Monthly Archives: January 2005

Frank E. Vandiver, RIP

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Former Rice University and Texas A&M University history professor and president Frank E. Vandiver, who was one of A&M’s most prominent professors over the past quarter century, died Friday in College Station at the age of 79.
During Vandiver?s tenure as president from 1981 to 1988, Texas A&M exploded in growth, reaching the the $100 million mark in research volume and becoming one of the nation?s largest enrollment universities. A&M’s endowment also surpassed $1 billion during Mr. Vandiver’s tenure. Prior to moving to A&M, Mr. Vandiver was acting president of Rice University in Houston from 1968-70.
Mr. Vandiver wrote and edited more than 20 books, including Mighty Stonewall, Their Tattered Flags: The Epic of the Confederacy and Black Jack: The Life and Times of John J. Pershing, the latter of which was a finalist for the National Book Award.
Mr. Vandiver is legendary in Texas history circles for publishing his first professional article at the age of 15 and earning his master’s degree at the age of 19. Mr. Vandiver was the son of an academic, and his family lived next door to Albert Einstein for a time during Mr. Vandiver’s youth while his father was a visiting professor at Princeton. In addition to Rice and A&M, Mr. Vandiver also taught history at Washington University in St. Louis, the U.S. Military Academy at West Point, and Oxford University in England.
After stepping down as president of A&M in 1988, Mr. Vandiver continued to teach at the university as a distinguished professor and holder of the John H. and Sara Lindsey Chair in Liberal Arts. Mr. Vandiver also served as the director of the Mosher Institute for International Policy Studies, which is an A&M think tank.
Mr. Vandiver is survived by his wife, Renee, three children and six grandchildren, and was preceded in death by his first wife, Susie. Funeral services for Vandiver are pending with Hillier Funeral Home in Bryan.

Ken Lay promotes his website

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The Houston Chronicle’s main Enron reporter — Mary Flood — weighs in today with this piece on how former Enron chairman and CEO Kenneth Lay is using sponsored links to direct websurfers to his website. Sponsored links appear prominently in searches for a word or name in an Internet search engine. They serve the dual purpose of making websites more noticeable and being a revenue source for search engines.
What are the chances that any prospective juror at Mr. Lay’s criminal trial who admits to reading Mr. Lay’s website will make in on the jury? Slim and none, in my view.

