Resentencing Skilling: Reading Between The Lines

Published April 12, 2013

The Wall Street Journal reported on April 5 that the federal prosecutors at the Department of Justice are considering a request to reduce the 292-month sentence imposed on Jeffrey Skilling for his conviction on one count of conspiracy, one count of insider trading, guilty on five counts of making false statements to auditors, and twelve counts of securities fraud. He was found not guilty on nine counts of insider trading.

The prosecutors are proposing negotiations with the Skilling defense with input from employees, shareholders and other victims of the Enron collapse. The resulting agreement, if reached, will be presented to Houston federal Judge Sim Lake who presided over the original trial and will have the final say about resentencing. The stated intent of the federal prosecutors is “to resolve certain disputed matters concerning sentencing.” It is not clear what those matters are.

Skilling has a pending petition for a retrial based on “newly discovered evidence.” The new evidence has not been publicly disclosed. However, I believe from reading decisions from previous appeals, they have to do with off-balance sheet special purpose entities where some of Enron’s debt was parked by Andrew Fastow, the chief financial officer. Special purpose entities (SPEs) are not illegal or contrary to accounting standards, if they meet some important conditions. The most important one is that the SPEs must be completely independent from the firm that created them.

That was not the case with the Enron SPEs. Fastow was in charge of the SPEs while he was still Enron’s CFO. He used the connection to syphon off tens of million dollars to his personal account. He subsequently pled guilty to wire and securities fraud. According to, Fastow also became an informant and cooperated with federal authorities in the prosecution of other Enron executives, including Skilling. Indeed, Fastow was characterized as the “star witness” according to the New York Times.  Specifically, Fastow testified that Skilling knew of and approved the illegal connection between Enron and the SPEs. For his testimony Fastow  served only six years in prison.

It was subsequently revealed by the appellate court that Fastow had claimed in an interview by the Federal Bureau of Investigation Skilling did not know of the SPE connection to Enron was maintained. Moreover, this exculpatory evidence was kept from the Skilling defense team by the prosecution with the permission of trial Judge Sim Lake.

It has been reported by CNBC that the federal prosecutors have invited “employees, shareholders and other victims … to voice objections by April 17.”  The very hostile environment in Houston was widely acknowledged. Even Supreme Court Justice Sonia Sotomayor, a former prosecutor, recognized “the deep-seated animosity that pervaded the [Houston] community at large.”

Presumably objections from “victims”will be based on Enron’s share price decline in 2001 from $80 to less than $1. However, the preceding increase in share price in 2000 from $40 to $80 will probably not be one of the objections.

What is also unappreciated is the nature of Enron’s business model. In a word, it was hedging. In particular it was for natural gas prices. Shareholders and especially employees ought to have known about the value of hedging. Indeed, many of them may have hedged against the possibility of a decline in Enron’s share price. But these shareholders may be tempted to hide their hedge in order to share in damage awards.

Natural gas prices in 2000 rose from $2.50 per million Btus to $9 and then fell in 2001 back down to $2.50 per million Btus. The price spike followed decades when the prices were stable around $2.50 per million Btus. Thus, Enron’s share price moved in parallel with natural gas prices.

This connection gives a plausible rationale to Skilling’s run-on-the-bank theory. The sharp price decline also appeared in the 2008 market crash when there was a similar run on the bank at Bear Sterns. In this latter case the share price in one year ending March 2008 went from $150 to $2. Bear Stearns was later forced by the Treasury into JP Morgan at $10 a share.

Other 2008 runs on the banks according to Time magazine include: Lehman Brothers, AIG, Citigroup, Freddie Mac, Fannie Mae, several hedge funds and Iceland.

Large market moves are usually followed with government actions to divert attention from its role in causing the crash. The Enron case is no exception. The collapse of the newly established electricity market in California was the proximate cause. The flawed system forced all transactions into day-ahead and same-day markets. The so-called deregulated market, established without a single no vote by the California legislature in 1996, actually prohibited utilities from hedging. The two spot markets began operating in April 1998.

For a while the spot markets produced low prices for electricity. This was considered proof that the deregulation was working. But the inevitable disturbance in the markets arrived in 2000 and continued until the markets collapsed in 2001. Note that the electricity prices tracked the natural gas prices. during that time and even today. The reason is that the fuel used at the margin to generate electricity is natural gas. This connection is similar to the relationship between crude oil and gasoline markets.

The crisis in California Generated a lot of political heat and attracted the attention of federal prosecutors. It was then that the prosecution of Enron began.

The Enron case was an early example of what Harvey Silvergate describes as a similar prosecution tactic for insider trading cases:

“Accused traders and portfolio managers, looking at decades-long prison terms, come to understand that a much-reduced sentence awaits them if they cooperate with prosecutors. The key is to testify that they let the boss know that their trading moves were based on prohibited tips—such as an impending announcement of the success or failure of new-product testing, or a coming tender offer—and that the boss responded knowingly and with an admonition not to spread the secret around.”

That is hauntingly similar to the Enron prosecution. Not only did the federal prosecutors withhold the Fastow interview by the FBI, with the help of trial judge Sim Lake, but raises the possibility that the Fastow testimony at trial was suborned by the federal prosecutors.

That is not farfetched. In the notorious case of Ted Stevens, Senator from Alaska, exculpable evidence was withheld at the trial by the federal prosecutors. The New York Times on May 24, 2012 quoted a Justice Department report that two prosecutors engaged in “reckless professional behavior” but were only suspended by Attorney General Eric Holder for 40 and 15 days that were later reversed. This, despite the fact the Senator Stevens conviction just before the 2008 election that cost him his seat. This in turn gave the Democrats a filibuster-proof majority in the Senate, which enabled them to pass the health care law. There were even allegations in a report ordered by trial judge, Emmet Sullivan, that the prosecutors suborned perjury.

With this as background, it raises the possibility that a similar review of the Enron prosecution might take place. To head this off, a hedging strategy for the prosecutors is to reach a deal on resentencing of Skilling. If such a deal is reached, Skilling would have to withdraw his petition for a new trial. The prosecutors would therefore avoid being investigated.

Skilling has always maintained his innocence. However, he has already been deprived of his freedom for more than six years. He must now be evaluating whether he wants to stand on principle or to go for an earlier release. That must be a very difficult decision.