Corporate Directors Increasingly Paying Their Own Penalties

The days when company directors could emerge from scandal both unpunished and rich may be over.

If several major legal settlements of the last few weeks are any indication, the Washington Post suggested, company directors more often will be held personally accountable for the financial misdeeds of the companies they are supposed to be overseeing. Personally accountable can mean paying fines out of their own pockets, giving up bonuses received while the scandals were taking place, or returning money earned through insider trading.

Consider a few recent cases: Ten WorldCom directors agreed to pay about $18 million, or 20 percent of their combined net worth, to settle shareholder claims against them. Similarly, 10 former Enron Corp. directors, on the same day the WorldCom agreement was announced, agreed to pay a total of $13 million to settle their shareholder claims. A few days later, Nortel Networks Corp. announced that 12 executives agreed to return $8.6 million in bonuses based on earnings figures that later had to be restated.

"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 L. 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 told the newspaper.

While shareholder advocates praise the new environment, some observers worry that qualified candidates may avoid serving on boards of public companies.

"I would be pretty nervous about sitting on any new boards now myself," said Warren L. Batts, a former chief executive of Premark International Inc. and Tupperware Corp., who has sat on several corporate boards. "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.' "

It's not only shareholders' lawyers who want directors to pay from their own bank accounts. Companies are starting to write into contracts so-called “clawbacks,” which require executives to pay back cash or stock awards if they turn out to be based on fraudulent numbers.

Johnson recognizes the “fine line” between holding directors accountable and scaring them off from serving on boards. The perfect environment would be one in which both fraud and lawsuits can be avoided.

"Frankly, if you look at it from an investor protection point of view, we are much better off deterring and preventing misconduct than we are trying to pick up the pieces after there has been a disaster."

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