Fear of flying

Corporate jets are common. But as Conrad Black knows, they can haunt you.

Such tales of pestilence and woe might have remained private, had it not been for how the couple got there. They flew in style aboard a Gulfstream IV business jet owned by Black's company, Hollinger International Inc. This excursion came back to haunt the former press baron at his criminal trial in Chicago. Among other things, prosecutors alleged that Black improperly caused International's shareholders to foot the bill. (When this story first appeared in Canadian Business a verdict had not yet been reached, it has since, click here for details.)

Privately owned aircraft have become a familiar feature of the corporate landscape. Prominent Canadian companies such as EnCana Corp., Magna International Inc. and Nortel Networks Corp. all have them. Useful though they may be, they've also played starring roles in many memorable business scandals. U.S.A. v. Black et al. offers a window into how those aircraft are used, the costs and benefits they present — and the considerable hazards executives face when they board company planes for non-business reasons.

The Chicago trial revealed just how out-of-step Black was with emerging corporate- governance conventions. Prosecutors published numerous missives in which he espoused his personal philosophy. Famously, Black once wrote to fellow executives: “We have a certain style that all these shareholders were aware of when they came in. We should finetune that style, not revolutionize it with a Damascene conversion to vows of poverty.”

Black's attitudes may have been partly rooted in early experiences. In 1975, during a power struggle at Argus Corp., shareholder Paul Desmarais proposed a formal aircraft policy under which opponent Bud McDougald (a mentor figure to Black) “could use the corporate jet when he wanted.” Black found it amusing. “This was not a serious analysis of the self-esteem of the Argus controlling group,” he wrote in his 1993 autobiography, A Life In Progress. “McDougald already used the airplane when he wanted it.”

This is not to say that Black endorsed abuses of perquisites. “McDougald's lassitude, greed and vanity were not constructive influences in the Argus Group,” Black observed. “Such was his cynicism that he had no policy but to pocket loose change as it appeared, albeit with as much pomp and sanctimony as possible.” Later, when Black and his associates explored alleged abuses at Dominion Stores during the 1980s, Black observed disapprovingly that one executive flew a “lady friend” about on the company plane. “The whole pattern of company operations was an anthill of dubious activities,” he wrote.

Black got his own plane — a Gulfstream II — in 1985. It cost US $5.1 million. David Radler, International's president, later inherited that aircraft, which was replaced with a Challenger jet in 2001 for US $11.6 million. International leased the Gulfstream IV for Black, at a cost of US $3 million to US $4 million annually. As with any vehicle, up-front purchase and leasing costs were just the beginning. International calculated that between 1995 and 2003, the jets cost US $61.3 million to finance, operate and maintain.

So what did International get in return? Private jets offer flexibility to fly at any time, to destinations served poorly — or not at all — by commercial airlines. Gildan Inc., for example, recently upgraded from a Cessna Citation to a Challenger 300 to fly between its headquarters and its manufacturing hubs in Central America and the Caribbean. “Flying commercial to our hubs on a regular basis is very time-consuming because of their locations and this is not viewed as an efficient use of senior management's time,” says chief financial officer Laurence Sellyn. Black himself emphasized that International owned hundreds of newspapers around the globe, many of them in small communities.

There's some evidence that International's jets served such purposes. In 2003, the company formed a special committee of its board to review past events. Over time, that committee became extraordinarily hostile toward Black, Radler and others. Even so, its final report observed that in 1996 and 1997, flight logs from Radler's aircraft showed he frequently flew to small airports in places that included Meridian, Miss., and Johnstown, Pa., areas where International owned community newspapers.

However, the report claimed that Radler's flights to such destinations dropped markedly beginning in 1998 — around the same time International began selling U.S. community papers. By 2001, International's newspaper portfolio was greatly reduced. The report also asserted that the bulk of Radler's flights were between large centers, such as Vancouver and Chicago, that were served by major commercial airlines. Black, meanwhile, “rarely used the planes for travel between Hollinger's vast and scattered properties.”

