The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (76 page)

As the government’s case soon made clear, this defense posed a serious problem: If there really was nothing wrong with Enron, why had so many of its former top executives pled guilty to committing crimes? By this point, sixteen ex–Enron managers had signed plea agreements admitting that they’d participated in fraud at Enron—and eight of them would take the stand to testify against Lay and Skilling.

Petrocelli urged the jury to ignore all of that testimony. Except for Fastow and Glisan, he would argue, the parade of government “cooperators” hadn’t really committed crimes at all, but had only cut deals with prosecutors because they’d been bludgeoned into doing so, for fear of a long prison sentence. Their testimony was of zero value, Petrocelli declared.

But for anyone listening to the former Enron executives in the courtroom, it was hard to believe that they were all just making it up. Mark Koenig and Paula Reiker, the investor-relations chiefs, testified about last-minute manipulations made to hit analysts’ quarterly earnings targets. Tim Belden described how Enron was really a speculative trading company. Ken Rice talked about the contortions required to make his numbers at broadband. Dave Delainey detailed how losses were hidden at EES. Fastow, appearing deeply repentant, testified about his secret side deals with Skilling and Causey on LJM. And Glisan described telling Lay about Enron’s dire financial straits, then hearing his boss tell the world that all was well. (Clearly stung by the testimony, Ramsey told reporters outside the courtroom that Glisan reminded him of a “trained monkey.”)

To be sure, the defense—especially the silver-tongued Petrocelli—scored points on cross-examination. And, to be sure, there was no smoking gun. But through twenty-two witnesses over two months of testimony, the government steadily built a case whose weight became overwhelming.

As promised, Lay and Skilling took the witness stand in their own defense, offering their best last hope of avoiding conviction. And here all expectations went out the window. Through weeks of prosecution witnesses, the two defendants had remained true to form. Skilling was often snarly and taciturn, reportedly trash-talking to prosecutors (“Figured out the business yet, Kathy?” he asked Ruemmler in court one day) and at one point (according to a courtroom source) mouthing “son of a bitch” to Koenig, who was then on the witness stand. Lay remained personally gracious and charming, even to reporters and prosecutors.

There were expectations that once he took the stand, Skilling would flash his infamous temper, maybe even implode. But during eight days of testimony, he maintained a surprisingly even keel. Nonetheless, his appearance was often weird (his mood seemed to shift at least once a day) and ultimately unconvincing. On direct, Skilling denied reality as virtually everyone else saw it, insisting that nothing had been amiss at Enron and rejecting every government charge in carefully crafted detail. On cross-examination, he was vague and evasive, displaying a string of sudden memory lapses. Berkowitz bruised Skilling’s credibility on two side issues: an attempt he’d made to unload five hundred thousand shares of Enron stock shortly after he’d left the company; and his personal investment in Photofete, a start-up company launched by an ex-girlfriend, which did most of its business with Enron.

But Ken Lay was the defendant who would lose his cool on the witness stand. Oddsmakers watching the case—bookies in Dublin and Costa Rica were actually taking bets—had properly given Enron’s founder a better chance than Skilling of beating the rap. He was further removed from events; he faced fewer charges; and there was, of course, his winning personality. But things had not gone well at trial. The government had produced a surprising amount of evidence from executives who told of warning Lay about dire problems at Enron, only to watch him then tell investors that all was well. Ramsey, the one defense attorney with whom Lay had a personal rapport, suffered heart problems midtrial and was never a factor in the courtroom. Worst of all, when Lay took the stand he appeared angry and self-righteous, even contemptuous of one of his own lawyers, George “Mac” Secrest, at one point snapping: “Where are you going with this, Mr. Secrest?”

