morally bankrupt

looking at the social costs of the
bethlehem steel reorganization

Speech before the Great Lakes chapters of the Turnaround Management Association

© by Mark Reutter

Posted 8/30/06

From fewer than 700 members in 1990, the Turnaround Management Association (TMA) has expanded to include more than 7,000 members and 35 chapters worldwide, underlining the boom in bankruptcy restructurings. TMA’s goal, according to its website, is “the restoration of corporate value,” and its practitioners include lawyers, bankers, accountants, appraisers, auditors, human resource consultants, distressed-debt financiers, and tax consultants who provide professional services for troubled companies, many of them in Chapter 11 bankruptcy.

About 120 professionals showed up at the 5th Annual Great Lakes Conference (May 18-19) at the Holiday Valley Mountain Resort in western New York. Some came from as far away as Denver and Boston, but the bulk were from the five TMA chapters that sponsored the event: Cleveland, Detroit, Pittsburgh, Toronto, and upstate New York.

While several participants later said that it “took guts” to address this group, I saw no evidence of switchblades anywhere (there were plenty of golf clubs, however). As befits well-educated and successful professionals, the members were cordial during evening cocktails and even curious about a journalist-author in their midst. “Many of us are still wondering what happened to the steel industry,” said Beverly Weiss Manne, the conference organizer and a lawyer at Tucker Arensberg in Pittsburgh, who had invited me to give the keynote speech the following morning.

I couldn’t help but notice that some members, washing down their scrambled eggs with coffee, looked shocked during the first minutes of my talk. But quite a few of them seemed to grow interested in the story that I was telling. The audience responded by asking some probing questions.

Asked how retiree benefits could be better protected in corporate reorganizations, I suggested that retirees be given equity positions in the reorganized company to offset reduced pensions and the loss of benefits. In this way, retirees could participate in the “upside” of any recovery.

Panel member Joseph R. House, manager of Corporate Finance and Restructuring at the federal Pension Benefit Guaranty Corp. (PBGC), said that an equity stake for “harmed parties” (i.e., retirees) was “a very novel idea, and if presented to the right people in the current environment, it could have legs.” Hopefully, Mr. House and his colleagues at PBGC are seeking out those people. Two other panelists commended my talk for raising “important ethical issues” that, they said, are rarely brought up during the long hours and tense negotiations of Chapter 11 proceedings.

Panel moderator James E. Van Horn of McGuireWoods, Pittsburgh, wrote afterward, “I am very happy you were able to speak to our group because I received a lot of positive feedback from folks regarding your talk and the issues you raised.”

Here is the text of the speech, edited for publication:

It was three years ago on March 24, 2003, when 71-year-old Rudolph Woods found out that the secure retirement he had counted on was about to disappear. On that day, Judge Burton D. Lifland of the U.S. Bankruptcy Court of the Southern District of New York approved Bethlehem Steel’s plan to stop paying medical benefits to its retirees and dependents.

Mr. Woods, an Army veteran, had worked for 40 years at the steel plant at Sparrows Point outside of Baltimore, before retiring in 1996. Now he was sick. A third stroke had left him confined to a wheelchair when he came to the Steelworkers Hall in East Baltimore to hear the news about the termination of benefits. “It’s a shame after the years of working for them that they sell us down the drain and throw us away,” he said. (1)

Jesse Godwin, age 84, walked into the union hall with the help of two canes and his daughter. Four decades of working in the tinplate mill had taken its toll on more than his legs. He had diabetes and congestive heart failure. Stanley Dondalski was hooked up to a small oxygen tank with tubes that ran into his nostrils. He had worked at Sparrows Point for 39 years, and now he suffered from asbestosis.

On “Black Monday 2003,” 95,000 retirees and dependents of Bethlehem Steel lost their health-care and life insurance benefits, effective April 1, 2003. Their numbers included not just unionized blue-collar workers, but also salesmen, secretaries, engineers, mid-level managers, and lawyers. Several thousand of them live not so far from this resort center around the once enormous mill at Lackawanna, N.Y.

Others lived in Pennsylvania – Johnstown and Conshohocken, Steelton and Bethlehem – as well as in Indiana and in the Iron Ore Range of Minnesota.

To be sure, the fallout from the largest bankruptcy in the American steel industry was not limited to retirees. Over the previous 15 years, Bethlehem common stock – once the bluest of blue chips – lost 99.6 percent of its value, which wiped out thousands of shareholders. Suppliers also were affected by Bethlehem’s unpaid bills, and some of them also tumbled into bankruptcy.

But the fate of the 95,000 seniors was most striking given that the former Bethlehem mills were operating profitably within months of their May 2003 sale to the International Steel Group, a company formed by New York financier Wilbur Ross to buy steel companies out of bankruptcy.

Ross had purchased Bethlehem as well as LTV of Cleveland in prearranged asset sales that followed the termination of the predecessor companies’ medical benefit plans. The companies’ underfunded pensions also were terminated and shifted to the PBGC. In the five years prior to the termination of Bethlehem Steel’s pension plan, the company had contributed a mere $71.3 million to the plan.