On trial in Chicago, Black pointed to another possible motive. Corporations value top executives highly and might suffer if they're injured or killed. Black's safety was threatened at least once: his lawyers pointed to one July 1999 e-mail in which an apparently disturbed individual, describing himself as a “prophet of God,” threatened to “harvest” Black. There was no evidence at trial that International's fleet was motivated by security concerns. But the company's audit committee did suggest in 2003 (well after the Bora-Bora flights) that Black and Radler avoid commercial flights due to terrorism concerns.

On July 30, 2001, Conrad Black and Barbara Amiel lifted off the ground in Seattle, destined for Honolulu. They then flew to Tahiti and on to Bora-Bora. The couple took the same route back to Seattle on Aug. 8, where they attended the Seattle Opera's performance of Wagner's Ring Cycle. Upon re-entering the U. S., Black stated the trip's purpose on a customs declaration by checking the “personal” box.

The following January, International controller Fred Creasey reviewed the G-IV's flight logs. He came upon the Seattle-Honolulu-Bora-Bora legs. International had newspapers in many places, but Bora-Bora wasn't among them. Creasey became confused.

What exactly was International's aircraft use policy? Creasey had never seen one in writing; he operated on assumptions and understandings. He testified at trial that during a conversation in the 1990s, senior company accountant John Boultbee said it was reasonable that Black and Radler travel aboard the planes to their various residences because “they're working all the time.” But generally, Creasey testified, “there was an assumption that it was always business use.” It was an assumption Black apparently didn't share. At trial, his counsel, Edward Greenspan, pushed Creasey to admit there was no formal policy prohibiting Black from expensing his personal travel to the company.

Creasey didn't know the Bora-Bora trip's purpose. He didn't actually care. His problem was more fundamental. Black's business empire included a tangle of related entities, and International itself contained a number of business units. All of them benefited from the aircraft; part of Creasey's job was to sort out which units should pay for which flights. He reviewed flight logs and allocated costs on a trip-by-trip basis, based on origins and destinations. He would charge flights in Europe to International's U.K. group, and flights within the U.S. to the Corporate group. Transatlantic flights he split evenly between those units. But Bora-Bora wasn't located in any region covered by this methodology. “It just didn't fit,” Creasey told the Chicago jury.

Creasey went to Boultbee's office. “I asked him how I should allocate all these hours,” he recalled on the stand. “He told me I should ask Mr. Black.” (Boultbee, now Black's co-defendant, was initially charged with mail and wire fraud in connection with the flights, but Judge Amy St. Eve summarily dismissed that part of the charges in June, citing a lack of evidence.) Creasey e-mailed Black, who raised a technicality he hadn't considered. The calculation of 23.1 unallocated hours didn't take into account that Honolulu was on U.S. soil.

Black wrote: “Fred: As these were mainly within the United States, let's charge them to [International]. I'm happy to pay, as to half, personally, if this doesn't cause difficulties.”

So that was that. But what Creasey did next came back to haunt him. Broadly speaking, aircraft costs can be split into two categories. Variable costs are those expenses that increase with use: fuel, maintenance, catering, phone bills and so on. Fixed costs, in contrast, are those incurred regardless of how often an aircraft is flown, such as insurance, hangar fees, leasing costs and salaries paid to crew. Conventionally, when calculating the expense of an executive's personal use of aircraft, one considers only the incremental or variable costs. In calculating the Bora-Bora expense, however, Creasey lumped in both fixed and variable costs for the entire year, and then calculated that the Bora-Bora flights represented 7.9% of the aircraft's total flying time in 2001. He rounded that up to 8%, and calculated the total cost of Black's vacation flights at a whopping $565,326.

This error was more than academic. Creasey believed that Black never paid for any portion of the flight, so he had a Canadian tax form issued to Black that characterized the $565,326 as a taxable benefit. When Black got wind of it, he was displeased. He wrote to company lawyer Peter Atkinson: “I just had a nice call from David [Radler], who to warm up my birthday celebrations, told me that there is some plan afoot to try to charge me $600,000 for my ill-starred trip to Bora-Bora. Needless to say, no such outcome is acceptable, but what is the real story?”

