The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (74 page)

In mid-2002, the Enron debacle prompted the passage of a controversial new set of corporate-oversight rules known as Sarbanes-Oxley, aimed squarely at the abuses that had led to the scandal. Among other provisions, it required CEOs and CFOs to personally attest to the accuracy of their company’s financial statements; imposed new requirements for auditor independence and independent audit committees; banned most personal loans to executives and board members; barred insider trades during pension-fund blackout periods; and stiffened penalties for securities fraud. President George W. Bush proclaimed the law “the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt.”

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For some, a reckoning of a different sort loomed.

While the array of government and private civil suits were ultimately settled, providing a small measure of solace (and compensation) to former Enron employees and investors, the biggest hammer belonged to the U.S. Justice Department. The investigation by its special Enron Task Force continued for more than four years. For most of that time, prosecutors produced a slow but steady stream of indictments and plea bargains—ultimately charging thirty-three individuals, including twenty-five former Enron executives—but recording mixed results at trial.

After the Andersen case, the first indictment came in September 2002, targeting the three NatWest bankers who helped Fastow carry out his Southampton scheme. Improbably, they became a political cause célèbre back in their native England, where they had returned, thanks to their protracted campaign in the British courts and press to resist extradition to the United States. Dubbed “the NatWest Three,” they finally lost their fight and were brought in July 2006 to Houston, where they were forced to wear electronic monitoring devices and were barred from leaving Texas until trial. In February 2008, they each pled guilty to a single count of wire fraud and later received sentences of 37 months.

Four Merrill Lynch executives—including Dan Bayly, the firm’s former global head of investment banking—faced criminal charges in the Nigerian barge deal. (Schuyler Tilney was never charged.) All four were convicted (along with a midlevel Enron executive; another Enron manager was acquitted), sentenced to between thirty and forty-six months, and sent to prison. But a successful appeal later freed three of the men (including Bayly), and charges against them were ultimately dismissed.

The cases against most Enron executives proceeded slowly. Prosecutors not only had to unravel Enron’s byzantine accounting, they also had to figure out how to make a criminal case, knowing that defense lawyers would argue that however misleading much of Enron’s accounting may have been, it was not technically illegal. For a long time, the government appeared to be following a strategy of pursuing executives who’d been involved in specific transactions, such as the Nigerian barge deal, where the wrongdoing seemed especially blatant.

On October 31, 2002, Andy Fastow was indicted. The government charged him with seventy-eight counts of fraudulent conduct, mostly involving the money he had pocketed through deals like RADRs and LJM Swap Sub. Six months later, the Justice Department indicted Ben Glisan for his involvement in Fastow’s schemes. The government also charged Lea Fastow with conspiracy to commit wire fraud, money laundering, and filing a false income tax return in connection with the alleged kickbacks involving her husband’s partnership.

Enron’s much hyped broadband business produced seven more indictments. Top executives Ken Rice, Kevin Hannon, and Joe Hirko, as well as two others, were charged with fraud and insider trading, accused of lying to the investing public about EBS’s technological capabilities to inflate market valuations of the business while collectively selling more than $150 million of stock. Kevin Howard and Michael Krautz were indicted for the Braveheart deal.

For a time after they were indicted, most of the Enron executives vowed to fight the criminal charges in court. As they saw it, the government was going after them because it needed scalps to show that it was serious about prosecuting corporate crime—and to satisfy public bloodlust in the Enron scandal. Many former Enron broadband executives were appalled at the indictments of Rice, Hirko, and the others, who had been accused of hyping the business and then selling their stock before the truth came out. According to their view, what the Enron executives had done was nothing worse than what dozens of CEOs had done in Silicon Valley, where people who worked for companies with far less to offer than Enron had fed Internet hype, cashed out, and walked away unscathed.

A more extreme version of this thinking was that Enron’s sins were not incompetence and fraud but rather innovation and free-spiritedness. Enron’s dwindling collection of defenders made the same argument as Michael Milken’s defenders had in the 1980s: They were being prosecuted because they were a threat to staid, old corporate America. “You can always tell who the pioneers are, because they’re the ones with arrows in their backs,” became their refrain.

