– PART I –


Sightings from The Catbird Seat

~ o ~

August 8, 2006

Public Pension Plans Face
Billions in Shortages

By Mary Williams Walsh, New York Times

In 2003, a whistle-blower forced San Diego to reveal that it had been shortchanging its city workers’ pension fund for years, setting off a wave of lawsuits, investigations and eventually criminal indictments.

The mayor ended up resigning under a cloud. With the city’s books a shambles, San Diego remains barred from raising money by selling bonds. Cut off from a vital source of cash, it has fallen behind on its maintenance of streets, storm drains and public buildings. Potholes are proliferating and beaches are closed because of sewage spills.

Retirees are still being paid, but a portion of their benefits is in doubt because of continuing legal challenges. And the city, which is scheduled to receive a report today on the causes of its current predicament, still has to figure out how to close the $1.4 billion shortfall in its pension fund.

Maybe someone should be paying closer attention in New Jersey. And in Illinois. Not to mention Colorado and several other states and local governments.

Across the nation, a number of states, counties and municipalities have engaged in many of the same maneuvers with their pension funds that San Diego did, but without the crippling scandal — at least not yet.

It is hard to know the extent of the problems, because there is no central regulator to gather data on public plans. Nor is the accounting for government pension plans uniform, so comparing one with another can be unreliable.

But by one estimate, state and local governments owe their current and future retirees roughly $375 billion more than they have committed to their pension funds.

And that may well understate the gap: Barclays Global Investments has calculated that if America’s state pension plans were required to use the same methods as corporations, the total value of the benefits they have promised would grow 22 percent, to $2.5 trillion. Only $1.7 trillion has been set aside to pay those benefits.

Not all of that shortfall, of course, is a result of actions like those that brought San Diego to its knees. And few governments have been as reckless as San Diego officials in granting pension increases at the same time as they were cutting back on contributions.

Still, officials in Trenton have been shortchanging New Jersey’s pension fund for years, much as San Diego did. From 1998 to 2005, the state overrode its actuary’s instructions to put a total of $652 million into the fund for state employees. Instead, it provided a little less than $1 million. Funds for judges, teachers, police officers and other workers got less, too.

To make up the missing money, New Jersey officials tried an approach similar to one used in San Diego. They said they would capture the “excess” gains they expected the pension funds’ investments to make and use them as contributions.

It was a doomed approach, leaving New Jersey to struggle with a total pension shortfall that has ballooned to $18 billion. Its actuary has recommended a contribution of $1.8 billion for the coming year, but the state has found only $1.1 billion, so it will fall even farther behind.

Illinois also duplicated one of San Diego’s pension mistakes. It tried to make its municipal pension plan cheaper by stretching its funding schedule over 40 years — considerably longer than the 30 years that governmental accounting and actuarial standards permit, and more than five times what companies will get under a pension bill that has just passed Congress.

Illinois is stretching its pension contributions over 50 years. At that rate, many of its retirees will have died by the time the state finishes tapping taxpayers for their benefits.

Colorado does not meet the 30-year funding guidelines, either. “At the current contribution level, the liability associated with current benefits will never be fully paid,” the state said in its most recent annual financial report.

Many officials dispute the suggestion that their pension plans are less than sound. The director of the New Jersey Division of Pensions and Benefits, Frederick J. Beaver, wrote recently that “our benefits systems are in excellent financial condition.”…

Still, the lack of a national response to what would seem to be a nationwide problem underscores a peculiarity of the public pension world: like banks and insurance companies, the pension plans are large and complex financial institutions, but they face no comparable systems of checks and balances.

“There’s no oversight; there’s no requirements; there’s no enforcement,” said Lance Weiss, an actuary with Deloitte Consulting in Chicago who advised Illinois on its pension problems. “You’re kind of working off the good will of these public entities.”

Experts do not think that is good enough.

In January, the board that writes the accounting rules for governments announced that it was looking for ways to tighten the rules for public pensions.

In July, Senators Charles E. Grassley and Max Baucus, the Republican chairman and the ranking Democrat on the Finance Committee, asked the Government Accountability Office to investigate the financial condition of the nation’s public pension plans.

In some states, lawmakers have been trying to stop some of the more egregious pension practices that have come to light. Illinois, Louisiana and Nebraska passed laws making it hard for employees to “spike” pensions higher by manipulating their salaries. Because pensions are often based on a worker’s final salary, workers have found ways to credit one-time bonuses to their last year and reap a lifelong reward. Arizona required that early retirement programs be paid for up front.

And today in San Diego, a former chairman of the Securities and Exchange Commission, Arthur Levitt Jr., is scheduled to issue a long-awaited report on the years of pension lapses that got the city into its current predicament.

Mr. Levitt is not tipping his hand on his findings. But given the activist stance he took on cleaning up the municipal securities markets as S.E.C. chairman, it would be no surprise if he called for tighter control over a sector where the amounts of money are huge and the amount of oversight is small.

The city of San Diego hired Mr. Levitt’s three-man audit team in February 2005, after the city’s outside auditor, KPMG, would not sign off on its accounts.

He is working with the S.E.C.’s former chief accountant, Lynn E. Turner, and Troy Dahlberg, a managing director in the forensic accounting and litigation consulting practice of Kroll Inc., the investigative firm that is a unit of Marsh & McLennan Companies.

Public plans are not governed by the federal pension law, the Employee Retirement Income Security Act, that companies must follow. They are not covered by the Pension Benefit Guaranty Corporation, so if they come up short, they must turn to the taxpayers.

Instead, they are governed by boards that often include municipal labor leaders, whose duty to represent their workers’ interests can easily conflict with their fiduciary duty to represent the plan itself. And even the most exemplary pension boards can be overruled, in many cases, by politicians whose priorities may be incompatible with sound financial management.

“When the state runs into financial trouble, pension contributions are something that they can defer without, quote-unquote, hurting anybody,” said David Driscoll, an actuary with Buck Consultants who recently helped Vermont come up with a plan to revive its pension fund for teachers. Politicians shortchanged it every year for more than a decade.

“In fact, they are hurting people, and the people they are hurting are the taxpayers, who, whether they realize it or not, are going into a form of debt,” Mr. Driscoll added. “Those pension obligations don’t get cheaper over time. They get more expensive.’’

Eventually the cost gets too big to ignore, as it now has in New Jersey.

Corporate pension funds have plenty of problems of their own. But they are at least required to adhere to a uniform accounting standard, which provides information that investors can use to decide upon stocks to buy and sell. The standards, in turn, are policed by the S.E.C.

Taxpayers have no such help. For municipal plans, the accounting standards are much more flexible, a decision that was denounced, when it was issued in 1994, by the head of the very board that wrote it.

James F. Antonio, chairman at that time of the Governmental Accounting Standards Board, attached a detailed 10-page dissent to the new rule, saying that it “fails to meet the test of fiscal responsibility” because it permitted “an extraordinary number of accounting options” and some governments were bound to choose the weakest one. Mr. Antonio has since retired.

Even though the governmental accounting board has now begun the slow process of improving the standard, it is unlikely to come up with the level of detailed disclosure required of corporations. And the board, with a full-time staff of just 15, has no authority to enforce its rules.

San Diego violated the rules for a number of years, using accounting techniques that hid both its failure to put enough money behind its pension promises and the debt to its workers that was growing every year as a result.

Several times, the city asked the government accounting board to make a special exception and approve its unorthodox pension calculations, but the board rebuffed it.

But the accounting board was forced to look on in silence as San Diego issued reassuring financial statements, because its charter bars it from issuing public pronouncements on individual cities.

San Diego might have gone on unchallenged indefinitely if not for the decision of one of its pension trustees, Diann Shipione, to blow the whistle, eventually forcing the city to correct the financial disclosures it had made in connection with an impending bond sale. Only then was it possible to see in one place what had been going on with the pension fund. And only then did the S.E.C. get involved.

The Depression-era laws that created the commission gave it no direct jurisdiction over municipal securities; it can pursue municipal wrongdoing only when it finds fraud at work. Lack of complete and accurate disclosure can constitute fraud, but the S.E.C. has only infrequently shown interest in throwing its weight around in the area.

One of those rare instances happened when Mr. Levitt was chairman of the S.E.C., in 1994, after Orange County, Calif., abruptly declared bankruptcy and threatened to repudiate its debts. Mr. Levitt became, as he said at the time, “obsessed” with cleaning up the municipal securities markets.

He created an independent Office of Municipal Securities that reported directly to the chairman; he championed rules to eliminate the pay-to-play practices then commonplace in the municipal bond business; he forced better financial disclosure; and he began an unheard-of number of enforcement actions.

