Skilling Resentencing: The Other Side of the Story

Published July 8, 2013

On June 22 of this year, federal Judge Sim Lake approved a 10-year reduction in the sentence meted out to former Enron Corp. CEO Jeffrey Skilling in 2006. In exchange, Skilling has agreed to abandon any appeals. 

Skilling originally was sentenced to 24 years and four months in prison. The reaction to the Skilling sentence reduction has been almost uniformly negative. That is regrettable because there were serious problems with Skilling’s conviction. Lake presided over the Skilling trial and that of former Enron Chairman Ken Lay, who also was convicted of felony crimes related to Enron’s bankruptcy in 2001. Lay has since died.

Skilling had a pending petition for a retrial based on “newly discovered evidence.” The new evidence has 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 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 siphon off an estimated $24 million to his personal account. He subsequently pleaded guilty to wire and securities fraud as a part of a plea agreement where he agreed to serve a 10-year prison sentence. 

According to, Fastow also became an informant and cooperated with federal authorities in the prosecution of other Enron executives, including Skilling. Indeed, The New York Times called Fastow the “star witness.” Specifically, Fastow testified that Skilling knew of and approved the illegal connection between Enron and the SPEs. For his testimony, and Skilling’s and Lay’s convictions, Fastow’s prison sentence was reduced to six years.

Opposite of Earlier Statement

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

CNBC reported the federal prosecutors invited “employees, shareholders and other victims . . . to voice objections by April 17.”

The hostile environment in Enron’s headquarters city of 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.”

The objections from “victims” were 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 was ignored by the alleged victims. 

Also unappreciated by Enron investors was the nature of Enron’s business model. In a word, it was hedging for natural gas prices. The natural gas futures and contracts, pioneered by Enron under Skilling’s leadership, are now very liquid markets that are used to hedge price risk for natural gas and electricity. 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—and hidden their hedge to increase their 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 at around $2.50 per million Btus. Thus, Enron’s share price moved in parallel with natural gas prices.

Similar Runs in 2008

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 Department into a merger with JP Morgan at $10 a share.

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

Large market moves are often followed by government actions to divert attention from government’s 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. California’s 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.

Price Moves in Tandem

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, writing in The Wall Street Journal, 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,” he writes. “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.”

Prosecutorial Chicanery

That is hauntingly similar to the Enron prosecution. Not only did the federal prosecutors withhold Fastow’s early interview by the FBI, with the help of Judge Lake, but the prosecutors also may have suborned perjury by Fastow at the trial. 

That is not farfetched. In the notorious case of Ted Stevens, the late Republican Senator from Alaska, federal prosecutors withheld exculpatory evidence. The New York Times on May 24, 2012 quoted a Justice Department report that two prosecutors engaged in “reckless profession behavior,” but they were only suspended by Attorney General Eric Holder—one for  40 days and the other for 15 days. This despite the fact that the conviction of Stevens just before the 2008 election cost him his Senate seat, which in turn gave the Democrats a filibuster-proof majority in the Senate.

There were even allegations in a report ordered by trial judge Emmet Sullivan that the prosecutors suborned perjury. After the passage of the Obamacare bill, the suspensions of the prosecutors in the Stevens case were canceled.  

There was a possibility that a similar review of the Enron prosecution might have taken place. To head this off, a strategy for the prosecutors was to reach a deal on resentencing Skilling. Such a deal required Skilling to withdraw his petition for a new trial. The prosecutors therefore avoided being investigated. 

Skilling has always maintained his innocence. However, he has already been deprived of his freedom for six and a half years. He must have decided to go for an earlier release rather than stand firm in his claim of innocence. That must have been a very difficult decision. 

James L. Johnston ([email protected]) is an economic adviser to The Heartland Institute.