The real story would come out in the Chicago courtroom.

Canadian executives routinely use corporate jets for their own purposes. At EnCana Corp., CEO Randy Eresman got an annual allowance of $37,800 last year, which, among other things, covered the taxable benefit associated with using company aircraft. Suncor Energy CEO Rick George's compensation included $27,555 toward his personal use of its jet. Glenn Chamandy, the president and CEO of Gildan Inc., incurred more than $23,000 in incremental aircraft costs his employer covered. Newmont Mining Corp. recently awarded its executives a new perk allowing “limited” use of its aircraft for family travel. Robert Schad, the founder and recently retired CEO of Husky Injection Molding Systems Ltd., racked up more than $223,000 last year in charges for “personal and charitable use of corporate aircraft.” Such details were disclosed in proxy filings.

Back in 2002, International had a decision to make: what would it tell its shareholders about the Bora-Bora flights? Its decision: very little.

At the time, both the U.S. Securities and Exchange Commission and the Ontario Securities Commission required that perquisites to top executives worth more than $50,000 (in U.S. and Canadian currency, respectively) be disclosed as “other compensation” in the executive compensation table of a public corporation's proxy statement. (The SEC has since lowered the threshold to US $10,000.) By August 2002, Atkinson (a defendant in U.S.A. v. Black et al. who was not charged in connection with the Bora-Bora trip) perceived a problem. “I am becoming concerned about the disclosure we make on executive compensation,” he wrote in an e-mail to Boultbee. “There is an 'Other Transactions' section which refers to the [New York] and Chicago apartments and to the auto and driver for Conrad in N.Y. and the auto for David in Chicago. We do not make any other disclosure about corporate perks?.In light of the strictness of the accounting rules are these issues we need to address and if so, now?”

Atkinson raised similar concerns with Black. “If the company is paying for personal flights should those expenses be disclosed?” he asked. “The issuance of a [tax form] suggests the answer is yes, at least for Bora-Bora?.I think these are questions we need to have answered.” At the same time, Atkinson sought to lower aircraft- related costs. He proposed outsourcing aircraft operations to an aviation management firm called Execaire. And he suggested executives consider taking the odd commercial flight.

Atkinson's proposals met resistance. He claimed Radler was “defensive” and wanted the matter dropped. Black responded: “He [Radler] is suspicious of alternatives for the planes and launches into angry mantras against the shareholders at the drop of a hat.” But Black encouraged Atkinson. “A degree of accommodation with contemporary norms is what we need,” he wrote. “Don't think of desisting; we will develop a satisfactory policy.”

Whatever Black's definition of “satisfactory,” it did not include transparency. The following month, he wrote a memo suggesting the policy should be drawn up “without mentioning it publicly or to the directors.” He continued: “Generally, personal use of the aircraft is discouraged. Henceforth, with reasonable interpretive latitude, any such use should result in the variable costs being charged to Ravelston and on to the user.”

Despite Atkinson's sense of urgency, no policy was forthcoming. In late March 2003, International eventually revealed in a proxy statement that the company paid Black more than US $248,000 the previous year in “other compensation,” an undisclosed portion of which was “an allocation of variable costs covering any occasion when the use of a corporate airplane is not entirely for corporate purposes.” This, coupled with other disclosures about Black's perks, provoked complaints.

“These sorts of disclosure items are a real distraction,” Black told auditors in a 2003 e-mail. “A number of shareholders have suggested they intend to push for a full audit of corporate versus personal use of each aircraft. In fact there has been no such use, with any liberality of definition at all. Such matters are monitored carefully and there are no abuses.”

Matters reached a boil at International's annual shareholder meeting in May 2003. Just days prior, one of the company's largest institutional investors, Tweedy Browne LLC , highlighted numerous grievances and concerns in an SEC filing. Among them, it cited an analyst report that estimated International's aircraft costs at US $8 million to US $10 million a year. Tweedy had questions. Given that the company's major operations were in Chicago and London — cities served by major airlines — why were International's private jets necessary? Were the aircraft used for personal purposes? And if so, how was the company reimbursed?

