They are paid millions, but some complain that its no longer worth it. These men and women argue that, as corporate directors and officers, they have too much chance of liability for operating the company. Because of this, they claim, the risks of serving as a director or officer have become too great, and it will become harder to recruit and retain competent directors and officers. But the truth is that they have about the same chance of being held liable for their poor management of a public firm as they have of being struck by lightning.
State law largely regulates the day-to-day management of a company. Take the instance of companies that are incorporated in Delaware. Delaware law on this matter sets an extremely high standard for finding directors and officers liable for a companys mismanagement. A Delaware court is not going to find directors liable no matter how stupid their decisions are. Instead, a Delaware court will find them liable only if they intentionally acted wrongfully or were so oblivious that it was essentially the same thing.
Under this standard, a Delaware court recently refused to hold Citigroups board accountable for its decision to enter the sub-prime mortgage market, a decision that resulted in billions of dollars in losses and the company's near failure. The boards of Bear Stearns and Lehman Brothers are also scot-free so far.
Recently, the board and management of Massey Energy won a case in a Delaware Chancery Court that would make it significantly more difficult for them to be held liable for their ostensible poor oversight of the companys safety practices. A breach thereof led to the Upper Big Branch mine explosion and the death of 29 men.
Even if there is liability or a settlement, it is almost always covered by directors and officers insurance. One study found that from 1980 to 2006, there were only two instances of directors of a company incorporated in Delaware being required to personally pay for their misconduct.
One of those involved litigation against the board of Fuqua Enterprises. The Fuqua directors had the unfortunate luck to be insured by Reliance Enterprises, which went bankrupt. They paid an undisclosed portion of a $7 million settlement.
The other known personal-liability case involved the sale in 1980 of the TransUnion Corp. The 10 TransUnion directors paid a total of $1.35 million. There you have it, no more than $8.35 million in personal payments by directors over more than 26 years.
There can also be liability for board members and executive managers under federal law. These are largely securities fraud cases where the directors or officers make a misstatement or omission.
This has nothing to do with the oversight of the company, but often there are statements about accounting or the companys financial condition. Instances of personal liability for officers and directors in these cases are only a bit less rare, again because the standards are high and insurance often covers the matter.
Among other instances, only nine cases where a director was held personally liable for securities fraud in a 26-year period. Three of these were highly notable, Enron, WorldCom and Tyco.
And no directors from the financial crisis have yet been found liable under these laws. Officers are faring just as well, and the only prominent payment was by Angelo R. Mozilo of the Countrywide Financial Corp. He paid $22.5 million of a $73 million fine. The rest was paid by Bank of America. Meanwhile, the fines of David Sambol, Countrywides former president, and Eric P. Sieracki, the ex-chief financial officer, were paid in full by Bank of America. The only financial crisis case to go to trial, involving officers of BankAtlantic, had its jury verdict finding civil liability overturned by the judge. And unlike with Enron and WorldCom, it seems there will be no criminal cases involving securities fraud stemming from the financial crisis.
What about the Dodd-Frank Act, you might ask? It doesnt change much. The main provision concerning the personal liability of officers and directors involves systemically important financial institutions, or the too big to fail entities. And if one fails, Dodd-Frank authorises the Federal Deposit Insurance Corp. to claw back two years of compensation from those held substantially responsible for the failure.
This is a weak penalty. An economically important bank with hundreds of billions of dollars in assets fails, and the penalty is only two years of pay? Nonetheless, the Securities Industry and Financial Markets Association and a number of other industry groups objected to the proposed rules on this requirement. The financial industry groups again argue that such a standard will drive away directors and officers as well as make it harder to recruit these people.
This is laughable. First, weve already seen that liability for boards and management is extremely rare. Moreover, many of the directors of Lehman and Bear Stearns continue to serve on other boards, and one Lehman director, Jerry A. Grundhofer, has apparently been so chastened about the liability issue surrounding large banks that he is serving on the Citigroup board. There is no empirical evidence whatsoever supporting this argument. Instead, you have the occasional self-serving statements by officers and directors that they are resigning because of liability reasons. Officers in particular like to say that they are taking a company private for this reason. But more often than not, it is because there is more money in being private.
This is not to say that it has not become more difficult to be a director or officer. Regulation has certainly increased. So has scrutiny. This has made the work of being a director or officer of a public company harder and more time-consuming. And yes, if a company declares bankruptcy, these people will lose a lot of their investment and may in rare circumstances have to pay back some of their salary.
But is that too much to ask? According to a recent New York Times study, the median salary of a chief executive at the top 200 major companies was $9.6 million last year. Salaries for chief financial officers at companies listed on the S&P 500-stock index shot up last year by 26.1 per cent, according to Equilar, and the median salary is now $3 million. The prominent law firm, Wachtell Lipton Rosen & Katz recently issued a memorandum calling for director salaries to increase because of the increased burdens on this position. Outside director salaries average about $200,000 for Fortune 500 companies, according to Tower Watson.
The upside of serving as a director or officer thus appears huge. The downside is very limited. Yes, there will be increased regulation to comply with and some of it may even be unjustified, but that conflates liability with regulation. Remind directors and officers of this the next time they complain about the risk they are taking because of their jobs.