The Criminalization of Director Misbehavior: The Case of Jefferey Skilling

A post on the appeal of Jeffery Skilling has taken some time to develop, primarily because of the need to digest a 242-page tome filed to support his arguments for reversal.  The tome can be found at the DU Corporate Governance web site. 

In many ways, Skilling’s conviction exemplifies the worst consequences of blurring the line between bad business decisions and criminal conduct, overzealous prosecution, and the ready resort to mob justice. The government’s case against Skilling was based on a conspiracy to deceive investors about the true performance of Enron’s businesses by cooking the books to increase reported earnings, reduce reported losses, maintain an investment-grade credit rating, and improve the price of Enron’s stock. In doing so, Skilling allegedly breached his fiduciary duty of “honest services.” The shocking truth is that Skilling’s conviction is founded on no evidence as to when, how, or why the conspiracy was hatched, or anything beyond self-serving testimony from Fastow that proved that he committed any crime. The conviction chillingly demonstrates the need to clarify the “honest services” theory if it is to serve any function in distinguishing risky business behavior from criminal behavior.

In US v. Brown, 459 F.3d 509 (5th Cir. 2006), the government’s “honest services” theory was rejected by the court in similar circumstances, and there is no reason why Skilling’s appeal should not be successful, at least in part. In Brown, Enron and Merrill Lynch employees were alleged to have engaged in a conspiracy to defraud Enron and its shareholders by “parking” the now infamous “Nigerian barges” with Merrill Lynch for six months to artificially boost Enron’s earnings. It was alleged that Merrill paid $7 million to acquire equity in the barges to help Enron post $12 million in earnings to meet its forecasts. The state’s case was that this was a sham transaction because Enron executives orally promised Merrill a flat fee of $250,000 and a guaranteed 15% annual rate of return for the six months that it was required to hold the asset. Further, the government alleged that the transaction was in the nature of a lease rather than a sale because Enron executives promised it would buyback Merrill’s interest if no third party could be found.

The court was unsympathetic to the government’s claims because the facts did not show that the defendants had acted at the expense of the company, or had engaged in bribery and self-dealing. Rather, their actions were to the benefit of Enron. According to the majority, “…where an employer intentionally aligns the interests of the employee with a specified corporate goal, where the employee perceives his pursuit of that goal as mutually benefiting him and his employer, and where the employee’s conduct is consistent with that perception of the mutual interest, such conduct is beyond the reach of the honest-services theory of fraud as it has hitherto been applied.” The test for a deprivation of “honest services” case, as the court held in Rybicki, is that the defendant is secretly acting for his own interest while purporting to act for the employer. This is consistent with the Seventh Circuit’s ruling in United States v. Bloom.

There is no evidence that Skilling engaged in bribery or self dealing. Nor did he act secretly for his own benefit at the expense of Enron. There was no deprivation of “honest services” because, if anything, Skilling’s interests were too closely aligned with Enron’s. Unless the causal link between Enron’s ultimate collapse, and Skilling’s alleged actions are conclusively established, there was no harm caused by Skilling’s alleged “crimes.” In fact, the immediate consequences of Skilling’s actions were that Enron and its shareholders benefited. The application of the “honest services” theory in cases where bad business decisions caused financial losses dangerously corrodes the very basis of criminal liability by conflating moral wrongfulness with risk taking. It must be clarified if it has to serve the intended purpose.

The case against Skilling is in part a consquence of the weakening civil standards for liability.  With Delaware law making a sham of fiduciary obligations, civil remedies are in decline.  The truth is that Skilling's behavior should have been resolved in a civil courtroom, turning on whether he fulfilled his obligations to shareholders.  But absent a state court system willing to sanction management for mismanagment in appropriate cases, criminal courts are seen as the location of last resort and often the only place where some kind of punishment can be meted out.