Posted on 7-2-2002

Get Lay
by Chris Mooney* (photo shows Chris Mooney)

Sometime in mid-January, the worm turned for Enron executives. You could
see it in the way George W. Bush raced to distance himself from his friend
Kenneth L. Lay, like Prince Hal denouncing Falstaff: "I know thee not, old
man. Fall to thy prayers." And it's beginning to look as if Lay, the
recently resigned chairman and CEO of the energy trading corporation, may
have need of prayer. Calls for criminal prosecution of Enron heads have
begun to sound—and remarkably, free-market conservatives, including one
formerly on the Enron payroll, have been the first to raise their voices.

"Jail 'em. All the Enron and Arthur Andersen principals and then some,"
wrote National Review economics columnist Larry Kudlow. "Why? To save our
system of corporate governance, which used to be the best in the world."
The fact that Kudlow himself was in the process of disclosing some $50,000
in consultant's fees from Enron made the denunciation all the more striking.

The case against Lay and other Enron executives, particularly former CEO
Jeffrey Skilling and former CFO Andrew Fastow, would likely center on two
recent revelations. First, there's the matter of document shredding on the
part of both Arthur Andersen and Enron. Evidence of such activity could
support an obstruction-of-justice charge. Second, and perhaps more gravely
for Enron chiefs, an August communiqué from Vice President Sherron Watkins
reportedly warned Lay that the company might "implode in a wave of
accounting scandals." Lay dumped some of his own Enron stock shortly after
receiving that letter—and yet, in a September online chat, he told
employees that company shares were an "incredible bargain." If Lay and
other Enron execs had personally acted on the basis of concerns like
Watkins's but kept them concealed from shareholders (including employees),
they could be convicted of securities fraud.

Before Watkins's "smoking gun" letter leaked out, it might have been
possible to believe that Lay was, as he was fond of claiming, merely a
company figurehead. Sure, he had great political connections; but of course
he wasn't aware of Enron's dealings through offshore partnerships like
"Raptor" and "Jedi II." (Andrew Fastow must have liked John Williams
soundtracks.) Now, this tale really strains credulity. But does that mean
that Lay and other members of the Enron team can really be brought up on
charges? Enron's executives cannot be presumed guilty, and we must remember
that we've only begun to hear their side of the story. The facts of the
case are not all known; more spill out every day in congressional and other
investigations. Nor is it possible to predict how federal prosecutors at
the Department of Justice (to say nothing of investigators at the
Securities and Exchange Commission) will ultimately decide to pursue
Enron's principals.

Nevertheless, it's probably safe to assume that there will be a serious
Enron dragnet and that it will muster politics and outrage in equal
measure. "It seems to me that letting Lay off with a plea or an easy
settlement is not as likely as it might be in another case," observes
Lawrence Mitchell, a corporate-law professor at George Washington
University and author of the recent book Corporate Irresponsibility.
"Essentially, this is almost the corporate equivalent of the O.J. trial."

Lay presumably knows that. On the same day that Kudlow was calling for
incarceration, The New York Times ran a cover story interviewing Lay's
attorney, Earl J. Silbert, who tried to explain away the appearance of
wrongdoing on his client's part. When Lay sold Enron shares late last year,
Silbert explained, he was merely trying to raise cash to pay off loans from
his own company. In fact, said Silbert, Lay was optimistic about Enron's
future at the time.

It sure sounds like Silbert wants to head off insider-trading charges,
which, according to Mitchell, are the "principal way" federal prosecutors
might hope to nab Lay. Such charges could entail up to 10 years in prison
and a fine of $1 million; additional civil damages could cost far more.
About Silbert's spin, Mitchell comments: "Whether or not Lay was optimistic
about Enron . . . , his team was not. His obligation to the market was
either to disclose that information or to refrain from trading."

The relevant law here is the 1934 Securities Exchange Act, which contains
several securities fraud provisions, including a two-pronged statute that
prohibits both insider trading and misdisclosure (concealing or
misrepresenting the company's financial status). The two offenses are
closely linked: Insider trading involves acting on undisclosed information,
whereas misdisclosure enters the picture when executives mislead their
shareholders. Because they were trading stock in their own company, Enron
execs like Lay could be vulnerable on both counts. These are not easy
charges to prove, however. For a criminal conviction, the prosecutor has to
establish willful intent (in a civil case, recklessness). The trouble then
becomes pinning down the defendant's mental state at a given time, perhaps
even on a given day—the day that Lay received the Watkins memo, for
instance. "If the executives can demonstrate that they were out of the loop
or misled by a subordinate such that they honestly believed, if somewhat
foolishly, that there was nothing bad going on, they may have a defense,"
says Donald Langevoort, a securities-law expert at the Georgetown
University Law Center.

