Sarbanes-Oxley Act of 2002: Retention of Records by Auditors and their Clients relating to Outsourcing
October 9, 2009 by Bierce & Kenerson, P.C.
Summary:
The Sarbanes-Oxley Act of 2002 was intended to prevent future destruction of documents relevant to audits of companies that report their financial information to the U.S. Securities and Exchange Commission. On January 24, 2003, the SEC issued a final rule defining the rules that auditors and issuers and registered investment companies must follow to ensure appropriate document retention procedures.
Significance.
The rule is significant because it affects the trust of investors in the marketplace (including the securities of outsourcing service providers, their customers and their listed advisors). The SEC has estimated that approximately 850 accounting firms audit and review the financial statements of approximately 20,000 public companies and registered investment companies filing financial statements with the Commission.
Rules Applicable to Auditors.
Section 802 of the Sarbanes-Oxley Act of 2002 requires the SEC to promulgate reasonable and necessary regulations regarding the retention of categories of electronic and non-electronic audit records, which contain opinions, conclusions, analysis or financial data, in addition to the actual work papers. The regulations implement this law.
Seven-Year Retention Policy.
The final rule, which is included in Regulation S-X, requires accountants to retain certain records for a period of seven years after the accountant concludes an audit or review of an issuer’s or registered investment company’s financial statements. The proposed rules do not require accounting firms to create any new records. Decisions about the retention of records currently are made as a part of each audit or review.
Documents to Be Retained.
Under the SEC rule, records that auditors must keep for the seven-year period include work papers and other documents that form the basis of the audit or review, and memoranda, correspondence, communications, other documents, and records (including electronic records), which are created, sent or received in connection with the audit or review, and contain conclusions, opinions, analyses, or financial data related to the audit or review.
Effective Date.
Because time may be required to develop systems related to the retention of documents (particularly electronic documents) and to train people to use them, the SEC made the rules effective as of October 31, 2003.
Rules Applicable to Reporting Companies.
Inapplicability to Issuers and Investment Companies.
In issuing the final rule relating to auditors’ obligations of record retention in respect of their audits, the SEC considered “whether issuers and registered investment companies should be required to retain documents that the auditor examines, reviews or otherwise considers during the audit or review but are not made part of the auditor’s records.” Ultimately, the SEC concluded that the rules apply to auditors, and are not intended to cover issuers and registered investment companies.
Under the final rule, reporting companies need not retain the same records or supporting records that are furnished, or made available to, the auditors.
Forensic Investigations: Distinguishing Ordinary Outsourced Investigation from Privileged Investigation
October 9, 2009 by Bierce & Kenerson, P.C.
Many providers of finance and accounting (“F&A”) services cover a broad array of managed services. The functions of internal audit, pre-litigation claims and, more specifically, insurance claims processing deserve special attention from a legal standpoint. This article addresses distinctions between ordinary managed services (subject to pre-trial discovery) and “privileged” investigations that are not disclosable to adversaries in litigation. The analysis applies across all forms of business process outsourcing (“BPO”), but is particularly appropriate for F&A, HR specialty outsourcing and Sarbanes-Oxley “Internal” Audit.
Normal Rules of Discovery or Disclosure.
Under American rules of civil procedure, litigants are required to disclose to their adversaries information that could be used as evidence, or that could reasonably be expected to lead to the disclosure of evidence. Ordinary conduct of business, including managed services (or “outsourcing”) is subject to the normal rule.
This rule (sometimes called pre-trial discovery, sometimes called pre-trial disclosure) has several purposes:
- to force each party to identify “reality” and not make any claims or defenses unless justified by the facts.
- to enable a party to discover and use the facts to challenge claims or defenses of its adversary.
- to promote settlements, and thereby reduce the burden of litigation on the court system.
- in criminal cases, to give the accused access to “Due Process” under U.S. Constitutional norms.
Work Product Exception.
