Podcast: Thomas Dunfee on the Enron Verdict

On May 25, a federal jury convicted former Enron CEO Kenneth Lay and former Enron president Jeffrey Skilling on conspiracy and fraud charges, with sentencing to be decided on September 11. As has been repeatedly noted in press coverage of this trial, Enron is the incredible story of a once powerful company done in by a group of top executives whose greed and fraud was breathtaking even by post dot-com standards. But it is by no means the only high-profile criminal trial in recent days, nor is it likely to be the last case brought by the government against CEOs who abuse their positions, their stockholders, their employees and the public trust. Thomas Dunfee, chairman of Wharton’s legal studies and business ethics department, and an expert on social contracts and the social responsibility of business, talked to Knowledge at Wharton’s Mukul Pandya and Robbie Shell about the Enron verdict.

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Yes I do.  I read that a number of the jurors indicated that they were sympathetic to Lay and Skilling at the beginning of the trial.  And after the two testified, where they came across as very controlling, perhaps even arrogant, that some of those originally sympathetic jurors changed their minds.

Knowledge at Wharton:

In the wake of this verdict, people might be inclined to say, “See the system works — they got convicted”.  But it did take 4½ years for the verdict to come down.  So in your view did the system work?

Dunfee:

Yes I think that it did.  As a matter of fact, you can turn it around and say, what would have been the reaction had the jury acquitted Lay and Skilling?  Because after all, this was the poster child case.  This was basically the name for the series of scandals that had occurred.  And had the government lost this case, it would have been I think very damaging to the attitudes about what had happened across corporate America.  I think it would have been damaging to future prosecutions.  So it’s natural that they would take a lot of time to carefully prepare what was a rather complex case.

Knowledge at Wharton:

So, to get back to my first question, you do think that it was the correct verdict then?

Dunfee:

We have a jury system where even Skilling said right after the verdict “That’s the way the system works. They were entitled to make that finding.” The jurors are the people that sat through every bit of evidence in the trial. They were unanimous. They were relatively quick when you consider how complex the case was and how long it had taken to try. One could imagine the jury being out for several weeks. So, yes, in our system where we have the jurors be the finders of fact, I think indeed the system seems to have worked. 

Knowledge at Wharton:

Do you expect to see a lot more trials and a lot more convictions now that the government has one such a high profile case?  And are there any candidates out there? 

Dunfee:

I think the value that comes from the decision is that the government really doesn’t have to bring as many cases now.  Think of the number of convictions. It is estimated that Lay and Skilling are likely to be sentenced to between a dozen and two dozen years in jail.  I have also seen that many experts think that the chances of a successful appeal aren’t very likely.  So I think that has value in and of itself and it’s not necessary to bring a lot more cases. 

Furthermore, because of the Sarbanes-Oxley reforms that occurred in 2002, we’ve had a number of companies make changes in their accounting control systems.  In fact it’s kind of remarkable the number of companies that had to do that.  If you remember that in a number of the other cases, the defense that was raised by CEO Koslowski being a prime example and Bernie Ebbers, was “I didn’t know what was going on”.  So these people were committing fraud and it was “I didn’t know it”.  Now there have to be systems in place in which the CEO is certified and much more likely to catch it.

Knowledge at Wharton:

In other words, you think there is going to be more transparency now that will make it possible for CEOs who are engaged in some sort of wrong doing to be identified before the problem gets very serious.  Is that an accurate reading?

Dunfee:

It’s interesting as to what was happening right up to the time of the verdicts and you were having a counter attack on the reforms. You were having businesses complain about the expense of filling out the reports and in some cases very liberally estimating the number of person hours it was taking to fill out the reports.  But you had this counter attack on the reforms.  My guess is that the verdicts in the Enron case will slow down that counter attack and will allow us to continue to have increased transparency in terms of corporate behavior. 

Knowledge at Wharton:

It might slow down the counter attacks, but do you think it will also serve as a deterrent for other CEOs and scare them off from doing the kind of things that Skilling and Lay did? 

Dunfee:

The critics of Sarbanes-Oxley say it not only scares them off and things like that but it makes them too risk adverse.  I’m not sure if that is true. Yes you would think with the number of convictions that have been obtained and the number of people that have gone to jail that this would cause both the people at the very top and others in the organization to be more cautious.  In many of the cases, Enron is an example of this. There were people who faced decisions where they decided not to act in a certain way, not to blow the whistle or to go ahead and take a certain action. 

You may recall that the board in Enron was twice asked to waive their code of ethics which restricted the kind of deals that Fastow (Enron’s CFO) was entering into.  I would hope the one lesson that would come out of this is if you are a board member and you are being asked to waive the code of ethics of the corporation in the context of some rather obscure financial deal that you think twice about before you vote affirmatively on that. 