Since Mr. Levitt’s departure from the S.E.C. in 2001, much of what he built has been dismantled. The Office of Municipal Securities is down to a staff of two and is no longer independent. The wave of enforcement actions against cities has slowed to a trickle. The S.E.C. investigators who went to work in San Diego after the pension scandal erupted have never said what they found.

When the S.E.C. shifted its gaze away from municipal finance, Mr. Levitt now says, it left “a regulatory hole.” If the agency were equipped to monitor state and local governments the way it monitors corporate disclosures, he said, “it could provide an early warning of financial conditions threatening the solvency of any number of communities.”


February 23, 2006

Aloha’s pension dealings probed

By Rick Daysog, Advertiser Staff Writer

The U.S. Department of Labor is investigating whether Aloha Airlines used employee pension funds to pay its bank loans.

Under federal law, an employer is barred from using workers’ pension money to pay for the company’s business expenses, including bank loans. Pension money must be used to pay for employee benefits designated by the retirement plans….

Continued at Aloha Airlines


January 5, 2006

IBM to Curtail Pension Plan

The Street

IBM announced plans Thursday to reduce its pension burden by curtailing its defined-benefit pension plans and shifting its retirement focus entirely to an augmented 401(k) program.

The moves, effective in 2008, are expected to save the IT giant $2.5 billion to $3 billion over the next four years.

IBM plans to stop the accrual of benefits in its pension plans in 2008, and will redesign its 401(k) plan to give pension participants a company contribution of up to 10% of pay. Big Blue will double its current 401(k) dollar-for-dollar match to up to 6% of salary contributions, with additional automatic contributions of 1% to 4%. Employees who don’t contribute directly to their plan also will receive an automatic 1% to 4% company contribution.

“We’re taking these actions to better control retirement plan expenses, position the company for business growth and competitive strength, and preserve employees’ earned retirement benefits, while instituting a leading-edge 401(k) plan that will be one of the richest in the country and a standard in the United States,” said Randy MacDonald, IBM’s senior vice president, human resources. “We also believe these are prudent and balanced steps at a time of uncertainty and conflicting legislative and regulatory directions about defined benefit retirement plans in the United States.”

The changes don’t affect IBM’s roughly 125,000 retirees, former employees with vested benefits or employees who retire before Jan. 1, 2008. Retirement benefits earned before that date will be fully preserved. (Or until IBM files for bankruptcy, that is! – CB.)

IBM plans to record a pretax charge of $270 million for its recently ended fourth quarter as a result of the new plan. The company expects retirement-related savings of $450 million to $500 million for 2006, but noted that it still expects its retirement plan costs this year to rise $400 million to $500 million over 2005 levels.

According to IBM, its 401(k) plan is the largest in the country, with $26 billion in assets. More than 90% of its U.S. employees participate in the plan. The company’s pension plan had about $48 billion in assets at the end of 2005.


December 6, 2005

DOE sues California firm over
lapse in pension fund

By Dan Martin, Honolulu Star-Bulletin

The Hawaii Department of Education is suing a California financial services company over the disappearance of nearly $2.3 million of contributions by department employees into their retirement funds.

The lawsuit, filed in California against Plan Compliance Group, accuses the company of fraud, negligence and breach of contract.

It alleges that Walnut Creek, Calif.-based PCG, and in particularly company President Francis W. Reimers, “took approximately $2,280,194.60 and converted the same to their own use.”

PCG had been handling the transferal of employee contributions into tax-deferred annuity funds for the department since 2002 until October. The funds are just one type of investment option available to department employees, and not all employees are affected….

The University of Hawaii, PCG’s other Hawaii client, has reported similar problems. Officials there have estimated that $420,000 of university employee funds remain unaccounted for.

It was unclear whether the university was considering similar legal action.

The office of state Attorney General Mark Bennett, which has been investigating PCG’s conduct since the allegations came to light, refused comment on the matter. UH officials did not return calls….

“We are deeply concerned at this apparent breach of trust and will work with the attorney general to do everything possible to recover the missing money,” schools Superintendent Pat Hamamoto said in a press release. She declined further comment.

Both university and education department officials say they have stepped in to make the payments missed by PCG and that employees will suffer no losses.

When it first bid for the Education Department contract in 2001, PCG touted itself as a nationally recognized leader in tax-sheltered annuity administration, the lawsuit said.

Yet department officials no believe that PCG was merely a “shell, instrument and conduit through which Reimers conducted business,” often mingling PCG funds with his own personal assets, the lawsuit stated.

See also: Hawaii Employees Retirement System


June 9, 2005

Committee on Health, Education, Labor & Pensions

“Protecting America’s Pension Plans from Fraud:

Will Your Savings Retire Before You Do?”

Opening Statement of Chairman Mike Enzi, R-Wyo

Good morning. I would like to thank all of you, especially my fellow members, for attending today’s investigative hearing. I would also like to thank the Committee’s Ranking Member, Senator Kennedy, for his support throughout this investigation. Finally, and most importantly, I would like to thank the witnesses for being here today. Your testimony will assist the Committee greatly in determining how best to address the vital issues raised in this hearing.

Today, we will examine the largest pension fraud in U.S. history, involving the investment firm of Capital Consultants, LLC. We will examine this case with several considerations in mind:

· Whether the Department of Labor, and other relevant agencies, are prepared to prevent future pension frauds and to ensure workers receive their promised benefits;

· Whether employers and workers receive sufficient education to recognize the signs of pension fraud;

· Whether the successful recovery of more than 70% of the funds lost to fraud in this case can serve as a model for the federal government and the states in addressing future pension frauds; and

· Whether there are legislative solutions that will aid in addressing pension fraud.

Through a complex Ponzi-like fraud scheme, Capital Consultants defrauded approximately 300,000 pension plan participants and their families out of more than $500 million. Today, the witnesses will describe how the loss of these funds impacted lives, how the fraud was perpetrated, and how the federal government is prepared to prevent future pension frauds.

Let me say upfront that this hearing is not an indictment of the Department of Labor, or any other agency responsible for policing pension plans. In fact, the Department of Labor can be very proud of its participation in uncovering this scheme. Moreover, the complexity of the scheme highlights the difficulty in uncovering pension fraud schemes.

Yet, the size of the fraud highlights the importance of examining the lessons learned from the Capital Consultants case. It is essential that the Committee determine the extent to which the Department of Labor is prepared to prevent future pension frauds….


May 15, 2005

SEC Targets Pensions

By Neil Weinberg, Forbes

Now the U.S. Securities and Exchange Commission is taking on the pension business.

The expected action involves companies that advise public and private pension funds how to allocate trillions of dollars in investments and which money managers they recommend. This has led to accusations that “pay-to-play” is rampant among consultants. Critics charge they favor money managers who buy services from them.

The consultants have denied such bias.

The SEC may have felt compelled to act in part because many pension fund managers appear oblivious to the conflicts inherent in the advice they are receiving. Forbes last year cited an official in charge of investments for the Santa Clara Valley Transit Authority who had no idea his consultant, Mercer Investment Consulting, a unit of Marsh & McLennan (nyse: MMC), was also receiving payments from many of the managers it recommended….

Although the SEC is not expected to announce specific enforcement proceedings against pension consultants on Monday, it is likely that such action will become public in coming months, a person familiar with the situation said.

The SEC’s report is expected to recommend that pension funds use a checklist of questions when evaluating consultants to ensure that the funds understand how their advisers are compensated and the potential conflicts of interest inherent in their businesses, these people said.

“It’s great that the SEC is finally alerting pensions to the dangers involved in hiring these consultants,” said Edward Siedle, president of Benchmark Financial Services, an Ocean Ridge, Fla., firm that investigates wrongdoing among money managers.

“This goes to the heart of a system involving corrupt gatekeepers that is costing many pension funds millions or billions of dollars.”

Among the firms the SEC reportedly requested to submit information in 2003 are Mercer, Callan Associates, Segal Investment Solutions, Watson Wyatt and Wilshire Associates….


April 12, 2005

Groups to Consider Suing AIG for $400M


Leaders of the nation’s largest public retirement systems said Tuesday they will ask their boards to approve suing troubled insurance giant American International Group, Inc. to recover $400 million in losses suffered since the company’s problems surfaced in February.

Treasurer Phil Angelides, a board member of the $182.9 billion California Public Employees Retirement System and $125 billion California State Teachers Retirement System, said “allegations of scandal and misconduct” at AIG have caused “grievous damage” to holdings of more than 2 million California retirees and employees.

“The losses are beyond the realm of excessive,” said CalPERS President Rob Feckner, who said he will ask the full CalPERS board on April 20 to begin legal action against AIG, its executives and auditors. CalSTRS will consider the request in its May 4-5 meeting….