Investigations by attorneys or persons under the control of attorneys may be entitled to escape the normal rules of disclosure. Such investigations are conducted in anticipation of litigation. Businesses at risk of liability to third parties, employers and insurance companies investigating claims are entitled to assert the legal privilege to avoid having their investigators be required to testify in pre-trial depositions and otherwise disclose evidence before trial.
As a matter of public policy, such investigations are confidential and privileged, and the investigators are not subject to depositions during the pre-trial discovery process in order to preserve attorney-client communications and to enable to develop attorney work product free of intrusion. The confidentiality and privilege enable clients to obtain legal advice free of risk of disclosure. The attorney-client privilege and attorney work-product privilege to do not, however, protect a client from the duty to testify as to facts witnessed directly by the client outside any attorney-client communication.
A string of recent court decisions has examined the conditions under which an insurance company’s examination of a claim crosses the line from being an investigation performed in the ordinary course of the insurer’s business (and thus not eligible for the legal privilege) or work performed in anticipation of litigation. Travelers Casualty & Surety Co. v. J.D. Elliot & Co. P.C., ____ F.3d ___, NYLJ Oct. 25, 2004, p. 25, cols. 3-4 (S.D.N.Y. 2004), Judge Pitman; Weber v. Paduano, 02 Civ. 3392 (GEL), 2003 WL 161340 (S.D.N.Y. Jan. 22, 2003); Mt. Vernon Fire Ins. Co. v. Try 3 Bldg. Svces., Inc., 96 iv. 5590 (MJL) (HBP), 199998 WL 729735 (S.D.N.Y. Oct. 16, 1998); Am. Ins. Co. v. Elgot Sales Corp., 97 Civ. 1327 (RLC) (NRB), 1998 WL 647206 (S.D.N.Y. Sept. 21, 1998); see also United States v. Adlman, 134 F.3d 1194, 1199 (2d Cir. 1998).
Burden of Proof.
The party asserting the work product protection bears the burden of establishing the applicability of the work product exception. If that party seeks to deny all testimony by an investigator, it must prove the availability of the work product exception at all stages of the investigation, from beginning to end.Standard for Determining When Work Product Exception Applies.
In the Travelers decision, the court noted that there is no “bright line” test for determining when an insurance company’s investigative work is not privileged (i.e., it is merely performed in the ordinary course of business) and when it is privileged as an investigation done in anticipation of litigation. The court rejected the use of a line based on investigation done prior to the filing of any insurance claim.
A first factor is whether the investigator was retained before any decision was made whether the insurance carrier would reimburse its policyholder for an insured loss. If the investigation is conducted before there is any reason to expect litigation from either the policyholder or against potential third party sources of reimbursement (under the principle of subrogation), the investigation does not qualify for the work product privilege.
A second factor is whether there was any actual threat of litigation at the time when the investigator was retained to conduct the investigation. If there is nothing in the file to indicate that litigation is on the horizon, or perceived to be “on the horizon,” the privilege will not apply.
A third factor is whether the investigator is hired by an attorney or merely by the business, employer or insurance company. There should be some showing that litigation counsel has been retained in order to justify work product privilege.
Impact on Outsourcing.
Internal investigations by providers of outsourced services are normally not eligible for work product privilege. Enterprises and their F&A outsourcing service providers should adopt certain “best practices” to preserve work product privilege.
- Identify that Litigation is Anticipated.
If the enterprise customer or the service provider does anticipate any litigation, whether between the two parties or in relation to a third party whose rights might have been injured by an act or omission of the enterprise customer or the service provider, then litigation counsel should be consulted. - Records Management.
The parties should establish a log of “anticipated litigation” and maintain it under the management of lawyers. The records should be clearly marked so that there is no doubt that the investigations are conducted with some specific fear or threat of identifiable litigation “on the horizon.” - Separate the “Ordinary Work” from the “Work in Anticipation of Litigation.”
The enterprise customer and the F&A outsourcing service provider should clearly define the scope (statement of work) to include separate categories of “ordinary work” (the usual managed services) and “work in anticipation of litigation” that could be identified and administered separately. This segregation would insulate the validly privileged internal audit from the non-privileged ordinary operations.
