Ice fishing; how Pillsbury, Quaker Oats, and Drexel Burnham got millions in cool cash from Alaska's Eskimos.
It was midnight when the Nome fire siren began to howl. Charlie Johnson, an Eskimo from the tiny village of White Mountain, was in a good mood as he walked past the bars that line Front Street. Earlier that day, a council of Alaska native leaders had agreed to a plan that Johnson hoped would shore up dozens of native corporations teetering on the verge of bankruptcy. Now Johnson and several of those leaders gathered at the siren's call to watch the end of a thousand-mile dog sled race from Anchorage. What Johnson didn't realize was that he was about to begin his own odyssey--one that would lead him 5,000 miles away to Capitol Hill and start a stampede of investment bankers to Alaska, line the pockets of lawyers and accountants by the score, and rip open a tax loophole that to date may have cost the U.S. Treasury $1 billion. All he had in mind was balancing the books.
In 1971, Alaska's natives won a giant settlement of their vast ownership claims on the state's territory. Instead of paying straight cash, or establishing reservations (as had been done with tribes in the lower 48 states), Congress created native corporations to manage the lands and money turned over in the settlement.
Now, 13 years later, Johnson, as president of one of those corporations, faced the prospect of having to tell his fellow shareholders that their most precious heritage--the land--was in danger of being lost through foreclosure. Many of the 187 native corporations faced the same danger, because they'd pledged land as collateral for business loans that had gone sour. But Johnson thought he'd found a way out--a potential tax loophole that would allow the native corporations to sell their losses to profitable companies seeking tax write-offs. If Pillsbury needed a $10 million tax credit, it could just buy it for, say, $7 million or $8 million from a native corporation. The native corporations get cash, the companies get a juicy tax break, and the U.S. Treasury loses money.
The plan would succeed beyond Johnson's wildest dreams. In the four years since that meeting in Nome, native corporations have made roughly 100 such sales, according to state financial records. I've been able to obtain figures for one-fourth of those transactions--and they show that in those cases alone the native corporations have picked up more than $500 million, at a cost to the federal government of more than $650 million in lost taxes. That $150 million difference is money lining the pockets of Drexel Burnham Lambert, Pillsbury, Marriott, Quaker Oats, Campbell Soup, and other wealthy corporations. With three-fourths of the records unavailable, even a conservative estimate would double the amount if all loss sales were known.
Since 1984, courtesy of Congress, Alaska's native corporations have been the only ones allowed to sell their losses to businesses seeking tax write-offs. Before that, many American corporations had sold their losses, costing the treasury billions of dollars. Congress closed that loophole, but exempted the native corporations. An amendment in the 1986 Tax Reform Act extended that exemption until 1991 to help ailing native corporations get back on their feet. At the time, Congress thought the measure would cost only about $50 million in lost federal revenue.
Because of the secrecy surrounding many of the deals, it's only recently that anyone in Congress has come close to realizing the full extent of the losses. In late April, Dan Rostenkowski, chairman of the House Ways and Means committee, introduced a bill to end the exemption, which has cost at least 13 times as much as originally predicted. "No one really knows how much it's cost so far, or how much more it may cost," said a Ways and Means committee aide. (In part, that's because native corporations are exempt from most Securities and Exchange Commission reporting requirements.) "But," continued the aide, "it's clearly a lot more than Congress intended."
The native corporations respond that they've done nothing that other businesses haven't also done. "I find it hard to apologize for making shrewd business decisions, particularly when others also receive... government financial incentives," wrote Byron Mallott, chief executive officer of the native corporation Sealaska, in a public letter last year. They argue the criticism being leveled against them is part of a larger pattern through which whites manipulate the law while natives suffer.
A series of articles published by The Philadelphia Inquirer in April bears out the fact that tax breaks haven't been reserved for Alaska natives alone. The paper found at least 650 exemptions in the 1986 tax act which saved wealthy individuals and companies more than $10.6 billion in its first year. Rostenkowski should know. According to the Inquirer, he approved the custom-tailored tax break that saved Joseph E. Seagram & Sons Inc. up to $40 million--after receiving $8,000 in speaking fees and political contributions from the company and its owners in the preceding two years.
Meanwhile, the benefit to be made from loss sales has diminished, thanks to cuts in the corporate tax rate that were part of the 1986 Tax Reform Act. That year, each dollar of losses saved 46 cents in taxes. That figure has now dropped to 32 cents on the dollar.