Things got worse on cross-examination. Eager to demolish Lay’s credibility—or at least, any remaining vestige of his nice-guy persona—prosecutor John Hueston went after Lay fast and hard. First, he accused him of attempted witness tampering, by placing calls to government witnesses. Next Hueston noted that Lay had stood idly by when Ramsey told reporters that Glisan resembled a “trained monkey,” charging him with character assassination. After that, Hueston suggested that Lay had violated the Enron ethics code by failing to report his own investment in Photofete. Over three more days of questioning, Hueston kept pounding, eviscerating the defense claim that Lay’s secret 2001 sales of more than $70 million in Enron shares had been forced by showing how Lay had had other ways to meet the margin calls. Meanwhile, Hueston pointed out, the Enron CEO had spent tens of millions on an extravagant lifestyle, including $200,000 in early 2001 to rent a yacht for Linda’s birthday party. Lay handled it all horribly, shooting back at Hueston in a loud, contemptuous tone.

Lay’s disastrous performance worried Skilling’s lawyers as much as his own. They couldn’t imagine a scenario where Lay was found guilty while Skilling won acquittal on all twenty-eight charges he faced.

And they were right. When the Enron jurors retired to deliberate on Wednesday, May 17, in the trial’s sixteenth week, they were an unusually unified bunch. They had begun each morning in the jury room with a prayer. On Valentine’s Day, they all had dressed in red for court. On Fat Tuesday, they wore Mardi Gras beads.

It took them six days to reach a unanimous verdict, finding Skilling guilty on nineteen of twenty-eight counts, and Lay guilty on all six charges he faced. Immediately after the jury’s decision was announced, Judge Lake weighed in too, finding Lay guilty on all four counts of bank fraud.

Interviews the jurors gave with the media afterward provided reassurance about how they had come to their judgment. It was clear, for example, that they had refused to demonize the two defendants, with more than one speaking of how they’d admired much of what Lay and Skilling had accomplished during their careers. Nor did they seize blindly on a single document or a single witness, choosing instead to assess the sum total of all that they had seen and heard. As juror Wendy Vaughan put it, it was as though they had been given “a puzzle with about 25,000 pieces dumped on the table.” Added Vaughan, of the defendants: “I wanted to believe very, very badly what they were saying.” Ultimately, the jurors concluded, that simply wasn’t possible.

At a sidewalk press conference outside the courthouse, Enron Task Force director Sean Berkowitz, flanked by the prosecutors and FBI agents who had worked with him, proclaimed that the guilty verdicts sent an “unmistakable message to boardrooms across the country: You can’t lie to shareholders. You can’t put yourself in front of your employees’ interests. No matter how rich and powerful you are, you have to play by the rules.”

Skilling responded publicly with an oddly casual air. “We fought a good fight, and some things work, some things don’t,” he told the media mob on the sidewalk. Petrocelli, who seemed to take the defeat harder, vowed a “vigorous” appeal.

As for Lay, he was surrounded after court adjourned by sobbing members of his family, who had erupted in gasps and tears as the guilty verdicts were read in court. Judge Lake, who would set a sentencing date for October 23 (both men were expected to get more than twenty years), had insisted that Lay surrender his passport and post a $5 million bond before leaving the building. As Lay waited in the courtroom for the necessary paperwork, he whispered consoling words to his relatives as they stepped up, one by one, to embrace him. “God has another plan now,” he told them. In the well of the courtroom where Lay had been found guilty, they then gathered in a circle with a pair of Houston ministers, held hands, and prayed.

“We’re shocked,” Lay told the press when he finally left the building. “I firmly believe I’m innocent. . . . Despite what happened today, I am still a very blessed man. . . . I have a very warm and loving and Christian family that supports me. . . . Most of all, we believe that God, in fact, is in control, and indeed, he does work all things for good for those who love the Lord. And we love our Lord. And ultimately, all of these things will work for good.”

Forty-one days later, Ken Lay was dead. On July 5, during a weeklong stay with Linda in a cabin outside Aspen, he had gotten out of bed at 1:00 a.m. to go to the bathroom and collapsed. Lay was pronounced dead at Aspen Valley Hospital of a heart attack. An autopsy report revealed yet another Lay secret: He had had a history of cardiac problems—“at least” two previous heart attacks, severe coronary blockages, and two stents that had been placed in his arteries to aid blood flow.

