The Kozmetsky-Hurwitz Connection:
A tale of corporate raiders in capitalist America
By Scott Henson and Tom Philpott
May 1990; pages 8-9, 11; Volume 1, No. 6
Editor's note: Much of the information from the 1970s in this article was obatined from Roger Baker, who researched George Kozmetsky for The Texas Observer in the late '70s. The editors thank him for his contribution to this article. The information from the '80s draws on congressional hearings and the national business press. Because of the complexity of the subjects, the authors had to draw on several sources to describe a single facet of a deal. Citations are available upon requrest.
On February 2, 1990, a man named Charles Hurwitz, chairman and CEO of MAXXAM Inc., came to the UT-Austin campus to lecture on "ethics." A band of Earth First! activists had gathered to protest the clear-cutting of ancient forests practiced by Pacific Lumber Co., a subsidiary of MAXXAM Inc. Earth First! was banned from the speech but maintained its demonstration outside, pounding on the walls of the room. Ultimately Hurwitz was given a police escort to his waiting car.
But he probably didn't leave town right away. Most likely, he paid a visit to his dear old friend and long-time business partner, George Kozmetsky, former business school dean, chief economic advisor to the UT-System Board of Regents and director of the Institute for Constructive Capitalism. Polemicist has decided to explore this relationship, to probe their mutual financial dealings and misdealings.
This article will focus on four separate deals involving Hurwitz and Kozmetsky, reconstructing instances of conflicts of interest, impropriety, and outright illegality. The instances recited here exhibit not only startling irresponsibility with vast sums of money, but also a trend toward production of paper profits rather than goods or services. These men embody the cliches of '80s capitalism: they indulge in hostile takeovers, junk bonds, raping the environment and bleeding S&L funds for speculation purposes. Interestingly, their paper gymnastics began long before the '80s.
UT Foundation, Inc.
In April 1967, the year after Kozmetsky came to the University as business school dean, the UT Board of Regents and the UT Development board obtained a state charter for a non-profit corporation to provide "charitable benefits" to the University. Kozmetsky managed the foundation's investments. At the same time, both Kozmetsky and Hurwitz were both directors of the Hedge Fund of America, which specialized in investments in speculative ventures.
Kozmetsky's position in the two entities helped facilitate a complicated deal between the UT Foundation, Hedge, and a third party, Barnabus, Inc., an investment firm. While no clear illegalities can be discerned, the deals point clearly to a conflict of interest on the part of Kozmetsky and certain associates.
The first gift to the UT Foundation was 100,000 shares of unregistered Applied Devices stock and $150,000 worth of convertible debentures (bonds not backed by collateral) to be managed by Kozmetsky for the benefit of the UT business school. But as it turned out, he apparently managed the gift for the benefit of the Hedge Fund.
The stock was donated by Applied Devices controlling shareholder Carl Loeb. Loeb hoped Kozmetsky could revitalize the ailing military contractor that had been accused of defrauding both its shareholders and the federal government. In return, the UT Foundation also opened an account with the investment firm Loeb Rhodes and Co.
Soon Kozmetsky's associates began to join the board of directors at Applied Devices, including Eugene Konecci, who still holds an endowed chair at IC2, and David Lerner who would be involved with Kozmetsky's business dealings in the future. In October 1968, James Bayless resigned from the board of the UT Foundation citing the "possibility of conflict of interest." But Bayless quit too late. In May 1969, the UT Foundation minutes disclose that Bayless had already been negotiating with the foundation for an option to buy the Applied Devices debentures and part of the stock in return for a five percent interest in Bayless' investment partnership Barnabus Inc.
Letters approving the deal were submitted to the UT Foundation by Kozmetsky and by Walston and Co., an outside investment firm. Both letters failed to mention that Barnabus and Walston had together recently underwritten $60 million worth of stock for Hedge Fund, directed by Hurwitz and Kozmetsky. Kozmetsky's and Hurwitz's Hedge Fund benefited directly from Bayless' largesse - and their connection through the UT Foundation perhaps facilitated this quid-pro-quo. Also, the UT Foundation's economic interests were now tied directly to those of the Hedge Fund through its stake in Hedge's underwriters.
Let's look at the aftermath of this deal. The Hedge Fund, which included among its investors various UT faculty, consistently lost money and became financially obscure three years after its creation. Applied Devices slid toward bankruptcy and 1972 until Kozmetsky's cronies on the board were replaced by a new board dominated by financiers - they facilitated a transfusion of new bank loans to revive the company. And Bayless went on to manage the Business School Foundation, which raised funds chiefly for Kozmetsky's Institute for Constructive Capitalism.
Shuffling Paper: SMR Holdings Inc.
Kozmetsky, Hurwitz, Lerner, etc. were also on the board of SMR Holding Company that controlled the Hedge Fund and other investments. In 1973, SMR acquired Federated Development Co. In early 1975, SMR underwent refinancing in which Hurwitz was personally liable for $5 million as part of the agreement. By June, SMR was in financial trouble again, and Hurwitz found another backer in World Service Life Insurance Co.