At termination, PBGC was left with the responsibility of paying $4.3 billion in unfunded liabilities promised to Bethlehem retirees. In terms of health-care benefits, the asset sale signed off by Beth Steel’s CEO and board of directors wiped away $3 billion worth of retiree health-care obligations – or more than double the entire $1.4 billion price that the Ross group paid for the assets of the nation’s second largest steelmaker. (2)

A generation ago, most executives would have sooner committed suicide than betray the trust of their retired employees. But in the new century, retirees have become targets of “heads-I-win, tails-you lose” Chapter 11 reorganizations.

About 150 major public corporations are now in some stage of Chapter 11 reorganization. This includes two of the nation's leading airlines and the world’s largest auto-parts maker, Delphi Corp. Steve Miller, who orchestrated the Beth handover to Wilbur Ross as the steelmaker’s chairman and CEO, predicts that Chapter 11 cases will only grow in the future.

Bankruptcy is a growth industry, Miller told the Detroit Economic Club in a speech in April 2006. Miller was hired last year as CEO of Delphi and promptly placed the auto-parts maker into Chapter 11.

So why the surge in corporate bankruptcies when the economy has expanded steadily since the 2001 recession?

The explanation heard most often is twofold: global competition and out-of-control “legacy” costs. Competition from low-wage assembly plants in China and Mexico is making life difficult for American manufacturers. But many of the wounds are self-inflicted. And Chapter 11 encourages clever guys like Miller and Ross to game the system.

Miller is emblematic of the shifting nature of bankruptcy law from a court of last resort to a venue of choice for sophisticated moneymen. Boasting an MBA from Stanford and a law degree from Harvard (despite the Harvard degree, he flunked the Oregon bar exam), Miller retired as vice chairman of Chrysler in 1992 to embark on a second career as a “serial CEO.”

Before taking the reins at Delphi, Miller was CEO or chairman or both of construction company Morrison Knudsen; auto-parts maker Federal-Mogul; trash-hauler Waste Management; insurance company Aetna; and steelmaker Bethlehem. In most cases, Miller headed each company for a very brief period, averaging about 18 months, just enough to steer the company through Chapter 11. Miller also sits on the board of United Airlines and played a pivotal background role in the contentious Chapter 11 reorganization of UAL, United’s parent.

Matching this “serial CEO’s” experience on the other side of the bankruptcy process is Wilbur Ross. A veteran Rothschild banker, Ross left the international private banking house amicably in 2001 to form his own boutique buy-out firm, W.L. Ross & Co., to buy distressed properties.

Ross first attracted notice in 2002 when he purchased the assets of LTV, the Cleveland steelmaker. The company had filed for bankruptcy in December 2000. Its collapse seems to doom steelmaking in Ohio’s Cuyahoga Valley. The bankruptcy judge had authorized the company to bank the furnace fires and liquidate. At this dire moment, Ross entered as the company’s deep-pocket savior. He formed ISG to take over the company’s physical assets, but not the health-care coverage of its 40,000 retirees.

He offered a little more than $300 million for assets with a book value of $2.5 billion. Because the retirees were unsecured creditors of the LTV estate, and the estate had nothing to offer them after accepting Ross’ offer, they were stripped of their health-care benefits. With the approval of the United Steelworkers president Leo Gerard (advised by former Lazard Frères banker Ron Bloom), Ross cut 4,000 of the 7,000 jobs and restarted operations.

The press hailed this move as brilliant, and, donning a Steelworkers hardhat, Ross declared himself a patriotic businessman seeking to save American steel from the ravages of global competition.

Ross performed the same financial operation on Bethlehem Steel a year later. He offered CEO Steve Miller $1.4 billion for the mills so long as Miller first chopped off the retiree health benefits. (Bethlehem’s pension plans had already been terminated and taken over by PBGC).

So on March 24, 2003, Miller dispatched a phalanx of lawyers to the courtroom of Judge Lifland. Detailing Bethlehem’s financial losses, the lead lawyer told the judge, “From day one, the public message has been that this company could not survive under the burden of its legacy costs.”

Thus stage-managed and approved by the court, Bethlehem was relieved of its retiree costs, and sick men in wheelchairs – men like Rudolph Woods – were hustled to the union hall and told that they were expendable.

It was one of those disembodied tactics of modern business life in which there is no apparent crime, only victims – 95,000 Americans in this case, who were left stranded between private medical insurance costing $10,000 or so a year and Medicare.

In his speech before the Detroit Economic Club, Miller pronounced the Bethlehem reorganization “a success story” and a model for future turnarounds. When Miller left Bethlehem, complimenting himself for another mission accomplished, he said: “I had two objectives. One was to put the plants in safe hands. The other was to do the best I could for the retirees. The second, I didn’t achieve. I was disappointed for the retirees. But there was no way to generate the millions needed to take on the legacy costs. That dog won’t hunt.” (3)

So the “dog won’t hunt” because the money just wasn’t there? Let’s look at what happened since Ross’ ISG bought these properties. On October 25, 2004, Ross struck a deal with Indian industrialist Lakshmi Mittal to sell ISG for $4.5 billion.

