The Enron Trial and Kenneth Lay and Jeffrey Skilling

SOC 205 – Society Law and Government 1
The Enron (Kenneth Lay and Jeffrey Skilling) Trial
Summary of the Trial
The Enron Trial dates as one of high profile case of corporate fraud in the US. Enron was founded in 1985 by Kenneth Lee Lay and was reported as the largest seller of Natural gas in North America by 2000. The American energy company recorded a spectacular rise with revenues increasing to over $100 billion in 2000 from $9 billion in 1995 and an increase of Enron’s stock prices recording a high of US$90.75 per share. Enron Corporation was ranked consistently as America's Most Innovative Company" between 1996 and 2001 by Fortune Magazine. The end of 2001 saw an unprecedented collapse of Enron’s stock price from US$90.75 per share to less than a dollar following an announced of $1billon loss in the first quarter of 2001 and resulting to declaration of bankruptcy by December 2001 as a result of negatively restating earnings by $405 million which saw the Enron’s debt grown by $628 million. The collapse resulted in economic loss to the employees and investors with the shareholders recording a loss of an estimated $11 billion. The federal investigation identified that the crumbling fall was as a result of institutionalized and creative accounting fraud that hid Enron’s losses and debts between 1997 and 2000. Enron got approval to use Mark-to-market (MTM) accounting method, a method that enabled writing off unprofitable business lines without negatively affecting the bottom line which in essence presented the company more as profitable than the actual figures which was the impendence for the accounting fraud (Thomas, 2006; Li, 2010).
A task force headed by Leslie Caldwell was established by the chief of the Justice Department’s Criminal Division Michael Chertoff to investigate Enron. The task force identified 3500 separate transactions with investments funds and banks that were configured to conceal Enron’s financial losses. Jeff Skilling was indicted for thirty-five counts entailing insider trading, fraud, and conspiracy, while Ken Lay was indicted for twenty-one counts entailing conspiracy to commit securities fraud, false bank statement, wire fraud, security fraud and bank fraud by the Houston grand jury in 2004. While Kenneth Lay passed before the ruling by Judge Simeon Lake, Jeff Skilling was fined $45 million and sentenced to 24 years of prison in 2006 (Moncarz, Moncarz, Cabello, & Moncarz, 2006).
Main Laws Violated in the Enron Scandal
Civil charges were initiated by The Securities and Exchange Commission (SEC) against the former Enron CEO Kenneth L. Lay and Jeff Skilling for orchestrating a wide-ranging scheme to defraud through misleading public representation and falsified financial results. The commission identified violation of federal securities laws including the Securities Exchange Act of 1934 - Section 10(b), the Securities Act of 1933 - Section 17(a); and the Exchange Act -  Sections 13(a), and 13(b)(2)(A) and (B). The Securities Exchange Act (1933) governs companies issuance of securities while the Securities Exchange Act of 1934 governs the sale, purchase, and trading of securities (SEC 2004).
The Securities Exchange Act of 1934 - Section 10(b) provides anti-fraud regulations to deter deceptive and manipulative practices in the stock market. "Rule 10b-5: Employment of Manipulative and Deceptive Practices” is the commonly quoted provision in charging people engaging in insider trading. Deception, misrepresentation, materiality, scienter, and connection with the sale/purchase of security are fundamental to prove to claim Rule 10b-5. At the heart of the Enron scandal was deception through fraudulent publicly reported financial statements that misrepresented the financial health of Enron Corporation. SEC argues that even with knowledge of deteriorating financial performance of Enron, Lay persistently represented Enron financial performance as robust. For example, Lay reported to the investors that the impairment of goodwill was $200 million, while the actual goodwill impairment of $700 million which was a misrepresentation of Enron (SEC 2004).
Securities Act of 1933 - Section 17(a) provides antifraud regulations enforceable at the initial issuance or sale of securities. Section 17(a) declares it unlawful to use scheme, device or artifice, falsified statements or engage in business that operates in fraudulent activities. The section 17(a) is similar to the SEC ’34 rule 10(b)(5) with primary differences being a demonstration of the specific mental intent of defrauding of the purchaser by the security issue. Skilling and Lay indictment principally charged them counts of conspiracy to commit fraud by covering Enron’s financial collapse and misrepresenting Enron through fraudulent books that indicated a robust performance despite Enron’s consistent failure to meet its financial targets (SEC,2004).
