Mises Daily Articles
Is Ken Lay Really a Criminal?
Concerning the federal court conviction of Ken Lay and Jeffrey Skilling, the punditry has been consistent: the "system" works because people who committed huge crimes have been convicted and will spend all or most of their last years in prison. Thus, Forbes ("The Guiltiest Guys in the Room" by Bethany McLean and Peter Elkind) could crow:
Guilty! … Guilty! … Guilty! Judge Sim Lake's reading of the jury's findings had a staccato rhythm to it. Lay, who was standing not with his lawyers but in the front row of spectators close by his wife, Linda, clutching her hand, turned red, his face strained. Skilling responded with a peculiar smirk. The prosecutors remained impassive, but celebrated later that evening at a Houston Tapas restaurant, clearly relieved to have won.
Indeed, as one follows the Forbes account, the usual platitudes of "the prosecutor as hero" stand out. The prosecutors won a "big one," but so did the "regular" people who lost money in the Enron collapse. According to Forbes:
Let's acknowledge some unambiguously positive implications of the Enron verdict. First, it finally offers a measure of consolation - or retribution - for those employees who lost everything in Enron's bankruptcy. And it reinforces a critical notion about our justice system: that, despite much punditry to the contrary, being rich and spending millions on a crack criminal defense team does not necessarily buy freedom.
Yet, as one continues to follow the story, it is clear that the case is not about what historically has been considered criminal behavior. Instead, Lay and Skilling were convicted because Enron became a colossal business failure. Write McLean and Elkind:
The most important implication of the verdict, though, is the lesson it delivers for business itself. In the beginning it seemed such a simple story, demanding swift justice: A highflying company disappeared almost overnight; a CEO bolted before the collapse; top executives sold tens of millions of dollars worth of stock - some of it secretly - while employees and investors were left with nothing.
Ultimately, at the heart of the story, for everything else one might hear, Lay and Skilling went down because Enron went down. Their crime was being in charge when the company was in the process of tanking. Contrary to Lay's assertions during his testimony, Enron was not done in by the short sellers; rather, the short sellers exposed Enron's house of cards. Because of the size of the business failure, and because of the earlier California electricity fiasco in which politicians wrongly blamed traders and producers for problems caused by the state's government, Enron's top people had no political capital, and they were easy targets.
In the aftermath of the convictions, however, I think it is instructive to look one more time at the substance of the charges for which Lay and Skilling were convicted. Furthermore, it is time to look at the bigger picture, for if there really was wide-scale financial fraud, it was committed by people other than Lay and Skilling and dozens of other Enron managers who are going to prison. Indeed, the maestro of the fiasco was part of the same government that prosecuted and now will imprison the two men, but Alan Greenspan will never have to face a jury in a court of law for the financial crimes that he committed.
In previous articles, I have noted that the stock bubble that inflated Enron's Wall Street prices did not originate from corporate America but rather from the Fed. When I first questioned the charges levied against Lay, I wrote:
The Bush Administration has taken much heat for the economic downturn that has marked much of its tenure, and the government has been looking for someone in the business community to blame. Instead of admitting its own faults (remember the steel tariffs and other economic shenanigans) and telling the truth about why this recession has occurred, Bush and his underlings have looked for scapegoats in the private sector and Lay and many of his associates have been juicy — and politically popular — targets. Lay and other executives that have been charged with crimes did not cause the recession — that is Alan Greenspan's accomplishment — but the government has been glad to jump on the "corporate crime wave" bandwagon and the lapdog press has followed suit.
One needs to remember how this business first began. The Greenspan Fed during the late 1990s aggressively pumped up bank reserves through open market operations, forced down interest rates, and touched off an unsustainable economic boom. The bubble first appeared in the stock markets, as stock prices became wildly inflated.
However, corporate profits peaked in 1998, so we were left with the untenable situation in which the boom was pushing stock prices to the stratosphere, but the fundamentals that should have been helping to shore up those prices simply were not there. The market itself was a house of cards, but the pundits and apologists for the Bill Clinton Administration claimed that this "prosperity" actually was the "New Economy" created by a 1993 tax increase that Clinton pushed. So, we were left with the ridiculous notion that increasing the top personal income tax brackets from about 33 percent to 39.6 percent touched off a wave of permanent prosperity.
In the aftermath of the stock bust, not surprisingly there were some spectacular business collapses, Enron not being the only firm that tanked after riding high. Like the failure of many savings and loans in the late 1980s and early 1990s following government interventions and bad policies, most of the business failures occurred because of issues other than fraud. But that did not keep the pundits from claiming that a sinister conspiracy had been in the works.
