JURIST Guest Columnist Douglas Branson of the University of Pittsburgh School of Law says that a comparison of the Andrew Fastow and Bernard Ebbers corporate fraud cases suggests that the sentences handed down for the two former high-flying executives - 6 and 25 years respectively - are unduly disparate and even perhaps backwards...
or Andrew Fastow, the wrongdoing CFO of Enron, Tuesday, September 26 was the best of times and the worst of times. It was the latter because he had his last embrace with wife Leah until 6 years pass, during which time he will be incarcerated. Those 6 years follow a year's separation that occurred when Leah was in jail for her Enron-related crimes. Fastow will also be apart from his two sons, who are middle school age but will be college-age when the prison releases their father.
But also it was the best of times. Fastow earned $46 million, over and above Enron salary and other compensation, acting as general partner of LJM1 and LJM2. He created the LJM partnerships Fastow to provide seed capital to special purpose entities (SPEs). Fastow then moved assets, and related debts, to the SPEs, off Enron's books. Enron thus preserved a decent credit rating, enabling it to borrow money at reasonable rates, postponing its comeuppance. Fastow will keep some of that money, even though most of the gain was secret, and illicit.
Federal Judge Hoyt sentenced Fastow to 6 years. The plea bargain agreement with federal prosecutors had called for 10. Department of Justice sentencing guidelines, which federal judges are scrupulously to follow, called for Fastow to do 40 years, which would have sent him to prison for life.
By contrast, Tuesday was the worst of times for Bernie Ebbers, the ex-CEO of WorldCom, Inc. Ebbers, 65 years old, reported to a federal prison to begin serving a 25 years sentence, which federal judge Barbara Jones decreed last Spring. The odds are that Ebbers will spend his life in jail. Ebbers will be in jail not only when Fastow is playing golf at his country club but when Fastow is playing shuffleboard as well. As a corporate governance expert, I ask myself the question: shouldn't it be the other way around? Is a band somewhere playing "The World Turned Upside Down."
Let's compare the two cases:
1. End Result.
Fastow helped build a house of cards, very little of which exists today, save for a small trading operation and ex-subsidiary Portland General Electric. By moving 54 % of Enron's debts off books, and by leading the way to accounting recognition of hundreds of millions in false profits, Fastow was absolutely instrumental in creation of the house of cards part. Investors lost $60 billion.
Ebbers built a substantial company, which started as a long distance discount reseller. Sixteen years and 60 acquisitions later WorldCom operated in 50 countries, supplied 60% of the Internet backbone, and was the number two long distance provider in the United States. It merged from bankruptcy court as MCI, Inc., a viable, substantial company that later became part of Verizon. The only reason for a bankruptcy is that banks pulled a $9 billion line of credit from WorldCom after the accounting irregularities came to light in June, 2002. WorldCom's directors than had no choice but to enter bankruptcy. Investors lost $30 billion, arguably due to what the banks did, but, in the securities law class action, some WorldCom investors recovered approximately $8.5 of $17 million. And WorldCom, with a different name, is still there.
Fastow kept his compensation secret because it was obscene in amount. Only when a director asked him point blank, in October, 2003, did Fastow reveal the $46 million number. Greed motivated Andrew Fastow.
Ebbers had his back to the wall. He had borrowed $250 million from Bank of America to purchase WorldCom stock. Ebbers's holding reached $900 million in early 2000. Ebbers not only encouraged but enforced a laudatory policy that WorldCom executives did not sell WorldCom stock except in the direst of circumstances. Then, in April 2000, the stock market began a 28 month slide that would see the market overall lose 40% of its value and the NASDAQ lose 70%. In September, 2000, as WorldCom's stock price fell, Bank of America called on Ebbers to increase the collateral or pay down the loan. Rather than sell stock, Ebbers convinced compensation committee chair Stiles Kellett to lend him $125 million of corporate funds. By April, 2002, Ebbers owed the company $300 million. How it got to $405 million is another, often mistold, story.
Ebbers became a victim of his own policies, policies that many governance and management gurus praise, that is, that corporate executives should own large segments of the corporation they manage. Greed was in the background certainly, but Ebbers became trapped by a policy he had created and that motivated him.
Andrew Fastow has a Masters in Business Administration from the Kellogg School at Northwestern University, rated the country's best MBA program in many polls. He served in successive more important posts at Continental Illinois Bank before he moved to Enron. He is an extremely sophisticated financial engineer whose cleverness knows few bounds.
At 6 feet, 8 inches, Bernie Ebbers came from Canada to tiny Mississippi College to play basketball. After college he coached basketball and got into the motel business. Later he formed a company to sell discount cards for long distance calling. Aside from building WorldCom, his only other activity was driving the tractor on his Arkansas rice farm. Ebbers may be a smart man but he is light years behind Andrew Fastow in education, background, knowledge, and perhaps sophistication.
Fastow piled up the money because he knew no one, including the directors on the finance committee, whose job it was to monitor him, was watching. Ebbers's financial difficulties were disclosed to the WorldCom board every step of the way, or nearly so. The compensation committee did not disclose the initial September $125 million loans until November, 2000, but board members all stated that they would have approved the loans anyway because they thought that Ebbers was so valuable to the company, at least at the time.
5. The Evidence.
I read the transcripts of the Ebbers criminal trial, as it occurred. I thought the prosecution had not laid a glove on him. It was CFO Scott Sullivan's word against CEO Ebbers's version of events and of the management arrangements at WorldCom. Flip a coin as to whom you would believe. Sullivan testified that Ebbers knew that Sullivan first poached line cost reserves and then capitalized line costs to lower expenses, making WorldCom appear profitable when it was not. Ebbers testified that he looked after sales and revenues and ways in which to grow the company; CFO Sullivan had exclusive control over and knowledge of the cost side of things. Ebbers knew nothing. Post trial the jurors reasoned, or speculated, "Ebbers was the CEO, he must have known."
Had Fastow gone to trial dozens of persons would have testified against him. They were willing and unwilling participants in Fastow's schemes. All of them would have testified further as to Fastow's greed, his stealth, and his knowledge of what he was about every minute.
What do we learn from this? One, corporate CEOs are much like ship captains: they may be blamed for everything that happens on their watch, whether they are complicit or not. Two, the much ballyhooed Department of Justice guidelines mean nothing in high profile white collar crime cases. They don't prevent lynching the less blameworthy; they also permit a mere slap on the wrist to the greedy, the sophisticated, and the stealthy if they turn state's evidence. Three, Ebbers should serve roughly the same as, or only a little more, or even a little less, time than should Andrew Fastow, at least if we are concerned about doing justice.Douglas M. Branson holds the W, Edward Sell Chair in Law at the University of Pittsburgh and is the author of
Corporate Governance (1993). His newest book, No Seat at the Table, about the dearth of women directors in the Fortune 500, will be published by NYU Press in December.