“I would love to make a large bet with the chief financial
officers of ExxonMobil, GE, General Motors and IBM, or with their actuaries and auditors, that over the next 15 years they will not average the (pension) rates they're postulating.”
-- Warren Buffett, 2001
CEOs to blame for pension fund crisis
DAVID OLIVE
COLUMNIST
thestar.com
In the bad old days, when a gluttonous CEO made a grab for his employees' pension assets, he was sure to set off alarm bells.
In a notorious mid-1980s confrontation with Ontario's pension regulator, Conrad Black laid claim to surplus pension assets at his ill-fated Dominion Stores Ltd. Black lost the tussle. Some time later, he left the country. More proof there is a God. Or so it seemed.
Late last year, a letter appeared in Business Week from a 32-year veteran of International Business Machines Corp. who begged to differ with Louis V. Gerstner Jr.'s generous self-appraisal of his turnaround heroics at IBM as related in his recent memoir, Who Says Elephants Can't Dance?
In addition to thousands of layoffs and the device of share buybacks to inflate the stock price, Gerstner "used the $17 billion (U.S.) in the pension surplus to boost the annual profits by 20 per cent with `vapour profits' that boosted the share price of IBM stock," wrote Mike Saville of Utah. "This same pension surplus is now less than $500 million (U.S.) today. Meanwhile, retirees received one cost-of-living adjustment in 10 years, the same year IBM did away with promised medical coverage for retirees."
Gerstner himself pocketed $127 million in pay last year, mostly from cashing in stock options made valuable by IBM's inflated stock price. IBM stock has since tumbled along with so many other blue chips that turn out to have massive pension-fund deficiencies. On his book tour, Gerstner brags about smashing the "culture of entitlement" among grassroots IBMers during his nine-year reign.
But he dodges questions about his audit stylings at the firm.
Never mind. As always, the truth will out. Last month, as Saville might have predicted, Gerstner's successor as chief executive officer found it necessary to bail out IBM's pension plans by the staggering sum of almost $4 billion to avoid running afoul of pension regulators.
A wicked combination of years of underfunding corporate pension plans and recent poor returns on the stocks and fixed-income securities held by those plans has triggered an epidemic of employer pension crises.
Statistics Canada reports that the assets of employer-sponsored plans in Canada dropped 10 per cent, or $59 billion (Canadian), between the summer of 2000 and mid-2002. Those numbers will worsen when the full-year figures roll in for 2002, an abysmal period for investment returns.
Canada's federal financial-services regulator has put 50 pension funds on its watch list. Far more plans might be in trouble, given that most are provincially regulated and not monitored by the federal Office of the Superintendent of Financial Institutions, which has not identified the 50 funds under its scrutiny.
Bombardier Inc. and Nortel Networks Corp. closed the books on fiscal 2001 with pension shortfalls of $1.6 billion (Canadian) and $1.02 billion (U.S.), respectively. Blue-chip firms such as Johnson & Johnson Inc., 3M Corp. and Ford Motor Co. have recently been forced to make unexpected payments in the hundreds of millions of dollars to pension plans to arrest a deterioration in their value.
The misery at General Motors Corp. is a warning for all investors about the widespread impact of the pension crisis. In recent days, GM forecast a 25 per cent plunge in 2003 pretax profits after pumping an emergency $2.6 billion into the company's underfunded pension plan. And GM now predicts it will have to drain its treasury by a further $13 billion over the next five years to cover obligations to pensioners.
"We know we have to feed this and feed it cash over time," John Devine, GM's chief financial officer, conceded last week. "We do have a substantial pension drag on both earnings and cash flow."
This legacy of executive greed in the late 1990s is bound to prolong the stagnation in the U.S. economy, with implications for Canada's gross domestic product.
Money that must be diverted to shoring up corporate pension plans will not be available for job creation, research and development and new plants and equipment.
Borrowing costs for expansion will rise for companies where pension deficiencies have prompted debt-rating agencies to downgrade the firm as a credit risk.