(Not surprisingly, the government blamed Michael Milken for the S&L collapse and the recession that followed. As Candice E. Jackson and I noted in a recent paper, the real villain in this whole affair was the US government, and especially US attorney Rudolph Giuliani.)
There is another myth that follows this conviction, that being that this was a "complicated web of financial transactions." At one level, this is true. According to Fortune:
…in the five years that followed — as government investigators devoted countless hours to unraveling the Enron riddle — many experts opined that a case against the two former CEOs wasn't winnable. The accounting issues were just too complicated.
Anyone who has attended a finance or accounting seminar can attest to the eye-glazing numbers, terms, and formulas that are presented; and trials — whether civil or criminal — that involve such information can inflict pain and boredom upon those who must pay attention. However, all accounting and finance practices are based upon rather simple premises, be they time value of money or some other form of opportunity cost. The various means or instruments that are used to finance various business projects can be complicated in how they are carried out, but ultimately can be understood without requiring years of experience on Wall Street.
The authors of the Fortune piece then opined: "The tactic that the prosecutors ultimately used, to great success, was to make the case about lies." Would that it were so, for if it were, then prosecutors might be forced to say that their employer, the US government, uses a huge web of financial deceit in the form of the federal budget, and, thus, is a criminal element itself.
If the Lay-Skilling case were simply about lies, then one also could point to the testimony of former officers and managers who were forced into guilty pleas — or face a huge pile of contrived charges that would bankrupt them even if successfully defended against — and then were instructed to give the government's take on things when they took the witness stand. I suspect that if one really did a fly-spec of the testimony, one could find half-truths and lies, all courtesy of US attorneys.
The way that US attorneys work is that they pry guilty pleas from lower-level employees, who have neither the means nor the experience to fight the mountain of charges that prosecutors threaten to dump on them. That the charges generally are nebulous or do not reflect mens rea, which used to be the bedrock of US criminal law, is irrelevant to federal prosecutors, who simply are playing to win by using all "tools" Congress and the federal courts have given them. That these "tools" generally violate the spirit — and sometimes the letter — of the US Constitution and all of the traditions of historical US and English law matters not a whit to prosecutors who are looking for a victory and who have journalists and most Americans cheering them from the sidelines.
The ultimate irony of the Lay-Skilling case is that they were convicted on criminal charges that were wrapped around legal activities. From the sale of Enron stock (for which they received guidance from company attorneys — more on this later) to the various accounting measures that the company took in order to hide losses, all of these activities in and of themselves can be deemed legal, or, at worst, in the gray area of securities and accounting laws and regulation.
Indeed, the US government engages in a number of activities to hide losses and deficits, called "off budget" expenditures. Thomas DiLorenzo and James Bennett have exposed the entire federal scam in one of their books. Moreover, even in 1999 and 2000, when the government was claiming it was running budget surpluses in the billions of dollars, the real "surplus" came from the Social Security System, and those surpluses were immediately transferred into government bonds, thus adding to the national debt. While politicians claimed that surpluses were to be used to "pay down the national debt," in reality the opposite was true. The portion of the federal budget paid by all other taxes ran deficits, which were made up by borrowing surpluses from Social Security. In other words, Congress and the president were committing criminal fraud — if one were to apply the same standards that US attorneys apply to private citizens.
Lay's jury convicted him of an "illegal" stock sale, and this conviction especially is troubling in its implications. As is the case with many CEOs, Lay had large amounts of Enron stock and sold some of it to pay margin calls and for other things. According to the record, he did not report the sale, which was the basis for the "crime." However, the record also shows that Lay sought advice from attorneys regarding whether or not to report the sale, and they advised him not to do it.
The troubling part here is that if a person who is not a lawyer seeks legal counsel and then acts on that counsel, unless he knows or strongly suspects that he is being advised to break the law — and that did not seem to be the case here — then the person is acting in a manner that he or she believes is legal. In other words, the mens rea standard should apply here, but prosecutors (and the jurors) decided that getting popular convictions are more important than applying the bedrock standards that for centuries separated the English and US legal systems from those based upon some form of Justinian (and later Napoleonic) code in which defendants are assumed guilty until proven innocent and law is reduced to rules passed by legislators solely to protect and promote the power of the state.
In fact, if Lay and his associates believed that the accounting methods they used were legal, and that they were assured by counsel that they were, then it would seem that a mens rea standard should apply. Instead, prosecutors invoked the usual "derivative" crimes in which a number of actions — some, if not all, legal in themselves — are bundled into another category called "fraud." Thus, Lay was accused of "securities fraud," which is highly nebulous and difficult for people charged with the crime to refute in a defense.
