Lay's actions take the spotlight
For those inclined to view Enron's former CEO as simply clueless, Tuesday's testimony was an eyeopener.
HOUSTON (FORTUNE) - Court opened for the week Tuesday morning, after a holiday break, with Randall Oppenheimer, one of Jeff Skilling's lawyers, finishing his cross-examination of Enron accountant Terry West.
Oppenheimer has a very different style from the other defense lawyers. You pay more attention to what the witness is saying than you do to him.
Prosecutors have presented evidence that on several occasions Enron changed the earnings figure it publicly reported after the end of a quarter just to meet or beat Wall Street's expectations. Oppenheimer used Enron's fourth-quarter 2000 results to show that earnings at Enron were a moving target, even past the end of a quarter, as the books were being settled.
By showing the detailed backup that went into the earnings computation, and that some of Enron's businesses missed their targets while others exceeded theirs, Oppenheimer also reinforced the notion that Enron was a real business, not a fantasyland factory that only manufactured earnings.
Of course, there's a difference between an earnings number changing because, for instance, a reserve was properly fine-tuned, and a reserve figure being fine-tuned because the desired earnings number changed. But like many things at Enron, the fungibility of its reported earnings isn't a black-and-white issue.
Paula Rieker, the number-two person in the investor relations department and briefly Enron's corporate secretary (she took minutes at board of directors meetings), took the stand after West departed Tuesday morning. So far, she's the perfect witness for the prosecution: friendly, polished, very articulate -- and knowledgeable.
There was a moment when Lay lawyer Bruce Collins objected to some of Rieker's testimony on the grounds that she didn't know anything about accounting. There was something condescending in the way he phrased his objection. (Do defense lawyers always drip with condescension when they're trying to discredit a witness?) Rieker proceeded to tell the jury that not only had she minored in accounting in school, but she had also gotten her CPA license while she was at Enron.
Prosecutor John Hueston used Rieker to reinforce and deepen the testimony of her former boss, IR chief Mark Koenig, on issues like the contribution that the sale of dark fiber and the gains on an investment in Avici (a high-flying Internet stock) made to broadband's earnings. (Rieker testified that she had a conversation with Skilling about Avici, in which "he told me that he did not want analysts to know that revenues for broadband were attributable to the increase in value of Avici.")
She also testified that it was wrong not to tell Wall Street that the sale of "peaker" power plants contributed roughly half of Enron Wholesale's earnings in the second quarter of 2001, and that the sale of warrants in an Enron-sponsored company called New Power had boosted EES' earnings.
Rieker also said that she told Ken Lay that EES' earnings weren't all from its actual business—that the sale of those New Power warrants had made a big contribution. Still, she testified, Lay continued to brag to analysts about the strong growth at EES.
Rieker also provided a window into her life at Enron when she recounted another episode that Koenig first testified about—the final quarter of 1999, when Enron, one day before announcing its results, boosted earnings from 30 cents to 31 cents to meet a last-minute change in consensus estimates discovered just that afternoon.
"I was shocked and horrified and panicked," Rieker said, of learning that the earnings expectation had changed. "I tried to get my nerve up to call Mr. Koenig, and I did call....he was disgusted and said, 'I guess I'm the one who gets to call Skilling.'"
Rieker testified that she "felt it was wrong" to change the number, and most important, that if analysts had known where the penny had come from, "it would have really hurt Enron's credibility"—and its stock price. (Analysts were, of course, thrilled with Enron's ability to always meet or beat its earnings targets.)
A key, although quiet, moment came early in Rieker's testimony, when Hueston asked her about what duties management had to shareholders. "Information should be given to the public that is truthful and complete," she testified.
"Is that satisfied by the half truth?" Hueston asked.
"No, that is not right," she said.
"What if the bad news eventually comes out?" asked Hueston.
"That hurts the people who bought at those high stock prices," prices that were unsustainably high because the information supporting them was incomplete or inaccurate, Rieker noted. This was a key point, because it has seemed, at times, as if the defense is arguing that because analysts eventually learned of Enron's bad news—that because items not disclosed in conference calls or earnings releases could still be found in 10-Q filings—that was good enough.
It's easy to fall into line with that way of thinking: "Oh, those lazy analysts, they could have discovered that tidbit if they had just dug harder." True enough. But that doesn't excuse the deceit—and, as Rieker pointed out, all the digging in the world wouldn't have saved the person who, for instance, bought in the interval between the conference call and the filing of the 10-Q.