California’s funds hold more than $1 billion worth of AIG stock – 20.9 million shares.

California’s losses on AIG stock – $240 million at CalPERS and $160 million at CalSTRS – come three years after the two funds lost $1 billion from the 2001 collapse of energy giant Enron Corp. and telecommunications giant WorldCom Inc. in 2002.

Four hundred million in losses means a direct hit to the taxpayers of California,” said Angelides, a Democrat and announced candidate for governor next year.

“That’s money that’s not in our pension fund to meet retirement obligations of teachers, police officers and firefighters.”…

For more, GO TO > > > AIG: The Un-American Insurance Group; Social Security: The World’s Biggest Nest Egg


October 27, 2004

Questions on conflicts of interest

State pension official wants details
of execs’ investments

By Alistair Barr, CBS MarketWatch

A North Carolina state pension official has asked executives of his fund’s major holdings if they have the same apparent conflicts of interest found at Marsh & McLennan, the embattled insurance broker.

Marsh & McLennan officials have been found to invest in businesses that provide services to their company, according to a letter distributed Wednesday by North Carolina Treasurer Richard Moore.

The North Carolina state retirement system, with $60 billion in total holdings, owns $16 million of Marsh & McLennan shares.

Moore said that allowing executives to hold economic interests in customers or service providers is “fraught with potential and real conflicts of interests and can result in transactions that misappropriate value rightly belonging to shareholders.”

Among the companies Moore contacted are Citigroup (C), Prudential Financial (PRU) and Wells Fargo (WFC).

Marsh & McLennan (MMC) was sued by New York Attorney General Eliot Spitzer on Oct. 14 for allegedly rigging bids and accepting payments for steering business to favored insurers.

Moore’s objections referred to MMC Capital, the private-equity arm of Marsh & McLennan that has raised more than $3 billion to invest in the insurance industry.

Jeffrey Greenberg, the deposed chief executive of Marsh & McLennan, and other top company executives and board members have invested in MMC Capital, the New York Times reported this week.

In recent years, MMC Capital has invested in at least 12 insurers, including Ace Ltd. (ACE), a company run by Evan Greenberg, Jeffrey’s brother; XL Capital Ltd. (XL); and Axis Capital (AXS), the New York Times reported. Those companies could do business with Marsh & McLennan, which would raise the appearance of a conflict of interest.

Charles Davis, chief executive of MMC Capital, is also a director on Marsh & McLennan’s board and sits on the board of Axis.

Jeffrey Greenberg used to be chief executive of MMC Capital from 1996 to 2002, the newspaper added.

Moore is not alone in his concern. The largest U.S. pension fund, the California Public Employees’ Retirement System, has voted against such directors as Warren Buffett for having business holdings on both sides of a transaction.

Marsh & McLennan shares closed 18 cents lower at $28.69 Wednesday.

See also: California Public Employees’ Retirement System; Kamehameha Schools Retirement Plan; Marsh & McLennan

For more, GO TO > > > Social Security: The World’s Largest Nest Egg


January 26, 2004

Retirement Plans: 96% of Employers Seeking Cuts

Pacific Business News

Most large employers are looking at ways to trim retirement plans, as more people retire and more money has to be poured into existing plans, reports Mercer Human Resource Consulting.

In a survey of 242 employers, Mercer found that fully 96 percent were making or considering making changes in their retirement plans to reduce costs.

“These changes include increasing or restructuring matching 401(k) contributions, freezing accruals, closing plans to new entrants, and eliminating or reducing the level of employer-paid retiree medical benefits,” Mercer said, referring mainly to “D.C. plans.” That stands for “defined contributions.”…

Hawaiian Electric Industries last week reported that the biggest item holding back growth in its profits was the need to make massive payments into its retirement funds.

United Airlines this month announced its intention to seek reductions in benefits for people who have already retired, after thousands of flight attendants retired early last year because United promised them in writing it would not do this.

Kaiser Aluminum, a corporation with the same corporate antecedents as Kaiser Permanente and the original Hawaii Kai development here, collapsed so completely into bankruptcy that its retirement plan has also collapsed, while US Airways, which emerged from bankruptcy last year, won court permission to scrap a retirement plan….

For more, GO TO > > > Social Security: The World’s Biggest Nest Egg


July 20, 2003

Companies Hurt Own Pension funds

Corporations seek government aid in wake of moves
that pumped up earnings, cut costs

by Ellen E. Schultz, The Wall Street Journal

A lot of big companies call it a looming crisis: They suddenly need to pour millions of dollars into their pension plans because the plans don’t have enough cash to meet legal requirements.

Congress is moving to offer relief, and the White House is planning a remedy of its own.

But what companies aren’t saying is that some of them contributed to the problem themselves. They did so through a variety of strategic moves to pump up earnings or cut costs, at the price of reduced funding for their pension plans.

During the past decade, U.S. companies have siphoned off billions of dollars from their pension plans. They’ve used the cash to pay for retirees’ health coverage, the costs of laying off workers and even fees to benefits consultants….

One way some companies eroded or reversed their onetime pension surpluses was by tapping the pension assets to pay for staff reductions.

Lucent Technologies Inc., the big maker of telecom gear, used about $800 million in surplus pension assets to pay termination benefits as it cut 54,000 employees from its payroll in 2001 and 2002.

In the space of a year, the Lucent pension plan went from having $5.5. billion more than was legally required (Sept. 30, 2001) to being $1.7 billion “underfunded” (Sept. 30, 2002).

Employers also contributed to today’s underfunding by lobbying successfully to ease funding rules a decade ago. Then as now, they fretted that their pension liabilities were made high by a combination of low interest rates and a weak stock market. Congress in 1994 softened funding requirements so company pension plans needed to be funded at 90 percent of government-required levels, not 100 percent.

Viola! Many companies’ underfunded pension plans suddenly appeared better-funded, and the companies were able to put less cash, or none, into their plans….

The Bush administration is proposing to extend a funding-relief provision, set to expire this year, for two more years. This provision lets badly underfunded plans use a corporate-bond rate.

In addition, companies seek extension of a provision that lets them withdraw pension assets to pay for retirees’ medical benefits. And they want the right to contribute more of their own stock when making pension contributions, in lieu of cash….

Besides other ways companies have tapped surplus pension assets, they’ve used some assets to hire the consultants who taught them how to tap. For instance, Internal Revenue Service filings show that International Business Machines Corp. used $18.4 million of pension assets in 2001 to pay fees to Watson Wyatt, a consulting firm that helped it convert to a cash-balance plan.

This was seven times the fee Watson Wyatt got when it began working for IBM in 1995….

See also: Lucent Technologies

For more, GO TO > > > Social Security: The World’s Biggest Nest Egg


Getting tough on
pension crime

Despite budget constraints, the chief US pension law enforcer has stepped up the pressure on pension-related crime.
But the critics say it still does not go far enough.

By Robert Stowe England

If numbers were any indicator, private pension and welfare plans would receive as heavy protection as society could muster against civil and criminal fraud and pilferage. Not only do their assets top $3 trillion, but the vast majority of US citizens – an estimated 200 million in all – either actively participate in or receive benefits from them, according to the General Accounting Office.

In 1974, ERISA established a group of federal investigators within the Department of Labor who are charged with investigating cases of diverted, expropriated, and misapplied pension assets, and with helping prosecutors to fine and/or jail wrongdoers.

Sadly, the resources federal authorities need to protect pension assets are lacking.

The chief enforcer for ERISA plans is the Department of Labor’s Pension Benefit and Welfare Administration. The PWBA has 382 investigators, whose job is to uncover potential wrongdoing at 750,000 pension benefit plans and 4.5 million welfare and health plans.

Another 112 investigators at the Office of Labor Racketeering (OLR) focus on organized crime, but they must cover the entire field of labor law – not just pension fund abuses.

Both the PWBA’s head of enforcement, Charles Lewis, and the OLR’s chief, Steve Cossu, readily admit that they could use more investigators.

The crimes they must contend with run the gamut. Multiemployer plans in some industries are prey to mob racketeering and embezzlement.

On the single-employer plan side, common offenses include overcharging plan administrators for investment and legal advice, actuarial and accounting services, and making imprudent investments.

Civil enforcement by the DoL relies heavily on voluntary compliance after investigators uncover evidence of improper conduct or violations of prohibited transaction rules. When voluntary compliance does not work, the DoL itself files cases charging civil violations of ERISA. When it has information about criminal violations, it passes this on to US attorneys, and sometimes to local district attorneys, for action. If it discovers that a plan has been overcharged, for example, the DoL first determines if this was inadvertent, or a systematic and deliberate abuse. If the latter, it may decide to pass the matter on for criminal prosecution.