The news of Lay’s death was met with a bizarre mix of sadness, frustration, and even suspicion. The front page of the
New York Post
carried a picture of Lay and a casket, accompanied by the giant headline:
BEFORE THEY PUT CHEATO LAY’S COFFIN IN THE GRAVE
CHECK HE’S IN IT
. Coroner’s report notwithstanding, the blogosphere swirled with insistent declarations that Lay wasn’t really dead, and Web sites sprang up titled kenlaylives.com and kenlaylives.org. Many weighed in that he had somehow escaped justice by leaving earth without spending a single day behind bars.

The June 12 memorial service at First United Methodist Church in Houston was eerily reminiscent of Ken Lay’s glory days at Enron—the days before he had become a pariah. He was packing them in one last time, more than one thousand people in all, with a heavy draw from the ranks of Houston’s rich and powerful. Former president George H. W. Bush was there with his wife Barbara. Former secretary of state James Baker. Former commerce secretary Robert Mosbacher. Legendary heart surgeon Dr. Denton Cooley. Former Texas governor Mark White. Houston Astros owner Drayton McLane. Former Houston mayor Bob Lanier. And on it went.

They were there not to bury Lay (whose body would be cremated), but to praise him. Mick Seidl, his early Enron colleague (and a bit player in the Enron Oil scandal), eulogized Lay as a “good, honest, God-fearing man who did not have a criminal bone in his body.” The Reverend William Lawson, a Houston civil-rights icon who had earlier likened Lay to Martin Luther King, Jr., and Jesus Christ, told the mourners that “he was the victim of a lynching.” Lay’s stepson, Beau Herrold, added bitterly: “I’m glad he’s not in a position anymore to be whipped by his enemy.”

Notwithstanding the anger of Lay’s family and friends, in the United States in 2006, a criminal trial in federal court—especially for a rich, white former CEO—hardly approximates a lynching. And beyond the small, privileged circle in Houston who filled a downtown church on that July day, the truth is that the conviction of Ken Lay and Jeff Skilling was generally received as the fitting culmination of a long, arduous search for justice.

Because he had died before Judge Lake imposed his sentence—and before his conviction had survived legal appeal—Lay’s sentence was ultimately erased as a matter of legal record.

Ken Lay’s death was yet another sudden turn in the long and painful Enron tragedy. Without Lay, Enron would never have existed, and for virtually its entire history, he was its public face. But the modern Enron, with all its errant ways, was Jeff Skilling’s creation. And now Skilling would be left alone to face the public reckoning, for himself and for the company he had built that had climbed so high—and fallen so far.

It came on October 23, 2006, when Judge Lake sentenced him to 24 years and four months in prison and a fine of $45 million. Skilling’s request to remain free while he appealed his conviction was denied. He reported to a low-security prison in Waseca, Minnesota, and began serving his sentence on December 13, 2006—with a projected release date of 2028, when he would be 74 years old.

“Ladies and gentlemen, Mr. Andrew Fastow!”

He was a most improbable Las Vegas headliner—especially for a national convention of fraud examiners. But by June 2013, the former Enron CFO had finished his prison sentence and become a popular speaker on business ethics. This new career, in contrast to his old one, was unpaid.

After serving more than five years, Fastow had returned to his family in Houston, where he went to work as a document-review clerk for the law firm that represented him in civil litigation. A few months later, after reading a column on the importance of teaching ethics by the dean of the Leeds School of Business at the University of Colorado-Boulder, he contacted the dean and volunteered to speak to his students. When Fastow appeared in Boulder, the auditorium was packed. By the time he arrived in Las Vegas, he’d given more than a dozen talks, addressing small business groups and students at such schools as Tufts, Tulane, and Dartmouth.

