- Martha Stewart may be heading to prison because she sold
stock after learning that a company was failing for a reason that was out
of her and other company officials control. Martha Stewarts Company was
playing by the rules, a product they invested a lot of money in failed
to be certified as safe by the Government so they knew the stock would
fall. If the following allegations are true, George Bush's profit was due
to underhanded accounting practices inflating the value of the stock, before
selling at a huge profit. Who should be in jail? Martha Stewart for selling
before her stock tanked for legitimate reasons? Or George Bush for profiting
from selling stock thatís value was inflated by Enron-style accounting
practices? --smg
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- Bush's Insider Connections Preceded Huge Profit
On Stock Deal
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- By Knut Royce
The Center for Public Integrity
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- It has been widely reported that Texas Gov. George W.
Bush made money over the years with a little help from his friends. But
new details show that he served on an energy corporationís board
and was able to realize a huge profit by selling his stock in the corporation
because an accounting sleight-of-hand concealed it was losing large sums
of money. Shortly after he sold, the stock price plummeted. That profit
helped make him a multimillionaire.
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- The year 1986 was very good for George W. Bush.
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- After a decade of striking Texas brown dust instead of
oil, his luck finally turned that year when go-for-broke Harken Energy
Corp. bought his failing oil exploration firm for stock. Four years later
the company concealed large losses just before the GOP presidential hopeful
unloaded those securities for a nice profit. That, in turn, helped finance
his stake in the Texas Rangers baseball club and catapult him into the
ranks of multimillionaires.
-
- And it was in 1986, too, that Harkenís CEO introduced
Bush, the companyís new director and consultantóas well as
son of then-Vice President George Bush--to a little startup health-care
company. He put in a modest investment, and a few years later walked away
with a six-figure windfall.
-
- There also was a little benefit on the side. In 1994,
when Bush was running for Texas governor, and scrambling for campaign cash,
insiders in that health-care company, now known as Advance Paradigm, contributed
$23,700.
-
- Bushís sale of the Harken stock in 1990 attracted
the attention of regulators and the national media because he was tardy
in filing the required public disclosure, and because the trade came shortly
before the company reported for the first time that it was incurring huge
losses.
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- Hemorrhaging Concealed
-
- But The Public i has found that Harken was bleeding profusely
even before Bush unloaded his stock. Harken effectively concealed the hemorrhaging
by selling a retail subsidiary through a seller-financed loan but recording
the transaction in its 1989 balance sheet as a cash sale. Securities and
Exchange Commission records suggest that Bush, a company director who sat
on Harkenís audit committee and was a paid consultant to the firm,
may nonetheless have been unaware of the sleight-of-hand accounting or,
for that matter, other significant company actions Nevertheless, SEC accountants
cried foul when it discovered Harken had recorded the 1989 sale as a capital
gain.
-
- But it was months after Bushís June 1990 sale
of the stock at $4 a share, for a total of $848,560, that the SEC directed
Harken to recast its 1989 annual report and to publicly disclose the extent
of its losses that year, according to records reviewed by The Public i.
-
- It is unclear how a timely acknowledgement of the true
losses would have affected the value of the stock when Bush sold. But most
investors look at a companyís balance sheet, among other indicators
of corporate well-being, before parting with their money.
-
- Two months after Bushís sale, Harken reported
for the first time in a quarterly report that it was losing a lot of money,
and the stock dropped to $2.37 a share. By the end of the year, it was
trading at about $1.
-
- Harken masked its 1989 losses when in mid-year it sold
80 percent of a subsidiary, Aloha Petroleum, to a partnership of Harken
insiders called International Marketing & Resources for $12 million,
$11 million of which was through a note held by Harken. By Jan. 1, 1990,
IMR, in turn, sold its stake in Aloha to a privately held company called
Advance Petroleum Marketing, and the Harken loan was effectively transferred
to Advance, though garanteed by IMR.