A $50 million hole
Like so much else in Alaska, the real beginning of this story can be found in the fight over the trans-Alaska pipeline. Alaska natives had been fighting for decades to get recognition of their land claims when, in 1968, they acquired a powerful new ally: the oil industry. That year Atlantic Richfield announced the discovery of 9.6 billion barrels of oil at Prudhoe Bay, and a group of oil companies subsequently unveiled a plan to build an Alaskan pipeline. Many of the native claims included land the proposed pipeline would cross. Fearing that their permits to build a pipeline would be held up interminably while native claims dragged through the courts, oil companies lobbied Congress for a settlement giving the natives large amounts of land and substantial discretion over how to use it. Ed Weinberg, the former Interior Department solicitor general, later told journalists that the 1971 settlement was due "two percent to the justice of the case, and ninety-eight percent to the need for oil."
Congress compensated Alaska natives to the tune of 44 million acres of land and $962 million. In an acknowledged experiment in social engineering, the land and money were turned over to newly created regional and village corporations in which all the natives were entitled to receive 100 shares. The corporations were supposed to use that money to develop those stereotypical Alaskan industries--like logging timber, mining minerals, and fishing. The idea was to make natives "total business partners in the state," said Alaska Senator Ted Stevens. The corporate structure was intended to give the natives financial security while protecting lands traditionally used for subsistence--hunting, fishing, trapping, and berry-picking. The corporations were even given special legal status: no stock could be sold or traded for 20 years, and undeveloped lands were exempt from taxes for the same period. The corporations were also given a mandate: go out and make money.
Unfortunately, in most cases they went out and lost money. Most natives just lacked the training and experience to charge full-bore into the brave new corporate world. Delays in implementing the claims act, and the downturns in fishing, timber, and oil didn't help matters. A sizable minority of natives remains convinced that the claims act was an elaborate shell game that will eventually leave them with nothing and the white man with everything.
"The dominant culture has more experience with games that are devious to most of mankind," said June Degnan, a board member of the Bering Straits Native Corporation. Bering Straits is the regional corporation for Alaska's wind-swept Seward Peninsula and for St. Lawrence Island in the Bering Sea. Its 6,500 shareholders are primarily Inupiat and Siberian Eskimos, most of whom still hunt and fish for what they eat and trade for what they need. After its incorporation in 1972, Bering Straits frittered away its capital pursuing a series of stunningly ill-advised investments, including a failed hotel venture in Fairbanks, which already had a hotel glut, a failed tire company, a failed concrete plant, and a failed construction company. Over a 14-year period, a succession of executives steered the corporation into a $50 million hole. By the early 1980s, when Charlie Johnson became its president, Bering Straits had been reduced to selling off chunks of land and foundering subsidiaries. In 1986, it was forced to file for protection from its creditors under Chapter 11 of the federal bankruptcy law. It wasn't alone. Only one regional native corporation--Ahtna Inc.--has stayed in the black every year.
Stevens says Congress is partly to blame because it delayed land transfers for years while other Alaska land issues were hashed out. "And Congress said `Oh, by the way, we'll pay you your money over a 10-year period,'" Stevens said. "So during Alaska's great boom they didn't have the land or the money to take advantage of it." A recent report by the Association on American Indian Affairs, a New York-based advocacy group, concluded that flawed implementation had cost native corporations "tens of millions" of dollars in legal and administrative fees alone. Due to rampant inflation during the 10 years over which most of the payments were made, the reports concluded, the settlement's "actual value was far less than anticipated." Seventeen years after the act and long past the boom, native corporations are still waiting to receive millions of acres of their land.
In 1983, Charlie Johnson was hunting for ways to keep his Bering Straits Corporation a step ahead of the wolves when he ran into Patrick Beattie, an accountant for the Anchorage office of Peat Marwick Mitchell & Co. At the time, any profitable company could slash its taxable income by buying small amounts of stock in companies with lots of losses or unused tax credits and then taking deductions. "But at that point there was no reason for profitable companies to do this with Alaska native corporations, when with creative accounting it was much easier to do it with other corporations," Johnson says, explaining that laws that barred native corporations from selling their stocks posed an obstacle.
Johnson says he and Beattie discussed whether his corporation could buy a small amount of stock in a profitable company, allowing that company to deduct Bering Straits losses--and funnel large portions of the savings back to the native corporation. Then they found out that the IRS was about to close that loophole, by requiring that a company buy at least 80 percent equity in an affiliate before any tax loss could be transferred. Johnson and Beattie decided to seek an exemption for the native corporations. After discussing the idea with leaders of other native corporations at that meeting in Nome, they went to Stevens for help.
