The defense team for Enron Corp. founder Kenneth Lay and former CEO Jeffrey Skilling continued its attack against the prosecution's lead witness last week, with former investor relations chief Mark Koenig spending the entire week on the witness stand in Houston. In testimony that was at times emotional and often tedious, the defense attempted to prove Koenig is wrong in his assertions that Lay and Skilling lied to investors and financial analysts about the state of affairs at the once mighty company.
Koenig will continue to be questioned by Lay's lawyer Mike Ramsey on Monday when the trial resumes. He spent the better part of last week under the cross examination of Skilling's lawyer Daniel Petrocelli, who tried to knock down earlier testimony through audio and videotapes of Enron earnings conference calls and employee webcasts.
Koenig began the week as a witness for the prosecution, telling the jury last Monday Lay wanted to keep details of the company's 3Q2001 $1.2 billion shareholder equity losses out of the earnings press release to minimize the details. Koenig said there was an internal debate about whether to include in the text of an Oct. 16, 2001 earnings release certain information about the $1.2 billion write-off.
To unwind itself from third-party balance sheet transactions put together by then-CFO Andrew Fastow, including the infamous LJM transactions, Enron repurchased about 55 million of its shares in 3Q2001, which led to the massive equity write-down -- a fact later uncovered by The Wall Street Journal and other news organizations (see NGI, Oct. 22, 2001).
Koenig, who was in charge of the earnings releases, said he wanted to include the equity write-off information in the press release, but he said Lay and former Chief Accounting Officer Richard Causey did not. (Causey, who was to go to trial with Lay and Skilling, pleaded guilty in December 2005 and is cooperating with the prosecution.) Koenig testified Lay and Causey thought the information should not be included because it was not an income statement item. As a compromise, two brief lines concerning the equity write-down were mentioned in the script of a conference call, but the equity write-down was not mentioned in the press release.
"By not putting it in the earnings release, that was an attempt to minimize it," Koenig testified.
"Do you feel you were being encouraged by Mr. Lay to conduct business in honesty and candor and fairness?" prosecutor Kathryn Ruemmler asked Koenig.
"At times, no," Koenig said.
After the 3Q2001 earnings report was released, Koenig testified a planned trip to meet with analysts in Philadelphia was canceled after several news reports cited the equity write-down and LJM partnership run by Fastow. Koenig testified there was a meeting at Enron the following Sunday to discuss the LJM partnerships.
"We had people working on ways to say LJM was okay, that it was approved by the board..., it was approved by auditors," Koenig said. "I was upset that with this investigation that we were trying to talk our way out of it. It was not going to cut it."
Koenig also testified about events during 2Q2001, when Enron sold several natural gas-fired power plants, earning $418 million on the sales. However, Enron did not include the power plant sales' financial figures in its public documents because, said Koenig, the asset sales within its wholesale business unit were not "consistent with the story that earnings were based on steady volumes and earnings margins." During a conference call to discuss quarterly earnings, an analyst from Goldman Sachs asked for a break out of the plant sales' revenues. However, according to Koenig, Skilling answered, "We don't even track that."
Koenig said investors and analysts questioned him about the lack of financial disclosures, particularly in quarterly conference calls, throughout 2001. "To Mr. Lay and Mr. Skilling, I communicated that," he said. Koenig also cited examples of Skilling failing to disclose losses or releasing misleading information about Enron's retail energy and broadband units during conference calls.
Last Monday afternoon, the defense took over, and lawyers spent the rest of the week trying to dismantle Koenig's character and trying to build the tarnished reputation of their clients. Petrocelli referred to earlier statements by Koenig, and noted that as part of a plea deal with the government, he remains out of prison and still has about $5 million in the bank.
"You're still in a mode of protecting yourself," Petrocelli said. The defense lawyer asked Koenig, "what does zero mean?...Isn't that the amount of time you want to spend in jail?"
Koenig, who will be sentenced after the Enron Task Force has completed its investigation, said he would "love" for the amount of time he spends in jail to be "zero." And he also affirmed Petrocelli's assertion that he would have to "produce a performance for the government" under the plea agreement.
"Is it fair to say your life is on the line testifying in this trial?" Petrocelli asked.
"My life has been on the line since August 2004," Koenig said, referring to the date he entered his plea agreement with the government.
