Lay *and* Skilling Found Guilty

Elizabeth Nowicki —  25 May 2006

See here! Skilling was found guilty of 19 counts (incl. conspiracy, fraud, false statements and insider trading). Lay was found guilty on 6 counts (fraud and conspiracy).

I imagine both men will make model prisoners, although Lay might be the better prisoner, since he is very good at closing his eyes to bad things and ignoring signs of trouble. (We are talking about potentially *decades* in jail, as we all know. I will be curious to see how that plays out. For the record, I do not think inmate attire is fitted for cuff-links, such that Lay might want to leave his trademark ‘links at home. Or perhaps he will pawn them to pay for his appeals. . .or fines of some sort . . . or recompense to his investors. . . .)

John Hueston, the prosecutor, made a statement a short while ago in which he said two things in particular that caught my attention:

1. He said something about the verdict proving that a CEO cannot just *not* ask questions. (Forgive the double negative, but one of the compelling points for the jury, in the prosecutor’s eyes, was that Lay failed, in part, by not pushing for information – not asking questions – ignoring the red flag information that was right in his lap – not acting in good faith! See here and here for my “Not in Good Faith” manifesto. Who would have thought that the same sort of the fundamental failings that trouble me about director behavior would translate so well (relatively speaking) to the criminal context when dealing with officers?)

2. In addition, Mr. Hueston emphasized that it is no longer acceptable to hide behind lawyers and accountants. I sure *hope* so! I wonder how long it will be before we have multiple sets of outside lawyers and accountants reviewing financials to ensure that nobody is hiding behind anyone. I see this as akin to when Boards started demanding their own counsel, apart from the GC and apart from the outside corporate counsel. I, for one, would be DELIGHTED if multiple layers of accounting and legal review turn out to be a short-term impact of today’s verdict. Even if the costs are duplicative and significant, those costs are still LESS than the cost to investors of another Enron-esque catastrophe.

5 responses to Lay *and* Skilling Found Guilty

    Capital Intensive 26 May 2006 at 1:47 pm

    Permit me to weigh in on Enron.

    SOX-Knee jerk reaction to isolated incidents. The ’33 and ’34 Acts have ample teeth and allow significant latitude to regulators/prosecutors to go after whatever malfeasance existed before or after Enron, which includes accountants and lawyers.

    Enron stockholder value/dimunition of 401(k)value, or the ubiquitous but inaccurate “wipe-out of stockholder and employee life savings.” Just for kicks, I reviewed the Houston Chronicle’s analysis from Bloomberg of ENE’s closing prices during 2001 to see why investors took such a beating. As it turns out, when Skilling assumed the helm (2/12/01), the stock price of ENE was around $80. On 3/9/01 it closed in the high 60s after announcement of the cancellation of the Blockbuster deal. It was in the mid 40s when Skilling was “pied” in the face on 6/21/01. On 8/14/01, the day Skilling quit the stock was around $44. On 9/11/01 it was around $33. On 10/8/01 Enron informs employees that the 401(k) will be locked up 10/29-11/20/01, stock is still around $33. On 10/22/01 stock is around $20-21 a share after the SEC informs ENE that it is looking at the Fastow partnerships and after the 10/16/01 announcement of a $638MM Q3 loss and $1.2B reduction in shareholder equity. On 10/24/01 Fastow is fired and the stock is around $16 a share. FIVE DAYS ‘TIL LOCK-UP!!! 10/25/01 ENE draws down $3B revolvers; still in mid-teens. The 29th of October comes, and after that-that’s when things are looking bad and we would have wanted to SELL, SELL, SELL!!

    The are several rules to successful investing. The most important is knowing what the hell you’re doing. Subsumed in that rule are the principles, among others, of portfolio allocation, diversification, never loving a stock too much (even your own company), and understanding that the markets, especially equity, are very fickle and don’t follow logic. I don’t care who you work for, if your comfort in retirement is solely dictated by your portfolio being made up of solely your company’s stock, you’re liable to have a crappy retirement.

    Second point about the numbers. Investors who lost their shirts always want to be made whole and want executives to be hammered. But the very facts that convicted Lay, et al. were the forces that drove ENE above $80-to wit, corporate chicanery. I haven’t yet heard a movement for all the investors who cashed out at the top to give up their gains. Remember, lots of ENE employees made tons of money selling stock, including Sherron Watkins. The ignorant rode the plane into the ground.

    A word about stock sales by insiders: I have serious reservations about the promotion of a stock being actionable when made at or near the time the promoter is selling the same stock. Recently a stockbroker/FA was hammered by NASD or maybe NYSE for selling stock in his former firm because of requirements of divestiture at his new firm, while still recommending old firm stock to his clients. That’s ridiculous. I am not broker, but often talk stocks with friends. I recently sold an issue because a family member needed some cash. I was selling at a gain, but was still “recommending” the issue because I thought the company was solid (and still do). Should I be prosecuted? I argue that Ken Lay had a duty to tell the truth, but also to recommend his company’s stock. That he sold to cover his lavish lifestyle is immaterial. The statements he made to employees were puffery, IMO.

