Executive Credit Crunch

The federal ban on corporate loans leaves some managers scratching their heads.

Newspapers were shocked — shocked — to learn that former WorldCom CEO Bernie Ebbers had borrowed $408 million, ostensibly to purchase company stock. That discovery, coupled with the disclosure that former Tyco International CEO Dennis Kozlowski allegedly “borrowed” $242 million from Tyco for yachts, fine art, and luxury apartments, served to make the ban on corporate loans one of the most popular elements of the Sarbanes-Oxley Act of 2002.

But the ban on corporate loans (Section 402) is so broadly stated, and guidance from the beleaguered Securities and Exchange Commission so hard to come by, that no one knows exactly how to interpret it. There’s no question that the ban would apply to loans of the type issued to Ebbers and Kozlowski. But it may also prohibit legitimate and productive uses of corporate loans. “The substance of Section 402 is simple — no loans to executives,” says Joe Martin, executive vice president and CFO of South Portland, Maine-based Fairchild Semiconductor Corp. “But [the term] loans hasn’t been defined, so there’s a lot of confusion about whom and what it affects.”

Indeed, even the act’s sponsors, Sen. Paul Sarbanes (D-Md.) and Rep. Michael Oxley (R-Ohio), have expressed concern that the statute could hit unintended targets. Many of the benefits used to attract and retain executives (and lower-ranking employees as well) involve loans or credit extensions. Regardless of the intent of Congress, the broad language of Section 402 may apply to a wide range of compensation practices, including relocation loans, expense-account advances, company-financed insurance coverage, stock-option exercise programs, even loans from 401(k) plans.

Until the SEC offers guidance (indeed, the agency hasn’t even said whether it will take up the issue), companies that use such arrangements will either have to scrap them or risk a challenge from regulators or prosecutors down the road. Not surprisingly, compensation consultants are unhappy. “Congress has performed brain surgery with a machete,” complains Paul Dorf, managing director of Compensation Resources Inc.

Suggestions, Please

But while the SEC remains silent, corporate lawyers have stepped in with second opinions. On October 15, 26 corporate law firms circulated a white paper on Section 402 issues, with interpretations of its impact on a variety of corporate practices. “Congress intended the law to be broad — it’s a question of how broad,” says Dixie Johnson, a partner with Fried Frank Harris, one of the law firms that signed the white paper. “People would welcome more articulation on the statute, but at this point, they have to figure out the law themselves.”

One thing is clear: sweetheart loans from public companies to executives will soon be a thing of the past. This category includes relocation and mortgage loans, and any other lending for the personal benefit of a senior executive. While existing loans are likely to be tolerated under a “grandfather” clause, from now on public companies will have to abandon some of the perks they have used to recruit talent. “This has put handcuffs on corporate compensation planners,” says Dorf.


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