Impact of Sarbanes-Oxley Upon Outsourcing
October 9, 2009 by Bierce & Kenerson, P.C.
Corporate Governance and Accountability under Sarbanes-Oxley Act of 2002.
On July 30, 2002, President George W. Bush signed the Sarbanes-Oxley Act of 2002. The bill establishes new rules of corporate governance and accountability for accounting for U.S. and foreign publicly owned companies whose shares are registered with the U.S. Securities and Exchange Commission. If you work for such a company, you have some immediate actions for timely compliance, some by August 30, 2002.
This legislation has potential importance to both outsourcers and their customers, as well as their accountants, executives, investment bankers, employees and attorneys.
Scope of the Law.
Enacted in the wake of a series of corporate accounting scandals, this vast and sweeping legislation establishes a public accounting oversight board, adopts certain minimal measures to preserve auditor independence, amends federal security laws to hold insiders and corporate executives and directors to higher standards of care in trading securities (including blackout periods during which such trading is prohibited), increases and extends corporate disclosures of accounting matters, sets standards for “corporate and criminal fraud accountability” and hardens the penalties for “white collar crime.” For particular provisions on corporate responsibility for financial reports and the accuracy of financial reports (including “off balance sheet transactions”), see our copy of the law at Sarbanes-Oxley_Legislative_Text.
Study on Manipulative Accounting.
Investment bankers will now become the subject of a new SEC study. But the study will go further, covering topics that affect virtually every publicly traded outsourcing services provider and its methods of operation. The study will review, among other issues relating to Enron and Global Crossing’s bankruptcies, the role of investment bankers and other advisors:
in creating and marketing transactions which may have been designed solely to enable companies to manipulate revenue streams, obtain loans, or move liabilities off balance sheets without altering the economic and business risks faced by the companies or any other mechanism to obscure a company’s financial picture.
Impact of Sarbanes-Oxley Act of 2002 on Outsourcing Service Providers.
For outsourcing service providers, the new law creates the risk that the SEC might seek to impose penalties for failure to adopt conservative accounting principles. We think that this law could create challenges for outsourcers that adopt the percentage of completion method of accounting, which may be appropriate but nonetheless perhaps not as credible or conservative as the “as collected” basis. Take our Survey on related accounting issues.
Impact of Sarbanes-Oxley Act of 2002 on Employees.
The Sarbanes-Oxley Act of 2002 protects employees from termination or other major adverse effect if they report alleged violations of the accounting rules or corporate governance requirements of that law. For a copy of the act as it applies to employees, please refer to our copy of the law at Sarbanes_Oxley_legislative_text
Please note that this gives new protections to whisteblowers who are employees, but also to non-employees as well. Please refer to our copy of the law at /Sarbanes_Oxley_ACT_2002_legislative_text
Impact of Sarbanes-Oxley Act of 2002 on the Role of Attorneys in Outsourcing.
The Sarbanes-Oxley Act of 2002 on corporate governance and accountability requires attorneys to take their concerns about accounting treatment to in-house lawyers and ultimately to the Board of Directors. Law firms assisting parties to an outsourcing transaction should consult with their clients concerning the accounting treatment implicit in the transactional structures.
Impact of Sarbanes-Oxley Act of 2002 on Venture Capitalists.
The Act will give pause to venture capitalists who fund start-up outsourcing services providers. It raises the legal liability of VC’s who serve on boards of directors, particularly if the portfolio company is targeting an IPO and board membership remains an important component of the VC relationship, compensation, “protection” of VC-organized investor interests and generally investment management.
Impact of Sarbanes-Oxley Act of 2002 on International Outsourcing Services Providers.
Being incorporated outside the United States may have its advantages as well as its disadvantages. Under the Sarbanes-Oxley Act of 2002, foreign companies whose shares are traded on U.S. stock exchanges must comply with new obligations on financial reporting, audit and corporate governance. Foreign services providers such as Accenture Ltd., of Bermuda, that were organized outside the United States prior to relevant “cutoff” dates are likely not to suffer the consequences of U.S. governmental retaliation for foreign “inversion” operations. Unless their securities are listed on a U.S. securities exchange, such foreign services providers may enjoy regulatory freedoms, but such freedoms may elicit suspicion by investors and prospective customers due to the lower level of corporate governance discipline and public disclosure of material information. If you have any question about this process, please contact one of our attorneys.