But that was a minority perspective. Most former Enron employees voiced outrage upon learning how their company had remained such a highflier for so long. Their faith in Enron—their pride in working for the coolest company in America—had been shattered. It was as though they all were now wearing a scarlet E.

By the fall of 2003, almost two years into the Justice Department’s investigation, complaints about the failure to charge Enron’s top executives—and speculation that they would escape prosecution entirely—became deafening. The country was reeling from a wave of corporate scandals that had come to light in the wake of Enron: Tyco; WorldCom; Adelphia; HealthSouth; Martha Stewart and ImClone. In all of these cases the CEOs had already been charged with crimes. Why, many people were asking, were Ken Lay and Jeff Skilling still free men? For most Americans, Enron remained the überscandal: not just the first, but the most brazen and the most devastating.

The truth is that the Enron Task Force was struggling to put the pieces together, slowed by Enron’s complexity, internal conflicts over investigative strategy, and changes in its leadership—it would have three directors in less than five years.

A case this complex required cooperating witnesses—insiders who cut deals to help the government in return for lighter sentences—and by mid-2003, the dominos were just beginning to fall. The first were Michael Kopper and Tim Belden, who both pled guilty and promised to cooperate in return for leniency. This provided the feds with a critical window into the complex worlds of Global Finance and California energy trading. (Both agreed to disgorge millions in ill-gotten gains—in Kopper’s case, $12 million; in Belden’s case, $2.1 million. When Belden appeared in court to plead guilty to manipulating California’s energy market he told the judge, “I did it because I was trying to maximize profits for Enron.” His lawyer later said that his tactics simply reflected the way Enron had trained Belden to do business.)

Then, in September 2003, Ben Glisan pled guilty to one count of wire and securities fraud for his role in Talon, better known as Raptor I. “This trans-
action . . . was accounted for in a manner inconsistent with its economic substance,” read his plea agreement. Glisan didn’t agree to cooperate, but he immediately began serving a five-year prison sentence, becoming the first Enron executive to go to jail.

In early October, the SEC announced that Wes Colwell, the former chief accounting officer of Enron North America, had settled his case. Colwell was not charged with criminal offenses, but he did agree to cooperate—which was a huge win for prosecutors given the complexity of Enron’s accounting. The nature of the charges against him revealed how the investigators’ strategy was shifting. The SEC’s complaint noted that Colwell, along with unidentified “others,” had carried out a “fraudulent scheme” that involved “manipulating Enron’s publicly reported earnings through a variety of devices designed to produce materially false and misleading financial results.” Instead of focusing on narrow illegal acts, prosecutors were now building the case that Enron was fundamentally a fraud—and it didn’t matter if this particular accounting move, or that one, was technically legal. Taken in their entirely, Enron’s accounting practices violated the law because they perpetrated that fraud.

This broader strategy became more obvious a few weeks later. On Octo-
ber 29, 2003, Dave Delainey, the former head of Enron North America and then of EES, pled guilty to one count of insider trading and agreed to forfeit a combined $8 million to the SEC and the Justice Department. Again, the admissions were sweeping. The Delainey indictment noted that “from at least 1998 to 2001, Enron’s executives and senior managers engaged in a wide-ranging scheme, through a variety of devices, to deceive the investing public about the true nature and profitability of Enron’s businesses by manipulating Enron’s publicly reported financial results and making false and misleading public representations.” The indictment covered everything from the improper reserves set up to conceal the profits the traders made in California to the burying of the EES losses in the wholesale business to the manipulation of Mariner’s valuation to the Raptors. And Delainey had admitted to it all and agreed to cooperate. (Delainey would later be sentenced to two and a half years in prison.)

For quite a while after the Enron bankruptcy, Andy Fastow had his own line of defense: He pointed the finger right back at Enron. According to people in his camp, Skilling and the other Enron executives created businesses that were either huge cash drains or didn’t make nearly as much money as Enron needed them to. Fastow was charged with the impossible task of raising the capital that allowed the company to appear successful and kept the stock price going up.

