Following up to Part 1 of this series, from 1978 to 2008 the U.S. experienced a sustained period of corporate reform resulting in some of the most sweeping legislation related to corporate governance. This next discussion, Part 2 of the series, focuses on a few key events that occurred in the 1970s that led to the beginning of an era of sustained corporate reform.
Collapse of Penn Central
On June 21, 1970, the nation’s sixth largest corporation, the Pennsylvania Central Transportation Company (PC), became the nation’s largest bankruptcy. According to the Lehman Brothers Deal Books, “the Penn Central’s collapse has been called the biggest business failure in American history.”
Prior to the bankruptcy, PC reached out to the Nixon administration for support on the basis of the company’s vital support to the military. The U.S. Congress balked and no measures for assistance were authorized. The bankruptcy freed the corporation of its commercial paper obligations and, fearing another bank run on deposits, the Federal Reserve stepped in to provide the reserves PC needed to meet creditor obligations. A ProPublica special report on the History of U.S. Gov’t Bailouts reminds us of this unprecedented government intervention.
After several other railroad bankruptcies, the U.S. Congress passed the Regional Rail Reorganization Act of 1973 (3R Act). The 3R Act authorized the creation of the Consolidated Rail Corporation (Conrail) for the purpose of acquiring and operating bankrupt freight railroads. Following the PC bankruptcy, it became known that the financial debacle was not merely the result of changing economic conditions and alternative transportation technologies. According to reports from the Philadelphia Inquirer, PC’s CFO, David Bevan, along with 49 other company officials, paid $12.6 million to settle a stockholders’ suit accusing them of company mismanagement, falsifying financial reports and insider trading. Statements from Governor of Pennsylvania Chairman Stuart Saunders indicated the merger was more of a maneuver to gain more borrowing power to further PC’s acquisitions (read more at BuyandHold.com).
Franklin National Bank Bailout
From 1973 through 1975, the U.S. experienced the most severe financial crisis since the 1930s. Some of the financial events contributing to the crisis included the oil embargo of 1973, the collapse of the Bretton Woods Financial Monetary System, the bankruptcy and bailout of PC and the bailout of the 20th largest U.S. bank, Franklin National (FNB). In 1974, when FNB crashed, the FDIC, the Federal Reserve and the Office of the Comptroller of the Currency arranged a bailout of the uninsured creditors and depositors of FNB. As mentioned in a Heartland Institute article, the FNB bailout was a turning point in U.S. economic history. It was the first bailout of an individual institution deemed “too big to fail.”
A closer look at the FNB bailout reveals the collapse was in a large part due to an internal management failure. For more than 30 years under Arthur Roth’s leadership, FNB thrived as Roth helped transform the banking landscape with credit cards, installment loans, the “full-service bank” concept and drive-up windows. In 1970, Roth was ousted and replaced by Harold Gleason, and in 1972, Michele Sindona bought controlling interest in the bank.
According to an article in the Long Island Business News, “Sindona, an Italian financier with reputed connections to the mafia…siphoned off money and led the bank into massive losses in foreign exchange markets.” On October 8, 1974, the bank was declared insolvent due to mismanagement and fraud. In 1980, the U.S. convicted Sindona of fraud; he was extradited to Italy and later assassinated in an Italian prison.
1970s, the Business Watergate
Most people do not recall that the Watergate scandal of the 1970s was not solely about the transgressions of the Nixon administration. The Watergate special prosecutor, the SEC and the Church Committee (the U.S. Senate committee led by Senator Frank Church) exposed illegal election and campaign contributions from executives of companies such as 3M, American Airlines and Goodyear Tire & Rubber. The committee’s inquiry surrounding these contributions made known that a violation of federal security laws had occurred.
Further investigations revealed illegal payments and widespread foreign bribery involving companies such as Lockheed, Northrop and Gulf Oil. The November/December 2007 issue of the Corporate Research E-Letter reported that in the 1970s, executives at more than 400 U.S. companies admitted making over $300 million in questionable payments and concealed millions of dollars of offshore payments on their financial statements.
Corporate accounting records are the underpinnings of the financial disclosures, and the widespread misuse of corporate funds caused the SEC to doubt the reliability and integrity of the financial statements. Foreign bribery also undermines the foreign policy objectives of the United States to promote democratically accountable governments and professionalized civil services in developing countries (see more at the 1976 Senate Report Committee on Banking, Housing and Urban Affairs).
In 1977, Congress responded to the revelations by enacting the Foreign Corrupt Practices Act, a U.S. federal law commonly known as the FCPA. The FCPA has two primary provisions, one addressing accounting transparency requirements under the Securities Exchange Act of 1933 and another addressing bribing of foreign government officials. For the first time, bribery of foreign government officials was a criminal offense under U.S. law, with fines up to $1 million and prison sentences of up to five years. The FCPA was a pioneering statute and the first law in the world governing domestic business conduct with foreign government officials in foreign markets.
One common theme that all three of these events share is an underlying morality issue, the principles concerning the distinction of right and wrong behavior. According to The Story of the Foreign Corrupt Practices Act in a 2012 Ohio State Law Journal, Vol.73, the SEC did not want to be the “guardians of corporate morality” and wanted to defer that responsibility to Congress. In Part 3 of this series, I will highlight the significant financial tragedies of the 1980s and the corresponding legislation passed that continued a sustained era of corporate reform.