The skills it needs in civil cases are primarily those of an auditor; however, DoL civil investigators monitor annual Form 5500 reports for signs of potential violations, and when they find imbalanced portfolios or other suspicious circumstances, they conduct an investigation that usually involves questioning the plan administrator and others. Civil cases are easier to prosecute and win than criminal cases, since they require only a preponderance of evidence to support a guilty finding.

The Federal Criminal Code specifies three principal pension felonies – theft or embezzlement of funds; kickbacks, payoffs, and other conflict-of-interest payments and receipts; and submitting false statements in required documents.

Criminal enforcement is a much more difficult proposition, requiring tougher, more detailed investigations. These rely more on the skills of a detective and sometimes require electronic surveillance or informants to put together the kind of evidence that can prove guilt “beyond a reasonable doubt.”

“Certainly we’ve got cases we can address, but we don’t have enough investigators to assign them to,” says Roy Landra, Cossu’s deputy. On the criminal side, DoL relies on outside investigative help from other federal and local agencies in pension investigations, including the Federal Bureau of Investigation, the Internal Revenue Service, postal inspectors, US attorneys, and state attorneys general and local district attorneys.

A lack of resources is only one issue.

The question of how those resources are allocated between civil and criminal cases is equally important, and is the core of a long-running debate in Washington. DoL officials, ERISA attorneys, and Congress disagree over what level of criminal enforcement is needed to establish an effective deterrent against pension crime.

Federal authorities have strong criminal provisions at their service, nearly all of which predate ERISA. In 1962, Congress amended the Welfare and Pension Plans Disclosure Act of 1958, which authorizes federal investigators and prosecutors to pursue labor racketeering cases that involve pension funds. The 1962 act expanded this to include felonies against pension funds including embezzlement, false statements and records, kickbacks and bribery. ERISA itself included an amendment to the criminal code that allowed them to pursue these and other types of cases when they involve ERISA funds.

The Racketeer-Influenced and Corruption Organizations statute of 1970 added to the federal arsenal of legal weapons against organized crime, and against mob abuse of pension funds.

Both a civil and criminal statute, RICO prompted creation of an interagency strike force to fight organized crime, which includes the FBI, the Justice and Labor departments, and the US Postal Service.

Federal enforcers’ success at fighting criminal abuses is hard to gauge, however. Pension fraud is rarely reported to regulators independently, so no statistics exist on the incidence – as opposed to the actual prosecution.

DoL investigators dig up cases by diligently poring over Form 5500 annual reports and performing random audits and other routine checks. But many pension-related crimes never see the light of day, because no annual reporting form can plainly reveal such crimes as racketeering, kickbacks and payoffs, while theft and embezzlement can be concealed with false information supplied on Form 5500s. The most difficult cases are often the most egregious, and are uncovered only after years of investigations, often begun by tipoffs and informants and sometimes requiring undercover agents to penetrate the world of organized crime.

Both civil and criminal enforcement of pension laws could become even more difficult if budget cuts now under consideration go through. The budget recently approved by the House would cut funding for both the OLR and the PWBA by 7.5% next year, according to a Labor Department source, and an uncertain outcome looms in a titanic budget battle between Congress and the president.

Landra at OLR expects that the number of investigators there, which has already declined from 118 in early 1993 to 112 today, may decline even more. The PWBA is determined to sustain the present level of field investigators in spite of projected cuts. But no one expects to see the number of investigators increased at either the PWBA or the OLR, despite widespread agreement that more are needed.

Emphasis on civil cases

In the first years after ERISA passed, the PWBA devoted 85% of its enforcement effort to civil matters. This has prompted some figures in the pension arena, including prominent ERISA lawyers and former regulators, to criticize the DoL’s enforcement efforts as inadequate, especially against organized crime.

A 1989 report on construction industry racketeering by the New York State Organized Crime Task Force concluded with this harsh verdict: “Federal policing of pension and welfare funds is too insubstantial to provide an effective deterrent to fraud and theft.”

Ian Lanoff, who during the Carter Administration was in charge of what later came to be known as the PWBA, put an overwhelming emphasis on civil prosecution. By concentrating on the recovery of assets, says Lanoff, now a partner with Bredhoff & Kaiser, a Washington, DC law firm, the department was “sending a message that if someone violates ERISA, they’ll have to pay the pension funds back out of their own pockets.” This, he believed, would act as a deterrent.

Lanoff notes that it is easier to win civil cases, where the burden of proof standard is easier to meet. Criminal cases require greater sophistication and longer investigations to produce enough evidence to convince a US attorney or local district attorney to take the case. Lanoff considered prosecution of civil cases easier to assure as well, since they are handled by the solicitor of labor. The decision on whether or not to pursue a criminal case that DoL investigators developed is up to criminal prosecutors at the Justice Department and other jurisdictions.

Besides, Lanoff says, “For every criminal put in jail, another is ready to step into his shoes.”

In the case of mob-dominated Taft-Hartley plans, for example, when one pliant union official was ousted, mob families usually had no difficulty finding another to step in. “The whole purpose of ERISA was that the criminal provisions had failed, and that civil recoveries were needed to protect pensions,” recalls a former official who worked in the DoL at the time.

Frank Clisham, the criminal coordinator at PWBA, says the decision to pursue a criminal case depends on the severity of the offense. Investigations usually start out as civil cases, and the worst offenses, if uncovered, become criminal cases.

Such arguments have never wholly convinced the critics that civil justice is the best remedy for the worst pension abuses, however. The most important penalty on the criminal side is the jail term, since stolen funds are often difficult to recover. Embezzlement of pension funds carries a maximum prison term of five years for each count. Criminal fines for embezzlement, for example, which used to be no higher than $10,000, have been subject to the stiffer federal sentencing guidelines since the late 1980s.

Michael Gordon, a Washington, DC attorney, helped write ERISA and is a persistent critic of what he calls the DoL’s “spotty” efforts in criminal enforcement.

Gordon charges that enforcement is not targeting enough white collar crime committed by plan administrators, accountants, broker-dealers, investment bankers, attorneys, and consultants. This failure sends a signal that the department is not worried about these matters, he says. This, in turn, encourages more criminal activity.

As for racketeering, the DoL was often criticized in congressional testimony during the early years of ERISA as the weak link in the organized crime strike force.

Since enforcing labor and pension laws is critical to any effort to curb mob influence in certain unions, the DoL’s failure to be an aggressive player weakened the federal effort to fight organized crime, critics claimed. Some critics even alleged that powerful unions exerted political pressure on the DoL to slow down the strike force.

After 1978, criticism of DoL’s criminal investigation efforts focused on the PWBA, which some saw as failing to devote enough resources to criminal cases to maintain a credible deterrent. The secretary of labor usually denied this. But when the DoL’s inspector general publicly criticized the department for failing to adequately pursue criminal investigations in 1988 and 1989, then-Labor Secretary Elizabeth Dole ordered a complete review of its criminal enforcement efforts.

This review led then-PWBA chief David Ball to seek and eventually gain congressional approval to increase his office’s number of pension investigators by one-third, from 266 to 357, between 1989 and 1992. Ball, now a senior partner and head of the Washington, DC law office of Williams Mullen Christian & Dobbins, doubled the amount of time the PWBA devoted to criminal investigations in response to the criticism. Today, 30% of the PWBA’s enforcement efforts go into criminal investigations, says Charles Lerner, the agency’s investigations director.

But has this established an effective criminal deterrent? Compliments are muted. “There is more of a deterrence today,” says Cossu, stopping short of a wholehearted endorsement. But while commending the PWBA for its civil enforcement, Cossu does not believe that the agency has yet reached its potential in criminal matters, in spite of some progress. The task is not an easy one, he admits: “You can’t build a criminal investigation capability overnight.”

The PWBA’s increased crime-fighting effort since 1989 has produced noticeable improvements. Criminal indictments against plan administrators, service providers, and labor racketeers have increased from a paltry 11 in 1990 to a more impressive 141 in 1994. And for fiscal 1995-October 1994 through last September-101 indictments have been handed down. But convictions have been harder to come by, rising from a tiny seven in 1990 to 34 in 1994, and 32 for fiscal year 1995. The PWBA’s Clisham predicts that the higher level of indictments of the last two years will soon be reflected in a similarly higher level of convictions.

The OLR, meanwhile, has shifted its focus increasingly towards pension-related cases, and today spends more than half of its resources on pension investigations, says OLR chief Steve Cossu. Much of this investigation follows on the heels of traditional bribery and kickback investigations to violate labor laws.