The reasoning, Johnson says, was that the many financially ailing native corporations couldn't take advantage of their losses because they were unable to raise any money through stock sales. Since they faced that special restriction, they should receive a special exemption. Stevens agreed, and lent a hand. When the 1984 tax bill passed, Johnson got the exemption. And Beattie's firm won the accounting contract for Bering Straits.
Beattie started helping Bering Straits set up a loss sale--and immediately ran into conflict with the IRS. Beattie thought the old law did not require the native corporations to buy substantial equity in the profitable company. But IRS attorneys--who were in the midst of legal battles to disallow similar deals between non-native corporations--were demanding a minimum purchase of 50 percent equity, which was too much for the cash-poor native corporations to manage. So Beattie and Stevens met with IRS Commissioner Roscoe Eggers to hash things out. Afterwards, they drew up an amendment that would wipe out any equity requirement. Stevens, various native corporations, and a flock of Washington attorneys began lobbying to tack that amendment onto the 1986 tax reform bill then before Congress.
At the same time, Beattie helped Bering Straits market itself. He crafted a sale of their losses to the Del E. Webb company, a large Arizona development firm that also manages four casinos in Nevada and New Jersey. On June 30, 1986, Bering Straits bought 1 percent equity in Sun City West development, a corporation in limited partnership with Del E. Webb. Through Sun City West, Webb applied $50 million in Bering Straits operating losses to trim its tax bill by an estimated $22 million, and paid the native corporation $8.5 million in return.
It was a straightforward business transaction, said Bering Straits attorney Dick Rosston. To satisfy IRS concerns that the deal was not just a tax dodge, the native corporation indicated it planned to get into the casino-leisure industry. It entered an ongoing real estate partnership with Del E. Webb. This deal opened the floodgates. By showing Congress that some loss sales would occur under the 1984 exemption anyway, it lessened resistance to the 1986 law that made the terms of the exemption more explicit and extended it until 1991.
In considering the extension, Congress's main concern was money: how much would it cost? Beattie drew up projections that were used by the tax committee to estimate a total pool of $250-300 million in native operating losses. The best current figures show the loss pool has turned out to be at least $1.6 billion. On the floor of the Senate, Stevens said the $300 million loss pool would cost the treasury no more than $50 million, adding "this is social policy, not tax policy." The amendment became law. Current estimates place the cost to the treasury at about $1 billion so far.
The same accountant who helped Stevens come up with the $50 million cost estimate has been among those most active in helping corporations create new and bigger losses to sell. "This sounds a little egotistical when you say it, but I would say we probably handle about 75 percent of the transactions," Beattie tole The Anchorage Daily News in late 1986. More recently, Beattie has declined to comment on any aspect of the loss sale or his role in any transactions.
Stevens says even if it should now be re-examined, the exemption was crucial. "That amendment brought a lot of capital into areas where it was badly needed," he explained, pointing to the fact that a number of bankrupt or barely solvent corporations have used cash from the sales to get back in the black and then diversify. "We weren't pursuing a give-away program," Stevens said. "We were saying our corporations ought to be eligible for the same benefits that companies in Texas, Louisiana, and everywhere else had for so many years."
The Juneau doughboy
However apt Stevens's comparison, his strategy of pursuing tax changes rather than direct aid took note of political reality: Congress was opposed to providing natives additional compensation to what they won in the 1971 claims act.
It's clear that for many native corporations, the loss sales have done exactly what they were intended to do--and more. The 13th Regional Corporation, which is based in Vancouver, Washington and represents 4,500 native shareholders living outside of Alaska, was a financial disaster back in 1986. It had lost more than $25 million by jumping into fish processing just in time for an industry-wide recession. It followed Bering Straits into Chapter 11 by five months. But within a year, 13th had repaid all its undisputed creditors, pulled itself out of bankruptcy court, and boosted its assets from $86,000 to more than $5 million. How? By selling its losses to Del E. Webb and Hilton Hotels for $5.2 million, according to the company's financial records.
Kake Tribal Corp., which represents some 500 Tlingit Indians in its tiny Southeastern Alaska village, plunged $4 million into debt thanks to a failed seafood storage plant. But then the village corporation unloaded thousands of acres of timber at a bargain-basement price--and declared an estimated $184 million loss which it sold to Emerson Electric Co. and Marriott Corporation for $61 million. (Those two companies, in turn, saved $15 million on their tax bills.) Kake not only cleared its debts but was able to establish a trust fund with more than $50 million and pay each shareholder a $10,000 return.
Goldbelt, Inc., the village corporation based in Juneau, extinguished $11.5 million in long-term debt by selling an estimated $110 million in losses to Winn Dixie, the Florida-based retailing giant, and to the Pillsbury Co. The buyers lopped about $47 million off their taxes and returned $37.5 million to Goldbelt.
