Corporate Shell Games Part Two: Behind the scenes of a corporate scandal

There are cases in corporate America today that rightfully enrage the American public. Corporate accountability is at an all-time low, and despite new legislation designed to promote a higher level of accountability in the corporate sector, the board room still has not won back the hearts and minds of the American public. Small wonder, with corporate CEOs raking in record high salaries while employees go without raises, pensions or acceptable healthcare benefits.

By Dan Blacharski
As posted at www.hamiltontaftandcompany.com

There are cases in corporate America today that rightfully enrage the American public. Corporate accountability is at an all-time low, and despite new legislation designed to promote a higher level of accountability in the corporate sector, the board room still has not won back the hearts and minds of the American public. Small wonder, with corporate CEOs raking in record high salaries while employees go without raises, pensions or acceptable healthcare benefits.

A corporate CEO makes an easy target indeed, and it’s easy to point the finger of blame when things go belly-up.  To be truthful, that finger of blame is often correctly aimed, and Wall Street’s recent history of lies, malfeasance and outright theft make us feel righteous in our indignation. That’s why it was so easy, in one case, for a much larger corporation like Federal Express to hide in the shadows, while a lesser-known company took the fall for FedEx’s own misdeeds. While America was shaking its fist at the San Francisco-based payroll tax provider, Hamilton Taft and Company, and its flamboyant CEO, Connie “Chip” Armstrong, FedEx was pulling the strings to make sure that blame stayed away from  where it rightfully should have been placed: square at the feet of Hamilton Taft’s biggest client, Federal Express Corporation.

In what The Wall Street Journal called “the white collar scandal of the decade”, a whirlwind of activity, a rush to judgment, and a trial by media killed Hamilton Taft and imprisoned its CEO. Remarkably, in the rush to  put this company out of business, courtroom protocol was not followed, a court-mandated evidentiary hearing never took place, and the facts of the law itself were manipulated time and again to suit the prosecution.

Internal government memos showed that no crime had been committed. Yet, to avoid being held accountable for its own very large mistake that led to the demise of Hamilton Taft, FedEx perpetrated the illusion of scandal against Hamilton Taft and Chip Armstrong. But the true scandal isn’t what Chip Armstrong did. Chip Armstrong ran a successful company, which fulfilled all of its corporate and contractual obligations. The government’s own internal documents showed that, despite claims to the contrary, Hamilton Taft was within the law as to how it handled client funds. No–the true scandal is that Federal Express Corporation killed off a viable company and caused a man to go to prison so that they would avoid being held accountable for their mistake.

The Collapse
As has been reported previously in print, online and on radio talk show discussions, the case can be summarized as follows. As a payroll tax processor, Hamilton Taft’s business model was to handle the often enormously complex payroll tax paperwork and payment procedures for Fortune 500 clients. Hamilton Taft advised clients as to their liabilities for each period, clients submitted those funds to Hamilton Taft, and then Hamilton Taft paid out the funds to the various taxing agencies. Clients, in exchange for enjoying a low fee structure, agreed to allow Hamilton Taft to have use of the funds in the period between when they received them from each client, and when they paid them out to the taxing authorities. Since funds were commingled into a general investment account, as a point of law, the funds were not legally trust funds held for each client, but were legally the property of Hamilton Taft. As per contract, Hamilton Taft had discretion to invest those funds, so long as they fulfilled their contractual obligation to pay the payroll taxes. And Hamilton Taft did fulfill those obligations, up until the time that FedEx itself rendered it impossible to do so by forcing the company into involuntary bankruptcy. Clients agreed to, and signed off on this model, in exchange for the low fees they paid for the service. Most of the funds, or “float,” was put into secure, very short-term bond issues, but a small percentage was put into longer-term, growth-oriented notes, in much the same way any fund manager would invest funds to realize a balance of good return with strong security and liquidity.