Eventually, the banks became insistent, and Hurwitz, Kozmetsky and Co. were forced to act. They decided on a complicated deal in which Federated Development, a subsidiary of SMR, would take over its parent company and assume its debt. The directors of SMR and Federated Development were virtually the same, and Hurwitz and Kozmetsky sat on both boards.
The losers in the deal were the stockholders in Federated, whose company assumed $10.8 million in SMR's liabilities - including the $5 million personally backed by Hurwitz. The Texas State Securities Board was required by federal law to rule on the fairness of the transaction, but the law only required "fairness" to the shareholders of the company being taken over - shareholders of SMR, that is, not of Federated.
The securities board concluded that the deal "raises serious questions about the fairness to Federated public shareholders and the satisfaction by Hurwitz and other Federated trustees of their fiduciary duty to Federated shareholders," but that Federated could not be prosecuted under existing laws.
According to testimony before the State Securities board, the board cut the deal at a meeting held on campus in the UT business school. The Board of Regents' rules prohibits such use of UT facilities for private purposes. Kozmetsky's violations went unpunished. (By contrast, Polemicist editors have been threatened with expulsion for violating regents' rules concerning newspaper distribution).
Redwoods vs. Junk Debt
In 1984 MAXXAM Inc. along with Drexel Burnham Lambert Corp. targeted Pacific Lumber Co. as a candidate for a hostile takeover. Pacific had a reputation for fair treatment of employees and for never cutting more timber than it grew that year. Pacific practiced selective harvesting, whereby no less than 50 percent of trees per acre were left standing after harvest to prevent erosion and depletion of timber supplies.
Along with Drexel's Michael Milken - who recently plead guilty to six felony counts totalling $600 million in fines - Hurwitz, Kozmetsky and the rest of the MAXXAM board saw Pacific's timber resources as a cash supply ripe for exploitation. Between June 24 and August 5, MAXXAM bought 994,000 shares of Pacific lumber, which brought it just below the five percent filing limit under the Hart-Scott-Rodino act regulating corporate takeovers.
The day after MAXXAM stopped buying, Jefferies and Co., an investment firm that's since plead guilty to "parking stock" for the notorious Ivan Boesky, began snapping up Pacific Lumber stock. It would eventually obtain 2.3 percent of Pacific Lumber's oustanding shares. Then on September 27, three days before MAXXAM would declare its intentions to takeover Pacific, Jefferies and Co. sold MAXXAM the 2.3 percent interest it owned in the lumber company for $29.10 per share - four dollars under the market price on that day. The deal saved MAXXAM $2.1 million.
The deal smacks of what's known as "stock parking" - that is, buying stock in a takeover target in collusion with the hostile purchaser in order to avoid the HSR restrictions. If a hostile company acquires over five percent without announcing its tender offer, it must receive 80 percent of shareholder votes to install its own board of directors. Otherwise the raider would need only 50 percent.
In October 5, 1987 hearings of the Oversight and Investigations subcommittee of the House Energy and Commerce committee, Hurwitz admitted to having advised Jefferies and Co. to buy the Pacific stock. A Congressman asked Hurwitz: "How did Boyd Jefferies know to purchase Pacific Lumber Stock beginning on August 5, 1987, 7 weeks before MAXXAM bought its Pacific Lumber holdings unless somebody associated with the MAXXAM takeover effort tipped him?" Hurwitz replied, "I told him." Also, Hurwitz could not explain to the congressional hearing why Jefferies sold him the Pacific stock at four dollars under market value.
In addition, Hurwitz and Kozmetsky associate Stanley Cohen along with his ex-wife used inside information concerning the Pacific deal to purchase Pacific stocks in September and then sell them at a tidy profit. Cohen was a partner in the law firm that handled the Pacific takeover for MAXXAM. Cohen later lied to the congressional subcommittee about his association with the law firm, claiming that his partnership was "inactive" and only for "tax purposes."
Insider trading plagued the Pacific takeover - everybody on Wall Street seemed to know about Hurwitz's and Kozmetsky's secret deal. Even Ivan Boesky, now serving time in a federal prison, reaped profits from the transaction. Boesky apparently learned of the deal from Dennis Levine, an investment banker in Michael Milken's junk bond division of Drexel who had sat in on planning sessions for the takeover. Just before MAXXAM's tender offer for Pacific, Boesky bought enough Pacific stock to boost the price to $40 per share, several dollars higher than Hurwitz had expected.
To execute the buyout, which placed both Kozmetsky and Hurwitz on the board of Pacific, MAXXAM had to incur $770 debt, both in the forms of bank loans and junk bonds. Of the $575 million in junk bonds, Drexel raised $450 million and received some $41 million in fees. Annual interest payments on the bonds - $83 million per year - far exceeded Pacific's historical annual profit for any year.
According to a memorandum from Rep. John Dingell (MI), "To sell the 'junk bonds,' MAXXAM advised investors it would terminate Pacific's pension plan and sell the headquarters and all non-timber assets to pay off the bank loan and then increase redwood cutting to pay off the bonds."
