Tuesday, February 10

Bad Faith, Addendum 2: Unintended Costs of the Railroading of PSU

When the BOT inner circle reached its "bad faith agreement" with the NCAA on the Consent Decree, it is likely that they thought the University would incur very little in the way of future expenses.  They were wrong, mostly because they believed their own hype.

By
Ray Blehar

According to PSU's progress web-site, as of June 30, 2014, the University incurred $79.7 million in expenses not including settlement of claims related to the Sandusky crimes.  Adding the settlements of $59.7 million, the current tab for the scandal is $139.4 million.  However, that does not include the additional $36 million in payments/donations owed from the lNCAA/Corman settlement.  

Adding those brings the total cost to $175.4 million... and counting.  But that figure is an illusion.  The cost to PSU is far lower -- but still a lot more than the BOT inner circle ever expected.


The BOT Inner Circle Misjudged Costs of Scandal
Based on the earliest accounting available, it is reasonable to estimate the scandal's expenses were in the $15 million dollar range when Erickson signed his name on the dotted line on July 23rd, 2012.  

It is also very likely that he and the cabal of Board members didn't believe that the scandal expenses would move much farther beyond that.  They believed they convinced everyone that there was a PSU cover up and that all future litigation in the matter was closed. 

To review, the BOT inner circle:
  • Created a narrative that the PSU "culture" was to blame for enabling Sandusky's crimes;
  • Hired Louis Freeh to conduct a phony investigation and create a report to justify their actions of firing Paterno and Spanier -- and to further indict the PSU culture.
  • Got the NCAA to repeat the "culture" narrative and to praise them for their actions that (allegedly) "saved" PSU football; and, 
  • Attempted to cut off future challenges to the consent decree by giving up PSU's rights to appeal to the NCAA or take other legal actions. 
The BOT inner circle, apparently believing the stuff they were shoveling, likely thought the only things left to happen after the consent decree was signed was that the "moving forward" train would leave the station and that everyone would jump on board.   

As Karen Peetz mistakenly stated, "by the time someone gets here in 2014, it will just be a distant memory." 

Their mistaken beliefs would cost PSU millions.


OOPS!  The Scandal Won't Cost PSU Anything

Unfortunately, the "smartest people in the room" were not only foolish to believe their own hype about the PSU culture being responsible for Sandusky,  but they were also foolish enough to believe their faulty assumptions about the costs of the scandal.  

According to a media source, PSU spokesperson David LaTorre stated that the scandal wouldn't cost PSU anything.  The University stated the situation a bit more eloquently.


"The University maintains General Liability and Directors & Officers insurance policies which are expected to cover the defense of claims brought against the University and its officers, employees and trustees. Legal and other expenses not covered by insurance are expected to be funded from interest revenues related to loans made by the University to its self-supporting units. As a common business practice, the central University -- which has the ability to finance bonds backed by its credit rating --is able to loan its self-supporting units money for special projects. These units do not have their own borrowing authority, but they are all part of the University's credit profile. As an example, in the case of the most recent $100 million Beaver Stadium expansion, the University bore the risk to finance a bond at a variable rate during a favorable financial period. The University then loaned funds at a fixed interest rate to Intercollegiate Athletics, which then repaid the loan with interest from its ticket sales, club seats leases, sponsorships and other income generated. The interest from this loan is then placed into a fund that can be used for more projects in the future or in emergency situations. Therefore, uninsured expenses can be covered by this interest and will not be funded by student tuition, taxpayer funds or donations. Compensation paid to all such attorneys, consultants and firms will be regularly updated and all expenses are audited."

The interest expected from the series of loans to PSU athletics is estimated at $43 million over the terms of the loans.  As the accounting shows, however, the university did not issue bonds and instead used funds from the institutional support budget.  That decision was likely driven by the fact that there were too many eyes watching the Board's every move.

Regardless of how the costs were funded, they total at around $32 million -- which is a lot more than zero.  

Sandusky Injury Claims ($59.7 Million and Counting)

Lubert's sub-committee blew it.
The legal and compliance sub-committee of the PSU BOT culminated research it began in February 2012 and in October 2012 the Board approved a resolution which stated the University was liable for injuries suffered as a result of the crimes of Gerald Sandusky.  Among the many reasons why this was a bad decision, the foremost was that the decision was made under the premise that  PSU's insurer would reimburse the University for the claims (up to the specified coverage limits).  The insurer, the Pennsylvania Manufacturer's Association (PMA) Insurance Company, denied the claims.  PSU sued and the case is scheduled to go to trial in March 2015. 