When the dust settled, Ross personally cashed out with $267 million in stock profits. He took half that amount in cash and half in Mittal Steel stock when the transaction was completed on April 13, 2005.

The sale ended a period of great activity by W.L. Ross & Co. In December 2003, Ross had arranged an IPO (initial public offering) to turn ISG into a public company that was traded on the New York Stock Exchange. Almost immediately thereafter, W.L. Ross & Co. began selling its 33 percent stake in ISG.

When ISG was private, Ross had paid an average of $3.42 for each share, but he sold the shares to institutional investors at between $25 and $35 each (the price range of ISG stock on the New York Exchange). These sales netted the so-called Ross Recovery Funds at least $800 million in profits even before his sale to Mittal.

Now let’s look at what happened to those who were left behind. The 95,000 retirees of defunct Bethlehem Steel collectively lost $380 million in health benefits between the time when Judge Lifland terminated the benefits and when Ross agreed to sell the former Bethlehem assets to Mittal.

Over the same period, PBGC paid out roughly $500 million to maintain a reduced level of pension benefits for ex-Bethlehem retirees. Roughly $200 million more in PBGC funds went out to 40,000 retirees at LTV and the 10,000 retirees at Weirton Steel, which also shed their legacy costs before these assets were bought by ISG.

In back-of-the-envelope terms, about 145,000 Americans and PBGC had to absorb about $1.1 billion in losses arising from Wilbur Ross’ rescue of the steel industry. Lord help the next group of Americans to get saved by Wilbur Ross.

What’s important to remember is that Ross did next to nothing to improve the properties he purchased out of bankruptcy. Little capital investment was made by ISG during its three-year span as a steel company. Nor did ISG develop new markets for steel or find any new innovative niche for its products.

Instead, Ross kept the mills running and, bolstered by rising steel prices, diverted the cash flow that had been going to retirees and a larger workforce to himself and his co-investors. These co-investors, by the way, were not little old ladies from Dubuque. They were savvy insiders such as Michael F. Price, whose Franklin Mutual Advisors scored a seven-fold gain when its ISG stake was sold to Mittal. I guess it’s these kinds of fabulous returns to the very rich that prompted Steve Miller to call the Bethlehem bankruptcy a success story.

Is there an alternative path? Bethlehem Steel’s longtime competitor, U.S. Steel Corp., did not go the Chapter 11 route, did not ditch medical benefits to its retirees, and did not burden PBGC with a huge pension shortfall.

In 2004, U.S. Steel paid $325 million for pension plans and other post-retirement benefits for its U.S. workforce, while reporting record earnings of $1.1 billion. In the same year, U.S. Steel’s common stock rose 46 percent. Here was a company that benefited all of its stakeholders without media fanfare and without Chapter 11 smoke-and-mirrors. (4)

The opposite of turnaround is breakdown. If turnarounds rend and unravel the social safety net and make a mockery of fair play and justice, the reaction of the American workforce and electorate may be unlovely to behold. If the finance and legal boys keep pushing it in Chapter 11s, there is the clear and present danger of a “cram down” on the order of Sarbanes-Oxley – a true SOX to your own source of income. (5)

TMA’s stated goal is the restoration of corporate value. Value is more than dollars and cents. The Bethlehem case amounts to an example of moral bankruptcy – an example of high-status professionals adopting a win-at-any-cost ethic, an example of how the earned benefits of many Americans were subordinated to the profiteering of a few deep pockets who cynically threw a lifeline to a company mired in a depressed steel market.

What to do? For starters, TMA can appoint study groups to identify practices that are abusive or amount to conflicts of interest. You can establish rules of professional conduct that break up the current temptation for investment bankers and management insiders to team up against creditors and labor during Chapter 11 workouts. And you can adopt a “code of rights” for employees and communities affected by these gut-wrenching reorganizations.

In short, you can act before political scandal erupts in the restructuring world, as it surely will if Delphi and General Motors and other big corporations head down the same route as the Bethlehem Steel reorganization.

As a longtime TMA member recently pointed out, “Bankruptcy should not be done just on the backs of labor. It should be treated as a shared problem, and everybody needs to make a concession.” (6)  The author of this statement? Wilbur Ross, who should be called upon by members of this organization to back up his fine words with action.

Notes

1. Baltimore Sun, March 25, 2003.

2. Testimony of Steven A. Kandarin, executive director of PBGC, before U.S. Senate Special Committee on Aging, October 14, 2003.

3. Transcript of Miller speech, April 3, 2006. As Miller spoke at the Masonic Temple of Detroit, 130 Delphi workers protested his leadership in the rain outside. Miller’s “two objectives” came from an interview published in Allentown (Pa.) Morning Call, April 30, 2003.

4. From U.S. Steel press releases for 2004 financial results.

5. In corporate finance, a “cram down” is a transaction in which stockholders of a bankrupt company are forced to accept undesirable terms due to the absence of any better alternatives. SOX is the nickname for the 2002 Sarbanes-Oxley Act, passed in response to the financial and accounting scandals at Enron, Tyco, and WorldCom.

6. Detroit Free Press, October 17, 2005.