The New York Times (3-2-88) reports that MAXXAM scooped more than $50 million of the $90 million pension fund and used it to pay off bank loans. And to pay off the junk-bond debt, as Rep. Dingell notes, MAXXAM "more than doubled redwood cutting, purchased a fourth timbermill and laid on extra shifts." Doubling its lumber output required the company's new management - i.e., Hurwitz, Kozmetsky, et. al. - to resort to a tactic that the previous management had never used in more than 100 years in the business: It began clear-cutting old-growth forests.
This meant literally chopping entire areas of old-growth land clean of 1-2,000 year-old trees that stand as high as 300 feet. Pacific owns the largest tracks of non-park old-growth forests in the nation, but as Business Week reported (2-2-87), Pacific's "old growth will vanish within a decade at the current rate."
William Bertain, a lawyer from Eureka Ca., testified before a congressional subcommittee in 1987 that "the old growth will be gone in a few short years ... Six-day 60-hour work weeks are common and employees realize that the more overtime they put in and the harder they work, the sooner they will be out of jobs. Old growth logs are now being sold on the open market to other timber companies in the region - a first to my knowledge.
The United Savings Imbroglio
But Hurwitz and Kozmetsky didn't limit their takeover activity to MAXXAM. They actually used a savings and loan in an attempt to takeover Castle and Cook, a Hawaii-based multinationl food conglomerate. In 1983 MCO Holdings and Federated Development Corp., both Hurwitz-controlled business, bought into United Financial Group Inc., the holding company for the Houston-based United Savings Association of Texas.. Hurwitz became chairman of the board, and Kozmetsky joined the board of both the holding company and the S&L itself. Also on the United board was Charles LeMaistre, then-Chancellor of the University of Texas System.
According to October 5, 1987 hearings report from a congressional subcommittee, United and MCO Holdings purchased about 12 percent of Castle and Cook stock in 1983. Castle and Cook sued in 1984 to stop a takeover, and eventually paid the Hurwitz group greenmail. United Savings' share of the greenmail amounted to $7 million. Hurwitz insisted in his testimony that it wasn't a hostile takeover attempt despite the lawsuit and the greenmail.
In addition to the attempted takeover, United Savings was also involved in the other cliche of '80s capitalism - junk bonds. According to United's 1986 Annual Report, the S&L had decided in 1984 to shift "away from the traditional mortgage lending savings activity and toward a more balanced retail/wholesale mix."
In practice, this meant massive investments in below-investment grade- and junk bonds. By 1987, literally 97 percent of United's corporate bond portfolio consisted of three types of securities. According to the above-cited congressional hearings, in 1986 United Savings showed $6.5 billion in assets, but as Rep. Ron Wyden (OR) said, "most of the associations net worth is good will and its tangible net worth is only 1 percent of assets of roughly $60 million."
United had fallen into the same speculation craze that has destroyed so many Texas S&Ls. In fact, United seems almost a parody of that craze. United maintained an arbitrage account - basically a slush fund to facilitate speculation - worth some $500 million. But the parody doesn't end there. United spent much of the '80s buying junk bonds, many of them from Drexel Burnham Lambert.
In 1985, for example, Drexel acted as the lead underwriter for 56 percent of all United junk bond purchases, and as sole underwriter for 37.5 percent. That same year Drexel bought six percent of United Financial Group - the S&L's holding company. Meanwhile, as noted above, Hurwitz, Kozmetsky and Co. issued $450 million in junk bonds through Drexel. As one congressman noted in the hearings, "there seems to be a circular kind of pattern where you [Hurwitz] are in a position to receive a high risk financing and they buy junk bonds from Drexel." United's position in junk bonds amounts to a clear conflict of interest, if not an outright quid-pro-quo in relation to Drexel's dealings with MAXXAM.
By 1988, the year Kozmetsky and LeMaistre left the board at United, the S&L was placed in receivership by the FSLIC. The company's business activities were limited to managing its current investments - its investment banking days had ended.
Here and Now
The Kozmetsky-Hurwitz link continues to flourish. According to Dun's Marketing Services Reference Book of Corporate Management (1989), Kozmetsky serves on the board of MAXXAM Group Inc. and as chair of MCO Resources, both subsidiaries of MAXXAM Inc.
Hurwitz, for his part, sits on the board of the RGK Foundation, a private trust owned by the Kozmetsky family. George Kozmetsky serves as Chairman of RGK, and his wife, Ronya, serves as president. The foundation funds charitable projects all over the world, but it also helps fund many projects and conferences of UT's Institute for Constructive Capitalism. It also owns 175,000 shares of MAXXAM, the largest cache of stocks on its books, according to its 1988 tax returns.
RGK leases space to IC2 off campus at 2815 San Gabriel. And former chairman of the Department of Marketing Administration Robert Peterson holds the Charles E. Hurwitz Centennial Fellowship at IC2.
With a corporate raider like Kozmetsky as its chief economic advisor, the UT System Board of Regents can almost be excused for its shameful discretion of the University in the name of industry. Along with Hurwitz, Kozmetsky exemplifies everything vile about American capitalism: greed, avarice, obsession with short-term gain and paper entrepreneurship. They deserve to be lashed, but instead they get rich.
Constructive capitalism indeed.