Petrocelli asked Koenig if he had ever told anyone at Enron about the alleged lies by himself or his bosses or if he ever confronted anyone about the alleged lies during analyst meetings and conference calls.
"You never said 'Mr. Skilling, why are you spearheading a criminal conspiracy,' did you?" Petrocelli asked.
"No," Koenig replied.
"And you never saw a single e-mail or memo that said Mr. Skilling broke the law? Or Mr. Lay?" Koenig said he had not.
At times, the exchange between Koenig and Petrocelli was emotional. During cross examination last week, the trial was recessed for a few minutes when Koenig broke down in tears after Petrocelli accused him of lying to try to protect himself.
Petrocelli asked Koenig, "At the time you pled guilty, how old were your three children?" Koenig started to answer, but he put his hand to his mouth and started to cry. U.S. District Judge Sim Lake then called a 10-minute break. When questioning resumed, Petrocelli asked Koenig if he was afraid his answers would not result in a reduced sentence from the government. Koenig faces up to 10 years in prison, depending on the leniency of the government's recommendation.
"To answer your earlier question, I have two children in college and one in high school," Koenig said. "Entering into the guilty plea and telling them was the hardest thing to do. I'm over the biggest fear."
For the most part, however, the witness remained calm, if not somewhat tense. As the cross examination has continued, Koenig was not afraid to interrupt defense questioning or correct his statements to the jury.
Koenig, who was responsible for writing the company's earnings press releases and scripting conference calls, recalled Tuesday telling Skilling and Causey that financial analysts were forecasting Enron would earn 31 cents/share for 4Q1999, a penny lower than the draft earnings press release, which indicated Enron would earn 30 cents/share for the period.
Koenig said Causey told him he would "work" on the numbers, and Koenig added, "a decision was made to increase the earnings." Koenig said he did not know who ordered the change.
Petrocelli explained to the jury that earnings estimates are only "estimates," and companies sometimes "sharpen the pencil" to make adjustments. However, Koenig disagreed.
"I know they figured out a way to come up with the extra penny. I didn't inquire into the exact transaction or adjustment, no," Koenig said. "To go back and sharpen a pencil to find another penny, I don't think that's fairly presenting the quarter." He added, "That's wrong."
Petrocelli asked Koenig if he knew how the accounting department made up for the one penny difference, which, if not adjusted, would have caused a drop in the company's stock price.
"I was not in accounting when they were adjusting the number, no," Koenig said.
Petrocelli then had Koenig read the following phrase out of Enron's annual report: "Some amounts are based on the best estimates and judgments of management."
Hours of audio and videotapes began to roll on Wednesday, and when they did, the defense team's strategy became more apparent. To counter testimony by Koenig that Skilling and Lay deceived analysts and Enron employees, Petrocelli replayed an hour-long webcast of a Feb. 21, 2001 all-employee meeting at Enron for the jury.
On the webcast, Lay discussed Enron's performance into early 2001, including the company milestone of reaching $100 million in profit. "Enron is laser-focused on increasing earnings per share," said Lay, and employees are seen cheering and applauding in the background. He also told employees the company planned to increase capital efficiency by selling less profitable businesses.
Skilling, named CEO a few weeks earlier, explained Enron's planned sale of Oregon-based Portland General Electric (PGE), and said the sale might be held up by legislative action in California, following the energy crisis in the winter of 2000-2001. Skilling also said more international assets were going to be sold, all part of a plan to earn a stronger return on equity. Enron at the time had about $8.7 billion invested in assets, which he said were earning about 3% in returns.
"Return on equity stinks as a company," said Skilling. "We have to get that up. That's what will let us maintain our multiple, our price to earnings multiple."
Skilling admitted the new business, Enron Broadband Services (EBS), was not doing well.
"The enthusiasm people had for broadband was at a peak level" in early 2000, and "it's probably through the floors now...I think bandwidth is going to go through an enormous change. Our business model is perfect for that change, but it's going to be a rocky road."
During the webcast, Skilling and Lay also unveil a strategic business plan.
"This is it," Skilling said, as Lay displays a banner that reads "From World's Leading Energy Company to World's Leading Company." As employees applaud, Skilling added, "Five years from now, I think there's a good chance we could be the leading company in the world."
After he had completed his strategy presentation, Skilling is heard taking questions from employees, including one concerning an article written in early 2001 by Fortune magazine. The article, "Is Enron Overpriced?" questioned the company's lack of investor information, and said the company was a "black box" because it was difficult to know how the company made money.
