[Congressional Record Volume 149, Number 25 (Tuesday, February 11, 2003)]
[Senate]
[Pages S2178-S2180]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
THE SARBANES-OXLEY BAN ON INSIDER CORPORATE LOANS
Mr. LEVIN. Mr. President, about 6 months ago, we enacted into law an
important set of reforms to curb some of the corporate abuses that have
shaken investor confidence in American business, from dishonest
accounting to price manipulation to cases in which company executives
have walked away from poor corporate performance with millions of
dollars in their pockets, while investors, shareholders, and employees
have watched their savings evaporate.
These corporate reforms, included in the Sarbanes-Oxley Act of 2002,
addressed a host of problems. Today, I want to take a few minutes to
discuss one of the most important reforms included in that bill,
Section 402, which has so far received very little attention.
Section 402 established, for the first time, a prohibition against
publicly traded corporations using company funds to give personal loans
to company officers and directors. This simple prohibition is having an
impact on corporate America, and I want to take a few minutes to
explain the importance of this loan prohibition, the abuses it is
correcting, and why it must be protected from efforts to narrow or
weaken it.
Last year, the Permanent Subcommittee on Investigations, which I then
chaired, conducted an extensive, bipartisan investigation into the
collapse of Enron. The Subcommittee reviewed 2 million pages of
documents, conducted 100 interviews, held four hearings, and issued two
reports. One of the issues we looked at were the loans that Enron gave
to its CEO.
In a report entitled, ``The Role of the Board of Directors in Enron's
Collapse,'' issued in July, the subcommittee found that multimillion-
dollar loans, using company funds, had been approved by the Enron board
for the personal use of Mr. Lay, then chairman of the board and chief
executive officer. The subcommittee found that the board's compensation
committee first gave Mr. Lay access to a $4 million line of credit,
increased this credit line in August 2001 to $7.5 million, and
authorized repayment with either cash or company stock.
The subcommittee found that, in 2000, Mr. Lay began using what one
Enron board member called an ``ATM approach'' toward his credit line,
repeatedly drawing down the entire amount available and then repaying
the loan with Enron stock. Records show that Mr. Lay at first drew down
the line of credit once per month, then every 2 weeks, and then, on
some occasions, several days in a row.
In the 1-year period from October 2000 to October 2001, Mr. Lay used
his company credit line to obtain over $77 million in cash from the
company. In every case, he repaid the borrowed cash by tendering shares
of Enron stock. In most cases, he obtained these shares by exercising
stock options granted to him as part of his executive compensation. Mr.
Lay withdrew these millions of dollars from company coffers at a time
when Enron was experiencing cash flow shortages, Enron's shares were
dropping, and Enron shareholders were suffering losses. After Enron's
collapse, it was discovered that Mr. Lay had borrowed a total of $81
million from the company in 2001, and failed to repay about $7 million.
When asked about these loans at a subcommittee hearing, the head of
Enron's compensation committee said that his committee had no duty to
monitor the CEO's loan activity. He also indicated that, while Mr.
Lay's loans were more extensive than anticipated, appeared to have
functioned as secret stock sales to the company, and affected company
cash flow at a critical time, he was not prepared to characterize the
CEO's actions or failure to repay $7 million as an abuse. He declined
to criticize Mr. Lay's conduct. The subcommittee concluded that the
Enron board had failed to monitor or halt abuse by Mr. Lay of his
company-financed credit line.
Enron was an eye-opener, but it turns out that it is far from the
only U.S. company handing out multimillion-dollar loans to executives,
often without regard to whether the issued loans benefit the
corporation or whether they will be repaid.
In December 2002, the Corporate Library, a non-profit organization
that provides information to help investors and stockholders, published
the most comprehensive analysis yet of the pervasiveness of company
loans to executives prior to enactment of Section 402. The report,
entitled ``My Big Fat Corporate Loan,'' presents information compiled
from reviewing SEC filings for 1,526 of the largest U.S. corporations
in the United States. This report relies solely on what companies have
disclosed to the public about their loans to executives, without any
attempt to verify or supplement these disclosures. The result is data
that may provide a conservative picture of company lending to
executives.
The Corporate Library report has determined that over one-third of
the largest 1,500 companies in the U.S. have outstanding loans to
company executives. According to the report, the average size of these
loans was 10.7 million in 2001, and the total amount of lending
exceeded $4.5 billion. The report also points out that when company
loans to purchase split dollar life insurance, described later, for
corporate executives are included, the percentage increases to over 75
percent. When short-term company loans allowing executives to exercise
stock options are included, the percentage tops 90 percent.
The list of companies issuing these loans include not only companies
marked by scandal, such as Enron, Tyco, Adelphia, WorldCom, and Global
Crossing, but also many companies perceived as solid investments with
good corporate practices and reasonable executive pay.