A former employee, having been dismissed for drug use on company premises, made a claim that the funds were being misused for Armstrong’s personal benefit. In fact, this claim was later shown to be false, and the funds that the employee and others had claimed were missing, were all accounted for. But, because of the former employee’s position, clients, led by Federal Express, took him at his word and immediately started withdrawing their funds from Hamilton Taft, causing a “run.” In fact, none of Hamilton Taft’s other clients were willing to take the extreme step of closing the company until FedEx stepped forward and took the lead.  By the time the dust settled and FedEx realized the error, it was too late, and too much damage had been already done. In the weeks and months ahead, FedEx led the charge to circumvent law, procedure, and due process to illegally force Hamilton Taft into involuntary bankruptcy and put Armstrong in prison. Why? To avoid being held liable for having caused a thriving company to go under. 

A Viable Company Shut Down
Interestingly, when the trustee shut down Hamilton Taft, the company was still a viable company. The intent of a Chapter 11 bankruptcy, whether it is forced or voluntary, is not to automatically liquidate a company. Liquidation is a last resort. A more proper use of these bankruptcy statutes is to determine the viability of a company and allow it to reorganize so that it may continue doing business.

When Chip Armstrong first took over Hamilton Taft, it was doing about $3.4 billion dollars a year in payroll tax processing business. Within a few short years, he took it to about the $7 billion level. The accusations of FedEx did convince many clients to pull out, and Hamilton Taft lost about half of its business in just a matter of a few days. But many of the clients had cooler heads, and did not break their contracts. As a result, when the trustee made the decision to close Hamilton Taft for good, the company still had contracts to handle $3.4 billion dollars a year in payroll taxes–about the same as it had when Armstrong first took over. Clearly, the company was still viable, and the liquidation was improper.

FedEx Makes its Own Rules
Federal Express is no stranger to payroll tax related difficulties. Hamilton Taft was forced by FedEx into involuntary bankruptcy in 1991, but there’s still another liability that’s not being talked about, and which FedEx has done its best to hide. In 1992, shortly after FedEx killed its own payroll tax processor, FedEx started using contract labor for the bulk of its driving force. Today, this action is causing FedEx no end of legal problems, and with good cause: the move to contract labor was nothing more than a calculated effort at avoiding payroll tax liability and other employee-related obligations.

FedEx drivers have brought several suits against the company, claiming that while they are brought in as “contract labor,” they are de facto employees. The courts agree, and today, Federal Express faces major losses as a result of these lawsuits. These losses are substantial, and big enough to leave FedEx stockholders reeling.

In a note from the IRS dated July 12, 2006, the agency reaffirms an opinion that a FedEx Ground driver, operating as a contractor, was in fact an employee. In fact, there have been hundreds of lawsuits brought against FedEx by drivers, and the courts have levied assessments against FedEx for over $100 million. A class action drivers lawsuit, filed in South Bend, Indiana, will substantially increase that total to well over a billion dollars once the decision is applied to every one of the 15,000 or so drivers in FedEx’s stable.

The courts have been in agreement in dozens of individual suit against FedEx; in a major ruling in California, the California Unemployment Insurance Appeals Board said that a former FedEx driver was eligible for unemployment compensation, despite being a contract employee. The Appeals Board noted that the individual “was clearly an employee of FedEx.” The Board ruled that the person had been misclassified as a subcontractor, and the company failed to deliver on its promises that he would be autonomous. In fact, FedEx wielded total control over his driving “business,” and was required to obey strict guidelines and was not free to regulate his work schedule. The driver’s attorney is quoted as saying, “This is another example of how FedEx Ground has shifted the huge expense burden from the corporation to the backs of hard working men and women.” The drivers’ claim, and the courts’ decision, have borne this out: in fact, the “contract status” of FedEx drivers is little more than a sham designed to avoid responsibility for payroll taxes and other standard employee obligations.