As always, he began with a
mea culpa
. “Why am I here?” asked Fastow, dressed in a blazer and button-down shirt, before a full house of 2,500. “First of all, let me say I’m here because I’m
guilty
. . . . I caused immeasurable damage. . . . I can never repair that. But I try, by doing these presentations, especially by meeting with students or directors, to help them understand why I did the things I did, how I went down that path, and how they might think about things so they also don’t make the mistakes I made.” (Fastow later explained that he kept his red prison ID card in his wallet and took it out every morning to remind himself “that I harmed so many people in what I did.”)

But he was also eager to sound a warning about current corporate practices. “The last reason I’m here,” he continued, “is because, in my opinion, the problem today is ten times worse than when Enron had its implosion. . . . The things that Enron did, and that I did, are being done today, and in many cases they’re being done in such a manner that makes me blush—and I was the CFO of
Enron
.”

But if Andy Fastow learned his lesson, it’s not clear anyone else did. Which is more than a little bit ironic, because even after Enron was out of the headlines, the scandal reverberated through the worlds of both business and popular culture.
Everyone
began talking about the importance of ethics. There were conferences (“Best Practices: A Blueprint for the Post-Enron Era”), academic papers (“Enron Ethics: Culture Matters More than Codes”), and case studies (“Enron and World Finance: A Case Study in Ethics”) devoted to the topic. At business schools across the country, ethics classes proliferated. Harvard, for instance, added a compulsory, full-length ethics class in 2004. Overall, the number of schools requiring a course in ethics, business in society, or a similar topic jumped from 34 percent in 2001 to 79 percent in 2011, according to the results of a survey by the Aspen Institute.

Perhaps not incidentally, the name “Enron” also became a cultural byword. In 2005, a documentary film made by Alex Gibney and bearing the title of this book had its premiere at the Sundance Film Festival. The following year, the film was nominated for an Academy Award. (It lost to
March of the Penguins
.) In 2009, a young British playwright named Lucy Prebble scored a huge hit in London’s theater world with her play about Enron, which literally brought Fastow’s Raptors to life as debt-eating monsters. The play even opened on Broadway but didn’t fare well after a devastating review in the
New York Times
.

The reaction wasn’t all just talk and show. Laws were changed, too. It was immediately after Enron’s bankruptcy, in the summer of 2002, that President George W. Bush signed the 66-page law known as Sarbanes-Oxley (officially titled the “Public Company Accounting Reform and Investor Protection Act”). While invoking Franklin D. Roosevelt at the bill’s signing, Bush declared that “the era of low standards and false profits is over; no boardroom in America is above or beyond the law.” He added that “free markets are not a jungle in which only the unscrupulous survive or a financial free-for-all guided only by greed,” and also said that “tricking an investor into taking a risk is theft by another name.” Although this didn’t get as much press, in 2006, Bush also signed the Credit Rating Agency Reform Act. Citing Standard & Poor’s and Moody’s failure to lower Enron’s credit ratings in a timely fashion, Alabama Republican Senator Richard Shelby said that the bill addressed an “industry that was beset by conflicts of interest and a lack of competition,” and that “ultimately, this compromised the integrity of the market and investors paid the price.”

The government’s aggressive prosecution of the former Enron executives (along with former WorldCom, Tyco, and Adelphia chiefs) was supposed to underscore the notion that everything was different now. We agreed. In
Fortune
, we called the trial of Ken Lay and Jeffrey Skilling “a milestone in American business history.” After the two men were convicted, we said, “The rules are now clear and the risks of another Enron that much lower. The message is not to start down the slippery slope . . . fudging the numbers, operating deeply in the gray zone, deliberately obscuring what’s going on in your business, isn’t just wrong. It’s a crime.” We added, “Maybe, just maybe, a couple of decades in the slammer for Ken Lay and Jeff Skilling will send the message home.”

