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Enron Hyped Earnings to Hit Targets, Witness Testifies

Enron Corp. founder Kenneth Lay and former CEO Jeffrey Skilling never broke the law, never stole any money and never lied to the public about hiding billions of dollars in losses, defense attorneys told jurors last week as the trial of the former top executives took center stage in Houston. The prosecution, however, relying on actual statements and an eyewitness, began to show how the ex-executives attempted to deceive the public in the months preceding Enron's implosion.

Lay, 63, faces seven counts of fraud and conspiracy. Skilling, 52, faces 31 counts of fraud, conspiracy, insider trading and deceiving auditors. Following the joint trial, Lay also faces four charges of bank fraud involving his personal banking.

In opening statements last Tuesday, Assistant U.S. Attorney John Hueston contrasted Lay's and Skilling's words with reality. "This is a simple case. It is not about accounting. It is about lies and choices." Lay and Skilling "chose to lie."

Jurors were shown a presentation Skilling made to employees in March 2001 in Portland, OR to discuss Enron Broadband Services (EBS), a relatively new unit at the time.

"We have got to get the cost structure down," Skilling said to employees on the tape. "The market is in absolute meltdown. The whole revenue opportunity we saw in this marketplace is gone or shrunk significantly." He added, "We're going to be redeploying about 240 people in EBS out of EBS. I know this is a downer. This is obviously not great." The glut of bandwidth in the market at the time made it "an unbelievably bad macro environment, particularly in the broadband business. There's going to be a couple of rough years... I've never seen anything like this. Revenues are gone. It's bad."

However, eight days later, Skilling held a conference call with financial analysts. In the broadcast call, Skilling said, "EBS is coming along just fine. I'm pretty optimistic about it. We are moving some people around inside EBS. This is very good news. I'm feeling very good about the position of bandwidth right now...EBS is looking good." NGI, which covered the conference call in March 2001, reported Skilling was predicting the broadband business would have 400-500 transactions in 2001, which would be "ahead of the plan. We expect it to do good business for us," he said (see NGI, March 26, 2001).

Thursday the court heard that Skilling was not always so polished during conference call presentations. In an April 2001 taped conference call Skilling was heard to call a hedge fund investor an "asshole" after the investor, Richard Grubman, grilled Skilling over the fact that Enron did not release balance sheets with its earnings reports.

There are 31 criminal counts against Skilling, several related to fraud that prosecutors allege was committed on financial statements for Enron's 1999 Form 10K, 2000 Form 10K and quarterly financial statements beginning with 1Q2000 10Q through 3Q2000 10Q. He also is accused of committing fraud in statements he made during a Jan. 25, 2001 analyst conference in Houston, which NGI covered (see NGI, Jan. 29, 2001).

Hueston also focused on Skilling's statements regarding how he came to sell some Enron shares in early September 2001. According to Skilling, he tried to sell 500,000 Enron shares Sept. 12, 2001, the day after terrorists attacked the country. In an exchange with the Securities and Exchange Commission, Skilling said he "agonized" over the decision because of the terrorist attacks. But Hueston played a tape of a conversation Skilling had with a broker on Sept. 6, 2001, in which he said he wanted to sell 200,000 shares of company stock.

"You want to sell Enron?" the broker asked. "Yes," said Skilling. Because Skilling was no longer an Enron officer, the broker said he would require a letter to verify the information before the transaction was completed. Because of the required letter, the sale was postponed until Sept. 12, 2001.

In his attack on Lay's credibility, Hueston zeroed in on statements by the former chairman, who resumed the CEO role when Skilling resigned in mid-August 2001. The charges against Lay relate to the months following Skilling's resignation, specifically statements made to employees, analysts and ratings agencies between Sept. 26, 2001 and Nov. 12, 2001.

Enron declared bankruptcy in early December 2001, but in the weeks preceding the filing, Lay made several public statements concerning how well he thought the company was doing. "The continued excellent prospects in these businesses and Enron's leading market position make us very confident in our strong earnings outlook," Lay stated during Enron's 3Q2001 earnings call, which NGI covered (see NGI, Oct. 22, 2001). Hueston said Lay falsely promised analysts and investors that Enron was pulling itself out of trouble in later analyst calls (see NGI, Oct. 29, 2001; Nov. 12, 2001; Nov. 19, 2001).

And within days of the company's bankruptcy filing, "Lay maxed out his line of credit at Enron and paid off his home mortgage," Hueston said. Lay never repaid the money to Enron, according to the prosecution.

Skilling's lead attorney, Daniel Petrocelli, said his client never took part in or knew of a conspiracy at the company. ""This is not a case of hear no evil and see no evil," said Petrocelli. "This is a case of there was no evil." After he resigned in August 2001, Petrocelli said Skilling offered to come back to help, and he was even planning to commit his entire savings of $60-70 million to help revive the company. Skilling never officially offered Enron any money, but Petrocelli said his desire to do it showed how much he was committed to the company.

Skilling is expected to testify in his defense, said Petrocelli. "I'm committing to you right now that this man will take the witness stand... You could not keep him off that witness stand...He's going to tell you in his own words whether he did any of those things. He's going to tell you how much he loved that company." Skilling "never broke the law. He didn't lie. He didn't cheat. He didn't steal...Mr. Skilling did not steal one nickel."

Petrocelli said except for former CFO Andrew Fastow and some others who stole from the company, Enron was a healthy company. "Enron was no house of cards...It was a wonderful company, a shining star."

