[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

As the W$J reports here, with the PBGC on track to becoming one of the largest shareholders in several of this country’s basic industries, there’s not a lot of joy these days in the Pre-Termination Processing Division (PTPD) at the Pension Benefit Guaranty Corporation (PBGC). According to this article, the PBGC owns about 7% of US Air, and is expected to own between 15% and 35% of UAL upon emergence from chapter 11. Regarding the PBGC’s mounting exposure to pension plans terminated in bankruptcy, the WSJ reports:

PBGC’s assumption of corporate pensions is resulting in a sharply widening deficit. At the end of 2004, the PBGC had $62.3 billion in obligations and $39 billion in assets — a gap of $23.3 billion. The deficit could swell if the Chapter 11 filings of Delta, Northwest and Delphi lead them to offload unfunded pension liabilities on the agency. The Congressional Budget Office estimates that the shortfall will widen to $86.7 billion by 2015….
The shares in the reorganized [US Air] that were awarded by the court to the PBGC amount to compensation for the $2.3 billion in unfunded pension liabilities it took over….
If Northwest and Delta shed their pension plans, it could saddle the PBGC with an estimated $11.2 billion in new unfunded liabilities.
Moreover, the PBGC estimates that Delphi, the largest U.S. auto-parts supplier in terms of sales, has an unfunded pension liability of $10.8 billion — and that the agency itself would be on the hook for $4.1 billion.

In related news from the UAL bankruptcy proceedings, Pension Benefit Guaranty Corp. v. United Air Lines, Inc., (Bankr. N.D. Ill., 10/26/05), the Bankruptcy Court ruled on the PBGC’s motion for an order of the Court terminating the UAL Pilot Defined Benefit Plan (the “Pilot Plan”) and establishing 12/30/04 as the plan termination date. According to the PBGC, if the Pilot Plan continued just six more months, the PBGC’s liability upon termination would rise by as much as $138 million (an amount disputed by UAL and the Pilots Union). The Bankruptcy Court for the Northern District of Illinois, however, denied the PBGC’s motion for summary judgment, stating:

Continue Reading UAL’s Bankruptcy Court Shifts Burden of Establishing Grounds for Pension Plan Termination to the PBGC, Which Faces Ever Widening Deficits as Plan Terminations Mount