January 21, 2004
Sarbanes-Oxley Fails to Kill Corporate Insider Loans, Some of Which Pay Posthumously
by William Baue
A new study from The Corporate Library documents the prevalence of insider loans, and the
persistence of benefits beyond the grave.
"To infinity and beyond!" Although this oxymoronic battle-cry (there is no such thing as
beyond infinity) belongs to Buzz Lightyear, the action-figure hero of "A Toy Story," it
could easily serve as the motto for recipients of corporate insider loans. A new report from The
Corporate Library (TCL), an
independent provider of corporate governance research and analysis, documents how these loans
persist even after being outlawed by the Sarbanes-Oxley Act of
2002. In some cases, payouts continue even after recipients pass away into infinity
themselves, as their beneficiaries reap the rewards of split-dollar life insurance policies with
premiums paid by companies as interest-free loans.
All existing loans to directors
and executive officers were grandfathered by Sarbanes-Oxley, according to the repo
rt, which is entitled The Low-Carb Corporate Loan. Some companies continued the
practice until a mere two weeks before the deadline for discontinuation, transgressing against the
spirit of the law. And the loan amounts, while not actually infinite mathematically speaking, seem
boundless to those earning honest pay who struggle to secure bank loans with reasonable terms.
For example, Union Pacific (ticker: UNP) CEO Richard Davidson received
a loan for almost $11 million. This figure exceeds the average amount of the total of insider
loans for entire companies ($10.7 million) in TCL's last such study,
My Big Fat Corporate Loan (December 2002). That study surveyed the 1,500 largest US
The current study surveys a random sample of 113 S&P 500 companies (plus two
from outside the index that had particularly egregious insider loan situations), and finds the
average companies' insider indebtedness to be $4.7 million. While this suggests that
Sarbanes-Oxley has indeed discouraged the practice, other statistics reveal that the problem is far
from dead. The report finds that 50 companies (43.5 percent) had outstanding loans in the 2002 and
2003 fiscal years, and only 12 of these companies had ensured that these debts were paid off by the
end of the fiscal year.
The terms of the loans are even more astounding.
the loans are made along typical market lines, with normal rates of interest, sometimes based on
the federal rate," said Paul Hodgson, TCL's senior research associate for CEO compensation. "Many,
however, are interest free--generally the kinds of loans only available for the rest of us from
family members or very close friends."
However, even kinfolk rarely forgive loans
altogether, a practice Mr. Hodgson documents again and again.
"It is, after all, easy to
borrow large amounts of money, if you know you are never going to have to pay these sums back,"
writes Mr. Hodgson in the report.
For example, Nike (NKE) extended a loan to an
executive to purchase a second home.
"Not only was the loan unnecessary, to add insult
to injury, the company indicates that it was fully forgiven approximately seven months ahead of
schedule, as if this is something to be proud," writes Mr. Hodgson.
The report documents
many examples of loans being forgiven despite the fact that the terms for forgiveness had not been
met. For example, Nextel (NXTL) lured Jim Mooney to its chief
operating officer (COO) position in April 2001 with a $3 million interest-free "retention" loan.
Nextel forgave the loan even though Mr. Mooney bolted less than a year and a half later.
"The question has to be asked: why?" writes Mr. Hodgson. "Indeed, why were any of the
so-called retention loans forgiven if the service condition was not satisfied?"
are such arrangements a waste of stockholder' money, they also discredit, and therefore undermine,
any attempts at retention and demonstrate how inappropriate loans made for this purpose were," he
The report also finds 23 examples of companies with split-dollar life insurance
policies. Sarbanes-Oxley disallows these, interpreting them as long-term loans because the company
pays premiums that are repaid interest-free only when the policy pays out. More than half of these
companies (13, or 56.5 percent) continue to have split-dollar insurance policies, including $49
million in coverage for Citizens Communications (CZN) CEO Leonard Tow and $50 million
for Reebok (RBK)
CEO Paul Fireman.
"The amounts involved here seem to add yet another layer to excessive
compensation," writes Mr. Hodgson. "Not only can CEOs be paid excessively during their tenure and
after their tenure--in retirement and consultancy--[but also] they continue to receive excessive
compensation in the afterlife."