Sons of Wichita: How the Koch Brothers Became America's Most Powerful and Private Dynasty

by Daniel Schulman

  Lyon and Wolf discovered that the section of pipeline that had ruptured near the Smalleys’ home was part of a 70-mile stretch of Sterling I that Koch Industries had taken offline in early 1993, after a newer pipeline, known as Sterling II, had gone into operation. But as demand grew, the company realized it could reap an additional $8 million annually by placing this section back into service.

  Constructed in the early 1980s, Sterling I had a history of corrosion problems almost from the outset. It had been constructed in wet conditions, and its anticorrosion coating had started to erode in some sections not long after the pipeline was installed. Before the company brought the decommissioned section back online, it threaded a cylindrical device through it called a “smart pig,” whose magnetic sensors recorded detailed data about the pipeline’s structural integrity. It discovered evidence of corrosion in 583 locations—just within the 46-mile length of line spanning Kaufman County. When the company had previously tested the pipeline, flooding it with water, it ruptured a mile and a half from Danny Smalley’s trailer.

  Koch maintenance workers repaired the pipeline and patched up the spots displaying the most damage, but left other corroded areas untended to. In January 1996, after the line passed a second hydrostatic test, liquid butane once again began flowing through it.

  Less than eight months later, Danielle Smalley and Jason Stone were burned alive.

  “I will tell you Koch Industries is definitely responsible for the death of Danielle Smalley,” Bill Caffey, an executive vice president and board member of Koch Industries, acknowledged during one combative deposition. “We made mistakes.”

  On October 6, 1999, when the case went to trial, Lyon displayed a large aerial map of Kaufman County marked with the route of the pipeline, which bisected the county from north to south; it was hard to go anywhere without crossing it. He wanted the jurors to think about the pipeline each morning as they drove to the courthouse, how perhaps it could have been them or their children who had been killed in a butane inferno.

  Lyon saved Smalley as his final witness. During the trial, some of the testimony had been so gruesome that the lawyer had periodically asked his client to step out of the room to avoid needlessly subjecting him to it. As Smalley testified, the forty-four-year-old father summoned every ounce of rage within him. “Money to them is blood,” he seethed. “That’s all it is. That’s their life force, is money. That’s all they care about. They’re so greedy, you know. It’s just greed. They put the value of a human life to a piece of paper that says this is money. I choose the life, not the paper. But that’s the only way that I can hurt them, is to take them for every penny that I can get.”

  During his closing statement, Lyon projected a clock on a screen and paused theatrically for 60 seconds to give jurors a concept of the agonizing length of time in which it had taken Danielle to die. “There is no more horrible death than a burn death,” he said. “There is no more horrible way to lose somebody than to see them burn to death in front of your eyes.”

  Lyon asked the jury to return a massive verdict—$100 million. Instead, on October 22, they awarded an amount nearly three times that. As the $296 million verdict was read, Marquette Wolf, who for more than two years had poured his life into the case, dropped to his knees. On the other side of the courtroom, Koch’s lawyers looked physically ill. The jury had heeded Smalley’s entreaty to send a message to the company. It was, at that point, the largest wrongful death award in U.S. history.

  For Charles and David, it was hard to fully digest this blow. Their focus was on Tulsa, Oklahoma, where, a little more than a year after the Topeka trial that was decided in their favor, Bill had dragged them into another bruising court fight. A federal investigation into allegations that Koch Industries stole oil from Native American lands had concluded in 1992 without returning indictments. Inquiries by the U.S. Bureau of Land Management and the Osage Tribal Council in Oklahoma had likewise failed to corroborate the charges. But to bring the allegations before a jury, Bill Koch had cleverly utilized the False Claims Act, allowing a private citizen to sue on the government’s behalf as a whistleblower in instances where alleged fraud had occurred. It was a civil case—not a criminal one, like the Justice Department had contemplated—so the standard of proof was lower than the beyond-a-reasonable-doubt threshold required for a criminal conviction.