International Outsourcing: Business Judgment Factors
October 9, 2009 by Bierce & Kenerson, P.C.
Summary.
Why do you need an international outsourcing strategy? You might be negligent if you don’t have one.
Fiduciary Duty.
Directors are legally responsible for managing their companies. They have a duty to exercise their own business judgment for the best interests of the company and its shareholders. Offshore outsourcing has matured in many industries to the point where it could arguably be a breach of that fiduciary duty not to send some work offshore.
The benefits to the company and shareholders of offshore outsourcing could include cheaper supplies, more competitive services by service providers or suppliers, lower cost of capital, speedier entry into the market and other reasons.
Against such benefits the directors must consider the commercial, legal, reputational, foreign currency, security, intellectual property, human resources and other risks involved in any outsourcing, particularly an international outsourcing.
Negligence.
Any lawyer will tell you what negligence is: you owe a duty to follow a standard of care, and when you fail to follow that standard of care, your failure proximately (predictably) causes the damage that actually results.
Business Judgment Rule.
One of the first principles of corporate governance is that the board of directors has a duty to exercise its business judgment in managing the affairs of a company. This rule requires active decisions, not neglect. Given the globalization of economy and the potential significant benefits of offshore outsourcing, it could be argued that every board of directors must consider international outsourcing.
Sarbanes-Oxley Act of 2002: Is Insourcing a Material Risk?
SEC regulations under the Sarbanes-Oxley Act requires disclosure of material contingencies. See Sarbanes Oxley and Outsourcing. Is it material not to seize business opportunities that could cut costs materially?
Investor Interest.
If your company’s shares are publicly traded, you need to consider the effect of your outsourcing strategy upon investors, particularly mutual fund managers and hedge fund managers.
Fund Manager’s Perspective.
In an interview published in The Wall Street Journal on January 28, 2003, Richard Lane, co-manager of a $650 million FMI Focus Fund, concluded that he would not invest his fund’s money in shares of companies that lack a “good outsourcing strategy to China.” His rationale: “The companies that are faster at outsourcing either products or components … will get a leg up on the competition.”Investment Banker’s Perspective.
Investment bankers advise on capital structures of companies. A management tool that harnesses low-cost suppliers effectively frees capital for spending on core business opportunities.
“Join the Bandwagon” into Foreign Sourcing.
In February 2003, Foote Partners reported as many as 35 percent to 45 percent of U.S. and Canadian Information Technology workers will be outsourced – replaced by contractors, consultants, offshore technicians and part-time workers – by 2005. The survey, based on discussions with 1,880 private sector and government employers, found American companies “can’t afford to do application development in the U.S. anymore (because) the nature of the business has changed.” Similarly, Forrester Research estimated in 2003 that the $4 billion in U.S. wages that floated offshore in 2000 will become a tidal wave of $136 billion – and 3.3 million IT-related jobs – by 2015. One reason: It’s now easier to contract maintenance and support via Web-based collaborative tools, high-speed data networks, cost-effective bandwidth and standardized business applications. U.S. IT workers facing displacement are encouraged to retrain in project management or technologies, such as IT security and wireless networking.
Caveat.
Outsourcing can involve considerable risk. For example, the existence of foreign legislation for protection of intellectual property or data protection might be clear, but the local government’s enforcement policy and judicial experience might not be favorable. Certain countries have a reputation for disregard of misappropriation of intellectual property rights despite laws protecting such rights. Depending on the type of functions or operations that can be outsourced, such risks might be mitigated by special strategies. Bierce & Kenerson, P.C. has advised multinational clients on such strategies.
