A Formula for Errors: Deferred maintenance, outsourcing, and stock fraud

A Formula For Errors Deferred maintenance, outsourcing, and stock fraud Stephen P. Prentice You might wonder why or how deferred maintenance and outsourcing has anything to do with stock fraud. Well, in this case it does. Read on...


A Formula For Errors

Deferred maintenance, outsourcing, and stock fraud

Stephen P. Prentice
Stephen P. Prentice

You might wonder why or how deferred maintenance and outsourcing has anything to do with stock fraud. Well, in this case it does. Read on . . .

The lawsuit
On March 3, 1999, long before Enron and similar cases came on the scene, the Teamster Joint Council Trust Fund (mechanics union) filed an action in the U.S. District Court of Arizona against an airline, its major shareholders, and some of its officers and directors. The Teamsters Trust Fund owned shares along with mechanics and others in this airline. The case alleged that the company made misleading statements to artificially inflate the value of its stock at the same time that controling shareholders engaged in "insider trading" making millions of dollars of profit, that is, they "bailed out" at the top. This is called a securities fraud class action case. The allegations were that the federal laws governing insider trading were violated. You may recall from recent news events following the Enron case that this is a hot topic now. The law also provides criminal sanctions where appropriate. As noted, this civil case was filed long before Enron and the other current cases involving corporate malfeasance surfaced.

Some history
In 1994 the airline filed for bankruptcy protection and during the reorganization efforts the investors who helped the airline back to solvency were given many shares of stock for their cash investments. The number of shares allowed these shareholders to have a controling interest in the airline. What you must remember at this point is this: When a company goes bankrupt shares become virtually worthless and all the shareholders usually lose their investment. In order to regain investors' confidence during reorganization the company must try to make it possible in some cases for the same losing investors and new ones to hang onto and enhance their investment, one way or the other.

Investors usually control a company by their ability to appoint directors and hire officers of the corporation. Directors also have a lot to do with the promotion, salaries, and bonuses handed out to officers. This is how it works.

New management - outsourcing
The Teamsters alleged in the complaint that the level and quality of maintenance on the airlines' aircraft had dangerously deteriorated during the term of a new executive officer. They alleged that during his term the rule was "don't gold plate the plane." This was further alleged to mean that mechanics were only to do the minimum required to get the job done. Open door and self-disclosure policies had been established with the Federal Aviation Administration (FAA), by the former chief executive. The former executive had maintained a cooperative environment with the FAA inspectors and he was highly praised by both FAA and his employees for his management and airline expertise. Alas, he was removed and replaced by the new director. The new man was alleged to be somewhat uninformed and uncooperative in regard to Federal Air Regulations (FARs) regarding outsourced maintenance and his responsibilities for quality control.

To those of us in the air carrier business self-disclosure is a well-known and frequently used program that allows a company to disclose violations of the FARs that it finds by itself. Reporting these violations before the FAA finds them can avoid fines or other sanctions, with certain restrictions (Advisory Circular 00-58). However, the program does open the door for further investigation of maintenance practices by the FAA inspectors charged with the duty to protect the public.

In addition, during this time the new executive fired half of the maintenance work force and maintenance was outsourced to a large third-party maintenance facility. The employees were fired and work was outsourced, it was alleged, so that costs could be further reduced.

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