The "plain language" of PSU's policy indicates that the University will lose.  Molestation and sex abuse aren't  covered.  

Also, there are three pending cases against PSU regarding the Sandusky case -- all which rely heavily on the Freeh Report as evidence that the University was at fault for Sandusky.  These are civil cases and the burden of proof is on the victims to show a preponderance of evidence supporting their respective cases (that PSU was a "third party" who contributed to or facilitated the crimes).   Obviously, the attorneys will also point to the language of the BOT's resolution that states the University is liable.   

PSU isn't looking good in these cases and they know it.  According to PSU's 2013 financial statements (p. 36), the University believes "a loss is reasonably possible in future periods which could have a material adverse effect on our current and future financial position, results of operations and cash flows."   

NCAA/PSU Unexpected Litigation Expenses ($8 million)

Given that the consent decree contained derogatory/defamatory statements about Paterno and other PSU leaders, it provided grounds for those individuals to sue for damages.  The Board's inner circle and the NCAA's belief a single sentence in the consent decree could stop damaged parties from litigating was rather foolish to say the least.  

The group of litigants claiming damages because of the University's, Freeh's, and NCAA's statements and actions include: Mike McQueary, Bill Kenney and Jay Paterno, the Paterno Family (et al), and Graham Spanier.   

As mentioned earlier, the BOT inner circle also erred in concluding that insurance would pay for Sandusky claims.  As a result, it hired Jenner & Block, LLP and Lee, Green & Reiter Inc. to litigate the PMA lawsuit.  

The legal tab incurred by PSU since the outset of the scandal is approximately $17 million. About half of those costs were unexpected.


Externally Initiated Investigations ($4.5 million)

The costs for externally initiated investigations has exploded since July 2013, when they were just $842 thousand.  Those costs were inclusive of the services provided by Margolis and Healy for consulting on Clery Act compliance.  The Department of Education issued its initial Clery Act compliance report in July 2013.  In addition, those costs included the services of Gene Marsh, who was brought in allegedly negotiate with the NCAA.

In August 2013, PSU released another statement revealing externally initiated investigations cost PSU about $1.1 million.   However, as of June 30, 2014, the cost of those investigations reached a whopping $5.6 million.  

Based on the firms listed, the monies are being paid to Buchanan Ingersoll, a governance consulting firm (but not Holly Gregory's)  and the law firm of Saul Ewing.  Saul Ewing holds the documents and related information related to the Freeh Report and has been supporting civil litigation efforts since the early days of the scandal.  The costs related to civil litigation and hiding the truth about the Freeh Report have escalated as the litigation efforts continue.  Given that some of  these cases are tied to Sandusky's criminal acts and some may be eventually be tied to criminal acts, it is unlikely that D & O insurance will cover the costs.

Indemnified Persons' Legal Defense ($4.1 million)

According to documents uncovered in the investigation, prosecutor Frank Fina advised PSU officials that he expected "C + S to flip" on Spanier.   Had that happened, the costs for the legal defense of the indemnified persons would have been much lower.  The Curley, Schultz, and Spanier cases would have been resolved by now, Spanier would have a criminal record, and the University would been done paying legal fees for indemnified individuals.  

Of course, none of that happened.


Much to the chagrin of Frank Fina and the BOT,
PSU officials have maintained their innocence. 
The three former PSU administrators have maintained their innocence and continue to fight in the courts.  

As of December 31, 2012 -- about two months after the OAG issued the Conspiracy of Silence grand jury presentment, the cost of indemnified persons defense was $5.8 million.  At the last accounting the cost was $9.9 million and counting as more Penn State officers file lawsuits.



Public Relations (Unexpected Direct Costs, $3M) 

Freeh, like Mitchell, was hired for PR purposes.
Considering that the hiring of Freeh and George Mitchell were nothing more than public relations ploys, the cost of PR for the scandal has reached $20.7 million.  Not so ironically, in the earliest accounting for the scandal, the Freeh investigation and public relations costs were combined in the same category.  

In February 2012, that total was $5.75 million.   However, the costs of Freeh and Mitchell ($11.6 million) were expected at the time of the consent decree.

As noted above, the OAG and PSU expected one or more of the PSU officials to roll and bring an end to the scandal and its related costs.  The cost of PR calculated at the end of 2012 was $6.2 million.  PR costs have now unexpectedly reached $9.2 million

Firms providing early PR support were:  Reed Smith LLP, Ketchum, Kekst and Company Inc. and Domus Incorporated.   Firms added in April 2012  at a cost of $2.5 million for a 12 month period were: Daniel J. Edelman, Incorporated and La Torre Communications.