But the real drama of the day was Rieker's testimony about Ken Lay. Indeed, if Lay was feeling neglected after last week, when Ken Rice's testimony focused on Jeff Skilling (Lay's lawyers asked Rice just one question on cross-examination), he sure wasn't feeling that way after yesterday. For those inclined to view Lay as simply clueless about the problems at Enron, Rieker's testimony was an eye-opener.
There were a lot of little details, but one particular moment was especially revealing. In the fall of 2001, Bank of America hosted a meeting so investors could ask Lay questions. The prosecution played a videotape of the meeting.
You see Lay sitting next to Greg Whalley, who was briefly Enron's COO. An analyst is pressuring Lay for the name of the "previously disclosed entity" that was part of Enron's massive $1 billion-plus third-quarter writedown. (Lay, by the way, is a man who seems to remember the name of every person he's ever met.)
On the tape, Lay stutters, refusing to answer, then says: "I'm not sure it had a name." Until yesterday, I would have believed that Lay really didn't recall the name of this "entity"—Raptor. But Hueston elicited testimony from Rieker that at a board meeting just a few days earlier, Lay had explicitly identified Raptor as the "second most contentious" finance vehicle at Enron, right behind LJM.
Rieker also testified about Lay's personal stock sales, made secretly through a special provision that allowed him to repay a multi-million-dollar company line of credit with Enron shares. She discussed a report by Goldman Sachs analyst David Fleischer, which said that the CEO was a "net buyer" of Enron stock. Lay did not correct the error, she said.
And Hueston skillfully juxtaposed the growing concerns about Enron's liquidity (a topic of board discussion as early as October 22, 2001) with Lay telling people on October 23 that liquidity was fine, even "strong."
By late November, the situation had gotten desperate ("conserve cash," warned a JP Morgan banker), and Lay cancelled Enron's holiday party because (as he wrote in an all-employee e-mail), "it could be considered imprudent for Enron to incur the expenses of such an event. "
Still, Hueston showed, Lay continued to use his loan program to draw millions in cash out of Enron. Despite repeated objections from the defense, Rieker also testified about the board's reaction when directors found out, post-bankruptcy, that Lay had taken some $70 million out of Enron during that last desperate year.
"They were outraged," she said. "John Duncan exclaimed that Mr. Lay was using Enron as a damn ATM machine."
Hueston also asked—in a question that anticipates Lay's likely defense— whether it mattered that Lay had a reason to sell his shares. Rieker replied: "If he had a reason to sell, then he could tell that reason, and analysts could make their own judgment." During this whole line of questioning, the jury appeared more animated than they've been during the entire trial. Everyone was taking notes, and jurors were whispering to each other.
There was also a tantalizing hint of possible fireworks to come. Rieker testified about the condition of Azurix, saying an additional writedown at the deeply troubled Enron water company in the fall of 2001 could have damaged Enron's all-important credit rating. But Enron somehow managed to convince Arthur Andersen that it didn't need to take the hit.
How did it do this? Hueston mentioned something about a promise Enron made to Andersen that it would pump money into Azurix to re-grow the business (such an infusion could justify not taking the writedown), then suggested the promise was falsely made just to avoid the writedown. This could be damning evidence against Lay—depending, of course, on what proof exists. But after a defense objection, Hueston dropped that line of questioning, so we'll have to wait on the edge of our seats (or rather, hard wooden benches) for more.
At the end of the day, Lay attorney Collins took the lead on the defense cross of Rieker, which is just getting underway. But so far, he's defended Lay by arguing that the money he siphoned out was insignificant relative to Enron's problems. He pointed out that by late November, Enron had $600 million in cash, and was facing almost $2.5 billion in potential cash outflows. (I'm waiting to see how this reconciles with Ramsey's claim in his opening statement that "there was close to $600 million available to Enron at the time it went into bankruptcy." Ummm, only if you don't count the debt.) Anyway, Collins thundered at Rieker: "Isn't $1 million lost in the bucket?"
"No," she replied quietly. Collins also took refuge in the notion that lawyers had approved Lay's action.
"The fact of the matter is that you know absolutely nothing about whether it was inappropriate," he told Rieker. Rieker acknowledged that she couldn't opine on the legal issues, responding: "I can only comment on what the board felt was right or wrong."
You can't help thinking that this sums up a lot of Enron's actions. They may have been legal. But they certainly don't feel right.
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