Corporate Fraud

Top Enron Executives Convicted

More than four years after Houston-based Enron had collapsed, federal prosecutors finally brought two of the company's former top executives to trial in Houston. The trial of former chairman Kenneth Lay and former chief executive officer Jeffrey Skilling began in January 2006 and concluded with their conviction on a number of charges on May 25. The cases against both men were strengthened by the testimony of other former Enron executives who pleaded guilty to corporate crimes.

Once the sixth-largest energy company in the world, Enron suffered a historic collapse in 2001. For years the company used a complex web of partnerships to hide company debt and misrepresent company revenue. By the end of 2001, the company's stock sank to "junk" status, and Enron filed the largest bankruptcy in U.S. history at that time. The company's auditor, Arthur Anderson, was convicted in June 2002 of obstructing justice for its role in destroying Enron documents. In 2005, however, the U.S. Supreme Court vacated the conviction due to faulty jury instructions given in the trial. Arthur Anderson, L.L.P. v. United States, 544 U.S. 696, 125 S. Ct. 2129, 161 L. Ed. 2d 1008 (2005). However, the company went out of business due to the scandal.

In the years leading up to the trial of Lay and Skilling, several top executives agreed to plea bargains. Former treasurer Ben Glisan pleaded guilty in September 2003 to a charge of conspiracy. He was sentenced to five years in prison. About four months later, former chief financial officer Andrew Fastow entered into a plea agreement and received a 10-year prison sentence on charges of conspiracy to commit wire fraud and conspiracy to commit securities fraud. Fastow's wife and former Enron assistant treasurer, Lea Fastow, later pleaded guilty to a count of filing false tax forms.

In February 2004, Skilling pleaded not guilty to 40 federal charges ranging from making false statements to auditors to insider trading. In July of that year, Lay was charged on 11 counts, including making false statements and securities and wire fraud. Shortly after Lay was formally charged, a New York judge approved Enron's bankruptcy plan, which called for the company to pay $12 billion of the $63 billion it owed to creditors. The company, as well as Skilling and Lay, also faced civil lawsuits.

On July 15, 2005, Enron announced that it had settled a case involving allegations of price gouging during an energy shortage in California in 2000 and 2001. As part of the settlement, the state of California received $47 million. It also became an unsecured creditor, along with the states of Oregon and Washington, in Enron's bankruptcy case.

In December 2005, former chief accountant Richard Causey, who faced trial with Lay and Skilling, agreed to plead guilty on a single charge of securities fraud in exchange for his testimony against the pair. Causey had originally pleaded not guilty in 2004 to 34 counts of money laundering, fraud, insider trading, making false statements to auditors, and conspiracy. His sentence was reportedly set at seven years, though it could be reduced if prosecutors were satisfied with his cooperation in the Lay and Skilling prosecution.

Jury selection in the Lay and Skilling trial began at the U.S. District Court for the Southern District of Texas in Houston on January 30, 2006. The prosecution's case lasted most of February and March. The prosecution sought to establish that both men lied to analysts, shareholders, and the Securities and Exchange Commission about the financial health of the company. The prosecution also alleged that the men participated in the company's manipulation of financial statements as well as in a conspiracy to inflate the value of Enron's stock.

The prosecution rested at the end of the trial's ninth week. At the conclusion of the prosecution's case, U.S. District Judge Sim Lake dismissed three charges against Skilling and one count against Lay. Each of these charges was based on alleged actions that were taken during the first quarter of 2000. However, the judge determined that prosecutors had failed to present any evidence of criminal activity during that period of time.

Skilling testified in April. He told jurors that he was "absolutely innocent" and that he would "fight these charges until the day I die." During the prosecution's case, Fastow testified that Skilling knew that Fastow had used partnerships to artificially boost company's earnings. Skilling denied this allegation and said that he thought that the company was in good financial shape when he resigned in August 2001.

Lay, who began to give his testimony in late April, similarly said that he thought that the company was in good financial shape in September 2001, a time when he informed employees that the Enron should see continued growth. He denied known that Enron officials had lied to auditors, investors, and employees. He gave a detailed account of the events during the fall of 2001, when allegations of financial wrongdoing began to surface. He said that he never envisioned that the company was headed for bankruptcy.