"Sorry, it's true," Skilling said, in answer to the question about the magazine article. "It's hard for us to show how money moves through, particularly the wholesale business." Skilling claimed the article by Fortune was done after competitor BusinessWeek published a favorable article on Enron. Skilling said Enron was upfront with financial analysts, and said Enron tracked volume growth from physical energy deliveries as a good indicator of the wholesale business revenue expectations. He said Enron's businesses were growing, so "that's a good black box."
Petrocelli also is framing an argument that efforts to sell Enron short by some investors helped to bring down the company's share price in 2001. He questioned Koenig about a meeting in February 2001 set up by Kynikos Associates, a hedge fund based in New York. Its meeting, called "Bears in Hibernation," focused on short-selling companies including Enron. He also showed the jury a report by Off Wall Street, a short-sellers research firm.
He played an audiotape of an analyst conference call in March 2001, in which Skilling addressed the company's falling stock price (see NGI, March 26, 2001). Skilling said the rumors about Enron were mostly "noise" with no basis in fact. He said, "I wish we didn't have to make this call, but with what's going on in the stock market, we thought we better have this call." At the time, Enron's stock had fallen to a 52-week low. Skilling detailed the problems with possible California legislation in the proposed sale of PGE.
Skilling also addressed the problems within the broadband services unit. Enron's failure to maintain a proposed long-term contract with Blockbuster for video-on-demand was real, he admitted, but, the contract "was not providing us the content that we wanted." The broadband unit was expected to eventually turn a profit, and Skilling said he was "very confident we'll have specific contracts to show you" before the end of the year.
Retracing his previous questioning, Petrocelli focused on Koenig's statements made to the jury about Skilling's relationship with investors and financial analysts. On an audiotape from July 2001 concerning 2Q2001 earnings, Skilling was heard explaining problems within EBS. Skilling told investors on the call that it had been a "difficult" quarter for EBS (see NGI, July 16, 2001). Periodically, Petrocelli stopped the recording to ask Koenig to clarify details on the calls, which Koenig attended. The prosecution contended in its opening statements that Skilling and Lay hid financial losses within EBS.
"You had no reason at the time to doubt that Mr. Skilling believed 100% in the company?" Petrocelli asked.
"I had no reason not to believe that, no," replied Koenig.
"Did Skilling ever ask you to hide the losses at Enron Broadband Services," Petrocelli asked.
"No," Koenig said.
After playing the audiotape, Petrocelli asked Koenig to read Enron's stock prices from various dates over the course of 2001, noting the volatility of the stock price. The defense is also maintaining Enron was a victim of short sellers trying to lower the stock price in 2001.
Petrocelli then questioned Koenig about Skilling's resignation in mid-August 2001. Koenig read from an interview between Skilling and BusinessWeek, in which Skilling indicated he left the company for personal reasons but also because of the falling stock price. Asking Skilling what his future plans were, he said he was considering becoming the head of an unnamed business school that had contacted him. Skilling also told the magazine, "I'm not leaving Houston," and added prophetically, "You probably haven't seen the last of me."
When he finally took over cross examination, Ramsey focused on the conference call conducted Aug. 14, 2001, the day Skilling announced his resignation (see NGI, Aug. 20, 2001). With Skilling's departure, Lay returned to his role as CEO. All of the seven counts against Lay in the current trial are based on his actions in the months after he returned to the CEO role. (Lay also faces four felony charges involving his personal banking, and he will face a separate trial after this one is completed.)
"I can honestly say that the company is probably in the strongest and best shape that it's ever been," Lay said in the recording. He said he regretted Skilling's decision, "as he has been a big part of our success for over 11 years. But we have the strongest and deepest talent we have ever had in the organization, our business is extremely strong, and our growth prospects have never been better." He said there were no company problems related to Skilling's departure. "There are no accounting issues, no trading issues associated with Jeff's departure," Lay said.
In a humorous aside, Lake called the prosecution and defense teams to the bench in the Thursday morning break, then announced after the sidebar discussion that "scheduling" problems would require an additional five-minute break.
The extra time was used so that Petrocelli could wash off his cologne. Apparently, a female juror sitting in the front row was overwhelmed by the scent while Petrocelli was cross examining Koenig. She told the judge she was "gagging" and felt strong enough to ask for a fragrance correction.
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