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With the second anniversary of Sarbanes-Oxley and the Corporate Fraud Task Force just past, and with criminal trials of corporate executives now a regular phenomenon, it is time to ask an impertinent question: Is the criminal sanction being used too freely? Applied to some recent defendants — Ken Fastow of Enron, Scott Sullivan of WorldCom or Dennis Kozlowski of Tyco — this question seems frivolous. Abundant evidence of self-dealing, under-the-table payments or insider trading seems clear, sufficient at least to justify indictment. But in other cases, some novel and questionable theories of criminal liability have surfaced. For example, in the Martha Stewart prosecution, the U.S. Attorney indicted her on the charge that she had committed securities fraud by denying her own guilt and thereby artificially inflating the value of her own company’s stock. This would seem to leave a defendant in her position close to speechless. Ultimately, the court properly dismissed this count for lack of evidence, but a future defendant could face up to a 25-year sentence on this charge. Even broader theories of criminal liability were announced last month in the indictment of Ken Lay, the former CEO of Enron. While no view is here expressed about Lay’s guilt or innocence, new theories of criminal liability are like genies that have escaped from the bottle. Once released, they seldom want to return. As a result, the law can quickly expand to the limits of its logic — and beyond. Much like Sherlock Holmes’ dog that did not bark in the night, what is most striking about the Lay indictment is what it does not allege. Lay served as CEO and chairman of Enron from its formation in 1986 until his resignation as CEO in February 2001. During at least the last several years of his tenure, Enron’s books appear to have been cooked to a burnt crisp. On Aug. 14, 2001, Jeffrey Skilling abruptly resigned as Enron’s CEO, and Lay returned as CEO, apparently reluctantly. Lay was unable to save Enron, whose nosedive into bankruptcy only accelerated. On Oct. 22, 2001, Enron announced that it was the subject of a Securities and Exchange Commission investigation; by Nov. 1, both major credit rating agencies had downgraded it; on Nov. 8, Enron announced its intent to restate all of its financial statements from 1997 through the second quarter of 2001. Lay’s only serious hope for a rescue was an attempted merger with Dynergy, a rival energy company, a plan that fell though in late November, after which Enron filed for bankruptcy on Dec. 2, 2001. In short, the end came fast, and on this basis, Enron’s doom was probably inevitable by the time that Lay returned. Of course, Lay could still be held responsible for Enron’s financial chicanery in earlier years, as most of its infamous “special purpose entities” (SPEs) were created in 1999 and 2000 when he was CEO. But this is where the indictment surprises. Only Skilling and Richard Causey, his co-defendants, are specifically alleged to have known that Enron’s SPEs did not comply with “generally accepted accounting principles.” Similarly, the indictment charges Skilling and Causey, but not Lay, with manufacturing earnings and concealing debt through fictitious sales of assets to Enron’s controlled SPEs. As the indictment portrays events, Lay was only a passive co-conspirator who is not alleged to have done anything specific — before his return to Enron. But his post-return conduct seems mainly that of a desperate cheerleader, who reassured employees at an “online forum,” who hosted conference calls with anxious securities analysts and who attempted to soothe representatives of a credit rating agency. Even assuming that he acted with criminal intent, Lay seems mainly a bystander to the tragedy of Enron, a Rosencrantz or Guildenstern, not a Macbeth or a Richard III. Nothing that he did post-return mattered because Enron was beyond saving. Historical irrelevance is, to be sure, no defense to a crime. Thus, Lay could be guilty of fraud or false statements, even if Enron was already doomed. But in the indictment, one finds the government generally focusing on statements that sound more like optimistic puffing than predatory fraud. For example, the very first allegation concerning Lay’s behavior involves statements to Enron employees at an online forum, on Sept. 26, 2001, at which Lay told them that “[t]he third quarter is looking great. We will hit our numbers. We are continuing strong in our businesses, and we’re positioned for a very strong fourth quarter.” This sounds much like the traditional CEO, acting as motivator-in-chief, trying to sustain employee morale during a crisis. Even if such statements were unduly optimistic, an intent to commit fraud seems lacking because Lay was neither marketing goods or services to his employees nor seeking financing from them. Lay also told Enron employees that “My personal belief is that Enron stock is an incredible bargain at current prices.” Rash as this sounds in retrospect, Lay had himself just bought $4 million