Knowledge at Wharton:

You mentioned Bernie Ebbers’ and Dennis Koslowski’s strategy, which was one of saying “oh, fraud, I didn’t know that was occurring”.  What do you think of Lay and Skilling’s strategy which was to claim the company actually did no wrong, except for people like Andy Fastow, but really was done in by negative press coverage and short sellers and a market panic?

Dunfee:

Interesting – I saw the editorial on Friday in the Wall Street Journal.  You might expect the Wall Street Journal to be sympathetic to Lay and Skilling, because part of their defense was that the Wall Street Journal had engaged in irresponsible journalism and that had caused the house of cards to start to fall. The Wall Street Journal was definitely not sympathetic to their case.  I found that defense to be quite bizarre.  I think that my colleagues in Finance who believe in efficient markets would find that to be bizarre.  I think many people intuitively would find this to be bizarre — that if you had a company of the size that Enron had, that a few stories in the Wall Street Journal could trigger a few short sellers and this would cause a collapse of a company of that size if it had the real assets that they were claiming that it had.  It just seems absolutely counter intuitive and bizarre.

Knowledge at Wharton:

That’s very interesting.  I wonder if we could ask you about something you said earlier.  You said that the experts think that an appeal won’t work.  Why not? 

Dunfee:

Well there are various issues that may be raised on appeal.  The judge required them to be tried together.  He didn’t allow the case to be moved from Houston. There were a series of decisions; the standard that he imposed … may be in question.  But unlike some of the other cases, like the well known Martha Stewart case or even the Arthur Andersen case, which both were basically changed on appeal, there seems to be pretty clear law in this area and the judge seems to have followed that fairly clear law.  It would be coming up in a circuit court of appeals that tends to be relatively conservative and pro government on these kinds of issues. You never know for sure but it seems like it’s a long shot.  I think by and large any appeal of this sort is a long shot to start with.  Here it seems to be even more of a long shot. 

Knowledge at Wharton:

Do you expect to see a wave of class action suits by shareholders to get their money back?  I mean now that Lay and Skilling have been convicted in a criminal case, aren’t they fair game for the easier civil cases?

Dunfee:

The problem with there being a bunch of civil cases is to find a deep pockets defendant who can actually pay the damages that you would obtain.  Neither the company nor Skilling and Lay personally have assets to make this worthwhile for somebody to pursue. The way that they try to find someone with deep pockets is to bring in the investment banks or those kinds of actions. Those are of course are a little harder to bring because they are farther removed from these.  I doubt if these verdicts in and of themselves would result in additional class actions. 

It’s interesting that Lay was also convicted of defrauding a bank when he took a loan and signed documents in which he promised that he would not use the money to buy Enron stock and then did so.  Again there was at least a piece of his defense there that was relatively bizarre.  He said that he had an electronic signature and somebody was putting his signature on these documents.  You know if you’re the judge deciding that case and here is somebody that comes across as very controlling and on top of everything.  He’s already testified in the other trial “I did everything I could using all of my skills to do it”.  But here he is not even in control of his own electronic signature; you’ve got to be skeptical.

Knowledge at Wharton:

Overall what do you think are the main ethical lessons to be learned from the whole Enron affair?

Dunfee:

Transparency is the critical principle for corporations and their financial reporting.  I think that one can say that Enron purposefully made their reports obscure, so that one had to do an enormous amount of digging to find out what was going on and analysts who did that were given a hard time by the senior executives of Enron.  So, for financial markets to work the way that they should it’s essential that financial reporting not only be accurate but that it be transparent. 

Internally within the organization you have a somewhat different set of issues, because here you had Enron that had in some ways the perfect code of ethics   which I understand you can buy on eBay and it’s still sealed in its plastic container where it’s never been removed.  They had a wonderful board that had some very prominent people on that board.  There have been articles written.  Where were the gatekeepers?  Where were the internal auditors?  Where was the board?  Where was the outside law firm?  They all failed to speak up at the point at which they should.  And if you see something that you think is seriously wrong you should do more than just sort of cross your fingers and sign on to it. So a code is not enough obviously by itself.  You have to have a real commitment to the values that too easily can be put up on the wall, but can be very unreal.

Knowledge at Wharton:

One final question and this is one that I know has been asked many times, many places.  Are there steps that business schools can take to help prevent Enron’s of the future?  In addition to what Wharton is doing, which I know, because I’ve talked to you about this, is very extensive. 

Dunfee:

One of the ironic values of the Enron case is that it probably will be written up into some teachable cases.  And business students can take a look at what happened there and can project themselves into the various roles.  We already teach the Worldcom case.  The Worldcom case is wonderful in one sense and that is the internal auditor under all sorts of pressures from Bernie Evers, stood her ground even to the extent of working it out so that one of her assistant’s could go in at night and get relevant data to find out what was really going on once she became suspicious.  And she held it in there against all sorts of pressure.