It is notable that Edelman's advice to PSU is likely to cost more than 40 times what the firm was  paid.  Here are his remarks from August 2012 about PSU's consistent messaging.


"Look, the school has lived through three major news cycles in the 
last two months, the Sandusky trial and verdict, the Freeh report, and then the NCAA

sanctions. In all three of these situations we've been responding to events not in control of

the events, but in each situation we've been able to provide consistent messages.



"And those are as follows: First, we take responsibility to insure this sort of thing
never happens again, and that we are going to fix the shortcomings so we're a stronger
institution in the future. 

"Second, we're committed to developing and supporting specific programs to protect children on and off campus.

Edelman: Learned nothing from Duke
"Third, we have a plan to improve the school's governance which will be informed in part by the Freeh Report's recommendations and will make this great University even greater in the future. This University has received praise in many corners in the past two months, despite these three big events in the sense that you have been willing to hold nothing back in the investigation and to take very strong actions, such as the removal of the statue in front of the football stadium prior to the NCAA sanctions.

In summary, Edelman's consistent message was to confirm that Penn State and Paterno was responsible for Sandusky's actions.   It should be noted that Edelman also advised the Duke administration's public relations efforts after the rape allegations lodged against its lacrosse team.  In that case, he relied on the media and the court of public opinion to form his beliefs and suggested that it might be right for Duke to do the same.  

It seems some people never learn from the past.


Conclusions

At this point in time, the unexpected costs for the scandal are $75.2 million -- well over the $43 million in interest that the University expected to cover everything.  Of course, those costs will continue to rise as the litigation continues and more potential lawsuits are filed over a variety of issues related to the Board's continued poor decision making.

Clearly, the BOT inner circle's analyses were flawed when they underestimated the direct costs (and indirect costs) of the scandal.  The only thing they may have underestimated worse was the resolve and intelligence of the University's alumni.

Next: Underestimating the alumni.

15 comments:

  1. SMH stream of consciousness:

    If David La Torre is La Torre Communications, his payments from PSU can be put in the same category as George Mitchell's. Saying nothing, literally, and doing nothing, apparently. Because, HELL, what can be said on behalf of PSU's decision-making! And because there was nothing TO DO regarding PSU's athletic integrity.

    What would these seemingly enormous interest collections be being used for if the BoT hadn't created this financial black hole?

    The BoT includes lawyers, business people, bankers, academics, likely other "highly accomplished" professionals. So do they look to themselves for sound legal guidance, sound Business 101 guidance, and sound Accounting 101 guidance? If not, why have such "so-called" (think Ken Frazier) pillars of successful citizens constitute the Board??

    Where you're headed next, Ray, may be my biggest head-shake. How could a BoT of ANY highly ranked university expect its faculty and graduates to be nothing more than dimwitted cows easily moved along???

    ReplyDelete
    Replies
    1. Becky,
      You are correct that the BOT is made up of business people and bankers who are highly accomplishedand are on the BOT to make a buck.

      When I found out that PSU was fined $60 million, my first thought was that the Board would issue a bond to cover the costs at a rate well above the market and give the BOT members the first shot at buying the debt. But, as I noted, there was much scrutiny on the Board's every move, they didn't do the bond and instead did the loan to the Athletic Department.

      One has to wonder how much money the Board members made on prior bonds? And which investment banks underwrote and sold those bonds on the "open" market? No doubt in my mind that PSU's conflict of interest policy allows conflicts of interest for this very reason.

      It's time for PSU to open up the books. We'll find out who was profiting from their membership on the Board.

      Delete
  2. As I have tried to follow this from the beginning it bothers me that a certain group on the Board have lead the rest on a trip to never never land. Why? If this is the group that is supposed to be the visionarys of the future of Penn State, why were many of the Board just "hop on the bandwagon" groupies? As more of the original Board members leave, when will it end?
    Although I am personally not clear on the financial aspects of this article, it never sease to amaze me the lack of involvement of more than just 5 or 6 on the Board.
    I think that the Alumni need to somehow demand a better accountably of the Board members and demand the overall involvement of each and everyone in the past, present and future of PSU!
    Please keep up the great work you have done so far and continue to demand the truth!

    ReplyDelete
    Replies
    1. Bob,
      As with most governing boards, a small group does all the heavy lifting and thinking for it, while the others (the sheep) just go along because it looks good on their resume's and they get some nice meals out of it. That was how the PSU Board worked up until 11/9/11.

      Even though a lot of the original sheep have left, some of the old wolves remain (or in Ira Lubert's case, were called back into service). In some cases, the old sheep have been replaced by new sheep -- with the exception of the elected alumni trustees.