Down-at-the-heels corporations haven't been the only ones putting losses on the block. Perhaps it shouldn't be surprising that the most consistently successful native corporation has been among the most aggressive in searching out paper losses to sell. Anchorage-based Cook Inlet Region Inc. (CIRI) is the regional corporation for some 6,300 Athabascans, Eskimos, and Aleuts in southcentral Alaska. As an Anchorage economist told The Washington Post several years ago, those in charge are not a bunch of people running around with sled dogs and furs. The company's 1987 annual report lists a net profit of $31 million, and assets of $296 million--both figures would place CIRI comfortably in the Fortune 500 if it were a normal corporation. Those assets include half-ownership of a New Haven television station and of 11 major market radio stations, working interest in several mature oil and gas fields, ownership of three drilling rigs on the North Slope and dozens of real estate properties throughout the United States. In addition, CIRI owns 800,000 acres of land and mineral rights on another 1.3 million acres.
In 1987, reporting its 11th straight year of increased profits, CIRI recorded $26.6 million in net revenues from operations and investments. Somehow, the company also racked up an estimated $300 million in tax losses--which it sold for a tidy $102.3 million (of which $73 million went directly into escrow until the IRS gives the deal a thumbs up). CIRI can report increased revenue and income at the same time it claims $300 million in losses because of differences between accounting for tax purposes and accounting for annual reports. CIRI isn't saying who it sold the losses to, although one board member acknowledged privately that at least some of the losses were marketed to Winn Dixie.
Axes to taxes
Not all the corporate deals are in the clear. A number of loss sales are now thought to be under investigation by the IRS. At issue: the nature of the loss. In accountants' jargon, there are "hard" and "soft" losses, explains Mike Stone, a partner at Peat Marwick's Anchorage office. Generally, a hard loss means cash out the door--it's "hard" because you know exactly how much money is gone. A soft loss--while just a real--is more nebulous.
The many loss sales involving timber provide a perfect example of a soft loss. Timber prices have plummeted since many of the lands were transferred to the native corporations from the government in the late seventies and early eighties. The timber is definitely worth less. But how much less depends on a particular corporation's appraiser. "It isn't a question of whether the loss is deductible," Stone says. "It's a question of how much is the loss."
In effect, the loss sales have provided a timber subsidy for native corporations throughout Southeast Alaska. They can cut the trees at or just above their operating costs and make millions. Last year, for example, the Shee Atika Village Corporation, based in the island community of Sitka, sold thousands of acres of standing timber at $20.15 per thousand board feet. That timber would have fetched five times that amount in 1979. So Shee Atika declared an enormous loss that it sold as part of a package to Quaker Oats and Drexel Burnham Lambert for $42 million.
To complicate matters further, few of the lands conveyed under the claims act were appraised in any detailed fashion at the time. So several corporations have gone back and reappraised their resources, "discovering" that the original value and subsequent loss were greater than first thought.
Available financial records suggest that roughly half the native corporation loss sales involve timber operations. State officials say the loss sale exemption has resulted in an explosion of clear cuts in which large portions are razed--raising concerns about environmental damage. In the Ketchikan area, for example, at the southern tip of Alaska's panhandle, the volume of logging has grown from 103 million board feet in 1986 to just under 300 million board feet last year. At several inspected sites, clearcuts on steep slopes resulted in landslides and erosion, leading to heavy silting of salmon spawning beds. And with a shortage of fish and game inspectors, many sites have gone unmonitored.
While the loss sales have been a boon for many of the native corporations, not all of them have benefitted yet. There are several ailing native corporations for whom planned loss sales could yet provide a lifeline. Among those, ironically, is Bering Straits--whose leaders engineered the loss sales in the first place. Since 1986, while dozens of other corporations sold their losses, squabbling creditors and legal obstacles scuttled a series of proposed deals Bering Straits had pursued. Now it has finally gained approval of the $100 million loss sale that would let it get out of Chapter 11 bankruptcy and recapitalize. But the sale, set for this summer would be blocked by Rostenkowski's bill.
With a policy that has now cost 13 times what Congress envisioned, poured hundreds of millions into the coffers of rich corporations like Quaker Oats and Drexel Burnham Lambert, and still left some of its intended beneficiaries ailing, an obvious question remains: wouldn't it have been cheaper just to bail out native corporations with direct grants?
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|Title Annotation:||Scams, Hustles, and Boondoggles|
|Date:||Jul 1, 1988|
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