The vicious circle is complete as corporate profits take a series of hits over the next few years until the pension shortfalls are corrected. The profit hits are already depressing share values — including the value of stocks held by pension plans.
In the roaring 1990s, CEOs with their eyes on the stock-option prize corrupted the books in many ways: by hiding debt in off-balance sheet transactions, by recording future hoped-for revenues as current sales and by failing to report enormous option payouts as a corporate expense.
Less noticeably, these CEOs also inflated reported profits by fiddling with retirement obligations to current and former employees.
Eager to shed long-term commitments to workers, many U.S. firms encouraged their employees to enrol in so-called 401(k) plans that replaced traditional plans paying a guaranteed fixed amount to retirees for the rest of their lives.
Employers matched employee contributions to these tax-sheltered plans, but, alas, often with company stock rather than cold hard cash — yet another means of boosting reported profits. The carrot for employees was the chance to manage their own retirement portfolios and ride the greatest stock-market boom in history, with the prospect of a much bigger retirement payout than a traditional fixed-payment plan would offer.
Millions of industrial employees, in other words, were conscripted into the stock-market mania. When the party ended, Nortel, for one, had to confess its company pension plan had taken a $1 billion (U.S.) hit on the shrivelling value of Nortel stock that the company and its employees had contributed to the plan.
The carnage is widespread, as 44 per cent of U.S. employers opted to make their pension contributions entirely in company stock. That stock has since plummeted by anywhere from 40 per cent (General Electric Co.) to 90 per cent (Sun Microsystems Inc.).
At the now-insolvent WorldCom Inc., CEO Bernie Ebbers demanded that employees show their faith in the company by lining their nest eggs with WorldCom stock, an exhortation that helped goose the stock price, given WorldCom's status as one of America's largest employers.
At now-insolvent Enron Corp., rank and file employees were stopped from selling company stock in their retirement accounts during a "blackout" period imposed by the company as the stock went into freefall in late 2001. At the same time, higher-ups such as founder Kenneth Lay were hastily dumping their own Enron stock.
Wall Street analysts are furious that the ticking pension bomb wasn't discovered before it went off.
Current methods for auditing pensions "have led to misleading financial statements that paint a rosy picture as the health of pension plans deteriorates," complains David Zion, accounting analyst at Credit Suisse First Boston.
In Canada, reformers are calling for more thorough and timely corporate disclosure of pension shortfalls, and of the overly optimistic projections that many firms use in calculating expected returns on pension assets.
And the U.S. Financial Accounting Standards Board is canvassing public opinion on the need for new rules to identify hazards in corporate pension management.
But this is yet another case where early warning signals were ignored.
GM and other companies justified underfunding their pension plans by forecasting overly aggressive returns of 9 per cent and 10 per cent on existing pension assets.
In a prescient Fortune essay in 2001, Warren Buffett wrote, "I would love to make a large bet with the chief financial officers of ExxonMobil, GE, General Motors and IBM, or with their actuaries and auditors, that over the next 15 years they will not average the rates they're postulating."
To put it mildly. GM expected a 10 per cent gain on pension assets in 2002, and instead suffered a 7 per cent loss. That's a 17 per cent swing that should cost someone his or her job.
Obviously, the remarkable meltdown in pension-fund assets is an indictment of the money management profession, where pay for investing sages rarely dips below the high six figures. More culpable, though, are CEOs who, for personal gain, put their current and future retirees at undue risk by starving pension funds during the good times and failing to set aside reserves for the day when Newton's laws will reassert themselves in the market.
Buffett would prefer a public flogging of self-interested CEOs than a brace of after-the-fact reforms. As he wrote a few months ago, "The most flagrant deceptions have occurred in stock-option accounting and in assumptions about pension fund returns.
"To clean up their act on these fronts, CEOs don't need `independent' directors, oversight committees or auditors free of conflicts of interest. They simply need to do what's right.
"They don't need studies or new rules. They just need to act." |
