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US: Big Test Looms for Prosecutors at Enron Trial

by Kurt EichenwaldThe New York Times
January 26th, 2006

In the court of public opinion, they were convicted long ago. But as Kenneth L. Lay and Jeffrey K. Skilling, the onetime leaders of Enron, step into a court of law next week, the outcome of their fraud trial is far from certain, creating one of the most closely watched and hotly contested white-collar criminal cases ever.

On one side of the Houston federal courtroom starting Monday will be two top-flight teams of defense lawyers, who will be taking the risky approach of proclaiming many of the controversial actions of Enron and some much-criticized statements of their clients to be legal and truthful.

On the other, the prosecutors for the Justice Department's Enron Task Force, who have racked up an impressive array of guilty pleas in the case, but whose performance at trial has been decidedly less dazzling.

"For the government, if they lose the Enron case, it will be seen as a symbolic failure of their rather significant campaign against white-collar crime," said John C. Coffee Jr., a professor at Columbia Law School. "It will be seen as some evidence that some cases are too complicated to be brought into the criminal justice process."

Of the three major Enron-related criminal cases brought by the government before juries, guilty verdicts stand from only one, which involved Enron's booking what the government said were phantom profits on the sale of Nigerian barges to Merrill Lynch. A second case, against the accounting firm Arthur Andersen, was thrown out by the Supreme Court on appeal. The third, involving the broadband division of Enron, resulted in no convictions, but the five defendants await a retrial.

Those cases involved narrower accusations of wrongdoing than those against Mr. Skilling, 52, who has been charged with dozens of counts, including fraud, conspiracy and insider trading, and Mr. Lay, 63, who is accused of seven counts of fraud and conspiracy. Indeed, this trial will be the first time that the government's theory of the existence of an overarching criminal conspiracy at the company has been put to the test.

Learning its lesson from previous corporate fraud trials involving Enron and other companies, the government is expected to keep this trial as simple as possible to avoid confusing and boring the jury. Riding on the prosecution's success, experts said, is public support.

The implications of the outcome of the case against Mr. Lay and Mr. Skilling, whose names have become fused to the scandals that have exploded across corporate America in recent years, are sure to be felt far beyond the courtroom.

"Most people in the white-collar world would agree that Enron is the granddaddy of all frauds in the last two decades," said Stephen L. Meagher, a former federal prosecutor who is now a lawyer in San Francisco. "How this comes out is a test of the limits of what the corporate community will tolerate in business practices."

The importance of the trial to the government and the defense is underscored by the millions of dollars each side is committing to the case.

Mr. Skilling, for example, has hired Daniel Petrocelli, a top civil lawyer who has no criminal trial experience but made his name winning a $33.5 million verdict for the family of Ronald Goldman in a wrongful-death suit against O. J. Simpson. Mr. Skilling alone has some two dozen people, half of them lawyers, working full time at a makeshift office near the courthouse. Several more are employed as trial consultants helping with jury selection, which begins Monday.

The government is also committing significant resources, with 8 lawyers and 10 agents of the Federal Bureau of Investigation working exclusively on this case.

In presenting the case, the government will be depicting a company where law breaking was commonplace. In official reports from the government, the bankruptcy court and the independent directors of Enron, and in the guilty pleas of former executives, Enron has emerged as a company that failed to follow the dictates of federal securities laws, with executives who deceived investors, directors and, in some cases, one another. While that is helpful to prosecutors, experts said that the government would have to be wary of focusing too much on the broad problems within the company.

"To the extent this becomes more of a trial about Enron and less of a trial about Skilling and Lay, that is likely to play into the defense's strategy to put the accounting techniques on trial rather than the individuals," said Robert A. Mintz, a former federal prosecutor who is now head of white-collar criminal defense at McCarter & English in Newark.

The defense case will focus on the requirements and dictates of accounting and securities rules. While both defendants deny knowledge of some of the brazen crimes, like transactions that resulted in millions of dollars from Enron's coffers being drained into other executives' personal bank accounts, there will be little effort to distance themselves from some of the financial dealings that have become infamous over the last few years. These include Enron's use of byzantine off-books partnerships that helped pretty up the company's balance sheet and improve its income statement.

Instead, according to people who know both men, their statements and actions will be defended with a simple response: their business practices may have been aggressive, but everything they did was lawful. Both men, who are expected to testify, plan to maintain that many of the accounting and financial decisions were both correct and appropriately disclosed, and their statements about them were truthful.

There are dangers to this strategy. At times, the defense - particularly that of Mr. Skilling, a former chief executive who is charged with playing a direct role in some of the partnership deals - will have to maintain that accounting rules allowed Enron to exaggerate earnings or hide losses, practices that strike outside experts as bizarre and that jurors may have a hard time accepting. There is the complexity of explaining why, if so much of what Enron did was legal and the company's finances were as strong as the executives maintain, the company quickly collapsed into bankruptcy.

There is also one final challenge, which experts refer to as the Simon problem. In a decision from the early 1970's in United States v. Simon, a federal court held that compliance with accounting rules is not, in itself, enough to disprove an accusation of fraud. In that case, the court held that there was also a positive duty for full and fair disclosure under the securities laws, which might not be met simply by following generally accepted accounting principles.