For example, federal prosecutors charged Martha Stewart with "securities fraud" because she declared publicly that she was not guilty of insider trading, which ostensibly was the "crime" for which the government was investigating, involving her original sale of Imclone stock. Although the judge threw out the "novel prosecution theory" ("novel" was the term used by the Wall Street Journal), it is also clear that had the charges remained, the jury would have convicted her of that "crime," too.
"Crimes" like "securities fraud" are a godsend for prosecutors, who can manipulate the law to charge just about anyone of anything. Like Martha Stewart's company, Enron was a "public" firm and its stock sold on the open market. There is no doubt that Enron's executives wanted to hide or at least mitigate some of their losses in order to keep the Wall Street analysts happy, but in some way or another, firms are almost always attempting to keep their stock prices high, even if some of the fundamentals demonstrate potential or current problems.
Yet, does this constitute a form of "criminal fraud"? First, executives will always learn — usually to their sorrow — that the market ultimately uncovers the problems with a company. Lay blamed short sellers for the company's downfall (just as some politicians blame energy traders for high oil prices — and Paul Krugman blamed Enron for the California energy fiasco that was caused by the state's price controls on electricity). Instead, short sellers realized that Enron was vulnerable and took advantage of that situation, just as Enron played according to the Byzantine rules laid out by California's politicians and bureaucrats.
Second, the job of any executive is to try to keep a company going. Prosecutors themselves unwittingly said as much in their closing statements when they declared that Lay and Skilling were hoping that there would be a turnaround in the market. Yet, someone who was simply using the company to enrich himself would not have cared to keep a company going; instead, he would have absconded with whatever money he could gather and leave the country. Indeed, it was the shenanigans of the Federal Reserve itself that pushed stock prices well beyond their fundamental limits, leading to the rise and crash of the dot-com companies that were the darlings of investors before the market spoke in unrelenting terms.
When Lay declared that Enron stock was still a good buy (and, yes, he even bought some Enron stock himself during that time, something the jury apparently did not want to take into consideration), he was doing what any good executive should be doing. (When President George W. Bush tells us that "progress" is being made in Iraq, are federal prosecutors waiting to charge him with "making false statements"?) Yes, Enron employees lost their paper millions when the stock crashed, but so did Skilling and Lay. There is no evidence that Lay was secretly selling all or most of his stock in hopes that he somehow could jump ship and swim to the proverbial Caribbean island to live his last days in splendor. Instead, Lay, too, went down with Enron.
Yes, those who approve of the verdict might answer, but wouldn't Lay be able to get away with millions of dollars while Enron employees had to start over? The answer is the civil suit, which is where this case belonged in the first place. Lay and Skilling, as well as other Enron executives, had a fiduciary responsibility to Enron stockholders and, unlike what used to be the case in criminal law, mens rea does not apply in the civil arena.
In other words, stockholders were free to sue Lay and the others down to their underwear if they so chose, and it would have been extremely difficult for them to hold onto their wealth, since they would have had no chance at all in civil court. Instead, the government stepped in and stripped these people of their freedom and relieved them of their money, too. Stockholders will get nothing.
Judging from the reaction of former Enron employees, they are happy to see Lay and Skilling go to prison. One employee was quoted as saying that she hoped Lay would "die" there, which says much more about her than it does about Lay. I suspect that if the judge were to sentence the two to being hanged, drawn, and quartered, most people in Houston, not to mention the rest of the United States, would claim that such a sentence was not harsh or cruel enough.
As I pointed out before, this was not a case of executives looting their company and then hiding those assets in offshore bank accounts and absconding with their ill-gotten gains. Instead, it was a case of executives who believed their own hype — and that of the financial press — and failed to apply the fundamentals of sound business practices to their decisions.
Lay and Skilling are hardly alone. The difference is that they are going to prison. Former presidents make big money speaking on the mashed potato circuit, former secretaries of the US Treasury gain jobs on Wall Street or on corporate boards, and Alan Greenspan now earns millions for speaking obtusely to cheering audiences (who probably have no idea what the guy is saying) instead of to worshipful committees of Congress, whose members inherit lucrative lobbying practices when they leave that august body of legislators.
Yet, if one examines their careers, their decisions, and their statements, one finds a series of lies, dishonest actions, misstatements, and outright deceptions that are always harmful to the public and to the economy. Compared to them, Lay and Skilling are Boy Scouts.