  Bill wasn’t a typical whistleblower. He’d brought the case for tactical reasons. It was another avenue for the out-for-blood Koch brother to apply pressure to Charles and David in his ongoing campaign to force them to pay up for allegedly scamming him and his allies over the sale of their Koch Industries stock.

  In early September, a month before the trial, Charles was diagnosed with prostate cancer and underwent surgery later that month. Bill wished him a “speedy recovery” in the pages of The Wichita Eagle. Even though in a few weeks Bill would take Charles to court in an attempt to prove him a corporate scofflaw, he told a reporter that he still held out hope for a reconciliation. “In spite of all that has happened, when this is over, I would like to take Charles for a sail” and “share several bottles of my best wine with him.”

  The notion received an incredulous reply from Koch Industries: “Bill Koch has been attacking Charles, David and Koch Industries for 20 years. That attack is continuing, and now he says he wants to share a bottle of wine and take them sailing?”

  The same week that testimony in the Danielle Smalley case began, Bill’s whistleblower suit went to trial in Tulsa. The normally dull courtroom had been outfitted for a spectacle: It featured a 20-foot-projection TV screen and so much multimedia gadgetry that the room plunged into darkness on several occasions when the equipment overwhelmed the turn-of-the-century building’s circuit breakers.

  As the proceedings got under way, Roy Bell, a mustache-wearing Vietnam veteran who was Bill’s longtime lawyer, told the jury that Koch Industries had engaged in a “deliberate pattern of fraud” that netted as much as $230 million in overages between 1980 and 1989—“overages” being benign oil industry lingo for crude a company didn’t pay for. Bell displayed a pyramid of photographs. At the bottom were the lowly oil gaugers who, the attorney said, had copped to oil theft. The pyramid rose through the company’s hierarchy until it reached Charles Koch, giving the impression that the bespectacled, white-haired businessman sat atop a criminal enterprise. One might have expected similar imagery at the trial of a Mafia don.

  In the weeks that followed, a parade of former Koch employees testified, in person and via videotaped depositions displayed on the large screen facing the jury. Seeking to stoke negative coverage of Koch Industries ahead of the trial, a Dallas-based detective working for an investigative firm hired by Bill circulated a highlight reel of the depositions to a host of Midwestern journalists. The investigator, Jack Taylor, also sent copies of the tape—dubbed “The Koch Method”—to trial lawyers suing Koch Industries, including Ted Lyon and Marquette Wolf, enclosing articles detailing the company’s legal entanglements and environmental misdeeds.

  Seated at the cramped counsel’s table, Bill scribbled notes and cracked an occasional smile as the gaugers testified. Hailing from at least a dozen different states, these ex-employees (some of whom had been fired or laid off by the company) told of learning to gauge oil the “Koch way,” by adjusting their measurements to “bring home the barrel”—make sure, in other words, that if Koch paid for a barrel at the wellhead, that much crude or more arrived at the transfer station.

  “I felt that it was stealing oil,” Dana Ehrhart, an ex-Koch gauger in Texas, testified.

  “It was enough to bother my conscience,” admitted James Spalding, who’d gauged oil for Koch in New Mexico in the 1980s before becoming an evangelist.

  “I feel like I’m up here telling the whole world I was a thief, and at the time I thought what I was doing was the right thing,” Curtis Henson, a twenty-five-year Koch veteran, tearfully told the court.

  “I had to do what they said to do,” noted forme
r gauger L. B. Perry, “or I wouldn’t have a job.”

  The company’s lawyers countered with the testimony of oil producers who had no qualms with Koch’s measuring practices and Koch employees who explained the inexactitudes of gauging. “I made what I felt were necessary and fair adjustments to get to the station with the number of barrels that I bought,” gauger Dale Sanders testified.