Failed Deals, Bankruptcy and Class Action Securities Fraud in Global Outsourcing: In re Alcatel Securities Litigation
October 9, 2009 by Bierce & Kenerson, P.C.
In a pre-Sarbanes-Oxley time, the hypergrowth Dot.Com era disintegrated into “Dot.bomb” implosions. Reciprocal deal-making in speculative ventures was almost the norm, particularly in telecommunications transport. The litigation aftermath of failed deals, bankruptcy and class actions for securities fraud is reaching resolution. This short case study provides a synopsis of some key points of failure in reciprocal transactions, with a focus on telecom.
Background.
Alcatel is a French technology corporation. On October 20, 2000, the company issued a U.S. initial public offering (IPO) for its Class O shares. This class was 100% owned by Alcatel, but served as a “tracking” stock for the company’s Optronics Division. The IPO raised approximately $1.2 Billion and created additional shares that could be used as currency in mergers and acquisitions.
The Reciprocal Deal.
Soon after the IPO, Alcatel announced that it had invested $700 million in its customer, 360networks Corporation. In turn, the customer agreed to purchase over $1 billion in equipment from Alcatel to create a proposed trans-Pacific fiber-optic network.
Announcements to Investors.
When Alcatel’s proposed merger with Lucent fell through, Alcatel issued an unexpected announcement to investors that warned of a projected $2.6 billion loss for the second quarter of 2001. The loss included charges associated with a write-down of goodwill for two acquisitions (Xylan and Packet Engines), a full write-down of the $700 million invested in 360networks and various inventory write-downs. Allegedly, the announcement downgraded its Optronics Division in light of that unit’s “high exposure to the submarine market and the increased lack of visibility and potential delays in large projects, as well as inventory build-ups.” In re Alcatel Sec. Litig, __ F.3d __, NYLJ Mar. 11, 2005, p. 23, cols. 1-4, p. 24, cols. 1-4, at p. 24, col. 3 (S.D.N.Y. Mar. 11, 2005) (Judge Casey) [“In Re Alcatel Sec. Litig.”].
Violations Alleged.
The Alcatel investors claimed securities fraud. Most of the claims were dismissed because of late filing. The case is a cautionary tale and reminds us of the interests of investors as key stakeholders in outsourcing, whether as shareholders in global enterprises or as shareholders or bondholders in service providers.
Recommendations.
The story of Romeo and Juliet brings to mind the aphorism “‘T’is better to have lived and loved than to never loved at all.”
In securities fraud litigation, the love has turned to hate. So we posit the modern aphorism, “‘T’is better to have solicited investment and warned than to have never solicited investment at all.”
In short, participants in outsourcing should each refocus on the specificity of their warnings surrounding the risks of outsourcing and other strategic relationships, the nature and risks of the issuing company’s supply chain of suppliers and customers, and the particular risks in the industry. The generic warnings might not be sufficient, so constant updating may be appropriate, even without considering the special certification, audit and control issues presented under the Sarbanes-Oxley Act of 2002.
Service Providers.
Reciprocal Dealings and Joint Ventures Pose Special Securities Risks.
Typically, the service provider’s investors are the ones with a securities fraud claim. To be put on notice to inquire further, the service provider’s investors need to receive a storm warning of the seriousness of a material problem that could affect an ordinary investor’s decision to buy, sell or hold the securities of the service provider. In the case of reciprocal business dealings and joint ventures between service providers and their enterprise customers, the standards of disclosure are heightened because the materiality is heightened: a bankruptcy by the enterprise customer (as in the case of WorldCom for EDS or in the case of 360networks for Alcatel).
Designing and Planning for Investor Notification.
Service providers should therefore consider the following prudent business practices:
- Interdependencies:
warnings to investors whenever they enter into reciprocal business dealings or joint ventures with customers, to identify the mutuality of commitments and dependencies for success, particularly specific risks of such dependencies. - Material Changes:
warnings to investors whenever such dealings or ventures give rise to material losses or other material risks of liability. - Keeping the Risks Small:
keeping the size and financial value at risk below the “materiality threshold” so that any failure to disclose would not trigger a claim of material securities fraud (or, in cases of a consortium contract with leading enterprise customers in an industry vertical, a claim that the contract restrains trade or otherwise violates competition laws).