The prosecution began cross-examination by questioning Lay about his contact with witnesses and about ignoring Enron's code of ethics. Lay began to become loud and angry when responding to the questioning by prosecutor John Hueston. On the third day of cross-examination, Hueston asked Lay about the latter's lavish lifestyle and several questionable withdrawals from Enron at a time when the company appeared to be in decline. Lay said that Hueston was being "unfair" and "mischaracterizing."

Lay's testimony concluded on May 2. Even on the final day of testimony, Lay continued to spar with Hueston. Commentators and observers said that Lay's demeanor came across as abrasive. One former prosecutor, Michael Wynne, said that "Lay was arrogant and defiant" in the fact of the prosecutor's questions. Moreover, Lay appeared to be grouchy during questioning by his own attorney, George "Mac" Secrest. Following the government's rebuttal presentation, the case proceeded to final arguments. The jury spent six days deliberating before returning its verdicts on May 25. Lay was convicted on all six counts against him, while Skilling was convicted on 19 of the 28 counts against him, including one count of insider trading.

Lay also faced additional charges in a separate trial that involved four counts of bank fraud and making false statements. Lay elected to have Judge Lake decide the case rather than a jury. Judge Lake found him guilty on all charges. The judge set September 11, 2006 for sentencing. Under federal sentencing guidelines, Lay and Skilling faced long prison terms and enormous fines. However, on July 5 Lay suffered a fatal heart attack at his vacation house in Aspen, Colorado. Because Lay had not been sentenced, his criminal case had not become final. Under federal law a criminal defendant convicted of a crime who dies before exhausting his appeals will have his conviction erased. Therefore, it was expected that the court would dismiss the charges against Lay, making him legally innocent despite the verdicts. Skilling will face sentencing alone.

Morgan Stanley Muddles E-mail

The largest monetary verdict of 2005, of $1.6 billion in damages including pre-judgment interest, was paid to financier Ronald Perelman by Morgan Stanley & Co., Inc., after a jury found the company guilty of defrauding Perelman, a billionaire businessman, with regard to the financial viability of Sunbeam Corporation in a deal that Morgan Stanley had managed.

The lawsuit stemmed from a botched deal in 1998, when Perelman relied on misleading statements from Morgan Stanley that the financially troubled Sunbeam could in fact afford to buy Coleman Holdings, Inc., his camping equipment company Sunbeam filed for bankruptcy in 2001, and both Perelman and Morgan Stanley claimed to have lost money as a resut.

Prior to the start of the trial, Perelman won a judge's ruling that allowed the jury to accept the fact that Morgan Stanley was helping Sunbeam to disguise its fragile financial state while advising Perelman to acquire the failing company.

A close look at the case revealed that Morgan Stanley's legal team was involved in discovery misconduct with regard to incorrect and ineffective e-mail searches that they have been unable to successfully defend.

Morgan Stanley executive Arthur Riel said in a deposition that more than 1000 backup tapes had not been searched for relevant e-mails prior to the trial. Consequently, Judge Elizabeth Maass told the jury members that they should assume that Morgan Stanley helped to defraud Mr. Perelman.

The logistics of handing over documents in legal battles have become increasingly complicated in the age of e-mail. "Lawsuits these days require companies to comb through electronic archives and are sometimes won or lost based on how the litigants perform these tasks," noted Wall Street Journal reporter Susanne Craig.

During the legal discovery process in 2003, Morgan Stanley resisted some of the judge's requests for documents. The company said that handing over personnel files of employees who had worked on the Sunbeam account would be an invasion of privacy. Judge Maass limited her request to documents relating to the relevant employees' "truthfulness, veracity, or moral turpitude."

William Strong, the top Morgan Stanley banker on the Sunbeam account, had been tried on bribery charges in Italy in the 1990s in connection with a previous job. Although Strong was acquitted, no information about the charges existed in his personnel file; Mr. Perelman's lawyers learned of the charges when they found a news clipping during the course of their research. Judge Maass determined that Morgan Stanley had deliberately withheld this relevant information.

Mr. Perelman's legal team requested e-mails dating back to 1998, and Morgan Stanley's legal team objected, saying that a search for the older documents would require "a massive safari into the remote corners" of backup computer files, which would cost several hundred thousand dollars and take months to complete. In April 2004, Judge Maass ordered Morgan Stanley to produce relevant documents from its oldest full backup, and Arthur Riel, the company technology executive, reported that the oldest records dated from 2000.

