[This post was retitled to highlight its connection with prior criticisms of Moore v. Bay]
Arthur Levitt, Jr., the former chairman of the SEC, and perhaps its best chairman to date, sounded a stern warning in a lengthy op-ed in today’s W$J, entitled “Pensions Unplugged,” about the dire consequences sure to follow for America generally “unless immediate action is taken to bring accuracy, transparency, and accountability to pension accounting.” He begins:

As the wave of pension defaults that began with the steel companies and the airlines now threatens to engulf auto-parts makers and even car companies themselves, the pension crisis has grabbed headlines. Proposals to shore up the Pension Benefit Guaranty Corporation (PBGC) are making their way through Congress. Meanwhile, the problem — in the private and the public sector — will only get worse unless immediate action is taken to bring accuracy, transparency and accountability to pension accounting.
Over the past three decades, we have allowed a system of pension accounting to develop that is a shell game, misleading taxpayers and investors about the true fiscal health of their cities and companies — and allowing management to make promises to workers that saddle future generations with huge costs. The result: According to a recent estimate by Credit Suisse First Boston, unfunded pension liabilities of companies in the S&P 500 could hit $218 billion by the end of this year. Others estimate that public pensions — the benefits promised by state and local governments — could be in the red upwards of $700 billion.
Claims on the PBGC have skyrocketed. If serious reform is not undertaken, the non-partisan Center on Federal Financial Institutions estimates that the PBGC could easily face a $100 billion hole, delivering to our overburdened treasury a crisis exceeding the massive savings-and-loan bailout of the late 1980s. It’s imperative that we reform the regulatory incentives and accounting rules that encourage employers to make, and employees to accept, promises that can’t be kept.

He then outlines three critical steps that need to be undertaken if disaster is to be averted. These are:

First, “bring transparency and honesty back to pension accounting”;
Second, “investors and pensioners deserve relevant and understandable information from pension plans about their fiscal health and operations, not impenetrable financial statement footnotes”;
Third, “while the most recent headlines have focused on the impending crisis in corporate pension plans, there is perhaps an even larger problem with the public pensions of state and local governments. Not only are unfounded liabilities moving toward $1 trillion, but the accounting standards in this arena lag behind that of corporate America.”

Levitt’s final two paragraphs read more like a passage from the Book of Isaiah: a long passage detailing society’s prospective demise from its self-inflicted failings, followed by a few words of hope, rooted in the possibility — however unlikely — of effective human action. He writes:

Unrealistic pension assumptions already have gotten a number of public entities — such as the city of San Diego and the states of Colorado and Illinois — into economic difficulty, trouble that will spread if these impractical assumptions are not reined in. This past year, I have served as a member of the audit committee charged with investigating and remediating allegations of problems surrounding San Diego’s pension funds and finances. I have seen firsthand how devastating apparent examples of bad pension accounting and mismanagement can be, and how vital correcting both are to the overall health of the capital markets and the retirements of tens of millions of workers and retirees.

Untangling the web of problems plaguing the automotive and airline industries, as well as those of municipalities and states, has not been easy. Putting their pension plan and finances on sound footing will require great sacrifice for all affected: investors, employees, management and citizens. To avoid the pain that Delphi and San Diego are undergoing, we must now place defined-benefit pension plans on solid ground. Doing so may be difficult for many cities and companies. But it will be very good for America.

We can only hope that this country’s politicians, bureaucrats, and corporate and union stewards will heed Mr. Levitt’s passionate call for action.
What does this have to do with bankruptcy litigation? A lot, actually. As often noted on these pages (including here and here), bankruptcy courts can be expected in the coming years to enter orders terminating pension plans, leaving the PBGC and us taxpayers holding the bag.
Also, if he’s right, as we know he is, then large numbers of companies are likely presently insolvent (at least from a balance sheet perspective, if not from an “equitable” or cash flow perspective). Split-offs, spin-offs, divestitures, and the like that have been or will be consummated by these insolvent companies may well be challenged years later by trustees in bankruptcy (or their post-confirmation equivalents) asserting that these transactions were constructive fraudulent transfers because the companies were insolvent at the time of the transaction and received less than “reasonably equivalent value” in exchange.
Given the unjust, but universally-acknowledged, rule of Moore v. Bay (referenced here, here, and here), any such transaction that is avoidable under state law as to even just a single creditor is avoidable to the full extent of the transaction’s value for the benefit of the entire estate (thus providing significant numbers of creditors with a bankruptcy windfall that would otherwise be unavailable under applicable state law).
Hence, for those contemplating vulture-style purchases of assets from companies that are technically insolvent based on their real (i.e., understated) pension liabilities, carefully consider Arthur “Isaiah” Levitt’s stern admonitions, for they carry another simple, implicit message: CAVEAT EMPTOR! (or, alternatively, consult your preferred bankruptcy advisor).
Steve Jakubowski
© Steve Jakubowski 2005