Despite the court decisions, FedEx to date continues to consider its drivers as contract labor. Yet in these days of enhanced corporate accountability and new regulations, the specter of shareholder lawsuits looms large. In fact, FedEx dodged hundreds of millions of dollars worth of payroll tax obligations, which in effect made the bottom line appear to be more favorable than it really was–and that’s what makes shareholders upset, and what forms the basis of shareholder fraud. Simply put, by claiming its driving force was contract labor, FedEx avoided paying for payroll taxes and other employee-related expenses, which were expenses that FedEx should have legitimately borne. By making the “contract employee” argument, FedEx has been able to consistently understate its expenses, and defraud its stockholders, for nearly 15 years. The courts have ruled that the drivers are employees, and FedEx is responsible for all payroll taxes and ERISA payments. With the existing judgments, along with the class action suit and a potential shareholder suit, FedEx could be liable for well over a billion dollars. But it doesn’t stop there. If the potential loss from its liability in the Hamilton Taft case were factored in, FedEx itself could face bankruptcy.

Shareholder disclosure
Shareholders have historically demanded more accountability and more information from the corporations in which they invest, and it’s not just the big shareholders that should get access. For example, in the past, major shareholders had a higher level of access to quarterly financials and transcripts of shareholder meetings; today, publicly-held companies are required by law to make that information generally accessible, generally by posting it on the company web site. To their credit, most companies have stepped up to the plate and have gone to great lengths to make this sort of information more transparent.

But FedEx hasn’t been keen on talking about its payroll tax liabilities with its shareholders, and very few realize that not only will FedEx be held liable for well over a hundred million in payroll taxes, they could also still be held liable for the demise of Hamilton Taft and Company. In fact, whenever a lawsuit is filed against a publicly held company, and that lawsuit has the potential of having material financial consequences, the board must notify shareholders. And further, SEC rules state that the public must also be notified. And while one may argue that the driver lawsuits have become common knowledge, FedEx’s duplicity regarding Hamilton Taft–and its potential liability–has been swept under the rug. FedEx’s 2006 annual report contains several very nice photographs of people at work, trucks and airplanes, and exotic destinations, but says absolutely nothing about the liabilities the company may face.

At the time FedEx was acquiring Kinko’s, the law firm representing Kinko’s, Piper Rudnick, knew of the potential liability FedEx faced due to Hamilton Taft, yet FedEx made no disclosures to the public or to the shareholders who would be materially affected. Here’s the connection: In 2003, Armstrong contacted former congressman Dick Armey, through one of his associates, Ms. Jean Campbell. Although Armey was reluctant to become involved in anything political at the time due to having just left Congress, Ms. Campbell, a government liaison for the law firm of Piper Rudnick, agreed to meet with Armstrong. Ms. Campbell stated that she would need to check for any potential conflicts with FedEx before agreeing to help Armstrong, and then she came to the prison to meet with him in September 2003. After a lengthy meeting, Ms. Campbell took with her many of the materials Armstrong had received under the Freedom of Information Act, and began discussing a strategy to bring in political power to help Armstrong. In January 2004, Armstrong received a short letter from Piper Rudnick, informing him that they would not be able to represent him any longer because FedEx had purchased Kinko’s. Interestingly, Kinko’s had been one of Piper Rudnick’s biggest clients, and it would have been unlikely that they would have been unaware of any potential acquisition by FedEx at the time they were meeting with Armstrong. The question is, since Piper Rudnick had represented to Armstrong that there was a potential liability to Hamilton Taft on the part of FedEx, did Piper Rudnick discuss this with their client? FedEx knew from the beginning that they could face liability for shuttering Hamilton Taft, and may well have been aware that Armstrong was planning to pursue legal action against them to hold them accountable.

The Government and FedEx
FedEx has been up front about the fact that it works closely with the government, specifically turning themselves into a government asset for spying on the American public without warrants. Naturally, this makes them a valuable resource worth protecting. When the Hamilton Taft “whistleblower” struck out with the FBI and the IRS, he appealed to Congresswoman Nancy Pelosi, who saw fit to protect the shipper, and orchestrate a trial by media in conjunction with the Wall Street Journal. Interestingly, Armstrong had been approached by attorney Gare Smith of the Washington law firm of Foley Hoag in October 2004 in an unsolicited request to represent him; Smith has worked closely with Pelosi in the past on several liberal issues. One may speculate that Pelosi had sent in Smith to get information and make sure Armstrong stays behind bars as long as possible.