  In December, as the trial drew to a close, Charles Koch himself finally took the stand. Liz, along with David and Julia, accompanied him to Tulsa for moral support. They watched from the gallery as he related when he had first learned about the vagaries of oil measurement during one of those backbreaking summers of manual labor in his teens. Fred Koch had put his son to work digging pipeline trenches near his refinery in Duncan, Oklahoma. One day, Charles recalled, a couple of oil producers teased him about his father’s “overages.” Their comments—calling his father’s ironclad integrity into question—concerned him enough to bring them up with the company’s pipeline managers. They “explained to me the nature of the crude oil measuring business and how a company like ours would tend to be over.” This was “accepted on both sides—by the producers and the purchasers.” But the rampant oil skimming that Bill had accused the company of simply wouldn’t fly in the industry, he said. “If the producers believe your measurements are not as accurate as somebody else’s, they’re going to take volume away from you.”

  The deliberations slogged on well into December. As Christmas neared, the judge mercifully gave the jury a half-day reprieve to complete last-minute shopping. The verdict arrived on December 23, as Charles and his family headed to Colorado for the holidays. The jury found Koch guilty of nearly 25,000 false claims against the government and the company faced a potential penalty of more than $200 million. JURY FINDS KOCH CHEATED, and variations of this headline, screamed from the pages of newspapers across the country on Christmas Eve.

  Koch’s chief spokesman, Jay Rosser, who’d spent the past few years attempting to douse the public relations brush fires Bill had started, described the verdict as “another unfortunate manifestation of Billy’s obsessive, 19-year campaign against the company and his brothers. Billy has stalked his brothers, suing them for imagined wrongs of every kind.” He hastened to add that the excommunicated Koch brother had “even sued his mother in the years before her death.”

  Publicly, the company maintained a veneer of confidence that the verdict would be overturned. Privately, the brothers and their advisors were shell-shocked. “It was a huge loss,” a former Koch Industries executive said.

  Bill had finally scored a big win against his brothers. And he took a victory lap. “This shows they are the biggest crooks in the oil industry,” he told a reporter. In the late 1980s, he had described the case as a Machiavellian tactic to bring his brothers to the bargaining table, but he now framed it as an effort to restore honor to the Koch family name and their father’s legacy. Fred Koch had built the company “on honesty and integrity. After he died, my brother took it over and it became a company that practiced organized, white-collar crime.” So much, it seemed, for reconciliation.

  Charles and his company were under siege. By his brother. By the government. By trial lawyers. By an avalanche of bad publicity. In the space of just a few months in late 1999, the company not only suffered a pair of damaging legal defeats, but also pleaded guilty to an array of environmental infractions in Minnesota—the site of the company’s Pine Bend oil refinery, which had been under investigation by the EPA and the FBI. The federal government fined the company $8 million for illegally dumping a million gallons of ammonia-laced wastewater and spilling some 600,000 gallons of fuel into a wetland and the nearby Mississippi River. This was in addition to a $6.9 million fine the company had already paid to settle a suit with the Minnesota Pollution Control Agency over some of the same violations.

  Once again allegations surfaced that Koch Industries had tried to conceal its environmental offenses, for example, by dumping pollutants under the cover of darkness and falsifying records. “There were times when… yeah, we lied,” Thomas Holton, an ex-employee who worked in the leak detection unit at Koch’s Pine Bend refinery outside the Twin Cities, told the Minnesota Star Tribune. “We did do that. And I won’t cover that up.”

  Morale at the company plummeted. Employees worried about the fate of Koch Industries, and Charles had done little to assuage those fears. What his employees needed was a pep talk, some reassurance that Koch would navigate this traumatic period, but Charles remained closemouthed about the assorted legal threats facing the company. In 1999, as tensions within the company mounted, Tony Woodlief, the Koch management consultant, poked his head into Charles’s third-floor office. Its built-in bookshelves were lined with the twenty-volume Oxford English Dictionary and books by his favorite economic and political thinkers, including Thomas Sowell, Friedrich Hayek, Ludwig von Mises, and Joseph Schumpeter.