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- ëGeorge and I Became Friendsí
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- Advance Petroleum was headed by a Texas entrepreneur,
David Halbert, who had been a friend and business partner of Harkenís
CEO, Mikel Faulkner. In 1986, Faulkner had introduced Harkenís newest
director, Bush, to Halbert. Harken, in a stock swap, had just acquired
the ailing Spectrum 7 Energy Corp., where Bush had been CEO and a significant
shareholder.
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- ìGeorge and I became friends,íí
recalled Halbert in a telephone interview with The Public i. Halbert said
that at the time Faulkner introduced Bush to him he had just formed a little
home-health-care firm, Allied Home Pharmacy, and was in the process of
raising $250,000 in seed money.
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- ìMikel said (to Bush), ëHey, you might want
to invest in this,íî Halbert recalled. ìI said fine.
I donít remember how many people we brought in, but it wasnít
that many. Maybe 25 or 30 . . . It was sort of friends and family, and
George invested.íí So did Faulkner. Halbert said Bush also
put in a little more money in an offering to existing shareholders in 1991.
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- Halbert said he did not recall how much Bush invested
in the company.
-
- Allied Home Pharmacy became known as Advance Paradigm,
one of the nationís leading pharmacy benefits management companies,
when it went public in 1996. Two years later, Bushís trust sold
his stock in the firm.
-
- Public records give no precise amount of how much he
earned on the Advance stock sale, but Bushís financial disclosure
form made public last year shows that he realized a capital gain, or profit,
of as much as $1 million on the sale. Asked how much the Texas governor
paid for the stock and how much he profited from the sale, spokesman Scott
McClellan referred all questions to the manager of Bushís blind
trust, Robert McCleskey. McCleskey declined to discuss his clientís
investment in the Advance stock. He said that under the terms of the Texas
blind trustóa legal requirement for the governor but less rigorous
than the blind trust that applies to federal executive branch officersóhe
cannot tell even Bush how much profit he made on the sale.
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- SEC Probe Was Limited
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- The SECís division of enforcement launched a probe
of Bushís sale of his Harken stock the day after the Wall Street
Journal on April 4, 1991, reported that he had been eight months late in
filing the required insider-trading form with the regulators. This investigation
was separate from the earlier division of corporation finance probe that
resulted in Harkenís recasting its 1989 balance sheet.
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- SEC enforcement investigators focused on whether Bush
dumped his stock on June 22, 1990, because he knew that the companyís
second-quarter report, announced on Aug. 20, would show a $23.2 million
loss and depress the stock. Part of that loss was $7.2 million that Harken
wrote off because it was being pressed by a nervous bank and renegotiated
the Aloha sale to generate quick cash. Alohaís buyer, Advance Petroleum,
was a clear winner in the renegotiated deal.
-
- The SEC probe was limited to whether Bush had inside
knowledge of the red ink that would be reported in the August filing and
concluded that he did not.
-
- It is unclear whether Bush, who holds a masterís
degree from the Harvard Business School, knew that the company, after five
straight years of profits, began to bleed profusely in 1989, its first
year of being traded on the New York Stock Exchange, though in its annual
report for that year it had declared a net loss of only $3,300,000.
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- Even that small loss would have surprised readers of
the January 1990 issue of National Petroleum News, a trade publication.
Interviewed some time during the fourth quarter of 1989 for a lengthy and
glowing article on Harken, company president Faulkner said that based on
the strong earnings during the first three quarters, he expected that year
to be the most profitable yet. ìWe made $6 million last year (1988)
. . .Weíll certainly be ahead of last year.íí
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- Alas, a year later, in an amended 1989 annual report
filed on Feb. 5, 1991, the company reported that after ìdiscussionsî
with the SEC, which insisted that Harken use the traditional ìcost
recoveryíí method of accounting, it was revising its declared
1989 net loss of $3,300,000 fourfold--to $12,566,000. Harken also filed
an amendment to its third quarter report for 1989 revealing that over the
first nine months of that year it had lost nearly $4 million, rather than
the $4.6 million profit it had declared.
