Now, execs pay for firm's sins

Almost before the ink dried on two landmark settlements this month, corporate watchdogs were debating whether to cheer or cry at the fact that former directors were spending their own cash to settle notorious fraud cases.

In one camp, Patricia Wolf was welcoming the multimillion-dollar payouts from the personal accounts of former WorldCom and Enron directors as a sign of their growing accountability.

"If directors think they could be held personally liable, they will do everything in their power to act wisely and prudently and knowledgeably," says Ms. Wolf, executive director for the Interfaith Center on Corporate Responsibility. "We look at this as a positive step for shareholders."

But others who track corporations received the news with trepidation. After all, who would want to serve as a director if one slip-up meant losing a lifetime of savings?

"The issue is: How do you strike the right balance between accountability and scaring people off?" says Nell Minow, editor at The Corporate Library, an independent investment research firm with a specialty in corporate governance. "It could be that the people we need to be on boards don't want to [serve] because it's not worth it.... Or the right people might want to serve, but they become so risk-averse that you'd be better off putting all your money in T-bills."

Before this year, investors didn't have to worry about the personal liability of directors. Liability insurance had always shielded directors' personal assets from lawsuits. Then on Jan. 5, 10 former directors of WorldCom agreed to pay $18 million from their own pockets as part of a $54 million settlement with shareholders over the company's collapse. Two days later, 10 former Enron directors agreed to pay $13 million of their own money as part of a similar $168 million settlement.

Now, investors wonder what this new age of personal liability at the top might mean for their own social as well as financial goals.

Directors aren't the only ones with heightened personal stakes. Under the 2002 Sarbanes-Oxley accounting-reform law, chief executives of public companies must take responsibility for contents of annual reports, a requirement which suggests personal liability for any information deemed deceptive. Lawyers say it's only a matter of time before a CEO is sued and must fight to defend his or her own bank account. In this charged climate, observers are watching closely to see whether captains of industry drop out of the game, get skittish, or instead become more vigilant under the spotlight.

In the meantime, some activists think they see an opportunity to advance their goals as ethical investors.

"It's given us an opportunity to make better business cases," rather than rely on moral arguments to persuade corporate leaders of the need for policy shifts, says John Wilson, director of socially responsible investing at Christian Brothers Investment Services, an investment advisory firm for Roman Catholic institutions. He routinely pressures corporate leaders to study social and environmental costs as if they were tinderboxes for liability cases in coming decades. "Personal liability gives us more hooks to make that case," he says.

For example, shareholder activists in the past two years have lobbied energy firms to report on the impact their businesses might have on global warming. Certain oil companies have staunchly resisted, despite a shareholder argument that such an impact could constitute a liability worth billions of dollars in the future. Now with their personal assets potentially at risk, business leaders might take this concern more seriously.

Another example involves human rights violations. Foreign nationals have tried, thus far without success in the United States, to use the Alien Tort Claims Act to hold US corporations responsible for complicity when they have benefited from a foreign government's disregard for international human rights standards. Here as well, Mr. Wilson says, some business leaders might be more careful if they know a gross negligence finding could someday drain their personal bank accounts.

Whatever happens in these cases, the relationship between board members and investors is changing. Fading fast are the days when retirees held the office as a largely honorary post and comfortably rubber-stamped management's decisions. Instead, activist shareholders are increasingly pressing for hands-on directors who scrutinize management and aggressively represent shareholder interests. One indicator of the shift: Shareholders of 49 companies are petitioning for the first time this year to add a requirement that board members be elected by majority vote.

Meanwhile, lawyers caution that personal liability among directors remains difficult to prove. In a stock-fraud case, for example, an accused director must have had direct involvement in the fraud, such as by signing an initial public offering registration that a court would deem "knowingly or recklessly" fraudulent, according to Sherrie Savette, head of the securities division at Berger & Montague, a law firm in Philadelphia. Despite the high threshold, recent cases are apt to make directors "take their jobs a lot more seriously," she adds. "It's really hard to imagine how a fraud like WorldCom's could happen if directors were paying attention and asking the right questions."

With legal precedent still in the making, personal liability at the top remains something of a wild card whose effects are apt to vary from one corporate culture to the next.

"It was quite clear that we weren't liable for any of our decisions because we had insurance," says Joan Cudhea, a former director of a New Hampshire gas company who now chairs the Committee on Socially Responsible Investing at the Unitarian Universalist Association. "I suspect there would have been a tougher environment and tougher questions asked of management" if each board member felt a personal stake in the company's outcomes.

Not all executives intend to make caution their top priority. Many already find themselves pressured by company attorneys to choose every word wisely, says Patrick Byrne, CEO of Overstock.com. "The lawyers say anything you write that's informal, and is not what they're used to, will be Exhibit A in a lawsuit against you someday. They make you so averse to risk that you become anodyne. [But] I think you owe the widows and the orphans who have trusted you with their savings a little more than that. You owe them an honest explanation of what's going on in their business."

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...

Save for later

Save
Cancel

Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items

OK

Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items

OK

Failed to save

You have already saved this item.

View Saved Items

OK