Creating a deterrent

If progress is to continue, some critics stress that the DoL’s criminal investigations will need clear and consistent support from the secretary of labor and the head of the PWBA.

Ball, for one, worries that concern for criminal investigations is already flagging, and that this will show up in a few years in fewer indictments. He faults Labor Secretary Robert Reich and PWBA head Olena Berg for their highly visible campaign for economically-targeted investments. This distracts the DoL from its principal pension responsibility, he says-deterring the theft of private pension assets through the investigation and prosecution of ERISA and related criminal violations.

“Enforcement is the primary responsibility,” he says. “Nothing else really matters.”…

Former PWBA chief David Walker, who served during the Reagan Administration, believes that deterrence is the agency’s underlying operating philosophy today – putting enough people in jail to discourage anyone else from flouting the law.

“You don’t need to send that many people to jail to send a message to the benefits community as to the importance of complying with the law,” says Walker, now a partner at Arthur Andersen in Atlanta. And with its current level of indictments and convictions for theft, kickbacks, bribery, and false statements, he believes the PWBA is succeeding in establishing deterrence.

Gordon disagrees, and cites as evidence the DoL’s failure to criminally investigate anyone associated with the termination of Pacific Lumber Company’s pension plan in 1986, which has been dragging through the courts since 1991.

Pacific Lumber was acquired in 1985 by Maxxam Group, the vehicle of Houston-based financier Charles Hurwitz, with the help of $450 million in junk bonds underwritten by Drexel Burnham Lambert.

Executive Life Insurance Company bought $100 million of the bonds. After Maxxam recovered $62 million of surpluses from Pacific Lumber’s pension plans, it replaced the benefits with annuities from Executive Life. This would violate ERISA’s prohibition against pension sponsors hiring service providers that are parties in interest to a deal under negotiation.

It also raises the suspicion that Executive Life may have received a kickback for buying the junk bonds that financed Maxxam’s takeover.

The troubled insurer was taken over by California authorities in 1991. Benefits were suspended for a time, and then resumed at 70% of their former level by the Aurora Group, the successor to Executive Life. Pacific Lumber has agreed to pay the remaining 30%.

The DoL prosecuted Pacific Lumber civilly for having carried out a prohibited transaction. But it chose not to pursue a criminal indictment, says Lerner, because the PWBA thought the case would not be as strong.

Lerner admits that “there’s a basis” for a potential criminal investigation, presumably based on Pacific Lumber’s purchase of the Executive Life annuities.

Critics further note that the DoL’s civil suit came only after Executive Life had been taken over by California authorities, and that the DoL should have taken notice of Pacific Lumber ‘s situation as soon as the pension surpluses were removed in 1986.

“Our concern was that when a pension plan terminates and it buys annuities, that the annuities should be the safest annuities available,” says Lerner. This would prevent corporations from buying lower-priced and perhaps less safe annuities, “to get as much of the reversion as possible,” he notes.

The last Congress gave the DoL expanded authority to prevent future Pacific Lumber incidents by passing the Pension Annuitants Protection Act, which requires plan sponsors to buy the “safest” annuities.

The Pacific Lumber matter remains unsettled. Employees have alleged in their civil class action lawsuit that the recovery of the surplus pension assets, and the selection of Executive Life, were prohibited transactions under ERISA. Their suit was thrown out in 1993 by a US District Court, but was reinstated earlier this year by the Ninth US Circuit Court of Appeals in San Francisco, and sent back to the District Court for trial. The DoL’s civil ERISA case is joined with the class action case, and will now go forward with the District Court trial.

Even if plan participants are made whole, “the question arises whether the purchase of bonds by Executive Life was a quid pro quo for the selection of Executive Life for the annuities,” Gordon says. On the surface, he asserts, “this appears to be a conspiracy to commit white collar fraud.

A quid pro quo arrangement would represent a violation of Section 18 of the criminal code, which prohibits bribes and kickbacks to pension funds, Gordon argues.

Congress has been skeptical about the DoL’s heavy reliance on civil prosecution almost from the beginning. Hearings in the mid-1970s by the Senate Permanent Subcommittee on Investigations, chaired by Sam Nunn (D-Georgia), regularly featured testimony about the dangers of ignoring the mob’s presence in multiemployer pension plans.

Congress responded with special provisions of the Inspector General Act of 1978, which reorganized a number of offices within the DoL to insure that investigations into criminal and mob influence on single and multi-employer plans would remain independent of any potential interference from the Secretary of Labor.

The act established an independent inspector general to investigate and audit activities in most federal departments and agencies. The DoL’s inspector general got an additional responsibility, the OLR. This organizational approach was an attempt to keep both the IG’s Office of Investigations and the OLR free of political pressure to minimize investigations into organized crime influence.

Still, the DoL continued to focus on civil, not criminal, cases. One DoL source attributes the long delay to Washington’s unwillingness at the time to take on a powerful political constituency, organized labor – a charge officials deny. Then in 1982, after yet more hearings, this time on waterfront corruption, and a DoL lawsuit, the first major union pension fund was taken out of the hands of a powerful union – the International Brotherhood of Teamsters.

Back in 1977, the Teamsters’ Central States, Southeast and Southwest regional fund, based in Chicago, was suspected of steering pension investments into Las Vegas casinos.

The DoL pressured Central States into appointing a special named fiduciary, the Equitable Life Insurance Company, to run its pension plan. But no ERISA lawsuit was brought at first.

Congressional hearings the same year again focused on organized crime’s influence on pension funds, and the DoL then filed an ERISA lawsuit. This eventually led to a 1982 consent decree requiring Central States to have a named fiduciary, now Morgan Stanley, and a monitor, former US senator and attorney general William Saxbe.

Supporters of civil prosecution against organized crime had scored a victory. But Congress was still not satisfied.

The President’s Commission on Organized Crime identified four big unions as being substantially under mob control – the Teamsters, the Laborer’s International Union of North America, the Hotel and Restaurant Employees International Union, and the International Longshoremen’s Union.

In 1984, Congress, unhappy with DoL’s failure to increase investigations of pension crime (outside the OLR) passed the Comprehensive Crime Control Act which included an amendment to ERISA that “practically demanded the secretary of labor increase the department’s criminal enforcement activities,” says former OLR chief Raymond Maria, who now heads his own consulting firm in Alexandria, Virginia.

The new law made the DoL the lead player in investigating criminal activities against pension funds, in response to complaints by department officials that the law was unclear on this point.

Nunn held another series of hearings at the Senate Permanent Subcommittee on Investigations in 1988, followed by a high-profile assault on the DoL’s intransigence by inspector general J. Brian Hyland. The result was a battle between the IG and Solicitor of Labor over whether 100 general investigators in the IG’s office (above and beyond those at the separate OLR) could investigate pension matters. The IG said “yes” but the Solicitor of Labor said “no.”

The dispute was finally resolved when the Justice Department’s Office of Legal Counsel issued an opinion that narrowed the powers of all IG’s throughout the government. This removed the IG’s 100 investigators from investigating pension funds and violations of labor, workplace safety and health, except through the OLR.

Critics like Maria call the Justice Department ruling a blow to criminal enforcement efforts designed to protect pensions.

It also meant that the 100 new agents that Ball brought on at the PWBA shortly thereafter did not necessarily represent a net gain of 100 investigators looking into pension matters. In fact, PWBA investigators generally lack the training in organized crime’s ways that special agents receive in the IG’s office, including the OLR. They also lack the authority to conduct electronic surveillance-vital in bringing a criminal investigation of organized crime to a successful close, Maria says.

Even today, OLR investigators still tend to view PWBA investigators as sophisticated auditors, not crime detectives. And finding evidence of a kickback and bribery sufficient to win a criminal conviction requires different skills than are needed to ferret out suspicious portfolio arrangements.

But the PWBA has become a valuable ally in cooperative criminal investigations with the FBI and the criminal division of the IRS. In one of the most important pension cases against organized crime in recent years, the agency played a key role in prosecuting an extraordinarily corrupt local of the Laborers International Union of North America, the Mason Tenders District Council of New York.

Steve Pine, deputy director of the PWBA’s New York regional office, says his investigators had begun to look into corruption at the Mason Tenders’ $270 million pension fund when the US attorney informed them that the FBI was investigating too.

The joint FBI and PWBA investigations, some going back to 1989, led to criminal indictments in 1990 and a combined civil RICO and ERISA case in 1994, all prosecuted by the US attorney for the Southern District of New York.

The criminal case led to more than a dozen convictions against mobsters, union officials, and corrupt service providers who systematically plundered the pension fund for decades through payoffs, bribes, money laundering, and embezzlement.