As Fastow saw it, he was hardly the only one who had cashed in from the convoluted financings he had cooked up.
Everyone
at Enron had benefited: the stock options worth millions; the excessive pay; the Enron lifestyle—Fastow had made all that possible. In his view, every Enron millionaire owed him a debt of gratitude. And yet now they were all throwing him to the wolves. There wasn’t much doubt that Fastow felt embittered, viewing himself as the fall guy for everything that had happened at Enron.

And in a sense, Fastow was right. Those who wanted to blame all of Enron’s woes on the greedy former CFO claimed that Enron had been a good business brought down by Andy Fastow. But that was never true. Ultimately, Enron was a bad business that was, for a time, propped up by Andy Fastow.

Rationalizations notwithstanding, Fastow’s situation became far more difficult once Kopper and Glisan pled guilty—and the date of his wife’s trial drew closer. After all, if he and Lea were both convicted, their two children could be left without a parent to raise them for years.

On January 14, 2004, in a highly unusual package deal, both Fastows pled guilty, setting in motion a strange chain of events. Lea admitted to filing a false income tax return in exchange for a likely prison sentence of five months—brief enough to ensure that she was released before her husband began his sentence. Andy pled guilty to one count of conspiracy to commit wire fraud and one count of conspiracy to commit wire and securities fraud, and accepted a ten-year prison sentence. He agreed to forfeit $23.8 million and abandon claims to another $6 million. Prosecutors believed that that covered most of what was left from LJM and Enron after Fastow’s massive legal bills. He also agreed to cooperate with investigators, acknowledging that he had “engaged in schemes to enrich myself and others at the expense of Enron’s shareholders.” More importantly for the prosecution’s ongoing efforts, he also admitted: “I and other members of Enron’s senior management fraudulently manipulated Enron’s publicly reported financial results. Our purpose was to mislead investors and others about the true financial position of Enron, and consequently, to inflate artificially the price of Enron’s stock and maintain fraudulently Enron’s credit rating.” (Citing Fastow’s cooperation with the government and his apparent remorse, the presiding judge ultimately sentenced him to just six years in prison.)

Within weeks, former chief accounting officer Rick Causey was also indicted for what the government called Enron’s “scheme” to meet or beat Wall Street’s earnings expectations without regard to economic reality. Causey pled not guilty, and began preparing to defend himself by arguing that Enron’s accounting met the technical requirements. “He has done nothing, absolutely nothing, wrong,” said one of his lawyers.

Lea Fastow’s deal, meanwhile, ran into trouble with another Houston judge. Convinced that she was getting off too easy, this judge took the highly unusual step of refusing to sign off on the agreement struck between her lawyers and federal prosecutors. The on-again off-again plea bargain was finally sealed in May 2004, just weeks before trial, when Lea Fastow pleaded guilty to a single misdemeanor of filing a false tax return. She was ordered to serve a one-year sentence at a grim federal detention center in downtown Houston. After her release, she opened an art-consulting business in Houston.

In July 2004, prosecutors scored another coup: Ken Rice, Skilling’s old friend, pled guilty to securities fraud for misleading analysts about the capabilities of Enron’s broadband business. Rice agreed to cooperate with the government, pay a $1 million fine, forfeit $13.7 million in cash and property, and accept a sentence of up to ten years. (Hannon soon pled guilty as well.) A year later, Rice was billed as the government’s star witness in the criminal trial of his former colleagues in Enron’s broadband business. But the trial, which ran aground on mind-numbing detail, went badly for the government, producing a hung jury or acquittal on all counts. Prosecuting the five men again required three separate retrials. Ultimately, charges against Scott Yeager were abandoned, while Mike Krautz won acquittal. Joe Hirko pled guilty to a reduced charge, forfeited $7 million, and served about 16 months. Kevin Howard and Rex Shelby cut deals that resulted in brief periods of house arrest.