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...

The thrust of the complaint was that outsourced maintenance did not follow airline standards and therefore should have required intensive oversight by the airline. Little if any oversight existed in this case. The FAA found this to be true, in its opinion, and it pointed out that the airline was responsible for all the maintenance (FAR 121.363b), something that management failed to understand. Incredibly, the new executive was alleged to have stated that the responsibility for maintenance quality was in the hands of the third-party repair facility not his! FAA took strong enforcement action against the airline because of its poor maintenance record. The result was a $5 million settlement of the FAA enforcement cases. This was the largest fine ever imposed on an air carrier by the FAA.

Case theory and deferred maintenance
The plaintiffs in this case were required under the law to show that the company was involved in a continuing effort to reduce direct operating costs so that it could drive up operating profits. This would hopefully raise the stock price to a level where insiders could sell at a substantial profit.

The complaint alleged that a combination of things including firing 375 mechanics, deferring maintenance on the aircraft as long as possible, outsourcing maintenance, not performing required inspections (AD's), and some routine maintenance items, all contributed to driving down operating costs and raising operating income, thus making management look good, and raising the stock price.

Bottom line
In summary, the Teamsters-Mechanics Trust Fund was saying that this scheme to raise the stock price in fact succeeded by overstating the operating income of the company, outsourcing maintenance, ignoring or deferring maintenance, and firing mechanics. This, it was alleged, raised the stock price allowing insiders to sell their stock at a handsome profit because of what they knew.

Needless to say, a vigorous and detailed defense was included in a motion by the company and other defendants to dismiss the complaint for insufficiency of the evidence.

The outcome in the trial court
The District Court Judge in June of 2001, decided that the Teamsters had not presented sufficient evidence to support their case under the law and therefore dismissed the case on the motion by the defendants. The plaintiff's lost at this point!

The appeal - the plaintiffs turn it around!
The Teamsters and shareholders appealed the decision stating that the District Court erred in dismissing the complaint.

On Valentine's Day Feb. 14, 2003, the Appellate Court after reviewing all the facts presented, reversed the lower court decision, remanding the case back to the lower court for further proceedings. This usually means that the case will go to trial, or it could settle. The fat lady had sung!

The effect of current events
When this case was filed there was no Enron, or the other bankrupt companies that have come to light where corporate executives ran away from their responsibilities much to the detriment of employees and other stockholders. Maybe the quiet business climate of the time had something to do with the lower court dismissing the case. In June of 2001 the court found that the evidence did not support the position of the plaintiffs even though the airline management's conduct was suspect at that time.

One must remember that statements in a complaint are only "claims" and "allegations" that are designed to support the case for violation of the law, thus allowing the lawsuit to be filed. Everything in a civil case has to be proved by a preponderance of the evidence presented to a jury. Even though the allegations sounded onerous, the shares of stock sold, and profits made, the first court found that this was not enough to violate the federal law on the subject. One has to wonder that if Enron and its progeny had not occurred whether or not an appellate court would have reversed this decision.

Present climate
At this point in time there is little sympathy for companies, their executives, and controlling shareholders, who sell their stock at a profit and in essence bail out on their duties. We are all familiar with the plight of former employees of Enron and others who have lost their savings. Perhaps, when this appellate court looked at this case they found little sympathy for the defendants because of what has taken place since the case was dismissed in June of 2001. We'll never know for sure.

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