Genovese family capo James Messera and former Mason Tenders’ president Frank Lupo pled guilty to racketeering charges in connection with the real estate scheme and other matters. Altogether, seven of the 26 indicted were sent to prison.

The civil RICO/ERISA suits were filed last fall, the US attorney alleging that more than $50 million in Mason Tenders’ pension and welfare funds had been looted and wasted since 1987.

Along with the purchase of the headquarters building and several other real estate scams, the suit alleged kickbacks and embezzlement.

The case was the first time the government sought relief under both RICO and ERISA in the same lawsuit, the purpose being to seek return of some of the looted pension assets. The tactic is likely to be used again in pension corruption cases, says the PWBA’s Clisham, since it offers a powerful one-two punch of fines and jail sentences (RICO) and restitution of pension assets (ERISA), and therefore could provide an effective deterrence. So far, $1.2 million has been forfeited by the convicted felons, he says….

The PWBA had already shown that it could play hardball in civil ERISA suits which were aimed at taking pension funds out of the hands of corrupt union officials. But the Mason Tenders case provided the first clear proof that the agency has learned to play effectively as a criminal investigator as well. More successful criminal investigations that lead to successful prosecutions like the Mason Tenders could go a long way toward erasing doubts about the DoL’s determination to fight pension crime as vigorously as it can with the resources available.

But can the DoL keep it up? In spite of assurances by some at the department that it will not reduce the PWBA’s staff of investigators, the budget cuts Congress is contemplating would seem to make a reduction inevitable.

“The budget will be down. There will be cutbacks. There’s no doubt about that,” says Dave Certner, a pension lobbyist at the American Association of Retired Persons. In that case, federal investigators will have to develop new strategies to maximize available resources if the current levels of criminal indictments is to be sustained.

Copyright © 1998 Asset International, Inc. All rights reserved. Plan Sponsor November 1995.


October 22, 2002

More Pension Shortfalls

by Stephen Taub,

At least three large, high-profile companies announced huge pension shortfalls on Monday.

Alcoa Inc. said it expects an increase in its pension liability of $700 million to $1 billion, mostly due to the decline in equity markets and interest rates, according to Reuters.

“Assumption changes for major plans are expected to impact after-tax earnings by approximately $50 million annually,” the company management said, according to the wire service. “There is no material change in funding expected in 2003.”

Alcoa is reportedly lowering its expected rate of return on its pension assets from 9.5 percent, but did not provide a new figure.

Also on Monday, 3M Co. said it would take a $1 billion charge in the fourth quarter due to a pension funding shortfall.

And United States Steel Corp. reported it may have to take a $750 million charge against equity later this year to account for possible shortfalls in its union employee pension plan.

Last week Credit Suisse First Boston said that 325 companies in the S&P 500 would have pension shortfalls by the end of the year.


February 4, 2002

Crime in the Suites

By William Greider, The Nation

The collapse of Enron has swiftly morphed into a go-to-jail financial scandal, laden with the heavy breathing of political fixers, but Enron makes visible a more profound scandal–the failure of market orthodoxy itself. Enron, accompanied by a supporting cast from banking, accounting and Washington politics, is a virtual piñata of corrupt practices and betrayed obligations to investors, taxpayers and voters.

But these matters ought not to surprise anyone, because they have been familiar, recurring outrages during the recent reign of high-flying Wall Street. This time, the distinctive scale may make it harder to brush them aside.

“There are many more Enrons out there,” a well-placed Washington lawyer confided. He knows because he has represented a couple of them.

The rot in America’s financial system is structural and systemic. It consists of lying, cheating and stealing on a grand scale, but most offenses seem depersonalized because the transactions are so complex and remote from ordinary human criminality….

In this era of deregulation and laissez-faire ideology, the essential premise has been that market forces discipline and punish the errant players more effectively than government does. To produce greater efficiency and innovation, government was told to back off, and it largely has. “Transparency” became the exalted buzzword. The market discipline would be exercised by investors acting on honest information supplied by the banks and brokerages holding their money, “independent” corporate directors and outside auditors, and regular disclosure reports required by the Securities and Exchange Commission and other regulatory agencies. The Enron story makes a sick joke of all these safeguards.

But the rot consists of more than greed and ignorance. The evolving new forms of finance and banking, joined with the permissive culture in Washington, produced an exotic structural nightmare in which some firms are regulated and supervised while others are not. They converge, however, with kereitzu-style back-scratching in the business of lending and investing other people’s money.

The results are profoundly conflicted loyalties in banks and financial firms–who have fiduciary obligations to the citizens who give them money to invest. Banks and brokerages often cannot tell the truth to retail customers, depositors or investors without potentially injuring the corporate clients that provide huge commissions and profits from investment deals. Sometimes bankers cannot even tell the truth to themselves because they have put their own capital (or government-insured deposits) at risk in the deals….

The people bilked in Enron’s sudden implosion were not only the 12,000 employees whose 401(k) savings disappeared while Enron insiders were smartly cashing out more than $1 billion of their own shares. The other losers are working people across America. Enron was effectively owned by them. On June 30, before the CEO abruptly resigned and the stock price began its terminal decline, 64 percent of Enron’s 744 million shares were owned by institutional investors, mainly pension funds but also mutual funds in which families have individual accounts. At midyear, the company was valued at $36.5 billion, having fallen from $70 billion in less than six months. The share price is now close to zero.

Either way you figure it, ordinary Americansthe beneficial owners of pension funds–lost $25-$50 billion because they were told lies by the people and firms they trusted to protect their interests.

This is a shocking but not a new development. Global Crossing went from $60 a share to pennies (as with Enron, the market had said it was worth more than General Motors).

CEO Gary Winnick cashed out early for $600 million, but the insiders did not share the bad news with other shareholders. Workers at telephone companies bought by Global Crossing had been compelled to accept its stock in their retirement plans. (Winnick bought a $60 million home in Bel Air, said to be the highest-priced single-family dwelling in America.)

Lucent’s stock price tanked with similar consequences for employees and shareholders, while executives sold $12 million in shares back to the failing company. (After running Lucent into the ground, CEO Richard McGinn left with an $11.3 million severance package.)

There are many Enrons, as the lawyer said.

The disorder writ large by the Enron story is this regular plundering of ordinary Americans, who are saving on their own or who have accepted deferred wages in the form of future retirement benefits. Major pension funds can and do sue for damages when they are defrauded, but this is obviously an impotent form of discipline. Labor Department officials have known the vulnerable spots in pension-fund protection for many years and regularly sent corrective amendments to Congress--ignored under both parties.

In the financial world, the larceny is effectively decriminalized – culprits typically settle in cash with fines or settlements, without admitting guilt but promising not to do it again.

If jailtime deters garden-variety crime, maybe it would be useful therapy for corporate and financial behavior.

The most important reform that could flow from these disasters is legislation that gives employees, union and nonunion, a voice and role in supervising their own pension funds as well as the growing 401(k) plans.

In Enron’s case, the employees who were not wiped out were sheet-metal workers at subsidiaries acquired by Enron whose union locals insisted on keeping their own separately managed pension funds.

Labor-managed pension funds, with holdings of about $400 billion, are dwarfed by corporate-controlled funds, in which the future beneficiaries are frequently manipulated to enhance the company’s bottom line. Yet pension funds supervised jointly by unions and management give better average benefits and broader coverage (despite a few scandals of their own). If pension boards included people whose own money is at stake, it could be a powerful enforcer of responsible behavior.

The corporate transgressions could not have occurred if the supposedly independent watchdogs in the system had not failed to execute their obligations.

Wendy Gramm, wife of Senator Phil, the leading Congressional patron of banking’s privileges, is an “independent” director of Enron and supposedly speaks for the broader interests of other stakeholders, from the employees to outside shareholders.

Instead, she sold early too.

With notable exceptions, the “independent” directors on most corporate boards are a well-known sham–typically handpicked by the CEO and loyal to him, even while serving on the executive compensation committees that ratify bloated CEO pay packages.

The poster boy for this charade is Michael Eisner of Disney. As CEO, he must answer to a board of directors that includes the principal of his kids’ elementary school, actor Sidney Poitier, the architect who designed Eisner’s Aspen home and a university president whose school got a $1 million donation from Eisner.

As Robert A.G. Monks and Nell Minow, leading critics of corporate governance, asked in one of their books: “Who is watching the watchers?”

Do not count on “independent” auditors, as Arthur Andersen vividly demonstrated at Enron. While previous scandals did not involve massive document-shredding, Andersen’s behavior is actually typical among the Big Five accounting firms that monopolize commercial/financial auditing worldwide. Andersen already faces SEC investigation for its role in “Chainsaw Al” Dunlap’s butchery of Sunbeam and has paid $110 million to settle Sunbeam investors’ damage suits.