Enterprise Customers.
Enterprise customers face questions, as securities issuers, surrounding the viability of their key suppliers. Best practices to avoid securities fraud claims should be considered.
- General Warnings about Dependency on Suppliers.
It is customary to identify that the issuer is dependent on its suppliers for continuity of business operations. - Specific Warnings about Limitations on Liability of Suppliers.
It is customary for commercial enterprises to negotiate limitations of liability. Enterprise customers seek such limitations when they are sellers, and they customarily allow certain limitations of liability to their service providers, subject to unlimited liability for certain key failures by the service provider. The enterprise customer should provide specific warnings of the risks of outsourcing. Any disclosure of mitigation measures taken would be in the nature of “comfort” to the investor, which could backfire and render the warning useless. - Consider Investing in Your Service Providers and Suppliers.
Enterprise customers may have more leverage over a publicly traded service provider if the customer is also a shareholder. The amount of the shareholding is not as significant as the fact that the enterprise customer can have access to company information for a valid corporate purpose in relation to its decision whether to buy, sell or hold the shares. Being a shareholder gives the enterprise customer a seat at the table in the judicial selection of the most representative shareholder to prosecute any shareholder class action. And it permits the shareholder to opt in or opt out of the securities litigation, which could be useful in governing the personal and corporate relationships as customer. - Negotiate a Good Contract.
A solid outsourcing contract, accompanied by effective contract administration and relationship governance, makes a difference. In-house counsel not experienced in the art of outsourcing should hire specialized lawyers. Reliance on consultants to process legal issues may be courting investor inquiry.
Bankruptcy in Outsourcing
October 9, 2009 by Bierce & Kenerson, P.C.
Overview.
The possibility of a bankruptcy is a legal risk that affects customers, service providers and their respective employees and their respective supply chains including subcontractors and indirect customers. Bankruptcy rules have a special bite in a normal outsourcing, since outsourcing does not necessarily involve a sale of goods by a vendor. Accordingly, special attention is needed for intellectual property and continuity of services. An understanding of the general rules of U.S. bankruptcy can help focus on solutions, both pre-petition and post-petition.
Customers and Suppliers affected by Bankruptcy.
Bankruptcy of your customer, or one of your direct or indirect suppliers, could deprive you not only of cash flow, but also of amounts already collected. It could also impose duties of a “custodian” to protect and preserve the bankrupt’s assets in your custody, assuming the bankrupt has a positive net worth (i.e., is not insolvent).
Key Issues in Bankrutpcy that Affect Outsourcing.
What should parties to an outsourcing know about bankruptcy before they sign a contract? For starters, you should understand not only the core concepts of a new “entity,” assignment and assumption (or rejection) of executory contracts, the automatic stay, the avoidance of preference payments made within the 90-day period (or, for insiders, one year) prior the filing of the bankruptcy petition, the avoidance of fraudulent transfers, priorities among creditors and the legal consequences of the filing of the bankruptcy petition as it relates to an intellectual property, the bankrupt debtor’s assets held by others and the payment streams to providers of goods and services.
Lost Deals.
Beyond the technicalities, bankruptcy may deprive both the customer and the services provider of the benefits of the bargain they crafted so carefully. To some extent, the parties can negotiate measures to limit the damage. But, once a party is in bankruptcy, exit strategies become less predictable.
Timing: The Beginning.
Bankruptcy occurs when a petition for bankruptcy is filed relating to an insolvent “debtor.” Rights and obligations are defined in relation to the date of the petition. Time is measured as “pre-petition” or “post-petition.”
Debtor; Trustee; Debtor-in-Possession.
Chapter 11 of the Bankruptcy Code specifies the processes and rules for reorganization of a bankrupt, which is referred to as the “debtor.” If the federal Bankruptcy Court fails to appoint a trustee to manage the debtor’s estate, then the debtor may do so as “debtor-in-possession.” A trustee is not appointed in the absence of some “good cause” to do so.
