washingtonpost.com: Blame for Scandals Entering the Boardroom

Correction to This Article
A Jan. 7 Business article on the liability of corporate directors misstated the role of Clifford L. Alexander Jr. on the board of Wyeth. Alexander is a member of the drugmaker's audit committee, not its chairman. He chairs the company's committee on corporate issues.

Most of the punishment from the recent wave of business scandals has fallen on corporate executives and in some cases the accountants and other professionals who advised them.

But corporate board members, who are directly responsible for protecting shareholder interests, have largely escaped untouched. Now that may be changing.

A handful of recent developments, highlighted by the tentative agreement of 10 former WorldCom Inc. outside directors to pay $18 million of their own money as part of a $54 million settlement of a shareholder lawsuit, suggests that board members at scandal-ridden companies may indeed wind up paying a significant price for failing to stop alleged misdeeds.

Two former WorldCom directors not involved in the $54 million deal are in settlement discussions. The settlement with the 10 other former directors has been signed by all parties and is expected to be filed in court for the judge's approval today.

What was once a gilded position offering hefty compensation for minimal work is becoming a more challenging job fraught with the risk of significant financial liability. "All of this will make directors begin to take their jobs far more seriously than they do now," said Laura G. Thatcher, an attorney and corporate governance expert at the law firm Alston & Bird LLP.

In addition to the WorldCom settlement, directors at Walt Disney Co. are being sued in Delaware over their approval of a $140 million severance package given to Michael S. Ovitz, who spent a disastrous 14 months as Disney's president. Experts said that before the rash of scandals, such a case would likely never have made it to court.

New York Attorney General Eliot L. Spitzer filed suit last year against former New York Stock Exchange director Kenneth G. Langone over Langone's role in engineering a $139.5 million payment to then-NYSE Chairman Dick Grasso. (Spitzer sued Grasso as well.)

In May, a judge in Delaware found two outside directors at Emerging Communications Inc. liable for approving a sale price for the company that shareholders said was too low. The judge said the two directors possessed enough financial expertise to know the deal was not a good one.

Former outside directors at Enron Corp., meanwhile, agreed last year to pay a total of $1.5 million out of their own pockets to settle a suit filed by the Department of Labor.

Until the Enron and WorldCom settlements, the idea that directors would pay a penny of their own money to shareholders was almost laughable. Stanford University professor Michael Klausner has studied the issue and said directors paid out of pocket around five times in the past 35 years. "You are talking about needles in haystacks," he said. "The numbers are very small."

Many observers applaud the apparently toughening standards. Others worry they will scare qualified candidates away from serving on boards. "The directors and director candidates I talk to will ask, 'Are we setting a precedent under which I will be held personally liable for something that I had little control over?,' " said Joe D. Goodwin, president of the Goodwin Group, a consulting firm that specializes in chief executive and director searches.

In the case of the tentative WorldCom settlement, however, several analysts discounted the possibility of a chilling effect.

They said the magnitude of WorldCom's collapse puts the company in a much higher echelon of misbehavior than most other firms. In addition, the judge overseeing the WorldCom class-action suit issued an opinion last month saying a registration statement filed by WorldCom with the Securities and Exchange Commission prior to a bond issue in 2001 included "false and misleading" information.

Henry T.C. Hu, professor of corporate and securities law at the University of Texas at Austin, said that under federal securities law, directors and underwriters could be held personally liable if they signed falsified registration statements.

Hu said that unlike under other legal provisions, plaintiffs in this instance do not need to show that the directors acted with any malicious intent. Instead, directors must show that they conducted a thorough review before signing the registration statement and could not have known about any misstatements.

Klausner of Stanford said the WorldCom directors probably settled because they feared their liability would be much higher if they went to court. "The directors would not have settled unless they thought there was a reasonable chance of losing at trial, which means they knew their facts were bad," he said.

Klausner also said the plaintiffs may have been eager to settle because they feared insurance companies would balk at paying if a trial showed the directors committed fraud. He said the lead plaintiff in the WorldCom case, the New York state public pension fund, also had an incentive to limit the directors' liability.

Had the case gone to trial, Klausner said, directors could have wound up losing everything. Under the terms of the settlement, however, the directors will pay more than 20 percent of their net worth, excluding the value of their primary residences and retirement savings. Klausner said institutions such as the New York pension fund "are the ones that are calling for more independent directors and a greater role for them. . . . So pushing too hard on independent directors could be very counterproductive."

Meanwhile, board members are still at far less risk than corporate executives directly responsible for financial misdeeds. Directors with no ties to management rarely face criminal charges because prosecutors must prove they acted with criminal intent, rather than just lazy indifference.

And directors at several scandal-scarred companies continue to hold board memberships at other firms. Former Enron director Norman P. Blake Jr., for instance, remains chairman of the audit committee at Owens Corning. Former Enron board member Frank Savage stepped down from his directorship at Qualcomm Inc. but remains on the board at Lockheed Martin Corp.

Some WorldCom directors who have agreed to the tentative settlement also hold other board seats. Former WorldCom director Clifford L. Alexander Jr., for example, is the chairman of the audit committee at drugmaker Wyeth. A spokeswoman for the company declined to comment on whether the settlement would have any impact on Alexander's board service. Alexander did not return phone messages left at his home.

In addition, legal experts note that previous crackdowns on director behavior have often led to new laws to further insulate board members. For instance, when a Delaware judge in the 1980s found directors liable for violating their duty of care, the state legislature responded by passing a law allowing shareholders to vote to eliminate financial liability for similar duty-of-care violations.