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The recent ridiculous dance involving former Enron CFO Andrew Fastow, his wife, their lawyers, federal prosecutors, and a judge was more than just a tortured negotiation over who's going to jail and for how long, though it was certainly that. It was an event with important meaning for investors, though the importance is a couple of steps removed from the actual goings on.
Lea Fastow was negotiating a plea deal with federal prosecutors over her small-potatoes role in the Enron scandal. She's accused of personal tax violations in connection with her part in some of her husband's mind-blowing machinations at Enron. As you may recall, Andrew Fastow's incomprehensible schemes eventually included deals in which he and his wife personally put in thousands of dollars and soon thereafter miraculously took out millions of dollars.
Anyway, the Fastows have two young kids at home and wanted to avoid doing time simultaneously. So they held out for a deal under which Lea would do just five months in stir, getting sprung before Andrew would even begin his sentence. Andrew would then agree to a plea deal giving him a 10-year sentence, though he probably wouldn't serve the full ten years. They'd also reportedly pay $20 million in penalties. Andrew would probably be free by age 50, and he'd probably still be rich.
Those are the factors on the Fastows' domestic front. Far more important to you and me is the other side of Andrew's prospective plea deal. Typically, a crucial element of such deals is that the defendant agrees to give evidence to prosecutors -- in this case presumably top quality triple-A-rated evidence they would use in building cases against Ken Lay and Jeffrey Skilling, Enron's two former CEOs, neither of whom has been charged with anything.
At first the judge wouldn't give final approval of Lea's deal for a five-month sentence. So she told prosecutors there wasn't any deal. So her husband told prosecutors there was no sense in him making a deal either. For a moment, it appeared that the prosecutors wouldn't have their critical evidence against Lay and Skilling.
Now we begin to see why this tangled plea negotiation in Houston is so important to investors. Thousands of people were hurt by Enron's misrepresentation of its financial results. They bought the stock in the belief that Enron's results were real. When they turned out not to be -- when they turned out to be instead one of the most incredible webs of deceptive financial engineering ever seen -- the stock fell to nothing and ordinary investors lost billions.
But here's the key fact: Nobody on the outside could detect the fraud. Even FORTUNE's now-famous article in February 2001 ("Is Enron Overpriced?") never suggested that Enron was cooking its books. Even super-sophisticated investors like Jim Chanos, who was one of the very first to question Enron's valuation in the pre-scandal days, was simply looking at reported financial results.
If even high-IQ professional investors couldn't see what was happening, what chance did the rest of us have? The answer is, no chance. Let's just accept it: No matter how much research you do on a stock, you will never detect Enron-caliber fraud. The people who concoct it are too good. By far the best book on Enron, in my biased opinion, is the one by my FORTUNE colleagues Bethany McLean and Peter Elkind, called The Smartest Guys in the Room. That was Enron. They were always the smartest guys in the room -- too smart for their own good, it turned out, but plenty smart enough to fool the rest of us for a long time.
So is there hope? Yes, and it comes from the criminal justice system. If we can never detect Enron-style fraud, we can scare executives away from perpetrating it. Prosecutors have probably made Andrew Fastow's life miserable enough already to deter other CFOs from similar actions. But unless the very top guys, the CEOs, face prison, then the overall deterrent won't be sufficient to protect ordinary investors.
Finally, after a week of brinksmanship, the Fastows and the prosecutors agreed on their plea deals. That's wonderful news for you and me.
Without a plea deal for Lea Fastow, there may never have been a plea deal for Andrew Fastow.
Without a plea deal for Andrew Fastow, he may never have given evidence.
And without Andrew Fastow's evidence, the former CEOs in this case might never be charged, as I now expect at least one of them will be.
Which is why the little negotiating dance in Houston was actually a big deal for every American who invests.
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