Mike Ramsey, Lay's lead attorney, told jurors, "Ken Lay has, does and will continue to accept responsibility for the bankruptcy of Enron. He was the man in control." But, Ramsey said, "failure is not a crime. Bankruptcy is not a crime. If it were, we'd have to turn Oklahoma back into a penal colony because there would be so many people we'd have to lock up." Even though Lay is accused of becoming wealthy from stock sales while telling others to buy Enron stock, Ramsey said his client did not sell stock when Enron was in its most dire straits except when he was "compelled" to do so.

Mark Koenig, former chief of investor relations for Enron, was the first witness to take the stand for the prosecution, beginning his testimony on Wednesday.

Koenig, who rose through the ranks at Enron, pleaded guilty in 2004 to aiding and abetting securities fraud, and he agreed to cooperate with investigators. Koenig has not been sentenced, but he faces up to 10 years in prison and $1.49 million in fines. At Enron, Koenig was responsible for issuing earnings releases and scripts for financial analyst conference calls. He also accompanied Enron executives on public speaking engagements, and he was the first point of contact between the company and financial analysts.

Koenig testified quarterly earnings estimates in 1999 and 2000 were revised upward to meet analyst expectations, telling prosecutor Kathy Ruemmler "it was wrong" to change the financial statements. However, he said he did not make the changes on his own.

Lay and Skilling regularly attended weekly meetings to discuss financial details of Enron, he said. And, Koenig testified both men were aware of the changes to the financial estimates, which were made only hours before quarterly earnings were to be released, and Skilling was the executive who had the authority to alter the figures. Newspaper articles from The Wall Street Journal and Houston Chronicle were entered into evidence, showing how well the altered earnings estimates were received by the stock market.

In testimony, Koenig said he first changed the earnings forecast in early 2000 in connection with Enron's plans to report 4Q1999 earnings. On Jan. 17, 2000, the day before the planned earnings release, Koenig said his office prepared a draft release that showed Enron had earned 30 cents/share for the final quarter of 1999. However, that afternoon, Koenig said the consensus estimate of analysts was 31 cents/share (see NGI, Jan. 24, 2000).

"I was kind of sick about it," Koenig testified. "My job was to keep that estimate in line." He said he worried about missing the estimate even by a penny because of a possible negative effect on the stock price.

That same day, Koenig said he talked with Skilling about the earnings. Several hours later, Koenig testified the earnings were adjusted to 31 cents/share, and the release was changed to reflect the adjustment. The next day, Koenig said Lay told him that when he had gone to bed the company planned to report 30 cents/share and he had woken up to find the company had reported 31 cents/share. According to Koenig, Lay was informed of the change via e-mail.

The second incident, involving the earnings statement for 2Q2000, Koenig testified Enron executives learned Wall Street analysts were forecasting the company would earn 32 cents/share.

"We had a desire at Enron to beat the consensus estimate by 2 cents," Koenig testified. "We thought it would maintain or increase the stock price."

In a meeting with Skilling and former chief accounting officer Richard Causey, Koenig said, "We discussed what the earnings were, and there was a determination made to report 34 cents per share." Ruemmler asked Koenig whether meeting the consensus estimate or running the company was more important to the top executives. "Meeting the consensus estimate," he said. Causey had been scheduled to go to trial with Skilling and Lay, however, he pleaded guilty in December.

In another incident, Koenig testified revenues reported in 2Q2001 for Enron Broadband Services (EBS) were not actual business transactions but rather were sales of unnecessary infrastructure. Koenig said the numbers were changed to make EBS appear more attractive to investors.

The prosecution played a tape of a July 2001 conference call with investors. In the tape, Skilling is heard telling analysts EBS is making money selling Internet bandwidth. Skilling told analysts the value of " dark fiber" sales was $50 million. However, Koenig said the sales exceeded $150 million and represented "virtually all" of the revenues for the quarter. Dark fiber is unused fiber optic cable.

"I was going along with the same disclosure, the incorrect disclosure, to minimize the contribution from dark fiber sales, to not let out to the market" that "virtually all of it" was from dark fiber sales, Koenig testified.

Koenig testified Lay and Skilling both sought to exclude from company meetings financial analysts who were critical of Enron. Koenig said Lay asked him if the company had to continue to invite analyst John Olson, who now co-manages the Houston Energy Partners equities hedge fund. Olson was working for Merrill Lynch covering Enron in 2001, and he frequently challenged the company's accounting methods. After a February 2001 analyst meeting, Koenig said Lay expressed his concerns about Olson, asking if Olson needed to be invited to future meetings. Skilling also asked whether Olson had to be invited to the meetings.

"He [Olson] was one of the few who went out on a limb in probing and had a negative opinion about the company," Koenig testified.

Olson continued to come to the Enron meetings until he was fired by Merrill Lynch. Olson has said it was Lay who pressured his former bosses because of his reviews of Enron (see NGI, Aug. 19, 2002).

During his testimony on Thursday, Koenig recounted how he was told by Lay of Skilling's departure from the company. "I was extremely surprised," he told the court. Koenig said Skilling's abrupt departure helped to raise fears among executives that skittish investors might dump the company's stock.

The jury, seated in record time last Monday, is predominantly white, with two Hispanics and one Asian American. Nearly all of the jurors hold college degrees or have attended some college classes, and some have masters degrees. All of the jurors are employed outside of the home; two are self employed, three work in education and three work in the energy industry. Two other jurors hold jobs in accounting-related fields. The jury will not be sequestered; members will be called back every Monday through Thursday as requested until the trial is completed.

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