A decade ago Andersen fronted for Charles Keating’s notorious Lincoln Savings & Loan, which bilked the elderly and then collapsed at taxpayer expense–despite a prestigious seal of approval from Alan Greenspan (Keating went to prison; Greenspan became Federal Reserve Chairman).

But why pick on Arthur Andersen? Ernst & Young paid out even more for “recklessly misrepresenting” the profit claims of Cendant Corporation$335 million to the New York and California public-employee pension funds. Cendant itself has paid out $2.8 billion to injured investors, but hopes to recover some money by suing Ernst & Young.

PriceWaterhouseCoopers handled the books at Lucent, accused of inflating profits by $679 million in 2000 and prompting yet another SEC investigation.

The corruption of customary auditing–and the fact that an industry-sponsored board sets the arcane accounting tricks for determining whether profits are real or fictitious–is driven partly by the Big Five’s dual role as consultants and auditors.

First they help a company set its business strategy, then they examine the books to see if management is telling the truth. This egregious conflict of interest should have been prohibited long ago, but the scandal has reached a ripeness that now calls for a more radical solution–the creation of public auditors, hired by government, paid by insurance fees levied on industry and completely insulated from private interests or politics….

Enron is unregulated, though it functioned like a giant financial house. So is GE Capital, a money pool much larger than all but a few commercial banks. Mutual funds and hedge funds are essentially free of government scrutiny.

So are the exotic financial derivatives that Enron sold and that led to shocking breakdowns like the bankruptcy of Orange County, California.

The government failed too, mainly by going limp in its due diligence but also by withdrawing responsibility through legislative deregulation. The one brave exception was Arthur Levitt, Clinton’s SEC commissioner, who gamely raised some of these questions, but without much effect because he was hammered by the industry and its Congressional cheerleaders.

Corrupt accountants and investment bankers now have a friendlier commissioner at the SEC–lawyer Harvey Pitt, whose firm has represented Arthur Andersen, each of the Big Five and Ivan Boesky, whose fraud case was settled for $100 million.

Pitt blames Arthur Levitt’s inquiries for upsetting the accounting industry’s self-regulation.

Given his connections, Pitt should not just recuse himself from the Enron case–a crisis of legitimacy for the SEC--he should be compelled to resign.

Similarly sympathetic cops are scattered throughout the regulatory agencies. At the Federal Reserve, a new governor, Mark Olson, headed “regulatory consulting” in Ernst & Young’s Washington office. Another new Fed governor, Memphis banker Susan Bies, has been an active opponent of strengthening derivatives regulation.

But the heart of the scandal resides in New York, not Washington. The major houses of Wall Street play a double game with their customers–doing investment deals with companies in their private offices while their stock analysts are out front whipping up enthusiasm for the same companies’ stocks.

Think of Goldman Sachs still advising a “buy” on Enron shares last fall, even as the company abruptly revealed a $1.2 billion erasure in shareholder equity. Goldman earned $69 million from Enron underwriting in recent years, the leader among the $323 million Enron paid Wall Street firms.

Think of the young Henry Blodget, now famous as Merrill Lynch’s never-say-sell tout for the same Nasdaq clients whose fees helped fuel Blodget’s $5-million-a-year income (Merrill has begun settling investor lawsuits in cash).

Think of Mary Meeker at Morgan Stanley Dean Witter, dubbed the “Queen of the Net” for pumping up Internet firms while Morgan Stanley was taking in $480 million in fees on Internet IPOs. The conflict is not exactly new but has reached staggering dimensions. The brokers whose stock tips you can trust are the ones who don’t offer any.

The larger and far more dangerous conflict of interest lies in the convergence of government-insured commercial banks and the investment banks, because this marriage has the potential not only to burn investors but to shake the financial system and entire economy. If the newly created and top-heavy mega-banks get in trouble, their friends in power may arrange another cozy government bailout for those it deems “too big to fail.”

The banking convergence, slyly under way for years, was formally legalized in the 1999 repeal of Glass-Steagall, the New Deal law that separated the two sectors to eliminate the very kind of self-dealing that the Enron case suggests may be threatening again. We don’t yet know how much damage has been done to the banking system, but its losses seem to grow with each new revelation.

JP Morgan Chase and Citigroup provided billions to Enron while also stage-managing its huge investment deals around the world and arranging a fire-sale buyout by Dynergy that failed (Morgan also played financial backstop for Enron’s various kinds of trading transactions). Instead of backing off and demanding more prudent management, these two banks lent additional billions during Enron’s final days, perhaps trying to save their own positions (we don’t yet know).

Instead of warning other banks of the rising dangers, Chase and Citi led the happy talk. Both have syndicated many billions in bank loans to other commercial banks–a rich fee-generating business that allows them to pass the risks on to others (federal regulators report that the volume of “adversely classified” syndicated loans has risen to 8 percent, tripling the problem loans since 1998).

These facts may help explain why former Treasury Secretary Robert Rubin, now of Citigroup, called an old friend at Treasury and suggested federal intervention. Rubin’s bank has a large and growing hole in its own loan portfolio. Could Treasury please pressure the credit-rating agencies, Rubin asked, not to downgrade Enron?

Though he styles himself as a high-minded public servant, Rubin was trying to save his own ass.

Indeed, he called the very Treasury official who, as an officer of the New York Federal Reserve back in 1998, had engineered the cozy bailout of Long Term Capital Management–the failing hedge fund that Citigroup, Merrill and other major financial houses had financed. Gentlemanly solicitude for big boys who get in trouble connects Washington with Wall Street and spans both political parties.

In this new world of laissez-faire, when things go blooey, the government itself is exposed to risk alongside hapless investors–if the commercial banks are lending federally insured deposits along with their own investment plays or are exercising what amounts to an equity position in the failed management. This is allegedly forbidden by “firewalls” within the mega-banks, but when a banker gets in deep enough trouble, he may be tempted to use the creative accounting needed to slip around firewalls.

“A bank that has equity shares in a company that goes south can no longer make neutral, objective judgments about when to cut off credit,” said Tom Schlesinger, executive director of the Financial Markets Center.

“The rationale for repealing Glass-Steagall was that it would create more diversified banks and therefore more stability. What I see in these mega-banks is not diversification but more concentration of risk, which puts the taxpayers on the hook. It also creates a financial sector much less responsive to the real needs of the economy.”

The fallacies of our era are on the table now, visible for all to see, but the follies are unlikely to be challenged promptly–not without great political agitation. The other obvious deformity exposed by Enron is the insidious corruption of democracy by political money. The routine buying of politicians, federal regulators and laws does not constitute a go-to-jail scandal since it all appears to be legal.

But we do have a strong new brief for enacting campaign finance reform that is real. The market ideology has produced the best government that money can buy.

The looting is unlikely to end so long as democracy is for sale….


What Wall Street kept
from the workers

By Fred Goldstein

As the World Economic Forum convenes in New York and bankers from the U.S. have to circulate among the financiers and capitalists of the world, they will suffer a certain discomfort.

After all, the powers behind EnronJ.P. Morgan Chase, Citicorp, Bank of America, brokerage houses like Merrill Lynch, investment banks like Morgan Stanley, and other titans of U.S. capitalism – will have to slide delicately past the subject of the tidal wave of corruption that has surfaced and engulfed their entire political establishment, both parties, as well as the White House and the Securities Exchange Commission.

These bankers are the financial powers behind the engines of globalization. They have preached the free market, financial transparency, monetary discipline, the rule of law, and every other pious and hypocritical phrase they could think of to mask their brutal takeover of economies all over the world.

They have caused untold mass poverty and suffering, cultural genocide and the destruction of the environment.

Now, because of the Enron collapse and all its fallout, they have been caught with their hands in the till–investing in phony partnerships, financing tax cheats, shredding documents and callously gambling with the life savings of thousands of workers.

High-paid corporate executives lied for profit, their accountants swore to it and their lawyers declared it all legal.

This cast of characters is not new on the stage of history. Only the names have changed.

In 1916, V.I. Lenin, the leader of the Bolshevik Revolution, wrote a ground-breaking book entitled “Imperialism, the Highest Stage of Capitalism.” In it he showed that imperialism was not a policy but a form of society. The early, competitive stage of capitalism inexorably developed into monopoly capitalism.

This happened in all the major capitalist countries of that time.

Each one was dominated by a financial oligarchy that exerted control over all economic life at home and was feverishly engaged in the export of capital abroad–where it could carry out the super-exploitation of hundreds of millions of colonial people.