Immediate Effects of the Petition.
By filing a petition, a bankrupt debtor can freeze trade credit existing at the petition date. This is potentially advantageous in the short run but potentially ruinous for the long run as suppliers respond by insisting on a “cash-and-carry” payment schedule.
Executory Contracts.
Bankruptcy can result in the undoing of executory contracts for future performance. The right of the debtor-in-possession to reject such contracts is a principal tool for restructuring and reorganizing the capital structure of the debtor. But the debtor cannot prevent the other party from termination of the contract for actual breach. For services providers, therefore, it is essential to manage credit risks.
This chapter refers to some of the normal operations in a bankruptcy. Since each situation is different, we remain available for consultation on planning pre-petition and strategies post-petition.
Labor-Management Relations and Sinecures for Life: Is There a Better Way to Automate the Logistics of Business?
October 1, 2009 by Bierce & Kenerson, P.C.
Transportation services have long been a haven for American labor unions. As other business processes are automated, unions face increasing threats to demand for jobs for their members. This case study considers a modern manifestation of such tension between employment and automation in the business of global logistics.
Union contracts under the National Labor Relations Act are sacrosanct. Union labor has been fighting to retain rights and controls. The negotiations, under the guidance of the Federal Mediation and Conciliation Service and with a little coaxing by President George W. Bush’s announcement of a Board of Inquiry, appear to have broken new ground in labor-management relations. Does this settlement suggest that Big Labor is now willing to negotiate deals that would convert a port operator clerk’s job into an outsourced job for a major outsourcing services vendor’s “unionized” subsidiary? Should non-union service providers play with “union fire” by accepting unions?
Does the Impending West Coast Port Settlement Opens New Doors for Business Process Automation and Eventual Outsourcing?
In early November 2002, the Federal Mediation and Conciliation Service announced that West Coast port operators and union dock workers had concluded a tentative agreement on key issues in technology, with potential 50% increase in productivity for port operators from San Diego to Seattle. The International Longshore and Warehouse Union (“ILWU”), representing 10,500 West Coast dock workers, agreed in principle to key concessions on the introduction of technology following a 10-day strike that closed the ports and led to President George W. Bush’s order for mediation and return to work.
Chronology.
As reported by a Presidential Board of Inquiry:
The contract between the parties expired on July 1, 2002. Before the expiration of the contract, in May 2002, the parties began to negotiate over a new contract. Negotiations proved unsuccessful and, after the contract expired, the parties began to operate under short-term extensions of the contract. On September 1, 2002, the parties’ practice of operating under short-term extensions of the contract ceased.
The impasse resulted in a lockout.
Affected Parties.
The labor dispute affected, on the one hand, employees represented by the ILWU and, on the other hand, employers and the bargaining association of employers who are (1) U.S. and foreign steamship companies operating ships or employed as agents for ships engaged in service to or from the Pacific Coast ports in California, Oregon, and Washington, and (2) stevedore and terminal companies operating at ports in California, Oregon, and Washington.
Union Practices under Scrutiny.
The operating business model that existed prior to the settlement resulted in a huge bottleneck. While the terminal operators had software that allowed expeditious transit of cargo through ports, their systems came to a stop because the union contract gave the union exclusive jurisdiction over the process of transmitting essential information. In short, only union workers could re-key and re-format the data inputs, resulting in duplication of costs and delays, with a loss of productivity of the West Coast ports as compared to Asian and other Pacific port and terminal operations.
Key Union Demands in Exchange for Introduction of Information Technology.
The introduction of new technologies was expected to eliminate between 200 and 600 jobs, particularly marine clerks. Initially, the ILWU demanded:
- minimum staffing levels for marine clerks, even if they did not have any job to do due to the efficiencies of automation;
- protection of those jobs of currently registered dock workers (whose salaries are reported to be approximately $106,000 a year on average) who are displaced, for the remainder of their career, until retirement;
- the union’s retention of jurisdiction over marine clerical work, which may include some yard and rail planning work but not including vessel planning work;
- the union’s participation in the productivity benefits and cost savings for the employers, in the form of increased management contributions to pensions as payment for a share of the “increased wealth” that the new technology would bring.