Enron outside directors settlement

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On the heels of this post earlier this week about the impending outside directors’ settlement in the WorldCom case, this NY Times article reports on the impending $168 million settlement involving the class action securities fraud and related claims against eighteen former directors on Enron Corp.’s Board of Directors. Most of the settling directors were outside directors of Enron.
This settlement has actually been in the works for several months as the class action plaintiffs’ lawyers became concerned that the extraordinary defense costs of Enron’s former officers and directors would soon exhaust the insurance proceeds available to fund a settlement under Enron’s officers & directors’ liability insurance policies.
Consequently, in October, the plaintiffs reached a tentative settlement with the Enron board members that provided for payment of the remaining insurance proceeds ($200 million) under the O&D policies despite the fact that such a result would leave dozens of former Enron officers and directors not included in the settlement without insurance coverage for their defense costs. In addition, certain settling directors agreed to pay an additional total of $13 million out of their own pockets, which was essentially 10% of each such director’s net gain from their Enron stock sales during the class period. The D&O liability insurers agreed to contribute $155 million toward the settlement, which exhausted the insurance coverage for the non-settling directors and officers.
With that agreement in principle in hand, Enron’s outside directors in late October obtained an injunction against Enron’s O&D liability insurers from the U.S. District Court in Houston that enjoined the insurers from using any further policy proceeds to pay defense costs of former Enron officers and directors pending the District Court’s consideration of the proposed settlement. Since that time, the plaintiffs, the outside directors, and non-settling former Enron officers and directors such as Kenneth Lay and Jeffrey Skilling have cut a deal in which $13 million of the insurance proceeds will be set aside for their future defense costs in return for the non-settling officers and directors’ consent to the outside directors’ settlement. The class action plaintiffs will get $155 million of the remaining insurance proceeds under the settlement and $32 million of the proceeds has been earmarked in the settlement for the Enron bankruptcy estate. The settlement does not include many former Enron officers, including all former Enron officers who have either pleaded guilty to criminal charges or who are currently facing criminal charges.
The outside directors settlement is the fourth major settlement in the class action lawsuit that was commenced against Enron’s former officers, directors, and financial institutions nearly three years ago on the heels of Enron’s hyper-publicized accounting scandal. Including the latest settlement, the class action has generated just under $500 million, which is really rather paltry compared to the over $30 billion in damages that the plaintiffs have alleged in the class action.
Indeed, contrary to the generally laudatory press accounts relating to this and other settlements in cases such as Enron and WorldCom, the handling of the Enron class action by the plaintiffs’ lead lawyers — Lerach Coughlin Stoia Geller Rudman & Robbins LLP — has been subject to sharp criticism among professionals close to the case. The genesis of that criticism was the plaintiffs’ lawyers alleged involvement in allowing a proposed $750 million settlement with Arthur Andersen slip away in early 2002 during the early stages while Anderson was still a going concern operation. In addition to the substantial settlement payment, that proposed settlement would have involved a resolution of the criminal charges against Andersen in a manner that would have allowed Andersen to continue in business as a major accounting firm, saving thousands of jobs in the process. When the proposed deal allegedly blew up in a dispute between the plaintiffs’ lawyers and the financial institution defendants, Andersen’s criminal trial went forward, resulting in the felony conviction of Andersen that prompted Andersen’s demise as an accounting firm. Andersen remains a defendant in the Enron class action, but it is a virtual shell that no longer has the resources necessary to pay $750 million in either damages or a settlement in the Enron class action. Consequently, the plaintiff’s lawyers appear to have left a considerable amount on the table, and have not made up for it yet.
Nevertheless, the plaintiffs in the class action are still seeking billions in damages from a large group of financial institutions for allegedly assisting Enron in defrauding shareholders and creditors. The financial institutions include J.P. Morgan Chase & Co., Citigroup Inc., Merrill Lynch & Co., and Credit Suisse First Boston, to name just a few.
The Enron directors paying the total of $13 million out of their pockets are Robert Belfer, Norman Blake, Ronnie Chan, John Duncan, Joe Foy, Wendy Gramm, Robert Jaedicke, Charles LeMaistre, Rebecca Mark-Jubasche and Ken Harrison. The other directors covered by the settlement who are not required to pony up any money out their own pockets are Paulo Ferraz-Pererira, John Mendelsohn, Jerome Meyer, Frank Savage, John Urquhart, John Wakeham, Charles Walker and Herbert Winokur. As is typical in such deals, none of the directors are admitting any wrongdoing as part of the settlement, which still requires final court approval.

SCOTUS grants cert in Arthur Andersen appeal

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The U.S. Supreme Court granted certiorari on Friday on Arthur Andersen’s appeal of its conviction of felony criminal charges in connection with allegedly destroying and altering Enron Corp.-related documents.
The Supreme Court will review this Fifth Circuit Court of Appeals ruling that upheld the former Big Five accounting firm’s June 2002 conviction by a jury in a Houston federal court. The key issue in the case will be whether the jury instructions that U.S. District Judge Melinda Harmon approved during the trial were too vague and broad for jurors to determine whether Andersen’s actions constituted obstruction of justice. The specific issue to be addressed is this: “Must Arthur Andersen’s conviction for witness tampering under 18 U.S.C. 1512(b) be reversed because the jury instructions misinterpreted the ‘corrupt persuasion’ and ‘official proceeding’ elements of the offense?”
The Justice Departent charged Andersen with obstruction of justice for its mass destruction of Enron-related documents in late 2001 as the Securities and Exchange Commission and Congressional Committees began investigating Enron’s complicated financial structure. As we all know, Enron catapulted into bankruptcy in early December 2001 amid revelations of accounting schemes to mask debt and inflate profits.
As Enron’s auditor, Andersen contended that it was only implementing its document-retention policy that called for destroying unneeded documentation to streamline files. Andersen argued during trial that employees who shredded thousands of documents simply followed the policy and had no intent to undermine any investigation of Enron.
Although an Andersen victory at the Supreme Court would be a Pyrrhic victory for the now defunct firm, this is a positive development for the Enron case in general. The Justice Department’s heavy-handed prosecution of Andersen reflected an egregious lack of prosecutorial discretion — the prosecution of Andersen ultimately caused the loss of thousands of jobs, most of which never had anything to do with Enron. Moreover, as noted here awhile back, the accounting industry has still not recovered from the Andersen fallout, and big business is finding it difficult to find enough auditors to fulfill the new Enron-era regulatory obligations.
Thus, a Supreme Court reversal will not help Andersen much, but it just might send the right message to a Justice Department that increasingly appears oblivious to the negative economic impact that results from criminalizing merely questionable business practices.