Still, federal prosecutors have tried-and-true methods for proving intent.
They can offer immunity to key players—in this case, perhaps document
shredders or Enron's second tier of corporate management—in exchange for
their cooperation with the criminal probe. The real fun could come in when
prosecutors turn to Arthur Andersen's and Enron's underlings and get them
to rat out higher-ups, resulting in back-stabbing, recriminations,
wire-wearing, and the like. As John Aisenbrey, a former assistant U.S.
attorney, told the Kansas City Star recently: "If I were prosecuting this
case, I would use the threat of indicting Arthur Andersen itself to crack
open the case against the Enron people."

Prosecutors can also throw a wide range of lesser charges at the little
fish in order to reach the big ones. The obstruction-of-justice front may
be "spiciest," according to Stanford Law School's white-collar-crime expert
Robert Weisberg. "The shredding of documents is simply the most dramatic
fact right now before the public," he says, "and it's the least
legitimately explainable thing that anybody did." Prosecutors would have to
trace the destruction of files back past the people who actually did the
dirty work and pin it on those who ordered it.

Other possible charges include catchalls like wire and mail fraud (which
"just cover an incredible variety of things," says Weisberg). These could
probably be used against executives or underlings. Prosecutors could even
invoke the Racketeer Influenced and Corrupt Organization Act and threaten
Enron peons with severe penalties unless they sing like canaries. It all
depends on how proactive and dogged prosecutors want to be—and that's a
political question. "There's a pretty good laundry list to choose from"
when it comes to criminal charges, notes Lawrence Mitchell. "And even if
Lay gets away without criminal convictions, I cannot believe that there
aren't some accountants at Arthur Andersen that wind up in jail."

Is there a chance that Lay will get away without criminal convictions? If
your vindictive juices are starting to flow, you might want to take pause.
Langevoort says that he would be "shocked" if we didn't see criminal
charges against Enron heads, in addition to a wide range of civil suits;
but he warns that the end result could easily be settlements all around,
"with self-serving statements by both sides saying that 'we were confident
that we would win, but we wanted to put this behind us.'" After all, many
such settlements followed the savings-and-loan scandals of the 1980s. And
we can be sure that Enron will have the best lawyers money can buy.

Ironically, the main thing blocking such a lukewarm outcome could be the
Bush administration. The White House just might feel obligated to convince
us that it was never soft on Enron. (Consider it a sort of Larry Kudlow
effect writ large.) Letting Lay and his cronies take the fall might help to
insulate the Republican Party from more sweeping criticism. There's also
the sheer size of the Department of Justice task force charged with
pursuing the Enron affair; attorneys from Washington, D.C., to San
Francisco, including a Houston-based field office, are already on the case.
Congress and the SEC have launched their own investigations. Revelations
from private suits—scores have already been filed—could end up filtering
into criminal ones. With this many lawyers and investigators turning the
ground, a lot of evidence will emerge. To what extent it will bear on Lay
and his cohorts remains a question, of course.

Sure, it's speculative. But the potential drama and magnitude of Ken Lay's
criminal prosecution inevitably brings another momentous case to mind: that
of Michael Milken, the so-called junk bond king of Drexel Burnham Lambert.
Taken down on charges of securities fraud in 1990, Milken served two years
in jail and paid a $1-billion fine. In a recent op-ed in The Philadelphia
Inquirer titled "Punish the real Enron villains: The top executives," the
University of Pennsylvania corporate-law professor and bankruptcy expert
David Skeel noted "eerie similarities" between the collapses of Drexel and
Enron.

As Skeel sees it, "Michael Milken invented the junk bond, and along with
Drexel rode that to very high highs. And at the point where the early wave
was cresting, and Drexel was no longer the only game in town, all the
criminal stuff came up." Likewise with Enron: "Enron pioneered the idea of
trading energy. It was the only game in town, had enormous early success;
then encountered competition, had a little more trouble maintaining its
profit levels"—and started to bend the rules.

The chief difference is that Lay and friends were officers of the company
whose stock they may have illegally traded; Michael Milken wasn't. But when
it comes to prosecution, the goal is to connect the dots between
individuals and actual crimes. In that sense, the Enron executives'
proximity to the alleged crime scene probably doesn't hurt. If anything, it
may make the case against them easier to prove.

* prospect.org/authors/mooney-c.html