As we wrote those words in the spring of 2006, the financial crisis was already underway, even if no one knew it yet. (So much for investors being protected and rating agencies being reformed!) Thanks in part to those conflicts of interest and lack of competition that Senator Shelby had talked about, along with a good helping of old-fashioned greed, the credit rating agencies had assigned AAA ratings (even safer than Enron’s rating) to billions of dollars of mortgage-backed securities that should have been labeled “junk.” If “tricking an investor” (let alone a homeowner) into taking a risk is indeed “theft by another name,” then Wall Street banks certainly stole; they packaged up bad securities and sold them to investors, sometimes while enabling a hedge fund client to profit by betting against the securities—or betting against the securities themselves. Firms around the country were engaging in what can only be called “fudging the numbers” by obscuring the amount of bad mortgage-related products on their balance sheets. Indeed, Citigroup later agreed to pay the Securities and Exchange Commission $75 million to settle charges that while it told investors its exposure to subprime mortgages was $13 billion, the real number was $50 billion. Its former CFO and head of investor relations agreed to pay $100,000 and $80,000, respectively. Neither they nor the firm admitted or denied guilt.

The government’s response to the financial crisis was both similar to its response to Enron—and very, very different. Once again, Congress quickly passed new legislation. In the summer of 2010, President Barack Obama signed the ponderous Dodd-Frank Wall Street Reform and Consumer Protection Act, which weighed in at 2,319 pages, even though much of the specifics of the new rules weren’t included because they were left up to regulators. (And they still are: As of summer 2013, Dodd-Frank rulemaking, which is technically complex and therefore highly vulnerable to a flood of lobbying dollars from the financial industry, is only about 40 percent complete.)

The financial crisis was “born of a failure of responsibility from certain corners of Wall Street to the halls of power in Washington,” declared President Obama. “For years, our financial sector was governed by antiquated and poorly enforced rules that allowed some to game the system and take risks that endangered the entire economy. . . . Reform will also rein in the abuse and excess that nearly brought down our financial system.” A cynic could be forgiven for thinking that sounds familiar.

This time around, though, there were no prosecutions—none—of major executives. Even civil actions by the SEC were fairly limited; in many cases, like the Citigroup case, firms paid but weren’t required to admit guilt. If individuals were named, they were often painfully junior, as in the case the SEC brought against Goldman Sachs. While the firm paid $550 million to make its case go away, the SEC named only Fabrice Tourre, a young Goldman vice president who the SEC said set up a vehicle that would enable a hedge fund to profit if people couldn’t pay their mortgages. (In August 2013, Tourre was found liable on six counts of civil securities fraud.) Countrywide Financial’s former CEO Angelo Mozilo, who was the face of the bad loans that devastated the country, was not charged criminally and settled an SEC lawsuit for just $67.5 million, which was paid not by Mozilo himself but by insurance and by Countrywide’s new owner, Bank of America. PBS’s
Frontline
devoted an entire documentary to the issue, called appropriately enough, “The Untouchables.” Public outrage only grew after Attorney General Eric Holder suggested that some firms were simply too big to prosecute—the economy couldn’t afford the damage that might result if the firms were tarnished. As the
New York Times
noted, “The same dynamic that helped enable the crisis—weak regulation—also made it harder to pursue fraud in its aftermath,” because regulators lacked the information necessary to build criminal cases.

Such criminal prosecutions are nothing if not complex. That was one of the lessons from Enron. That’s because much of what seems so wrong in commonsense terms is actually perfectly legal, and it’s hard to hold senior executives accountable when accountants and lawyers gave their blessings. Executives exploit this unfortunate reality. As Fastow explained in Las Vegas, accounting rules and regulations and securities laws and regulation are “complex . . . what I did at Enron and what we tended to do as a company [was] to view that complexity, that vagueness . . . not as a problem but as an opportunity.” The only question was “do the rules allow it—or do the rules allow an interpretation that will allow it?” Fastow insisted he got approval for every single deal—from lawyers, accountants, management, and directors—yet noted that Enron is still considered “the largest accounting fraud in history.”