“Aviation expensesâ?¦are another item bandied disapprovingly about,” he said. “In this sort of climate, it has become obviously a bugbear to some people.” He acknowledged that the company had fewer properties than in the past, claimed efforts were afoot to reduce aircraft expenses, and observed that the G-IV's lease “doesn't have long to run.” And he repeated his claim that no flights were for personal use. “I think our record in this area is really quite defensible and comparable to other well-run companies,” he told the assembly.

After that meeting, Black and International's vice-president of investor relations, Paul Healy, met with representatives from Highfield Capital Management, a prospective investor. When Highfield officials questioned Black on aircraft use, “He said, somewhat flippantly, 'I could have a [Boeing] 747 if I wanted,'” Healy testified. Highfield declined to invest.

Shareholder discontent and internal power struggles at International came to a head in late 2003. That Nov. 15, International struck an arrangement with Black. Among other things, he agreed to step aside as CEO to make way for Gordon Paris, a New York investment banker. Together, they would develop a new policy under which the aircraft were to be restricted solely to business purposes. Four days later, Black resigned early, and International announced it would ground both aircraft as a cost-saving measure and phase out the fleet. That goal was promptly accomplished. International terminated the lease on Black's G-IV on Jan. 15, 2004 — a move that saved an estimated US $4.7 million to US $6.5 million a year. Around the same time, the Challenger fetched just over US $7 million at auction. “Basically, we got rid of the jets because we deemed them costly and an unnecessary expense for our company,” said Tammy Chase, an International spokesperson.

The Bora-Bora allegations against Black are reminiscent of other recent cases involving alleged corporate lootings. Former Tyco International CEO Dennis Kozlowski was accused of using corporate aircraft for his own purposes “at little to no cost.” The SEC accused Kozlowski of knowing that his personal flights and other perquisites weren't disclosed to shareholders. John Rigas, the incarcerated former senior executive and founder of Adelphia Communications Corp., took a company plane to Kenya on a safari. Jurors at his trial learned that the company flew a Christmas tree to the home of one of his daughters in New York every year. His son, Tim Rigas, allowed actress Peta Wilson, star of the late-1990s TV series La Femme Nikita, to fly “Air Adelphia” several times in 1999 and 2000.

Black's prosecutors claim that he breached his fiduciary duties by failing to present his personal flights to the audit committee's attention. “Instead, Black took it upon himself to determine who should bear the cost of his personal use of International's corporate jet,” they alleged. Furthermore, they continued, Black had an obligation to disclose his personal use of the company plane in International's proxy statement, which he signed as CEO.

Black's representatives disagreed. “The government has offered no evidence that Mr. Black was legally required to disclose any 'perks,'” his attorneys wrote in a motion to dismiss the charges against him. In fact, Black's team estimated the variable costs for the Bora- Bora flights were well below the US $50,000 reporting threshold. “Mr. Black was not required to disclose the compensation he received from personal use of the plane,” they argued. Greenspan also said International made no distinction between corporate and personal aircraft use. Gone were Black's claims that the plane never flew for non-corporate purposes.

Black cast himself as a victim. Greenspan mocked Creasey's accounting of the Bora-Bora flights, arguing that his methods overstated the true cost. He claimed the fair market value for one flight hour in the G-IV was $6,000. On the stand, Creasey conceded that had he calculated only the variable costs, Black would have been billed considerably less. “You charged Conrad Black for the most expensive flight to Bora-Bora in history,” Greenspan countered.

That is perhaps no more than the plain truth. But the Bora-Bora excursion cost Black more than money: it damaged his reputation. The case offers lessons to both executives and investors. One sensible rule for the first group would be to err on the side of caution when it comes to disclosing perquisites, even if the rules do not explicitly require it. Another would be that you should be cautious when using things that don't belong to you for personal gain.

Investors, on the other hand, should pay close attention to how corporations disclose executive perks. Black did not espouse his philosophy on corporate assets directly to shareholders. But International telegraphed its corporate culture by providing so little transparency about perks in SEC filings. Public companies that resist publishing details of how their top dogs use corporate assets should be approached with caution.