    Additionally, has anyone calculated how much of the “massive losses” of the employees are attributable to shares that were gifts, bonuses, matches? To me that’s found money, so you can’t count those losses (or should be able to).

    A final word (thanks for hanging in there). Enron was terribly managed. However, Enron never could have become a synonym for greed and hubris but for complicity with the Board of Directors, outside auditors, investment bankers, analysts, credit rating agencies, the finanical press, and yes, regulators. We all know about the directors, auditors, I-banks, the rating agencies and the financial press (save for the contrarians and skeptical who exposed this long before the collapse), but regulators are underfunded and overworked. I was working at the SEC when ENE imploded. There was relief there that ENE was so large that they hadn’t been recently reviewed. (For those who aren’t familiar with the system, mega-companies with longer track records are generally not reviewed in depth by the SEC on a yearly basis, but sometimes only every third year (it may be a longer interval, but I’m not sure). This is because the staff is overwhelmed with the number of public companies and only newer issuers and other higher risk registrants are reviewed annually.

    As an aside, I used to believe that the SEC truly did advocate for and protect the individual investor. I now believe that the SEC is more concerned about not making ENE-like mistakes, and ensuring the capital markets don’t fail. Witness recent hedge fund regulation and comments about LTCM at the Annual Institute of Sec. Reg. in NY last November. I’d rather repeal SOX, do my own due diligence and not have profits hammered by more needless regulation.

    Elizabeth Nowicki 26 May 2006 at 10:51 am

    HBSer and Steven, thanks for the comments.

    Your comments fit together nicely. HBSer makes a point that I partially agree with – I think holding directors more accountable would go far in precluding some future Enron-esque debacles. Absolutely. If you’ve read my “Not in Good Faith” manifesto (I link to it in my above post), you will know that I am very much in favor of being more thoughtful in how and when we hold executives and directors accountable.

    As to HBSer’s comment (and Steven’s, to a degree) that more lawyers and accountants will not help, note that I suggested it would be a good short-term result. I absolutely agree that throwing away fees on layers of lawyers and accountants long-term is not a good plan. But a bit of paranoia, double-checking, and lawyer/auditor bickering *in the short term* is not a bad thing, in my view. I would hope that it would remind our executives and directors that it is not acceptable to be lax. I would hope that it would tune-up everyone’s ability to temper law with good practices and morality.

    I would rather have accountants, lawyers, executives, and directors bickering about financial statement footnotes than basically barely *skimming* the footnotes. That bickering will go away, in my view, when the new “norms” (which include being more thoughtful as a matter of course) are established. I imagine the need for double lawyering-auditing-accounting will go away at our new “paying more attention” behavior becomes habit.

    Steven, according to your math and assuming that some of the SOX costs are sunk costs (or start-up costs), the Enron investor would still want to incur SOX-related costs, no? (For the record, I take no position on SOX except to say that. . . it is what it is — a quickly-drafted piece of legislation responsive to a seeming pattern of financial fiascos.)

    Thanks to both of you for your comments!

    Steven Donegal 26 May 2006 at 10:08 am

    That should be $135 billion in market cap. It’s early and I’m only on my second cup of coffee.

    Steven Donegal 26 May 2006 at 10:08 am

    What was the ultimate cost of Enron? It’s market cap at the peak was $64 billion in 1999 and $52 billion in 2000. On the other hand, SOX 404 compliance cost, on average, about $3 million per company. So for the Russell 3000, that’s $9 billion of lost earnings. At an average market cap of, oh let’s be conservative and use 15, that’s $1.35 trillion in reduced market cap due to SOX 404 compliance. Now I understand this is a very simplistic cut. But as a long-time securities lawyer, I also am reasonably confident that had SOX 404 been in place at the time Enron was growing, the troubles that befell Enron would in all likelihood not have been prevented. They might have prevented WorldCom, but in all likelihood they would just have made Ebbers commit fraud in a different manner. From what I have seen in my practice, SOX 404 does not deliver a benefit equivalent to its cost. Another pernicious aspect of SOX 404 is the deterioration in the relationship between the independent auditors and the companies. While we have all seen the problems that can arise from a too cozy relationship between a CFO and the audit partner, the adversarial relationship that now exists between the Big 4 and their public company clients does not do a service to the investment community.


    Re: Your comment No. 2
    Yeah, that’s just what we need!! Another layer of lawyers and accountants. That’ll make sure everything is on the up and up.
    What a load!! What is needed is fewer lawyers and accountants and corporate executives and boards being more accessible directly by and accountable to shareholders. Another layer of greedy, unprincipled “professionals” is NOT the answer.