Attempting to cure the PBGC blues

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This earlier post noted the growing concern in the business community that the Pension Benefit Guaranty Corporation — the quasi-governmental insurer of private company pensions — is facing a string of large company bankruptcies and pension defaults that could lead to another multibillion-dollar taxpayer bailout similar to the Savings and Loan bailout of the late 1980’s.
Now it appears that the growing private pension problem is being noticed at the highest levels of government. This article from today’s NY Times reports that officials in the Bush administration are close to unveiling a rescue plan for the PBGC.
The PBGC is a government-owned insurance company that Congress created in 1974 after a string of corporate bankruptcies left retirees without pensions. The PBGC’s mission is to provide a limited guarantee of private defined-pension plans, which are pensions that provide retired workers with a set amount each month based on wages and years worked. If a pension plan terminates without adequate resources to meet its obligations to its retired workers, then the PBGC guarantees up to $45,614 annually for employees who retire at age 65.
To finance its activities, the PBGC collects annual premiums from employers with defined-benefit plans that are required to participate in the program. Last year, the premiums totaled about a billion dollars. The PGBC also receives funds from terminated pension plans that it is forced to take over.
With five U.S. airlines already wallowing in bankruptcy court, the PGBC is under an incredible load of financial pressure. Yesterday, the US Airways Group, Inc. bankruptcy court approved the turnover of three employee pension plans to the PBGC at a cost of a cool $2.3 billion. Likewise, last week, the PBGC took over the UAL Corp. (the parent of United Airlines) pilots’ pension plan in UAL’s pending chapter 11 case. The takeover is likely to cost the PBGC at least another $1.25 billion. With these kinds of growing liabilities, a taxpayer-funded bailout of the agency is inevitable unless an overhaul of the pension-insurance system is approved quickly.
The Bush administration will probably propose to prop up the pension guaranty fund with increased premiums for all participating companies, including higher fees for businesses that are on the brink of bankruptcy. However, that latter proposal shows how misguided this type of “reform” can be. Charging higher premiums to companies that are already at heightened risk of bankruptcy will actually make it harder for the companies to avoid bankruptcy. Thus, that proposal could well place PGBC fund at higher risk rather than making it more secure.
Moreover, passing any reform through Congress will not be a cakewalk. Business groups and labor unions — recognizing that a federal bailout is likely under the currently broken system — are already raising concerns about how far the changes should go. Employee groups and unions contend that imposing higher premiums or stiffer rules could prompt some companies to freeze or eliminate the lucrative but uneconomic current pension plans. Labor unions simply prefer an immediate government bailout, as they see the writing on the wall. Last year, the PGBC had a deficit of $23.3 billion, which was double the prior year’s decifit. So, we are clearly dealing with an agency here that is is bleeding badly.
And the projections are not rosy, either. The Center on Federal Financial Institutions (a Washington think tank) estimates that the PBGC will run out of cash and rack up a $78 billion deficit within the next 16 years.
As with Social Security, there will be political voices who contend that the PGBC’s current problems are not all that bad and that the reforms are just part of the Bush Administration’s pro-business and anti-labor bias. However, you can take this to the bank — the first loss on a problem such as this is the least expensive one. If we put off dealing with the problem, the cost of the bailout will increase substantially.

Hammering the Hammer

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Earlier this week, House Republicans reversed course and rejected dubious Ethics rules changes that were proposed late last year that would have allowed members indicted by state grand juries to remain in a leadership post. Earlier posts on the rules changes are here and here.
The rule changes were transparently proposed to benefit Houston congressman and House Majority “Leader” Tom DeLay in the event a Travis County grand jury indicts him in connection with an investigation of campaign financing that has already resulted in the indictment of three of his political political associates.
In today’s Washington Post, David Ignatius provides this interesting profile of the Colorado representative — Joel Hefley — who decided to take on Mr. DeLay over the change in the ethics rule and, in so doing, pulled out an unlikely victory for Congressional ethics. Read the entire informative piece, which concludes with an astute observation about Mr. Hefley and Congress:

He will pay the price, but he doesn’t seem to mind. He knows he did the right thing. May his number increase.