The report describes the purpose of the loans as reported by the
companies in their SEC filings. The largest proportion of the loans,
about 35 percent, had a stock-related purpose, such as to allow a
company executive to exercise stock options, purchase stock, or retain
stock after a margin call. The report expresses dismay at examples of
executives using interest-free loans to buy company stock, being
excused from repayment of the loan, and thereby acquiring a substantial
company investment without expending any of their own money.
Loans to help an executive relocate to a new area, including buying a
house, comprised the second largest portion of company loans to
executives. These loans comprised about 27 percent of the total,
according to the report. While relocation loans sound reasonable, the
report provides examples of disturbing abuses, including loans for
millions of dollars. In one case, Millennium Pharmaceutical issued a
loan to a senior vice president to buy a house in the Boston area and
allowed the loan to be forgiven over time. In another case, the
president of a Nike business unit was given a so-called loan for a
second home. By its terms, that loan was intended to be forgiven over 5
years. Another example, not mentioned in the report but discussed in
the media, is the $16.5 million loan issued by Tyco International to
its CEO Dennis Kozlowski to buy property in Boca Raton and Nantucket.
Tyco also loaned $14 million to its general counsel, Mark Belnick, for
a New York apartment and to build a home in Utah, a State where Tyco
has no operations.
It boggles the mind to think that high-paid corporate executives were
using company funds to build themselves mansions and then, in some
cases, skipping repayment of the funds altogether. It is unlikely that
a company would issue a loan to an average employee to build a
multimillion-dollar residence or to build a second home, since there
would be no business justification for it. There is no justification
for lending company funds to a corporate executive either, yet these
[[Page S2179]]
types of loans were becoming commonplace. Section 402 was intended to
stop these loans cold.
The Corporate Library report tells us that the third most frequent
type of company loan for company executives was issued for
``unspecified'' reasons. In other words, millions of dollars of
stockholder funds were loaned without disclosing to the stockholders
the purpose of the loans. The authors of the report not only express
dismay at this unexplained use of company funds, they also suggest that
the absence of this information is a clear violation of SEC disclosure
requirements.
Another issue highlighted in the report is the extent to which
individual companies were devoting substantial dollars to executive
loans. According to the report, Wachovia Corporation led the pack last
year with a total of $2.2 billion in company loans to executives.
Adelphia issued over $263 million in loans to members of the Rigas
family that owned it. Worldcom loaned its CEO $160 million. Kmart, now
operating in bankruptcy, has outstanding executive loans of $30
million, including a $5 million so-called ``retention'' loan that it
gave to its former CEO.
The report also presents data showing that companies are issuing
substantial loans to executives on terms that disadvantage the company.
Many companies have been charging below-market interest rates or no
interest at all. Others have been allowing their executives to escape
all loan repayment, simply by forgiving the debt owed. The report
states that only half of the companies it examined indicated any plan
to charge interest, and a careful examination of loan terms revealed a
number of methods to forgive interest or provide additional loans to
cover it. The report also identifies over 100 companies that had, or
were in the process of, forgiving loans to their executives. It also
describes a number of companies that increased outstanding loan amounts
to include a ``gross up'' to take care of taxes owed by the executive
as a result of the forgiven loan.
Finally, let's look at split dollar life insurance loans. These loans
had become very popular among corporate executives in the last few
years. The way they work is that the company obtains the insurance
policy for its executive and pays the premiums, while the executive
names the policy beneficiaries. The policies are called ``split
dollar'' because, when the policy pays out, the company is reimbursed
from the benefits for the cost of the premiums. The remainder of the
insurance benefits, often millions of dollars, goes to the named
beneficiaries, such as the executive's family. Because the funds are
insurance benefits, the payments to the beneficiaries are mostly tax-
free. The result is a company-financed loan to the executive to cover
the cost of the insurance premiums, enabling the executive to afford a
generous policy and provide tax-free benefits for his or her
beneficiaries.
Many of the split dollar life insurance policies that U.S. companies
provide to their top executives involve large payouts and large
premiums. At Enron, for example, Enron provided its CEO, Ken Lay, with
a $12 million split dollar life insurance policy and agreed to pay
premiums exceeding $1 million.
The Corporate Library report found that over 60 percent of the
companies it examined had purchased split dollar life insurance for one
or more of their executives. The report determined that a number of
these policies involved substantial sums of money. For example, the
report stated that many of the policies cost ``up to $25 million per
officer''; Estee Lauder disclosed paying $26 million for premiums on a
split dollar life insurance policy for its CEO; Comcast disclosed
paying more that $6.5 million in 1 year and $20 million over 3 years
for premiums on a policy for its chairman; and First Virginia Banks
reported providing all of its executives with insurance coverage of up
to a $1 million each.