The third law applicable to the Enron Trial was the violation of Exchange Act -  Sections 13(a), and 13(b)(2)(A) and (B). Exchange Act Sections 13(b)(2)(A) mandates that issuers of securities maintain records, accounts, and books that reliably and fairly mirror the disposition assets and transactions of the issuer. Section 13(b)(2)(B) on the other hand mandates devising and maintaining of the system of internal accounting control by the issuers of securities that sufficiently and reasonably provide assurance of execution of a transaction in conformity to the Generally Accepted Accounting Principles (GAAP). Under the leadership of Lay, Enron concealed the business failure of Enron (Thomsen, 2005) Energy Services (EES) by moving the losses of EES to Enron Wholesale that was making robust earning to absorb EES losses while realizing its internal targets. As well Lay and Killings were cognizant of the use of structured transactions such as raptors and prepay to disguise financial statement which was in contravention of the Exchange Act Sections 13(b)(2)(A) (SEC, 2004)
Possible Penalties for Violation of Federal Securities Laws
The primary authority securities fraud prosecution lays with the federal government and administered by the Securities and Exchange Commission division of enforcement. Additionally, the state operates a state securities commission that administers. Notably, security fraud is prosecuted as a federal crime both by federal law and state law. Securities fraud is punishable by both criminal penalties (prison and/or fines) and civil penalties (license restriction and/or fines). A violation of the US securities act can attract a mix of criminal and civil penalties as evidenced in the SEC vs Kay, Skilling where the ruling entailed civil money penalties and disgorgement ($90 Million), permanent bar from officer or director role in public limited companies and injunction against future violations of the federal securities laws (Thomsen, 2005). Thomsen (2005) analysis of multiple financial fraud cases in the US provides an outline of the various penalties enforceable in violation of federal securities law. The penalties include; disgorgement, civil penalty; prejudgment interest; cease-and-desist proceedings; subpoena enforcement action; permeant injunction from practice; compliance order; 5-year probation; and 5-year federal prison per count of offense (SEC, 2006).
Enron Trial in the Federal court system
The Enron trial (Jeffery Skilling & Kenneth Lay Trial) which began 30th January 2006 was held in the Houston federal district court in Southern District of Texas and presided over by Judge Sim Lake. Pursuant to Sections 21(d), 21(e), and 27 of the Exchange Act the Federal District Court had jurisdiction and over action against Jeffery Skilling & Kenneth Lay trial (SEC, 2006). The US court system has two distinctive court system; federal courts and the state courts mainly differentiated by jurisdiction. The state courts have diverse jurisdiction and cover cases such as family disputes, traffic violations, robberies, and violated contracts. The federal court, on the other hand, has limited jurisdiction but covers lawsuit against the US; violation of constitution and violation of federal laws such as cases on bankruptcy, copyright, criminal, maritime, patent and antitrust. However, some cases entail overlapping jurisdiction which allows the accused a choice of the type of court to attend to avoid the double jeopardy.
Ruling
The 4-month federal jury in Houston found Jeff Skilling guilty of 19 counts of falsified statements, conspiracy and securities fraud and not guilty of insider trading (9 counts). The jury found Kenneth Lay guilty and convicted the defendants for conspiracy to commit securities fraud (11 counts); false statements to a bank (3 counts); securities fraud (4); bank fraud (1 count) and wire fraud (2 counts). Since Ken Lay succumbed to a heart attack in July, he was not present at the sentencing held on October 23rd, 2006 presided by Judge Simeon Lake. The judges pronounced the jury’s verdict for Jeff Skilling of a civil penalty of 24 years $45 million, 24 years of imprisonment and permanent injunction from taking an officer or director role in a public traded company. A resentencing by the federal appeal court pronounced by US District Judge Sim Lake III in 2013 saw the years of imprisonment reduced by 12 years to 14 years following an agreement of seizure of $40 million from Skilling’s fortune to be redistributed to the victims of the Enron scandal. The resentencing saw the release of Jeffrey Skilling from Prison in 2017 after serving 14 years (SEC, 2006; Moncarz, Moncarz, Cabello, & Moncarz, 2006).
The opinion of the Case Outcome
The bankruptcy of Enron occurred six months after the resignation Jeffrey Skilling. Although Enron share price was already declining, the September 11 attack left a devastating impact on the NYSE which arguably caused a further reduction of Enron’s stock price. Therefore, the verdict that bankruptcy was entirely on accounting fraud may be unqualified. Again A deal by Andy Fastow - Enron Chief Financial Officer to reduce his sentencing term was a foundation for the 19 counts of falsified statements charged against Jeffrey Skilling. Andy Fastow confessed to entering into a secret deal with Skilling and Lay to misrepresent troubled assets which would conceal losses in Enron’s financial statement which had an implication on the verdict. Lastly, holding the trial hearing in Houston which was the headquarters of Enron, hence the Enron scandal was highly publicized would manifest in prejudice by the jury and limit the jury’s fairness in the ruling.




References
Li, Y. (2010). The Case Analysis of the Scandal of Enron. International Journal of Business and Management.
Moncarz, E. S., Moncarz, R., Cabello, A., & Moncarz, B. (2006). The Rise and Collapse of Enron: Financial Innovation, Errors and Lessons. Financial Innovation, (218), 21.
SEC. (2006). SEC Charges Kenneth L. Lay, Jeffrey K Skilling, and Richard A Causey, With Fraud. Retrieved April 16, 2019, from
https://www.sec.gov/litigation/complaints/comp18776.pdf
SEC. (2004). SEC Charges Jeffrey K. Skilling, Enron’s Former President, Chief Executive Officer, and Chief Operating Officer, With Fraud. Retrieved April 16, 2019, from https://www.sec.gov/news/press/2004-18.htm
Thomas, C. William. (2002) "The Rise and Fall of Enron." Journal of Accountancy. 41- 48
Thomsen, L. (2005). International Institute For Securities Market DevelopmenT. U.S. Securities and Exchange Commission.