John O’Neill’s firm merges with Howrey Simon

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Washington, D.C. based Howrey Simon Arnold & White LLP announced yesterday that seven partners from the Houston-based litigation boutique of Clements, O’Neill, Pierce, Wilson & Fulkerson LLP — including Swift Boat veteran John O’Neill — have joined Howrey Simon’s Houston office.
The move was Howrey Simon’s second major move in Houston over the past several years. In 2000, Howrey Simon merged with Houston-based Arnold White & Durkee, which was Houston’s most prominent IP firm at the time. Howrey Simon Arnold & White is now a big international firm with about 550 attorneys in its 10 offices in the U.S. and Europe.
In addition to Mr. O’Neill, the other partners from Clements, O’Neill that will join Howrey are managing partner Jack O’Neill (no relation to John), Jesse R. Pierce, Sashe D. Dimitroff, Kelly J. Kirkland, Reagan D. Pratt and Mark A. White. Eight associates and 10 other attorneys will also make the move to Howrey Simon.

Thoughts on USC’s National Championship

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Don’t miss USC Professor Peter Gordon’s thoughts on the effects of his university’s national championship football team.

WorldCom outside directors settlement

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10 of the 12 former outside directors of WorldCom Inc. have agreed in principle to pay $18 million out of their own pockets as a part of a $54 million settlement of the class-action lawsuit that WorldCom bondholders and shareholders brought against them in connection with the telecommunications company’s massive accounting scandal and resulting chapter 11 bankruptcy case. Paul Curnin of Simpson Thacher & Bartlett LLP in New York represents the ten former directors.
The directors’ liability insurers will pay the remaining $36 million of the tentative settlement. The $18 million that the former directors will pony up under the settlement represents about 20% of their combined personal net worth, excluding exempt property such as primary residences and retirement accounts.
WorldCom emerged from Chapter 11 bankruptcy protection last year and has changed its name to MCI. The reorganized company has an entirely different board of directors.
The tentative settlement is being watched closely be the business and legal community because it is precedent for expansion of the potential liability of outside directors whose companies commit accounting fraud. By way of comparison, the outside directors of Enron are currently attempting to settle similar litigation by using the remainder of approximately $200 million of the Enron officers and directors’ liability insurance while paying only 10% of their net Enron stock sales during the class period out of their own pockets.
As a general proposition, outside corporate directors have been among the most difficult defendants to tag in securities and accounting fraud litigation because of their lack of involvement in a company’s management and accounting processes. Although outside directors can face liability in such cases for oversight failures if their dereliction of duty is proven to both severe and demonstrable, the cases that have successfully proven such conduct are extremely rare. As a result, most cases against outside directors are settled by the directors’ liability insurer without the outside directors paying any portion of the settlement amount themselves.
The planned settlement comes about several months after Citigroup Inc.’s $2.65 billion settlement in the same lawsuit. Citibank — one of WorldCom’s leading bond underwriters — was one of 18 underwriters in the case, which also includes J.P. Morgan Chase & Co., Deutsche Bank AG and Bank of America Corp.
Update: Professor Ribstein provides his typically insightful analysis of the settlement here, and offers the following astute observation:

Well, the audit committee was independent, and at least one member did have the requisite expertise, but according to the complaint that didn?t prevent them from completely falling down on the job. Moreover, the complaint details disturbing governance failings at all levels ? executives, underwriters, accountants.
I believe an important lesson from all this is that our current model of corporate governance just isn?t working, and that we delude ourselves if we think that Sarbanes-Oxley is going to fix it.

So what?s the answer? First, we need high-powered market-based incentives that would be provided by the return of an active market for corporate control. Second, as I?ve been saying (e.g., here) we need to encourage alternative business structures that take near-absolute power over corporate earnings away from corporate executives and give it to the firm?s owners.
In other words, cases like WorldCom tell us that the answer to the corporate governance problems lies in getting rid of the corporation as the exclusive structure for business enterprise.

Markets finally working in the airline industry

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Dallas-based Southwest Airlines Co. announced Wednesday that start service to Pittsburgh International Airport in May.
Southwest’s move comes on the heels of US Airways Group‘s disastrous performance over the holiday season and the troubled airline’s service cuts at the airport. US Airways has gradually cut about half of its flights from Pittsburgh since the September 11, 2001 attacks on New York and Washington.
This is Southwest’s second move to compete directly with US Airways in Pennsylvania over the past year. In early 2004, Southwest entered the Philadelphia market that US Airways used to dominate, a move that has already increased traffic and lowered fares there. Southwest’s venture into Pittsburgh continues its countercyclical growth, which is reflected by its 10% capacity increase over the past year while most of the other airlines have been reeling.
By continuing to execute its tried and true low-cost business plan, Southwest has been able to remain profitable during the airline industry’s troubled period since the Sept. 11, 2001 attacks, and its strong liquidity position is unparalleled in the airline industry.