      As for the financial aspects of this article, I'll boil it down in a few points.
      1. The FOOTBALL program is paying its full $60 million share, plus interest.
      2. The University gets the interest ($43M).
      3. The interest will help defray the cost of the victim settlements, but PSU will be left holding the bag for $16.7M.
      4. Other victim payments are expected to be in the $25M range.
      5. Legal bills for PSU officers are paid by insurance, but if someone (like Cindy B.) is convicted of a crime, the insurance money must be reimbursed.
      6. Other bills for PR, Freeh's investigation, Mitchell, and legal actions against the insurer or in defense with the NCAA are on PSU's tab.


      Delete
  3. Nice accounting.

    The notion that Penn State could publicly announce they would compensate all Sandusky victims, hand out $59.7 million and then bill the insurance company was ludicrous. Insurance companies don't work that way especially when such huge amounts are involved. The insurance company would want to vet the claims themselves.

    Where will Penn State get the money for all these unexpected costs?

    ReplyDelete
    Replies
    1. Tim,
      See above. The victim settlements will be partially defrayed by the interest off the loans made to the football program -- but the interest won't cover all of it.

      The University's Institutional Support budget has been used to cover most scandal related costs that were not covered by insurance.

      Delete
  4. Has anyone identified which projects are not happening because the Institutional Support & Loan Interest monies are being sucked up by the BoT's self-created & self-benefiting black hole? Has this diversion of otherwise University-wide Support funding created any blowback from those whose projects got nixed?

    ReplyDelete
    Replies
    1. Becky,
      Right after the UPUA voted to not "reinvestigate" the Freeh Report (because it was more important for the students to "move forward"), I pointed out that former President Erickson stated the University could not make up for the $40M shortfall for tuition related expenses.

      Even though the University said money to pay for the scandal wouldn't come from tuition or from tax payer dollars, as most people know -- money is fungible.

      So, yes, the students unwittingly voted to keep tuition costs high when they voted to move forward.

      Delete
  5. Ray:

    This is a bit off subject but I just read some of the deposition documents released by Sen Corman. Omar McNeil, JUDGE FREEH's hand picked day to day investigative team leader answered "I don't recall" or variations of that over 150 times in his depo. Imagine if Spanier et al had answered like that. The PN and their media friends would have a field day, but did not even notice McNeil's memory problems. He couldn't even remember the names of the investigative team he supervised, day to day.

    No wonder the NCAA, FREEH, and BOT fought to keep a lid on the back room dealing. McNeil learned well from law school that 'I don't recall" means I know but I won't admit it, you have to prove it!

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  6. Corman's lawyer complained to the judge that defendants were not forthcoming in depositions. Perhaps the 150 "I don't recall"s are part of that.

    I'm disappointed that no reporters have written articles on new revelations from Corman's document dump. Maybe there is nothing there because the witnesses didn't recall.

    ReplyDelete
    Replies
    1. Tim,
      There is plenty there, but you have to do some work to pull it out. As you know, the media can only work with direct evidence, such as the "bluff" quote, or with total innuendo and assumptions so long as they come from someone in a position of authority (i.e., Louis Freeh, Linda Kelly, etc).

      I will show the FOUR tracks of communication that went on within Penn State (2) and the NCAA (2). The timeline and the emails will show who the liars were, when they lied, and what they lied about.

      Delete
  7. “Penn State Intercollegiate Athletics continues to remain a healthy, self-supporting unit with the assistance of short-term borrowings that are being leveraged to financially bridge us into the future, when several revenue streams will return and increase,” athletic director Sandy Barbour said in a statement.

    Short-term borrowing? With $43m interest on $60m loan?? Robbery.

    ReplyDelete
    Replies
    1. Hilarious.

      Again, the University must think the people are stupid...and they're right. Watch how many sports reporters tout "the company line" without bothering to fact check.


      Delete
  8. "The Pennsylvania Commission on Crime and Delinquency will be in charge of distributing the money, though the exact details of where the funds will go has yet to be determined. Craig says that the commission will accept grant applications from child abuse advocacy organizations and will make decisions on how to distribute the funds based on the applications"

    So the PA Treasury will receive the $48m from PSU, to invest "conservatively". Then the PA Commission on Crime and Delinquency will decide how this fund is spent.

    So the PA Treasurer (just resigned) is under indictment for extortion. Now, WHO THE HELL runs this "Commission on Crime and Delinquency" and WHY are they in charge of the money intended to protect kids?????

    ReplyDelete