That these executives and this case would ultimately serve as a symbol of an era of corporate corruption might have seemed laughable five years ago, when Enron was repeatedly proclaimed by Wall Street and academics as among the best of the best, a cutting-edge company redefining the boundaries of business.

The government, however, hopes to bring in evidence that it contends will prove that Mr. Lay oversaw a reckless organization from soon after its founding as a gas pipeline company in 1985 with the merger of Houston Natural Gas and Internorth of Omaha. By early 1987, Mr. Lay, then the chairman and chief executive, was confronted with evidence of potential financial wrongdoing by top executives at Enron's oil trading unit in Valhalla, N.Y.

The government will seek to admit testimony that despite hearing the evidence, Mr. Lay allowed the executives to remain and, months later, those same executives committed other improper acts that exposed Enron to as much as $1 billion in losses. While prosecutors have been arguing that they should be allowed to present the Valhalla episode to the jury to show that Mr. Lay had a pattern of tolerating wrongdoers, the federal judge who is hearing the case, Simeon T. Lake III, has not issued a final ruling on whether he will allow such evidence.

A crucial witness in the government's case will be Andrew S. Fastow, the former Enron chief financial officer who has pleaded guilty and is cooperating with the prosecution.

Mr. Fastow was a specialist in the growing business of structured finance, a technique that companies use to gain access to new capital by essentially selling off portions of their risk through the use of off-books partnerships. When such transactions are done properly, at least 3 percent of the entity's capital is contributed by an independent investor. Under the accounting rules, assets sold to the entity can then be moved off the balance sheet and the purchase price can be reported as revenue.

By 1996, Mr. Fastow began committing crimes through use of the off-the-books entities for personal enrichment. He arranged to be the 3 percent investor himself - a strategy that would not have met the accounting standards for independence - then set up elaborate schemes in which bogus "investors" stood in as fronts for him. In one deal, called RADR, Mr. Fastow funneled money to various investors, who then returned profits to him. In another, called Chewco, Mr. Fastow allowed a close colleague, Michael J. Kopper, to control the 3 percent investor, then accepted kickbacks on the deal.

While neither RADR nor Chewco appear in the criminal indictments against Mr. Lay and Mr. Skilling, the defense lawyers have already argued that they need to explore both transactions in front of the jury to try to prove that Mr. Fastow had a pattern of hiding illicit personal profits from his bosses.

It is this point - from Mr. Fastow's crimes beginning in 1996 to the charges against Mr. Skilling for actions years later - that will serve as a crucial battleground, with both the defense and the government fighting over the questions that the jurors should be asking themselves.

If Mr. Fastow engaged in crimes involving RADR and Chewco without the knowledge of his superiors, the defense argues, how can the jury believe that he told his bosses in later years about similar illegal acts that were used to manipulate Enron's financial reports? But, the government will counter, would Mr. Fastow - along with other executives who have pleaded guilty, including Richard A. Causey, the former chief accounting officer - have engaged in subsequent illegal acts that seemed to solely benefit the company without consulting superiors?

Numerous allegations against both Mr. Lay and Mr. Skilling relate little to Mr. Fastow. Instead, they portray the executives as consistently working to disguise the true economic realities of Enron in violation of federal securities laws.

The economic underpinnings of Enron began to become unhinged in 1998. That summer, Enron entered into several capital intensive transactions that ultimately proved to be abject financial disasters, including a venture into the water business and the purchase of a portion of an electricity distribution plant in Brazil.

The government's case is built not so much on showing that Enron was destroyed by fraud, but rather on showing that fraud, including the suspected deceptions by Mr. Lay and Mr. Skilling, prevented the marketplace from knowing how badly things were going inside the company. But the cases against the two men are very different. Mr. Skilling faces the most complex series of allegations, which essentially accuse him of leading a concerted effort to make Enron appear more financially sound than it actually was.

Through the use of the off-books partnerships, the company avoided reporting losses and was able to generate tens of millions of dollars in profit. It wrote up the value of certain assets when it needed income, and did not write them back down when circumstances changed. It entered into transactions in which there were secret buyback agreements that would have required accountants, had they known, to remove the related profits from the company's books. All of this, according to the indictment, involved Mr. Skilling.

The charges against Mr. Lay are far narrower, on the other hand. He is not accused of involvement in the partnership machinations; rather, the vast majority of the allegations against him involve public statements he made in the final few months of Enron's existence. The government says that many of those statements, including upbeat assessments of the company's liquidity and business performance, were lies through which Mr. Lay continued the earlier deceptions involving Mr. Skilling.

In many ways, it is fitting for Enron's tale to end with a trial that is widely viewed as a verdict on business practices in the late 1990's. When it was flying high, the energy giant was celebrated from boardrooms to business schools as a lodestar for the future of the corporate world, the embodiment of a company that got everything right. But with its collapse into bankruptcy in 2001 - costing investors billions and pushing thousands of employees out onto the street - it became emblematic of everything wrong in corporate America.

"Enron has become a poster child for an era, so I think people will remember what happens at this trial more than any other white-collar trial that occurs," said Linnea Bernard McCord, associate professor of business law at the Graziadio School of Business and Management at Pepperdine University. "It made a real imprint on everybody's psyche."

Alexei Barrionuevo contributed reporting from Houston for this article.



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