-
- Faulkner, now Harkenís chairman, did not return
repeated calls from The Public i seeking comment on the Aloha sale and
the subsequent public filings.
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- Company Directed to Correct Reports
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- The SEC can prosecute company officers for willfully
filing fraudulent reports. But in the Harken case, as in most similarly
questionable filings, the investigation was conducted by the agencyís
accounting staff, which did not believe there was intent to defraud and
therefore did not refer the matter to the SECís enforcement division.
Instead, the agency directed the company to publicly correct its reports,
according to a retired SEC official familiar with aspects of the case.
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- It is also clear that Harken did not draft the misleading
1989 annual report, filed with the SEC on April 16, 1990, merely to buttress
the value of Bushís stock. The filing date was two months before
the company reported it became aware that Bush wanted to sell.
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- In its 1989 annual report, Harken recognized a profit
of $8 million on the sale, which allowed it to limit its declared losses
to only $3,300,000 for the year. But the SECobjected, saying that the income
can be recognized only as the principal of the loan is reducedóthat
is, when real cash comes in.
-
- A corporate accountant interviewed by The Public i agreed
with the SECís claim, saying he found it ìunusualíí
for a company to declare an earning on the sale when it is contingent on
a loan. The accountant, who asked to not be further identified, said he
knew of no other instance when a company declared full gain on a sale based
on a loan.
-
- Why Harken initially sold to IMR is unclear. But a senior
tax lawyer who works for a leading auditing firm told The Public i after
reviewing portions of the SEC filings that he believes Harken wanted to
show a cash infusion to mitigate the 1989 losses.
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- ìIt looks like the sale was done (to IMR) in order
to show a book gain of $7 or $8 million,íí said the attorney,
who also asked not to be further identified. ìThat would have eliminated
a good part of their loss during that time. Given the fact that the sale
was to a related entity, I would guess they were just trying to show a
better financial statement at that time.íí
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- Advanceís Halbert said that he believes IMR bought,
and then quickly sold, Aloha because of a sudden change of heart. ìI
think it had something to do with IMR wanting to own it [Aloha] but there
was some concern about the affiliate relationship [between Harken and IMR],íí
he said.
-
- The SEC, too, was curious about the transaction, according
to agency records obtained under the Freedom of Information Act.
-
- Six weeks before Harken publicly announced in January
1991 that it was revising its 1989 losses upward, the SEC asked the company
to explain ìwhether the sale of Aloha to Advance was contemplated
at the time IMR purchased Aloha from Harken.íí In a letter,
it also asked Harken to explain why the company and its independent accountants
concluded it could declare a capital gain on the sale.
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- The SEC declined to provide Harkenís responses
to The Public i.
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- Conflicting Accounts Offered
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- In its public filings to the SEC, Harken gave conflicting
accounts of who sold Aloha, who bought it, and even when the sale occurred.
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- In its 1989 annual report, for example, it declared that
it sold Aloha to IMR on June 30. In one passage of the report, it says
that IMR then sold Aloha to Advance on Jan. 1, 1990; in another it says
IMR sold on March 30.
-
- But in its 1990 report, Harken declared that it was its
subsidiary E-Z Serve Holding Co. that sold Aloha to IMR.
-
- Adding to the confusion, E-Z Serve, which shortly after
the transaction was spun off as a separate publicly traded company, claimed
in its 1991 annual report that it had sold Aloha to Advance Petroleumónot
IMRóin 1989.
-
- Harken was notorious during that period for filing confusing
reports. In 1991, Harken founder Phil Kendrick told Time magazine that
the companyís annual reports ìget me totally befuddled.ííQuoted
in the same article, Faulkner had this advice to those trying to figure
out the companyís financial statements: ìGood luck. Theyíre
a mess.íí
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- The corporate fog did not, however, obscure the fact
that by the time the SEC directed Harken to recast its 1989 report, Bush
already had already sold his stock in the company.