Here are just a few examples of how Federal Express functions as a de facto arm of the American government: The Wall Street Journal disclosed in 2005 that FedEx’s information technology plays a major role in the government’s hunt for terrorists; the company has opened up portions of its customer database to government officials, who cross-reference shipper’s names, addresses, and credit card information with data in their own databases. In fact, the Journal article refers to FedEx as “one of homeland security’s best friends.” Furthermore, the same article makes note of the fact that FedEx has actually created its own private police force, which is recognized by the state of Tennessee and works closely with the FBI. Furthermore, the companies 250,000 employees (and contractors?) are trained to be “spotters” for the feds–the next time the FedEx man delivers a package, if he decides you look like a terrorist, your friendly neighborhood delivery guy may go back out to his truck and report directly to the FBI. In fact, as reported by the Journal, the heightened level of cooperation is not advertised, and most customers aren’t aware of it. For example, while the US Postal Service has strict regulations about inspecting packages, FedEx has no such regulations governing it, and whenever you ship a package via FedEx, you automatically consent to having the contents of your package inspected without a warrant. The Journal notes that this is a legal “gray zone” that has never been tested in the courtroom, and according to an analyst interviewed for the story, such relationships could undermine privacy laws that are currently in place. Interestingly, last year FedEx signed an $8 billion deal with the US Postal Service, in which FedEx carries large quantities of US Postal Service Priority, Express, and First Class mail. When one sends a package via the US Postal Service, one assumes a certain level of privacy exists; but when that mail falls into the hands of FedEx, that constitutional right to privacy disappears. One may assume, understanding FedEx’s level of cooperation and information sharing with the government, that this has become standard practice among all shippers. Nothing could be further from the truth, and other shippers, including UPS, have consistently refused to grant the same level of access without court order.

In short, FedEx, though a private corporation, functions in many respects as an arm of the federal government, often circumventing due process and constitutional protections against unlawful search. FedEx needed for its mistakes–the fact that they pushed to have Hamilton Taft shut down improperly–to be hidden, and the American government complied.

Placing a Revolving Door on the Law
Hamilton Taft and Company was illegally put into involuntary bankruptcy, and there are several areas that show where the courts, mostly at the urging of FedEx, made an end run around the law.

Bankruptcy law states that it takes three companies to place a company into involuntary bankruptcy. At first glance, there are indeed three companies placing Hamilton Taft into bankruptcy; FedEx, Stanford Hospital and Stanford University. Stanford University was not a client of Hamilton Taft at the time, and had not been for over six months. The bankruptcy documents given as evidence were signed by only two clients; not the required three.

And besides that, Hamilton Taft didn’t owe anybody any money. In fact, FedEx did not lose any money with Hamilton Taft in payroll taxes or penalties, until they took the responsibility of putting the company into bankruptcy.

The smoking gun lies in the treatment of an arcane point of law that was bandied back and forth by the courts and the court-appointed trustee. In short, Hamilton Taft’s accusers’ case hinged on their contention that Hamilton Taft funds were, in fact, trust funds, even though no trust relationship had been forged. Hamilton Taft’s whole business model, which was put out for all to see from the very beginning, was created around those funds explicitly not being trust funds. The basis of each Hamilton Taft contract was that Hamilton Taft was to have dominion over the funds for the purpose of making short-term investments. The clients understood this, and benefited from it in the form of lower fees. If the funds were trust accounts, Hamilton Taft would not have had the ability to invest the funds as it did, and claims of mismanagement would have been legitimate. The forced bankruptcy, and Armstrong’s criminal case, all hinged on the Orwellian concept of calling something that it was not.

