A big story today is the guilty verdict on Enron executives Kenneth Lay and Jeffrey Skilling. There are many interesting issues involved in this, but the one that I wish to draw to attention of readers here is that Lay and Skilling were not found guilty of stealing money or looting the treasury, but of dishonesty and withholding the truth.
For example, see this summary of the prosecutor’s closing argument:
But all the talk from lawyers ended Wednesday morning at 10:35, when prosecutor Sean Berkowitz summed up the government’s case against the defendants with a simple maneuver.
Berkowitz pulled out a large poster, which he displayed on an easel. On the one side, in big, capital letters, was the word, "TRUTH," and on the other, "LIES." After all the intricately detailed testimony that came before the jury about "dirty hedges," "goodwill write-downs," "monetizations" and "dark fiber sales," the black-and-white chart boiled it down to those two words.
"These men lied," he declared. "They withheld the truth. They put themselves ahead of the investors. I’m asking you to send them a message, that it’s not all right. You can’t buy justice. You have to earn it."
The people who bought Enron’s stock, Berkowitz said, "weren’t entitled to much, but they were entitled to honesty." After he finished, deliberations began.
It looks like the sentences are going to be stiff.
"But even if they are convicted of just one count each, their sentences are sure to be stiff. Judge Lake, for one, has already shown that he takes corporate fraud seriously.
He sentenced Jamie Olis, a former vice president of finance at Dynegy Inc., to 24 years in prison for his role in a $300 million accounting scam at the Houston energy firm.
Last year, the Fifth US Circuit Court of Appeals in New Orleans threw out the sentence, but upheld the fraud conviction. Lake has not yet resentenced Mr. Olis.
"These men [Lay and Skilling] are going to be in jail for decades if convicted," says Mr. Zamansky.
There is some very interesting blog commentary on the Enron here/
In this case, the verdicts are going to be appealed. Lay and Skilling did not necessarily do the actual fraudulent calculations themselves. Andrew Fastow has already been convicted as the main architect of the fraudulent calculations. The question for Lay and Skilling is whether they remained "deliberately ignorant".
The relationship of the frauds at the heart of the present charges to the Enron collapse is interesting and I don’t think that it is well understood. The frauds in the present charges are a series of limited partnerships that were concocted to disguise writeoffs. But the losses in these limited partnerships were not what caused the collapse of Enron. The losses in these limited partnerships were a very small fraction of the total writeoffs involved in Enron. Had all these limited partnerships made good, the Enron collapse would have been delayed only a little while. The real problem with Enron is that they made a lot of crappy investments with minimal due diligence. But Lay and Skilling were not charged with making lousy investments. They were charged in connection with things that probably constituted less than 5% of the total collapse in monetary terms, if that.
But while the direct impact of the frauds on the balance sheet was (I think) not the direct cause of the collapse, the leverage was fantastic as the frauds made Enron look profitable, which was essential for it to keep raising money. If they had reported even a slight loss at any time, the wheels would have fallen off the money raising, people would have asked questions. So they avoided taking writeofs, developed ever more fantastic methods of parking non-performing assets , just to get knife-edge profits. Even slight profits were enough to satisfy the "consensus" of investors that this was one terrific company. In fact, by "consensus", in 2000, Enron was voted the best-managed firm in the U.S. and convicted felon Andrew Fastow was the "consensus" financial executive of the year.
In Eichenwald’s terrific book on Enron, the first person credited with noticing the problems was a short seller, who really came out of left field. He simply noticed what was, in effect, a statistical anomaly – the profits were miniscule relative to the capital employed and they always came out fractionally positive. When you had large fluxes in and out, it didn’t make sense that the knife edge always came out just positive. He wondered what accounting decisions had been made. I think like a short seller. Whenever I see knife edge balances, like the knife edge balance by which the net index from modern proxies comes out a hair warmer than the index from medieval proxies in many multiproxy studies, I wonder what accounting decisions were made. You can dress it up in statistical language, but civilians can think of the issues as being accounting decisions. Sometimes you need to look at more than one thing. Andrew Fastow did.
I often talk here about the need for full, true and plain disclosure. I don’t say this out of any belief that businessmen are more honest than academics. I don’t think that at all. All I’m saying is that breaches of the obligation of full, true and plain disclosure are serious and people are being sent to jail for breaching these obligations. Maybe not enough. Withholding the truth, as noted above, is a form of criminal dishonesty just as much as overt lying and was clearly involved in the charges against these two Enron executives. Codes of academic conduct have fairly similar obligations and the omission of adverse results can amount to misconduct, in much the same way that withholding truth from investors can amount to fraud.