A letter from the AFL-CIO’s Secretary-Treasurer Richard Trumka was sent to Sprint urging against the reappointment of Ernst & Young as the company’s auditor. Trumka said Ernst & Young has compromised its independence by selling tax shelter advice to company executives while auditing the company’s books, according to a news release.
In the letter, Trumka said Ernst & Young compromised its position as auditor after receiving $5.8 million for the creation of the tax shelters, $5.1 million for audit-related services, and $8.4 million for other services from Sprint: “Ernst & Young received more income from the company in 2000 as a result of its tax evasion advice than it did from auditing Sprint’s books … We believe this unbalanced fee structure compromised Ernst & Young’s independence.”
The move by the AFL-CIO is being touted as in the interest of union member pension protection. “The current crisis in investor confidence is a threat to the retirement security of working America,” Trumka said in the news release.
If Sprint fails to put forward a new auditor for shareholder approval at its annual shareholder meeting, the AFL-CIO pledged to launch a “vote-no” campaign against Ernst & Young’s reappointment, leveraging the estimated 16.45 million shares of Sprint stock, its pension funds currently hold.
The recent controversy erupted in February when then chairman and chief executive William Esrey and Chief Operating Officer Ronald LeMaythe where dismissed by the company’s Board of Directors for utilizing a tax shelter, know as the “tax deferral method” to defer taxes on stock option exercises (See Sprint Board Forces Execs Out Under Tax Scrutiny).
Tax deferral, which was promoted to the two former executives by both the company and Ernst & Young, allowed the two an opportunity to offset a large tax bill associated with profits from the exercise of options by establishing a separate investment that enables the executive to exercise his stock options without paying the taxes that would normally be due that year. This method, commonly promoted by Ernst & Young, is known as “ECS.”
ECS promises to delay the income-tax bill from the exercise of options for up to 30 years by putting the options in a limited partnership that could involve family members. In return, the executive would get an unsecured promise to pay the money back, but not a note.
Under IRS rules, if the transaction was a real business deal, known as “arm’s length,” then there would be no tax bill when the options were exercised by the partnership. In addition, the partnership could sell the shares and diversify its holdings to cut the executive’s risk. However, it should be noted, while the use of such a tax shelter is currently under scrutiny, it has not been deemed illegal.
The Sprint controversy in part, led to Ernst & Young being the first of the big four accounting firms coming out in favor of stock option expenses being reflected as an expense on corporate financial statements (See E&Y Reverses Course on Options Expensing ).
No Vote Atmosphere
The threatened “vote-no” campaign is similar to the one touched off in a separate letter to Lockheed Martin. That letter raised concerns the union has about the re-nomination of former Enron director Frank Savage to the Lockheed board, due to alleged involvement in the energy company’s demise and last year’s 28% vote against his re-election by Lockheed Martin shareholders.
Additionally, the union disputes Nominating Committee Chairman Norman Augustine’s independence as a director because he is a former Lockheed Martin top executive. “These vote-no campaigns aim to give substance to an otherwise hollow system of corporate accountability. If the boards of directors are not responsive, we will hold them individually accountable,” Trumka said in the letter.
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