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.

The Putin Puzzle

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The Wall Street Journal’s ($) Holman Jenkins, Jr. finally weighs in on the Russian government’s heavy-handed takeover of OAO Yukos, and he correctly notes that the Yukos case signifies the end of any hope that Russian president Vladimir Putin will lead the country toward a European-style social democracy with an economy based on at least reasonably free markets:

Foreign investors puzzle over Mr. Putin and his seeming ineptitude at making Russia into Thailand writ large, a gracious and dutiful partner for trade and finance. But perhaps Mr. Putin never really had “reform” in mind. Western imaginations didn’t quite grasp that Saddam Hussein fancied himself a conqueror, an empire builder, a man of destiny (and was content to limit his country’s economic potential to the oil under his direct control). Western leaders and investors may be suffering from a similar myopia when it comes to Mr. Putin.

Mr. Jenkins goes on to point out that, despite Mr. Putin’s tactics, Western investors continue to line up to invest in various Russian business ventures. That’s true, but my sense is that it is a relative trickle in comparison to what the West would be willing to invest in Russia but for the Russian government’s takeover tactics. Until that changes, Russian economic development will continue to lag far behind the West.
Along similar lines, Boston Globe columnist Cathy Young — author of Growing Up in Moscow: Memories of a Soviet Girlhood (Ticknor & Field, 1989)– provides this Reason Online article on Mr. Putin and the implications of his grip on the Russian government for the West.

The WSJ on the case against Ken Lay

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This John R. Emshwiller and Rebecca Smith Wall Street Journal ($) article provides an overview of the Justice Department’s criminal case against former Enron chairman and CEO, Ken Lay.
Mr. Emshwiller and Ms. Smith have been covering the Enron scandal from the beginning and have written a book on the subject — 24 Days: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America (HarperBusiness 2003) — that certainly would prompt one to question their objectivity in writing about the issues covered in the article. As noted several times in this blog, the best book on the Enron affair to date has been the one written by Fortune reporters Bethany McLean and Peter Elkind, Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (Portfolio 2003). So, if you want to read just one book on the Enron scandal, read the latter.
Nevertheless, Mr. Emshwiller and Ms. Smith at least acknowledge in the article that the government’s case against Mr. Lay is difficult because it largely relies on public statements that he made in support of Enron as the company was spiraling downward during the latter stages of 2001. What you will not find in the article is any meaningful analysis of the policy implications of the government prosecuting a businessman for the “crime” of making public statements about a troubled company that were clearly intended to try and save the company for the benefit of its shareholders and employees. Apparently, the government prefers that Mr. Lay not have said anything and ensured that Enron went down in flames?
This previous blog post provides a more objective analysis of the policy implications of the government’s case against Mr. Lay. The demise of Enron effectively marked the end of a speculative stock market bubble that was the result of many bad decisions by businesspersons and investors alike. There was even criminal behavior involved in some instances. However, to paint the entire management team involved in a business failure such as Enron as criminals is akin to using a sledgehammer where surgical precision is needed. The results of such an approach are hopelessly arbitrary and capricious, as we have already seen with cases such as those involving Jamie Olis , Sheila Kahanek, and Global Crossing, Ltd. Indeed, such questionable prosecutions are how someone such as Mr. Olis ends up serving a longer prison sentence than a true business criminal such as Martin Frankel.
Mr. Emshwiller and Ms. Smith do not have much interest in exploring this angle of the Enron case. That’s a shame, because it may just be the most important policy issue arising from the scandal.

USC, National Champs

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USC 55 Oklahoma 19

In another bowl game that was not as close as the final score indicates, the USC Trojans absolutely laid the wood to the Oklahoma Sooners in the BCS National Championship Orange Bowl game on Tuesday night.
In this previous post on November 7, I noted that OU’s defensive secondary was probably not good enough to beat USC, and that certainly turned out to be the case as USC QB Matt Leinart (18-35 for 332 yds; 5 TD’s; 0 Int) sliced and diced the OU secondary as if he was preparing a salad.
Meanwhile, OU’s offense could never find a rhythm against the speedy USC defense. OU QB Jason White (24-36 for 224 yds; 2 TD’s; 3 Int) finished a marvelous college career by throwing three interceptions and looking generally overwhelmed the entire game.
White’s first interception — the result of a brain fart decision of throwing into triple coverage while under pressure — was arguably the turning point in the game. It came at the end of the first quarter as OU appeared poised to tie the game at 14, and USC promptly took the ball and drove for a quick TD and a 21-7 lead. After an OU receiver slipped and White threw another interception on the next possession, the Trojans quickly scored another TD and the game was effectively over.
USC is now 34-3 over the past three seasons with one and a half National Championships and two Heisman Trophy winners. They are now indisputably the best program in college football at this time.