The court itself went back and forth on the issue, changing their viewpoint on the trust issue depending on what it needed to accomplish at the time. Never before in a court of law has such a shell game been successfully and so blatantly carried out by the government. The first example is in the issue of preference payments. This is a bankruptcy law term referring to payments that were made by the bankrupt entity just prior to the bankruptcy. Preference payments can be legally recalled by the trustee, and added back to the bankrupt’s estate for the purpose of equitable distribution. But, recalling these payments requires the money to have belonged to the bankrupt entity in the first place. The court-appointed trustee sought to recall some $39 million in preference payments–payments that Hamilton Taft had made as part of its contractual obligation to its clients. But in order to do so, the trustee had to convince the courts that the funds had belonged to Hamilton Taft, and were not trust funds. If the funds were defined as trust funds, then they could not be recalled, because by definition, they were not Hamilton Taft property to begin with. The court agreed with the trustee, at least temporarily, issuing a ruling that overturned the previous court decision that that the funds were held in trust. Preference payments were collected, and the estate of Hamilton Taft was enriched with funds that had already been paid out on its obligations, and the trustee earned a bigger piece of the pie in the process.

Shortly afterwards, a motion was filed by the government, and the Ninth Circuit Court mysteriously vacated its ruling, noting simply that it is “with the best interest of all parties.  Clearly, it was not in the best interest of Chip Armstrong, or the business entity of Hamilton Taft. No further explanation or justification for this bizarre vacateur was offered. The court, in essence, temporarily suspended the rule of law for the benefit of a few rich lawyers. But it did so at its own peril, because in so doing, the duplicity of the government becomes obvious. When the Ninth Circuit Court, at the behest of the trustee, ruled in the case of in re. Hamilton Taft that the funds were the property of Hamilton Taft and not trust, they in essence lent credence to Armstrong’s own defense, which correctly stated that if the funds were the property of Hamilton Taft and not trust. When the Ninth Circuit overturned the previous decision that the funds were held in trust, they were stating that the funds were the property of Hamilton Taft, and therefore tacitly agreed that no crime had been committed, since Hamilton Taft had fulfilled all of its contractual obligations.

The ruling that the funds were the property of Hamilton Taft, and the ruling’s mysterious and unexplained vacateur, was not allowed to be admitted in court in Armstrong’s defense, and Armstrong was denied the only way he had available to prove himself innocent. The courts duplicity in the matter was hidden from the public.

Remarkably, this is not the only instance where the government spoke out of both sides of its mouth. The government relied upon the fact that the preference payments, which were enabled only out of the vacated in re. Hamilton Taft decision, to prosecute Armstrong and justify the illegal shutdown of the company. Yet, Armstrong was denied the opportunity to use that same decision in his own defense. Remarkably, even as the government argued in Armstrong’s trial not to allow the Ninth Circuits decision that funds were Hamilton Taft property to be used in Armstrong’s defense, the government also argued at the same time, successfully, that the preference payments that were made possible by the Ninth Circuits decision, served as evidence of loss, and therefore that a crime had been committed. Those same preference payments were also used as the basis for enhancing Armstrong’s sentence from six months to nine years.

In short, the government on one hand, argued that the decision of the Ninth Circuit that the funds were Hamilton Taft property was valid. But, at the same time, they also argued that the decision was invalid when Armstrong wanted to use that argument for his own benefit. It is illogical for a decision to be both valid and invalid at the same time, yet the government, in a classic example of doublespeak, made it so.

In short, the government relied on actions that were taken by the trustee, which were dependent on a decision of law stating that the funds were the property of Hamilton Taft in order to prosecute based on loss; yet at the same time, the government denied the law which enabled the collection of preference payments to be used in Armstrong’s defense.  Ironically, the very same federal district judge that ruled that the preference payments could not be collected because they were trust, later allowed those preference payments to be introduced as evidence of loss during the trial. This is ill founded, illegal, and unconstitutional, and that this shell game was allowed to persist is beyond belief.

Dan Blacharski, a former employee of Hamilton Taft & Co., currently divides his time between South Bend, Indiana and Bangkok, and works as a freelance business writer and entrepreneur. You can reach him at dan@blacharski.net

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Posted in Corporate Fascism & Technocracy, The American Sell-Off, Economy in Crisis & Too Big to Fail.