Last week, President Bush gave an impassioned speech about the need for greater honesty and integrity in corporate boardrooms. In his speech, delivered to 1,000 or so corporate executives in a Wall Street auditorium, the President noted: “At this moment, America’s greatest economic need is higher ethical standards.”
Will corporate executives take the President’s moral prodding seriously? Possibly. As former Securities and Exchange trial counsel Christian Bartholomew told CFO.com last week: “The President is putting his political capital behind all of the issues, which means corporate accounting problems have become mainstream.”
But corporate America’s enthusiasm for Bush’s “higher ethical standards” may wane as more details emerge about Bush’s own role as a director of Harken Energy Corporation in the late 1980s.
In fact, according to internal SEC documents recently uncovered by the Center for Public Integrity, a Washington, D.C.-based watchdog group, the President’s profits from the sale of Harken stock in 1990 may have resulted from the very behavior he condemned in his speech.
In a accounting treatment eerily similar to the bookkeeping “irregularities” that have led to the mega-restatements at both Enron Corp. and WorldCom Corp., management at Harken appears to have violated a basic accounting rule. And also like Enron and WorldCom: it appears Harken’s auditor, Arthur Andersen, as well as the company’s board audit committee, completely missed the error.
Pres. Bush was a member of the Harken audit committee at the time. But when reporters asked Bush to discuss Harken’s accounting practices, the President dithered. Eventually, he noted that, in accounting, “Things aren’t always black and white.”
Forced to Restate
To be sure, criticism about Bush’s sale of Harken stock — a sale that yielded the then-Harken board member $848,560 — seems overblown. While Bush did miss the deadline for disclosing the transaction, that notification is considered trivial by SEC regulators.
What’s more, Bush did comply with the SEC disclosure requirement concerning his intention to sell the Harken stock (a requirement regulators take much more seriously). And the president’s comments about the sale during a July 8 press conference were more or less consistent with what he’s said in the past about the transaction — a transaction that was vetted by the SEC years ago.
Still, Harken’s accounting treatment for its sale of a company called Aloha Petroleum clearly did not cleave to generally accepted principals of accounting. Harken sold its 80 percent stake in Aloha to Intercontinental Mining & Resources Ltd. (IMR) in June 1989. After the sale, Harken booked a one-time gain of roughly $8 million, reducing its total loss for the year to $3.3 million. (Bush sold his Harken common stock in May 1990, when the stock was trading at $4 per share.)
But shortly after releasing its earnings statement, the SEC required Harken management to restate the company’s results for 1989 because the accounting for the sale of the Aloha stake violated federal guidelines. As a result, Harken lowered its previously stated results, this time reporting a $12.6 million loss — almost four times the initial number.
Why the difference? Because the gain on the Aloha transaction should not have been recorded all at once, but rather over the course of several years.
Indeed, SEC documents show that Harken actually loaned IMR $11 million to finance the purchase of Aloha Petroleum. Since the buyer was highly leveraged (making repayment of the loan uncertain), SEC guidelines spelled out in Staff Accounting Bulletin 81 stipulate that the deal be accounted for under the “cost-recovery” method. Under the cost-recovery method, proceeds from a sale to a highly indebted company should only be booked as income when loan principal is repaid.
According to public records filed with the SEC, Harken was to receive no more than $3 million in principal payments no earlier than March 31, 1991, with the balance not due until two years after that. SAB 81 was issued on April 4, 1989 — about three months before the Aloha transaction.
Defer, Don’t Book
It would seem that any member of a board audit committee would be aware of that SEC bulletin — particularly since it had just been released and was in the news.
But at the press conference last week, Pres. Bush went to great lengths to differentiate the circumstances surrounding Harken’s restatement from those involving Enron. He pointed out that there was no malfeasance involved in Harken’s accounting error.
But so far, no malfeasance has been proved in Enron’s case, either. At the very least, Harken management’s sale of the company’s interest in Aloha raises similar questions about conflicts of interest between insiders and shareholders.
The restatement, for example, suggests that the energy company was in far worse shape in 1989 than management claimed it was. If Harken management — including Harken’s audit committee — had properly followed SAB 81 to begin with, it seems probable that the stock price would have traded at less than $4 a share.
In fact, a few weeks after Pres. Bush sold his Harken stock at $4 per share — raking in around $850,000 — Harken reported a $23 million loss. At that point, the stock price fell by more than 40 percent.
Moreover, IMR (the group that bought Harken’s 80 percent stake in Aloha) was run by — you guessed it — Harken senior management. Although CFO.com has not been able to track down an exhaustive list of principals of IMR, several of the company’s directors were Harken managers. As one accounting expert says, the Aloha deal resembled “a typical management buy-out.”
But, adds the expert, “in practice,” proper accounting calls for “the typical management buyout to defer reporting the gain.”
Yet on Jan. 1, 1990, a mere six months after it purchased the Aloha stake, IMR sold its stake to Advance Petroleum. Advance Petroleum, a company that held an option to purchase the remaining 20 percent of Aloha, was backed by a friend of the Bush family. Four years later, Advance Petroleum reportedly contributed to Bush’s first gubernatorial campaign.
Related Party Lines
While the Aloha transaction clearly enriched Bush, it wasn’t nearly as beneficial to other Harken shareholders — shareholders Bush had a fiduciary obligation to protect.
Under the terms of IMR’s sale of its interest in Aloha to Advance, Harken agreed to forgive $5 million in loans it had made to Aloha and about $1 million in interest payments. That resulted in write-offs that accounted for almost a quarter of the $23 million loss Harken reported just weeks after Bush sold his Harken shares.
In its investigation of the deal, the SEC concluded that Pres. Bush was unaware of the magnitude of the write-downs until afterward. Some critics point out, however, that Bush’s father was president at the time of the SEC inquiry.
One securities lawyer also notes that the younger Bush’s liability in the case ultimately depended on various factors, including the degree to which Harken’s audit committee vetted the mistaken accounting. “Of course a director has a fiduciary obligation,” says the lawyer, who asked not to be named, “but there’s a question as to why (the mistake) has occurred.”
Further, the Aloha sale took place long before the accounting debacles at Enron and WorldCom prompted calls for greater independence and expertise among board members serving on audit committees.
Still, it’s hard to get past President’s speech to corporate executives last week. In that oration, Bush called for a crackdown on executives who profit from stock sales because their companies “cook the books.”
Did Harken cook the books? Difficult to say. While the SEC never leveled charges against the company’s management, the Commission certainly took the energy specialist to task over its accounting for the Aloha Petroleum sale.
And to a few outside observers, the Aloha sale in 1989 — a sale which involved a loan to a purchaser that was run by the seller’s management — seems to look more like self-dealing than square-dealing. At the very least, the circumstances surrounding the selling of Aloha Petroleum to a related-party would likely fail to qualify as “higher ethical behavior.”