They face new accountabilities and could pay out of pocket for company woes.
When lawyers for New York State Comptroller Alan Hevesi first sat down for settlement discussions with a group of former WorldCom directors 18 months ago, the lawyers made a shocking demand.
The directors, who presided over WorldCom as it headed toward the largest bankruptcy filing in U.S. history, would not be allowed to settle their part of a class-action suit unless they paid a significant percentage of their combined net worth.
Attorneys for the directors were stunned. Impossible, they said. Directors never pay. Insurance companies do, or sometimes, if they aren’t in bankruptcy proceedings, the companies at which the alleged fraud occurred provide money for settlements. To make board members dip into their own pockets would set a dangerous precedent. Who would serve on a board if their financial lives could be upended by other people’s fraud?
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“To put in mildly, we did not receive the request warmly,” said one person close to the former WorldCom directors. Another person close to the talks was less restrained: “People were jumping out of windows.” Another said, “I’ve spent 45 years trying not to do this exact thing.”
All three people spoke on the condition of anonymity because a federal judge has not yet approved the deal announced this month under which 10 former WorldCom directors agreed to pay 20 percent of their combined net worth — around $18 million — to settle their part of the shareholder lawsuit.
Experts say the WorldCom settlement and other similar ones are part of an evolving trend in which shareholders, regulators, legislators — and even companies themselves — are demanding that those who commit financial misdeeds, or fail in their duty to stop them, pay significant penalties, often with their own money.
Although there have been isolated incidents in the past of directors and executives being held personally responsible financially or volunteering to forgo payments, in recent weeks the emphasis on paybacks has picked up momentum.
The same day the WorldCom deal was announced, the University of California said it reached a similar settlement, under which 10 former Enron directors agreed to pay a combined $13 million of their own money to settle a shareholder class-action case. The amount represented 10 percent of pretax proceeds earned by the directors on what plaintiffs claimed was insider trading in Enron stock.
Days later, Nortel Networks restated its earnings for 2001 through 2003 and said 12 of its executives, none of them directly involved in the earnings manipulation, would voluntarily return $8.6 million in bonuses triggered by the phony numbers. The company also is trying to get back $10 million from ex-Chief Executive Frank Dunn and nine others.
Current and former Walt Disney Co. directors are being sued in Georgetown, Del., with shareholders demanding they repay a $140 million severance package awarded to Michael Ovitz, who spent a disastrous 14 months as Disney’s president. Should the directors lose, it could unleash scores of similar lawsuits against directors for failing to exercise proper oversight of management, which many investor groups say was at the heart of the business meltdowns of the past few years.
And Rep. Richard Baker, R-La., chairman of the House Financial Services subcommittee on capital markets, demanded that ousted Fannie Mae Chief Executive Franklin Raines and other current and former executives at the troubled housing lender return millions of dollars in bonuses they received since 2001.
Officials at Fannie’s regulator, the Office of Federal Housing Enterprise Oversight, say that if they determine it is warranted, they have the means to force Raines and others to give up the money.
Each of those instances involves unique facts and circumstances, but the thread that runs through them is personal accountability.
“Unfortunately, the way the system has worked, it has been very profitable for people to engage in fraud and have insurance companies and the corporations pay,” said Keith Johnson, general counsel of the State of Wisconsin Investment Board, which manages Wisconsin’s $70 billion pension fund. “And the costs end up being passed along to shareholders and customers.
“It’s important to us, as large investors, as major players in the market, to have the system work in a way that discourages misconduct and encourages people to keep their eye on the ball and to take their responsibility very seriously,” Johnson said.
Shareholder advocates generally praise the changes, saying they will help end an era in which many involved in business fraud, beyond a few individuals, emerged unpunished — and often quite wealthy — while employees and investors were burned.
But others, especially directors themselves, worry that they could go too far. Qualified candidates could be scared away from serving on public-company boards, which could ultimately damage shareholder interests.
“I would be pretty nervous about sitting on any new boards now myself,” said Warren Batts, a former chief executive of Premark International and Tupperware. Batts has served on several corporate boards, including those of Allstate and Sears, Roebuck and Co. He is now on the board of Methode Electronics in Chicago. “If I were seriously considering it, I’d certainly do a lot of homework, interviewing all of the other independent members of the board. … It’s all about doing that homework and then leaving quickly if you find that, ‘Hey, I can’t trust these guys.’ ”
Officials at large public pension funds say they will step up demands that directors and executives use their own money to pay class-action settlements. Wisconsin, for example, awards higher fees to its outside lawyers if they negotiate settlement deals that include personal payments.
The Securities and Exchange Commission, meanwhile, has stressed its intention to hold individuals personally responsible and has followed up by demanding in some settlement agreements that executives forgo insurance reimbursement.
The Sarbanes-Oxley Act, which takes full effect this year, demands that CEOs and chief financial officers repay bonuses based on fraudulent accounting. But many companies are going further, using provisions called “clawbacks” that require executives at any level who get cash or stock awards based on fraudulent numbers to pay the money back.
“It’s something we are seeing in a lot of new employment contracts and in broader compensation plan designs,” said Jannice Koors, managing director of Pearl Meyer & Partners, an executive-compensation consulting firm.
“A lot of companies now are saying: ‘We don’t want to be ambiguous about this. We want specific language saying, in the event that bonuses or stock payments were due to the achievement of performance targets that in retrospect were not met, then the company reserves the right to force executives to disgorge that money.’ “