However, in May 2004, Morgan Stanley employees found additional tapes from the 1990s that had not been searched for information relevant to the Perelman case. Subsequently, Riel was placed on administrative leave for reasons not related to the Perelman case, and his successor, Allison Nachtigal, was finally brought up to date on the case by early 2005.

Morgan Stanley continued to turn over e-mail in the first few months of 2005, but the company also continued to report software problems, and offered to pay the court to delay the trial. However, by March 2005, Judge Maass was determined to move forward with the case, and employed an extreme legal tactic—an adverse inference order—at the request of the Perelman legal team. This order cited the "willful and gross abuse of its discovery obligations" and put the pressure on Morgan Stanley to prove its innocence as a result.

This discovery misconduct turned a case that could have been settled quietly into a "monstrous legal liability," wrote Susan Beck in the April 2006 issue of The American Lawyer. "To what extent these acts were deliberate deceptions, good faith mistakes, or errors of incompetence—or some combination of all three—is still not entirely clear," Beck noted.

Morgan Stanley plans to appeal the verdict.

WorldCom CEO Convicted of Corporate Fraud

Bernard Ebbers, the founder and CEO of WorldCom Corp., was convicted by a federal jury on March 15, 2005 of fraud, conspiracy, and filing false documents with regulators as part of the largest bankruptcy in U.S. history. Ebber was sentenced to 25 years in prison on July 13, 2005. At age 63, Ebbers would not be eligible for release, assuming good behavior, until he was 85. The sentence was the toughest handed down in a string of corporate scandals that included the energy company Enron and the cable television company Adelphia. The court granted Ebbers bail, allowing him to remain a free man while awaiting the decision on his appeal to U.S. Second Circuit Court of Appeals.

Ebbers entered the telecom business in 1983 with a diverse background that included work as a milkman, basketball coach, and hotel owner. He devised the business plan for WorldCom himself, and acquired many other communications companies throughout the 1980s and 1990s. WorldCom's inflated projections of Internet growth included a statement that Internet traffic was doubling every 100 days, which increased the demand for Internet and telecommunications stock. Even when Internet growth slowed significantly in the late 1990s, WorldCom executives continued to cite rapid exponential growth, which left competitors such as AT&T cutting costs and laying off workers in attempts to match the fictitious growth rates of WorldCom.

WorldCom declared bankruptcy in 2002 in conjunction with charges of committing nearly $11 billion worth of accounting fraud. Many employees lost their jobs, and many stockholders lost significant savings as a result. In addition, WorldCom investors filed a securities fraud suit against the auditor and former directors of WorldCom, and against several banks including Bank of America, Citigroup, and Deutsche Bank. After declaring bankruptcy, WorldCom re-emerged as MCI, which was purchased by Verizon in 2006.

Ebbers was indicted in 2004. The charges included conspiracy to commit securities fraud, securities fraud, and filing false financial reports with the Securities and Exchange Commission. Prosecutors alleged that he had initiated the fraudulent activities in 2000, when the company began to cut spending on telecom products and services. Prosecutors accused Ebbers of acting out of a desire to protect his personal assets, many of which were invested in WorldCom stock. Although Ebbers took the stand in his own defense and denied knowledge of the fraudulent accounting at WorldCom, he was not able to win over the jury. The jury heard damaging evidence from his former right-hand man and chief financial officer, Scott Sullivan, who said that Ebbers had played an active rile in the fraud. They falsified statements of the company, adjusting revenue to meet the expectations of financial analysts. An example of the fraudulent activity was a "close the gap" process, in which the company found one-time revenue sources, such as selling something, during each fiscal quarter that allowed the company to meet the target revenues that it had predicted. Sullivan, along with several other former WorldCom executives pleaded guilty to securities fraud charges and cooperated with the prosecution.

In his appeal, Ebbers claimed that the trial was unfair because several high-level WorldCom executives were prohibited from testifying on his behalf. One of his lawyers was quoted as saying that the jury received incorrect information; they were told that Ebbers could be convicted based on "conscious avoidance" of the fraudulent accounting practices at WorldCom. The appeals court, which heard oral argument on the case in January 2006, had not issued a decision as of early July 2006.