ACS's Darwin Demonstrates 'Survival of the Fortunate'

Yesterday, Merger Market reported that ACS and its special committee have decided not to file suit –brought “on the grounds of auction interference”—against ACS Chairman Darwin Deason and Cerberus.

In an April letter, the chair of ACS’ special committee overseeing the deal questioned whether a truly competitive bid was possible given Cerberus’ exclusive agreement with Deason to negotiate the take-private transaction. Also at issue was Deason’s employment agreement, as it may have been a deterrent to buyers:

[Deason’s] employment agreement is unusually strong for a chairman and grants him chief executive-type rights, including the exclusive and sole right to all hiring and compensation activities at the executive level, as well as the sole right to nominate board members… Further, to obtain the agreement’s termination, notice must be provided 30 days prior to 18 May of any given year. Thus any buyer of ACS would not be able to terminate the agreement until 18 April of next year, it was pointed out.

But ACS and the special committee are betting that the threat of litigation has appeased wary buyers:

ACS and the special committee believe the pursuit of litigation would not get additional mileage as the communicated threat toward Deason was adequate. …[A]s a result of the threat, the special committee feels the auction process may be enhanced.

Deason must be particularly relieved to have withstood another round of scrutiny, as his role in the take-private bid was likely motivated by a desire to move his business dealings out of the spotlight. Deason began deal talks with Cerberus back in November 2006, at about the same time as the backdating scandal that saw the forced resignations of ACS’ chief executive and chief financial officers. Deason (alleged in pending litigation to have been personally enriched—to the tune of $71 million—by the options tinkering) claimed to be unaware of any backdating, and came out unscathed. (The WSJ reported that Deason may have known more about ACS’ backdating practices than previously acknowledged. In a hand-written note uncovered during a probe into ACS’ backdating practices, Deason stated that the company “always” picked the “lowest” prices “so far” in the quarter to award stock options.)

Seems to be a survivor, that Darwin Deason. But he’s not out of the woods, yet. He’s been named in two, still-pending, shareholder lawsuits related to the deal.

Birds of a Feather…

ACS will feel right at home alongside IAP Worldwide, the Cerberus-owned government contractor. Both are facing criticism for repeated delays in implementing large government contracts – and forcing taxpayers to pick up the slack.

This Sunday, the Nashua Telegraph reported that New Hampshire’s contract with ACS to handle the $61 million upgrade of the state’s Medicaid Management Information Systems has reached a “critical juncture.” The system upgrades have been plagued with delays and is a full year behind schedule. Last week, the Health and Human Services Deputy Commissioner told the state’s executive councilors that ACS is reimbursing the state for costs related to the delays. However, ACS is not paying the federal share of delay costs – even though the feds are funding 75% of the project – and there’s no guarantee that the feds will pick up that cost.

Cerberus might say this is the kind of inefficiency the firm hopes to correct after the buyout. However, IAP’s five-year, $103 million contract with the IRS to process income tax returns has also been held up by extended delays. IAP was expected to have taken over at seven processing sites by Dec 1, 2006. By April 2007, IAP had started work at only two facilities. Further delays were reported as a result of IAP not meeting contractual obligations related to background checks.

Hmmm…taxpayers paying for contractors’ mistakes. Under Cerberus’ watch, such mishaps add insult to injury when you consider the tax advantages enjoyed by PE which we raised in our last post. Can we expect more of the same if Cerberus acquires ACS?

What, me pay taxes?

Cerberus knows a tax dodger when it buys one. According to a comprehensive 2004 study on corporate tax avoidance, ACS reportedly paid an effective tax rate of 14.2% over the three year period between 2001 and 2003 instead of the statutory income tax rate of 35%. While certainly not the only company to benefit from Bush’s corporate tax breaks, ACS enjoyed the cut rate despite earning over $1 billion in profits during that period.

Recall that ACS is a major government contractor, deriving 41% of its revenues from government work. So while ACS was paying less than its fair share of income taxes, it was also raking in taxpayer dollars – twice over fattening its bottom line at the expense of the tax system.

Who lost out? According to Citizens for Tax Justice and the Institute on Taxation and Economic Policy:

· The general public, who must pay higher taxes, lose public services, or be responsible for big future debt burdens.
· Relatively disadvantaged industries and companies that will find it harder to compete for investment capital with tax-favored corporations.
· The U.S. economy, which is harmed by the distortions that corporate subsidies produce.
· State governments and state taxpayers, which see their corporate tax systems erode along with the federal system.
· The integrity and sustainability of the tax system as a whole.

Surely Cerberus can appreciate a kindred spirit. After all, Cerberus too is benefiting at the expense of taxpayers since the carried interest management earns from the firm’s funds is taxed only at the capital gains rate of 15%.

Led by Republican Sen. Charles Grassley (Iowa), proponents of legislation that would raise private equity managers’ tax rates from the 15% capital gains rate to 35% income rate are making similar arguments about who is losing in the current system. Even defenders of the Bush tax cuts can’t argue that taxing private equity firms at cut rates has any trickle-down benefits.