Indeed, in many ways, Enron was a legal fraud. Fastow’s guilty plea—and Skilling’s and Lay’s convictions—were due to specific incidents where prosecutors could show that the Enron executives had crossed the line. But they didn’t speak to the larger fact that Enron’s financials were basically a complete misrepresentation of reality. “I knew that what I was doing was misleading,” Fastow told the Las Vegas crowd. “But I didn’t think it was illegal. I thought: That’s how the game is played. You have a complex set of rules, and the objective is to use the rules to your advantage.”

That seems to be how the game was played in the financial crisis, too. It’s enough to make you wonder about a lot of things. Is there a way to change the laws so that there isn’t such an oxymoron as legal fraud? Or does the problem go deeper than mere laws can solve, to fundamental human failings of self-delusion, greed, and ego run amok? You could even argue that Jeff Skilling was right about at least one thing, which is that people in the modern business world are motivated by money beyond all else. As long as the prize for winning the game is wealth beyond most people’s wildest dreams, even if the victory is short term and purely selfish—because the company or the whole economy will soon fall apart—play the game they will.

The “game” Fastow identified also offers, perhaps, an explanation as to why Skilling still insists on his innocence. After his conviction, he never offered the tearful confession that people wanted to hear—or for that matter, even a smidgen of remorse. While Skilling went to prison, his lawyers continued to appeal his conviction, bringing it all the way up to the Supreme Court. In 2010, the Supreme Court invalidated one theory that the government had used to prosecute Skilling. This was a long-controversial statute that makes it a crime for an executive to deprive a company of his or her “honest services.” But the Supreme Court did not overturn Skilling’s conviction. It instead sent the case back to the Fifth Circuit Court of Appeals, which affirmed his conviction in its entirety, ruling that the verdict would have been the same even if prosecutors hadn’t used the honest services statute.

After a winding road that included another appeal to the Supreme Court (which was denied), finally, in 2013—seven years after his conviction—the government and Skilling’s lawyers reached an agreement. At a hearing on June 21, 2013, Judge Sim Lake, who had presided over Skilling and Lay’s trial, reduced Skilling’s sentence by 10 years, from 24 to 14. With credit for good time and a drug and alcohol program that many white collar defendants try to take advantage of, Skilling, who is now 59, could get another two and a half years off his sentence, meaning that he will be out of prison by his mid-60s. Most of the sentence reduction was mandated by a Fifth Circuit ruling dating back to 2009, but the government, and Judge Lake, granted him additional leeway. In exchange, Skilling agreed to abandon further appeals and gave up more than $40 million that had been held in escrow pending resolution of his appeals. The money will be distributed to Enron’s victims.

There are those who believe that this is a travesty and that if we can’t make anyone pay for their roles in the financial crisis, well, then Jeff Skilling should pay all the more. “As if you didn’t know this already, we’re coddling criminals in America,” wrote the
Los Angeles Times
in an editorial. “What’s most unfortunate about the Skilling deal is that it comes at a time when the government’s efforts to punish white-collar fraud have lost all credibility.” The
Times
argued that the deal was especially “unsavory” given that Skilling is “one of the precious few executives whom the justice system succeeded in making into an example.” (Given the role Enron played in manipulating California’s energy market, the
Times
’s rage is understandable.)

But there is another side. At the sentencing hearing in June, Lake, according to the
Houston Chronicle
, noted that Skilling was also the architect of Enron’s rise from an obscure pipeline company to an innovative and diverse energy giant and that he will end up spending more time in prison than anyone else connected to the company’s collapse. Everyone else convicted in the case is already out of prison. “The two most significant factors are the need for the sentence to deter others from similar action and to reflect the seriousness of the offense,” Lake said. “The court is not persuaded a longer sentence is necessary.” To be sure, Skilling has paid a heavy price, more than mere years could ever cost: During the time he’s been in prison, both his parents and the youngest of his three children have died.