Agreement on Terms of Service.
In early November 2002, the Pacific Maritime Association, which represents West Coast terminal operators and shipping companies, agreed to the protection of jobs and the union dropped its demand for minimum staffing, a practice formerly known in the railroad industry as “featherbedding.” Reportedly, the jobs will secure for the lifetime of the clerical workers. The union reportedly retained the jurisdiction over the marine clerical work and some other work in the terminal yards. At this writing (mid-November 2002), the sharing of productivity benefits had not been resolved, but the union took the position that such sharing was a “deal-breaker.” Negotiations appear to be on track for a contract only because, under federal law, the President has the power to force the parties to “go back to work” and use a “cooling off” period to negotiate a workable new contract.
Legislative and Judicial Context.
The “back-to-work” order, signed by President George W. Bush under the Taft-Hartley Act, ended the lockout instigated by the Pacific Maritime Association in anticipation of an impending strike. The President appointed a Board of Inquiry. See Section 206, 209 of the Labor Management Relations Act, 1947 (61 Stat. 155; 29 U.S.C. 176, 179). A federal judge began monitoring compliance by each side with the legally mandated procedures during such a back-to-work order.
Union Negotiations as a New Business Opportunity for Outsourcers?
The approach of the ILWU in the contract negotiations suggests that it will be a long time before unions voluntarily agree to improve productivity using information technology. The ILWU demanded that the jobs of the incumbent employees be protected for life at current salary levels and the union share in the productivity gains from changes in union work rules.
Competitive service providers will see this episode as further proof that unions do not accept business process re-engineering or any other change in the union’s “jurisdiction” over the “work” as classified in the union contract. Companies and governments that seek to improve their business processes through changes in work rules can be expected to confront similar resistance.
Is there a “Better Way”?
Nothing in the press announcements of the apparent reconciliation suggests that the unions were willing to accept any conditions on their “life tenure in employment” contract for the affected clerical workers. There was no mention of any duty to seek retraining, to increase personal productivity, to learn and apply new skills, or to make any other change in “business [process] as usual.” If their jobs had been eliminated due to imports of goods, they would be eligible for federally funded worker adjustments and retraining, as a principle of promoting international free trade under the WTO and U.s. enabling legislation.
In defense of the union, elimination of jobs due to technology is a constant threat to the number of union members. With declining numbers of members, a union becomes weaker and more subject to further defections.
In conclusion, there may be a “better way” if there are ongoing improvements in quality of service as a condition of job tenure. This law of business applies to business enterprises, which must constantly compete on the basis of service quality. Similarly, the classic “siren song” of the outsourcing service provider, willing to take over the “overhead” and “back office” employees of a customer as part of a long-term service contract, has been that the individual employee will become part of a team, dedicated to service quality, process improvement and where skill and initiative will be rewarded with upward mobility.
This promise of a new career path probably falls on deaf ears, though. Union leaders distrust the benefits of such a new employment environment, which might be available only to the best and most ambitious workers and not available to the larger mass of “ordinary” workers.
Management of unionized operations struggle for productivity improvements. Extrapolating on the ILWU-Pacific Maritime Association dispute, there will remain sharp differences between unionized operations and non-union operations. Where union labor has a right to share, as an equal “equity” partner with management and shareholders, in all productivity gains from business process improvements, they are only pushing management to find ways to circumvent their “jurisdiction,” such as by exporting jobs or eliminating entire classes of work. This struggle, under rules defined in the 1930’s, continues.
International Perspective.
Perhaps, in the long run, government and the parties will see the issue as one of international labor competitiveness. By applying worker adjustment assistance and retraining of workers who need ever increasing skills to remain competitive, government, labor and business might find a “better way” through such transitions to a redesigned workplace. Otherwise, valuably human capital investment opportunities could be lost forever to foreign labor and business.