The Case Against Ken Lay

By Julie Rawe

Oct. 23, 2001, stands out as a particularly bad day for Ken Lay. As word circulated that the energy giant he founded was under investigation for balance-sheet shenanigans, the CEO tried to pull Enron's stock out of a tailspin by arranging a special conference call with analysts. "We're not trying to conceal anything," he told them. "I'm disclosing everything we've found." After Lay got off the phone, he gathered Enron's thousands of employees via a live webcast and video teleconference, and tried to reassure them too. "Our liquidity is fine," he said of the company that was about to flame out in one of the biggest accounting scandals in history. "As a matter of fact, it's better than fine. It's strong."

Those comments came back to haunt Lay last week in an 11-count indictment accusing him of conspiring to cook Enron's books even as he touted its tainted stock. For starters, prosecutors claim that Lay failed to mention to analysts several massive problems he knew about, including some $7 billion in hidden debts. And he neglected to tell employees that the company's liquidity hinged on an emergency billion-dollar loan Enron had just obtained by offering its precious pipelines as collateral. But one egregious comment Lay made that fateful October day could end up as his salvation. During the conference call with analysts, he professed the "highest faith and confidence" in the company's chief financial officer, Andrew Fastow, who the next day suddenly took what became a permanent leave of absence. Nearly three years later, Lay claims he was unaware of Fastow's misdeeds, a defense strategy casting Lay as the world's most clueless CEO, sincerely waving his pom-poms as his team got crushed.

Government prosecutors are patting one another on the back for finally hooking the biggest fish in an investigation into what U.S. Deputy Attorney General James Comey described last week as Enron's "spectacular fall from grace." Lay, 62, was the public face of the once stodgy pipeline firm that morphed into the seventh biggest U.S. company by trading natural gas and megawatts of power. A minister's son with a Ph.D. in economics, Lay was spared being charged with approving Enron's now famous off-the-books partnerships that hid so much debt for so long. And unlike the two former colleagues he will be tried with--Enron's onetime CEO Jeffrey Skilling and chief accounting officer Richard Causey--Lay wasn't charged with insider trading by the Justice Department (although last week the Securities and Exchange Commission did so in a separate, $90 million suit in civil court, where the standard of proof is less stringent). Instead, the bulk of the charges against Lay allege that he helped keep the deceit alive after he resumed his role as CEO in August 2001, when Skilling abruptly resigned. The remaining charges deal with an obscure bank-fraud rule involving Lay's personal-loan applications. "I have to go home and look up something called a Reg U," Lay's attorney griped. "That's a stretch."

The case won't be easy to win. Lay's claim that he believed the company stock was a good buy is bolstered by the fact that he kept purchasing more and sold shares only when forced to by margin calls. Jurors' heads will be spinning from all the byzantine financial data. And, says Houston securities litigator Thomas Ajamie, "the complexity of this case will work in the defense's favor."

Even before the Enron accounting scandal started to unravel, many people were calling for Lay's head. His company was suspected of wrongdoing in early 2001, during the California energy crisis. Last month, following the release of tapes in which Enron traders gleefully spoke of ripping off Golden State grandmothers, California's attorney general sued the firm for violating the state's unfair-competition and commodities-fraud laws. After Enron collapsed, smashing the nest eggs of rank-and-file employees, political pressure to build the case against Lay intensified. One of George W. Bush's top contributors during the 2000 campaign, Lay was nicknamed "Kenny Boy" by the President. As the months went by with no indictment, Democrats in Washington grumbled that he was being insulated by the White House.

Determined to nail Lay & Co., the Justice Department created its first-ever company-specific investigative team. The Enron Task Force cherry-picked seasoned fraud prosecutors from across the country as well as dozens of financially sophisticated FBI agents, including two former auditors. Until this spring, the hard-charging team was led by Leslie Caldwell, a former criminal-division chief in the U.S. Attorney's office in San Francisco who was adept at getting defendants to "flip"--cooperate with prosecutors in exchange for lesser charges. The team first went after mid-level managers and got plea bargains or agreed not to prosecute in return for their cooperation, and would eventually climb the corporate ladder all the way up to Lay.

The task force also pored over the paper trail, looking for evidence that the CEO knew that the company was in deep trouble. The day after Skilling resigned, future whistle-blower Sherron Watkins gave Lay a memo detailing some of the shadiest transactions that might cause Enron to "implode in a wave of accounting scandals." As Lay tasked a law firm to look into the middle manager's allegations, his chief of staff beseeched him in an e-mail to address the company's aggressive accounting practices and "near mercenary culture." A few weeks later, general counsel Lance Schuler, in an internal document, likened the firm's off-the-book transactions to "crack cocaine."

The prosecutors finally managed to break into Enron's upper management in January. Former CFO Fastow, who invoked the Fifth Amendment before Congress in 2002, agreed to cooperate in a plea bargain reached after his wife Lea, the mother of their two young sons, was indicted for tax evasion. "There was no Godfather moment," says a lawyer familiar with the case. "They just indicted his wife and let him and his lawyers draw their own conclusions on what that would mean for his family." This week Lea Fastow, whose six felony charges were dropped to a single misdemeanor, is scheduled to become the second ex-Enron staff member to go to jail.

To date, the task force has charged 31 defendants and netted 10 guilty pleas from former Enron employees. And Lay's indictment may not be the grand finale. Federal prosecutors made clear last week that more charges are coming. Arthur Andersen, the Big Five accounting firm convicted of obstructing justice in the Enron investigation, is now defunct, but other companies like Merrill Lynch that were involved in questionable partnerships may face further scrutiny. Enron's greatest legacy, however, is no doubt the passage of the Sarbanes-Oxley Act, which, among other things, requires CEOs to sign off on the veracity of their company's financial statements.

In the wake of the indictments, the behavior of Enron's former management team has run the gamut from arrogant (this spring Causey asked a judge to unfreeze some of his assets to pay for a country-club membership) to paranoid (in April, Skilling got picked up by police following a drunken scuffle in which he accused fellow bar patrons of being undercover FBI agents) to surprisingly defiant. Lay launched a p.r. blitz last week, using a post-indictment press conference to express grief at his failure to save the company while angrily proclaiming his innocence. "Failure does not equate to a crime," he said. The question is whether jurors will agree.

--Reported by Cathy Booth Thomas and Deborah Fowler/Houston and Elaine Shannon/Washington