  When Woodlief first met Charles in 1997, he had been completing his doctorate in political science at the University of Michigan. They were introduced at a conference sponsored by the Institute for Humane Studies, a libertarian organization where Charles had served on the board since the 1960s. The businessman had given a presentation on his management philosophy, which was steeped in libertarian concepts; his goal was to replicate a free-market society within his firm. To Woodlief, then a thirty-year-old academic, Charles’s management system sounded good in theory, but he was skeptical that it could work. Charles liked being challenged on his views, and he enjoyed debate, so he invited Woodlief to Wichita for a firsthand look at his operation. Woodlief took him up on his offer and left with a job.

  With many Koch employees on edge, Woodlief asked his distracted boss for a word. They repaired to the company’s large cafeteria, where Charles usually ate lunch, and sat down with their trays. “I think you ought to have an all-company meeting and just talk to them about the struggles we’re facing and reassure them,” Woodlief said. “People respect you and right now they want to hear from you. They don’t expect you to have all the answers. They just want to know that you know they’re worried about the future of the company. They just want to hear from you.”

  Charles thanked Woodlief for his advice, but said he wasn’t going to follow it. There were too many unknowns and open questions. If the company didn’t fully understand the regulatory onslaught it faced, how could he tell his employees that everything was going to be okay?

  Charles later realized his mistake. Months later, after some of Koch’s regulatory troubles had begun to clear up, he left an apologetic voice mail for Woodlief: “You were right. I should have talked to them.”

  As 1999 drew to a close, Koch Industries faced the prospect of still another headline-grabbing trial. In the space of less than two years, it had been dragged into court three times—first by Bill, Frederick, and the Simmons family, alleging the company duped them on the sale of their Koch Industries holdings; then by the grieving father of Danielle Smalley; and then yet again by Bill Koch, billionaire whistleblower. Now, after more than four years, the Clean Water Act case that Angela O’Connell and her Justice Department colleagues had pursued was poised to go before a jury. The case hinged on the accusation that Koch Industries had fouled the environment by leaking millions of gallons of oil from its pipelines and storage tanks, and that the company frequently sought to cover up these accidents by masking or minimizing its spills. During the fall of 1999, the case came so close to going to trial that Justice Department attorneys began looking for hotel accommodations. At the last minute, the company entered into a series of tense negotiating sessions with federal prosecutors and lawyers at the Texas Attorney General’s Office, also party to the case.

  Shortly after the New Year, the Justice Department and EPA announced that Koch had agreed to pay a $35 million fine, the largest ever levied under the Clean Water Act up to that point. Accusing Koch of “egregious violations,” EPA Administrator Carol Browner said that the landmark fine “sends a
strong message that those who try to profit from polluting our environment will pay the price.” Despite the record fine, some of the lawyers working on the case felt Koch Industries got off lightly, especially given what former Texas Deputy Attorney General Linda Eads described as the “willfulness” of its behavior. “I didn’t feel like it was a win. I didn’t,” she said. “I felt like it was a draw. I wasn’t sitting there giving high fives to everybody.”

  Koch Industries, with ample help from Bill along the way, had by now developed a reputation as a corporate outlaw—a company that placed profits over safety, stole from oil producers, and flouted government regulations.

  In many ways, the company was an extension of Charles, a reflection of his values, beliefs, and persona. His humble, taciturn style was its humble, taciturn style. His rigid free-market philosophy was its rigid free-market philosophy. If the company had taken an antagonistic view toward government regulation, it had flowed from him.

  “We should not cave in the moment a regulator sets foot on our doorstep,” he once thundered in a call to arms to the business community, penned in 1978 at the height of his libertarian fervor. “Do not cooperate voluntarily; instead, resist wherever and to whatever extent you legally can. And do so in the name of justice.”

  But during the recent legal onslaught, Charles had received a wake-up call. The world he lived in was not the libertarian paradise he wanted it to be. “It was a seminal moment in his life, because he finally began to understand the costs of what they now call public sector,” said one Koch veteran. “There’s a cost—a high cost—for not being a world-class company.