in Enron stock. The government, however, alleges that because he had also sold $24 million somewhat earlier, his statements omitted material facts and thereby breached a fiduciary duty of “honest services” that he allegedly owed to his employee/shareholders. Yet these earlier sales seem largely the result of margin calls over which Lay had little control. Three analyst conference calls made by Lay during October and November 2001 provide the principal evidence for the securities fraud charges. At the first of these, on Oct. 16, 2001, Enron, through Lay, conceded for the first time that it had suffered large losses of roughly $1 billion in some areas of its business. Yet the indictment alleges that Lay falsely described these losses as “nonrecurring” — that is, a one-time event. The line between “recurring” and “nonrecurring” losses can be a fine one, and Lay was not an accountant. Lay also acknowledged that Enron’s shareholder equity would be reduced by $1.2 billion, but the indictment again alleges that he defrauded the market because he gave the wrong reason for this write-off, attributing it to the unwinding of a hedge transaction and not a more basic accounting error. A second analyst conference, held on Oct. 23, followed Enron’s third-quarter earnings announcement and a resulting 25 percent fall in its stock price. Trying to re-establish credibility, Lay stated “[w]e’re not hiding anything … I’m disclosing everything we’ve found.” In response, the indictment alleges that Lay failed to disclose some material facts — but disclosing everything is close to impossible in an analyst phone call. The final analyst phone call on Nov. 12, 2001, came after Enron had restated its financial statements and been downgraded by the credit rating agencies. The end was near, but again Lay stressed to the analysts: “We don’t have anything to hide … I’m disclosing everything we’ve found.” Again, the government has indicted on the ground that these statements were materially false and incomplete because Lay was allegedly aware of the need to take an additional writedown that he had helped hide from Enron’s auditors. This sounds more material, but everything depends on what Lay knew and when he knew it. An evenhanded evaluation must recognize that the government has not overcharged in the usual sense. That is, it has not accused Lay of direct responsibility for Enron’s egregiously cooked financial statements for 1999 and 2000, apparently because it has recognized that he was a remote, hands-off manager who delegated much decision-making to Skilling and Fastow. Still, under the government’s view of analyst phone conferences, seemingly anything less than an encyclopedic recitation of Enron’s accounting irregularities would result in material omissions in violation of Rule 10b-5. The irony here is that these same oral statements would have likely been insufficient to support a private action for damages. Why? Because they would have qualified for the protection of the safe harbor for forward-looking information in �21E of the Securities Exchange Act of 1934. But that safe harbor only applies to private actions. For the future, the chief implication of the Lay indictment may be that other CEOs and chief financial officers are far more vulnerable than they perceive. In the wake of Sarbanes-Oxley, the focus of attention had been on the annual and quarterly certifications mandated by that act. In response, corporate counsel have implemented elaborate due diligence procedures by which subordinate corporate executives certify up to the chief executive that their division’s financial results “fairly present” its financial condition. As detailed as these procedures may be, they will be of little avail if a prosecutor in a future case decides to focus instead on the more offhand and casual comments made by the same CEO in an analyst conference call. Frequently, these comments will be made under pressure from aggressive analysts or in response to unexpected questions. In this light, the preparation for analyst conferences probably needs to include a legal review of the expected script and preparation of some standard “bespeaks caution” caveats. More than that, an after-the-fact review by counsel is likely required to determine if amended statements or qualifications should be issued in a follow-on press release. Finally, the Lay indictment shows that even the ordinarily innocuous context of an employee forum can give rise to mail and wire fraud charges. Much that seemed pedestrian now looks liability-laden, as the criminal law increasingly encroaches on the everyday life of the corporate manager. To be sure, an intense political need to indict Lay may explain why prosecutors have pushed the envelope of securities and mail fraud theories to their limit. But what happens once will predictably happen again. John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia Law School and director of its Center on Corporate Governance. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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