds. [The film not only didn't present Lay and Skilling's side, but lampooned their efforts to defend themselves.]

Meanwhile, we also know that Lerach himself, who got substantial screentime to essentially present, unchallenged, the plaintiff's side in the Enron case, is on the way to jail.  Also, while a significant segment of the film hyped the case against the banks that funded Enron, the Supreme Court is about to consider, and possibly reject, the theory on which they were sued.

This doesn't mean that the Enron defendants were blameless. It is to say that criminal trials were never an appropriate way to deal with the wrongs, and that part of the problem is that these trials may be motivated more by public storytelling, in film, magazines, newspapers and pleadings, than a search for justice.

In the end it's possible that Enron may acquire yet another meaning -- as a symbol of prosecutorial, journalist and filmmaker excess.