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- The bulk of the $848,560 went to pay off a bank loan
he had taken out in 1989 to buy a partnership interest in the Texas Rangers
for $600,000. He received nearly $16 million for his stake when the team
was sold two years ago.
-
- Bushís run of financial good luck starting in
1986 is in stark contrast to the woeful performance of his previous oil
ventures, which he had launched in 1977. Though he had little difficulty
in rounding up investors for his Arbusto, Bush and Spectrum 7 oil exploration
firms, they were all money losers.
-
- Even as Harken in late 1989 and early 1990 appeared to
be trying to minimize its losses, its bankers were clamping down because
the company was having trouble meeting its loan payments.That led to a
renegotiated loan agreement in May 1990, which required Harken to come
up with fresh cash, raised the interest rate, required new guarantees from
major shareholders and featured stricter terms overall.
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- ìAfter closure (on the sale of Aloha) Harken discovered
they had trading losses on gasoline purchases and they came back to us
and said, ëWe really need some cash,íî Halbert recalled.
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- Cash Raised in Nick of Time
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- Halbert said he was able to raise the cash in the nick
of timeójust three days before Iraq invaded Kuwait, setting in motion
huge gasoline-price increases that drove numerous small distributors out
of business.
-
- Under the original contract, Harken had given Advance
an option to purchase the remaining 20 percent of Aloha, or 60,000 shares,
for $50 each, or a total of $3 million.
-
- By the time the contract was renegotiated in August,
Advance agreed to pay off the $10 million note by the following year, which
it did, instead of in March 1993 as stipulated in the original contract.It
also relieved Harken from picking up the cost of fixing leaking underground
tanks to meet environmental standards.
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- In turn, Advance got the $3 million of Aloha stock for
$1. Harken also forgave $5 million in loans it had made to Aloha and about
$1 million in interest payments.
-
- The renegotiated contract reduced Harkenís bottom
line, and the SEC clearly believed the write-off might have helped depress
the stock. During its investigation of whether Bush benefited from insider
information when he sold his stock, the SEC on July 25, 1991, asked both
Bush and Harken to disclose when the companyís officers and directors
ìfirst became aware . . . that the Advance note . . . was going
to be renegotiated; and that Harken intended to write down its investment
in Aloha.íí
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- Unaware of Magnitude
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- After the SEC ended its investigation, according to one
of its memos, the regulators concluded that Harken and Bush were unaware
of the magnitude of the write- downs until at least mid-July, or after
Bushís stock sale.
-
- While the renegotiated contract clearly hurt Harkenís
bottom line, Halbert admits it clearly was beneficial for Advance Petroleum.
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- Meanwhile, Bush was generating admirers among Advance
Paradigmís insiders, the limited number of shareholders.
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- In 1994, when the company was known as Advance Health
Care and Bush was making his first run for Texas governor, those insiders
gave him $23,700 for his first gubernatorial run, including $14,500 from
Halbert, his brother, Jon, their father and their wives. Virtually all
the money came on the same day, July 22.
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- ìThat was his first time around, and he was trying
to raise money any way he could,íí recalled Halbert.
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- And, as has been the case throughout Bushís career,
a long-time friend of the family came to his aid.
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- This time it was Benno C. Schmidt, the pioneering venture
capitalist and partner in J. H. Whitney & Co. in New York. Schmidt,
who died last October at age 86, had been a director of Advance Health
Care, and J. H. Whitney had provided the firm with much needed capital
in 1993.
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- ìBenno was an old friend of the Bush family. He
called me one day and said, ëDavid, I think we ought to do something
for young George,íî Halbert recalled. ìHe said, ëI
think we ought to have a fund-raiser.íî
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- So after a board meeting on July 22, Bush spoke at a
private little dinner attended by the directors and their wives and walked
away that night with $20,750.
-
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- Knut Royce is a senior fellow at the Center for Public
Integrity.
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