The book was written in the midst of World War I, the first great imperialist war. It described the motive force of the war: to re-divide the globe, which had already been divided up among all the imperialist powers.

Even a cursory look at the Enron scandal confirms Lenin’s writings on imperialism.


Enron had 25,000 miles of natural gas pipeline in the United States, 8,000 more miles in South America, water treatment plants in Britain, power plants in Italy, Poland, Turkey, Guatemala, Nicaragua, Puerto Rico and the Philippines, a 65-percent stake in a major Indian power plant–and that’s just for starters.

Enron tried to rise above being just an industrial corporation to become a broker and a trader. Thus it was both industrial and financial. It has been supported and controlled in this endeavor by the biggest banks in the U.S.

It recruited Brig. Gen. Thomas White to be the head of Enron Energy Services, then a decade later sent him into the present Bush administration as Secretary of the Army. It dictated its energy policy to now-Vice President Dick Cheney, a militarist who was Secretary of Defense during the first Bush administration. It had dozens of Pentagon contracts.

Enron is the epitome of an aspiring, new-on-the-scene imperialist corporation. Its demise has shown to the whole world how a corporation, backed by the banks and tied to the military machine of U.S. imperialism, can control the regulatory process and use its financial power to direct the policy of the capitalist state.

On the domestic front, the sudden collapse of a corporation the size of Enron, which claimed $100 billion in revenue in the year 2000 and had $66 billion in stock outstanding at its peak, raises numerous questions and issues for both the ruling class and the working class. But the real issues are buried beneath a mountain of hypocrisy and deceit.

The ruling class pundits are trying to frame the issue as corrupt corporate practices versus playing by the rules. They point to Enron’s use of partnerships to hide its losses. They seem to be truly indignant that Arthur Andersen, one of the holy Big Five accounting firms, actually signed off on these schemes as within accounting guidelines. They excoriate the prestigious Houston law firm of Vinson & Elkins for dubbing the whole thing as legal.

Now everyone is suitably outraged.

But the real issue is not one of playing by the rules. The real issue is that even though they broke the rules, they lost the game. They cost the rich billions of dollars, discredited the stock market and the 401(k) Wall Street pension scheme and, in the process, aroused the ire of the masses, who saw 15,000 workers lose $1.3 billion of their life savings while the executives walked away with more than $1 billion in stock sales.


The truth is that every one on Wall Street knew that Enron was not playing by the rules.

As early as 1999 the German energy giant Veba was contemplating a merger with Enron. But, according to the New York Times of Jan. 27, Veba backed away from the deal after the firm “became concerned about the levels of debt Enron had and with what a senior executive said were Enron’s ‘aggressive accounting practices.’

Consultants from PricewaterhouseCoopers told Veba that Enron, through complex accounting and deal making, had swept tens of millions in debt off its books, making the company’s balance sheet look stronger than it really was.”

The second of the Big Five accounting firms, PricewaterhouseCoopers was only “one of several banks and consulting firms that worked on the Veba-Enron deal. Other advisers included Goldman Sachs, Credit Suisse First Boston and McKinsey & Company, brokers and consultants said.”

“In the wake of Enron’s collapse,” added the Times, “it has become apparent that many financial firms-from Enron’s lenders to Wall Street bankers who underwrote the company’s partnership, to investment houses that bought into them, to the accountants who reviewed their books-knew more about Enron’s condition than the company publicly disclosed.”

In fact, when Veba backed out, it had concluded that the company’s total debt load amounted to 70 to 75 percent of its value. In short, it was a debt-inflated bubble waiting to burst.

“Enron executives enticed wealthy individuals and institutions to invest in one of the partnerships that helped wreck the company by dangling the prospect that inside knowledge could potentially help them double their money in a matter of months,” reported the Times on Jan. 25.

The records show Enron executives offered “Wall Street firms and wealthy investors inside knowledge about Enron and its off-the-books holdings-information they denied company shareholders.”

Some of the biggest corporations in the world were involved, including Citicorp, Travelers Insurance, Morgan Stanley and American Home Assurance….

While perhaps not all the intimate details of the Enron scams were clear, the general picture was known all over Wall Street long ago.

If Goldman, Sachs, Credit Suisse First Boston, PricewaterhouseCoopers and other giant Wall Street firms knew, then Robert Rubin, Clinton’s Secretary of the Treasury and former head of Goldman, Sachs, knew.

The Securities and Exchange Commission members must have known.

The Public Oversight Board that is supposed to oversee the accounting profession must have known.

Mutual fund managers, brokerage houses, stock analysts, all knew that the Veba merger had fallen through because of phony accounting.

The word must have gotten to the heads of the Senate and House banking committees, who hob-knob with bankers.

It is highly probable that word of all this wafted its way up to the Olympian heights from which Alan Greenspan, head of the Federal Reserve Board, periodically descends to utter his ambiguous, carefully hedged truisms about the capitalist economy….


Now everyone is screaming about regulation, oversight, standards, etc. But no one rushed to demand regulation of “aggressive accounting” and questionable partnerships BEFORE Enron crashed-when the parasitic bankers, brokers and other coupon-clipping parasites were making 212 percent on their investments in three months.

No one wanted to blow the whistle when Enron stock was rising and all the investors’ portfolios were increasing in value, making them rich on paper.

But now they are all crying foul, lining up to get their money back from the bankruptcy proceedingsCitigroup, J.P. Morgan Chase, Bank of America, and others that either participated in the schemes or kept quiet. Lawsuits are flying back and forth….

Today the working class has to learn the lessons of the Enron scandal. It has to separate its problems from those of the bankers and financiers.


The issue for both classes is one of accounting and control. The capitalist class has minimal central control over the conduct of the giant monopolies, the banking houses, the industrialists. The monitoring of the ruling class has been largely allocated to the accounting profession. The capitalist state has little or no responsibility except after the fact, when a violation is uncovered. On a day-to-day basis, it is up to the accountants.

But the accounting profession is part of the ruling-class establishment. They are a profit-gouging group of exploiters, just like the capitalists they are supposed to monitor. Thus, at the end of the day, the capitalist class has no reliable way of preventing wholesale fraud, because they are all engaged in it. It is part of capitalism.

For the Enron workers, who had their life savings tied up in company stock, and for the millions of other workers whose pension funds also held millions in Enron stock, there was no one in this entire affair to stick up for them during all these backroom dealings.

This is what the working class must concern itself with.

There was an unholy capitalist alliance between Enron, its accountants, its lawyers, the commercial bankers, the brokers, the investment bankers, congressional oversight committees and the regulators–all either trying to make a killing or covering up for Enron.

It’s a microcosm of what exists generally throughout capitalism. No one raised one word about the workers and their life savings. All this took place for years behind the backs of the working class, in a conspiracy of the rich to protect themselves.

Now 10 congressional committees, the SEC, the Justice Department and others are trying to get into the act, talking about reform and oversight. But the lesson of the Enron scandal is that the workers have to have an independent position and defend their own class interests.


The first thing to declare is that all this money belonged to the workers. All the money in those 401(k) plans was wages that had been deferred. This was compensation for labor performed.

If the managers made it disappear because of fraud, then all that labor, in the millions of dollars, was performed for nothing.

The capitalist government, which was supposed to protect the workers against this fraud, and the investors who got rich from it–including not only Enron executives but the Citigroup investors, the Travelers Insurance investors, the Morgan Stanley investors and any other parasites who invested in schemes that ultimately devalued the workers’ holdings–should make good on every single penny.

The workers should be first on line as the primary creditors in the bankruptcy proceeding, of course. But they should not wait in agony during a prolonged judicial process to get relief. The Bush administration–or should we say the Enron administration–should immediately set aside funds, not only for the Enron workers, but for all the pension plans that held Enron’s watered stock.

It could start by diverting money from the huge $48 billion increase Bush is proposing for the Pentagon and its aggression around the world.

The labor movement should get behind a massive counterattack to protect all the workers who have been cajoled and swindled out of their pensions, which have wound up in the hands of Wall Street speculators. The workers should fight back against being tied to stock options and demand guaranteed, fixed pensions instead of having their wages turned over to a gang of financial gamblers.

The government should be putting extra money into Social Security, not figuring out ways to rob it and gamble with it.

The working class should find ways to intervene in the Washington struggle over reform and oversight to protect its interests and not get involved in fixing things for the capitalists.

But in addition to opening up an immediate struggle, a longer-term evaluation of this collapse and the revelations surrounding it must be made….

– Reprinted from the Feb. 7, 2002, issue of Workers World newspaper

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Last updated August 15, 2006, by The Catbird