Since Section 402 has gone into effect, most companies have
apparently discontinued providing their executives with split dollar
life insurance loans, and the executives themselves have declined to
pay the premiums. The result has been a dramatic drop in sales of this
insurance. Insurance groups have been lobbying the SEC and Congress to
create an exception to Section 402 to permit companies to resume
providing split dollar life insurance loans to their executives, but so
far they have been unsuccessful in reversing Section 402's ban on this
type of corporate loan.
All of the loans banned by Section 402 are loans to corporate
officers or directors who are among the highest paid individuals in our
society. In 2001, for example, average CEO pay at the top 350 U.S.
companies was $11 million. That is 400 times the pay of an average
worker in this country. These loans were on top of that pay.
All of these executives could have turned to a bank for their loans.
Instead, they turned to their employer and asked to use company funds.
The practice of U.S. companies loaning company funds to their
executives is relatively new. Given the huge amounts involved, the
absence of reasonable interest rates, and the common practice of
companies forgiving the debt altogether, the question becomes whether
many of these ``loans'' were simply elaborate ways to enrich corporate
executives at the expense of the investing public. The Corporate
Library report shows that these loans were pervasive and that abuses
were commonplace. The work of the Permanent Subcommittee on
Investigations suggests that too many boards of directors do not have
the will or incentive to limit the loan amounts or to detect or prevent
abuses.
That is why, last July, our subcommittee included in its first Enron
report a recommendation to stop companies from loaning company funds to
executives. That is why, later that same month, Congress enacted
Section 402. That is why, in September of last year, Senator Collins
and I sent a letter to the SEC urging it to resist any attempts to
narrow or weaken Section 402's ban on insider loans to allow corporate
executives to purchase company stock, exercise stock options, obtain
insurance, relocate for work or pay taxes.
Section 402 has put an end to a large set of abuses associated with
company loans to executives. They include loans issued without
interest; loans used to build personal mansions at company expense;
loans used to provide executives' families with tax-free insurance
benefits; loans for every purpose and loans that are never repaid.
Company funds belong to shareholders and are intended to benefit them
and the company they own; they were never intended to act as a pool of
funds available to be loaned or given to company executives.
Congress acted wisely in passing Section 402. This measure, alone, is
stopping companies from giving billions of dollars in insider loans to
corporate executives. Ending these loan abuses should help restore
investor confidence in corporate America. Opponents of this reform are
continuing to seek ways around it, but I hope my colleagues will join
me in understanding the importance of this reform and the need to
ensure it reaches it full potential.
I ask unanimous consent that the Levin-Collins letter to the SEC be
printed in the Record.
There being no objection, the material was ordered to be printed in
the Record, as follows:
U.S. Senate,
Committee on Governmental Affairs,
Washington, DC., September 25, 2002.
Hon. Harvey L. Pitt
U.S. Securities and Exchange Commission, 450 Fifth Street,
NW, Washington, DC.
Dear Mr. Chairman: The purpose of this letter is to urge
the Commission to resist any efforts to narrow or weaken the
insider loan prohibition established by Section 402 of the
Sarbanes-Oxley Act, codified at 15 U.S.C. 78m(k), a key
reform designed to stop a common insider abuse found at Enron
Corporation, Worldcom, Tyco International, and other publicly
traded companies.
Issued related to insider corporate loan abuses were
examined by the Permanent Subcommittee on Investigations in
connection with its ongoing review of Enron. In its
bipartisan report, ``The Role of the Board of Directors in
Enron's Collapse'' (July 2002), copy enclosed, the
Subcommittee found that multi-million dollar loans, using
company funds, had been approved by the Enron Board for the
personal use of Kenneth Lay, then Chairman of the Board and
Chief Executive Officer (CEO). The Subcommittee found that
the Board's Compensation Committee first gave Mr. Lay access
to a $4 million line of credit, increased this credit line in
August 2001 to $7.5 million, and authorized repayment with
either cash or company stock. The Subcommittee found that, in
2000, Mr. Lay began using what one Board member called an
``ATM approach'' toward his credit line, repeatedly drawing
down the entire amount available and then repaying the loan
[[Page S2180]]
with Enron stock. Records show that Mr. Lay at first drew
down the line of credit once per month then every two weeks
and then, on some occasions, several days in a row. In the
one-year period from October 2000 to October 2001, Mr. Lay
used the credit line to obtain over $77 million in cash from
the company and repaid the loans exclusively with Enron
stock, at a time when the company had significant cash flow
issues. After Enron's collapse, it was discovered that Mr.
Lay had failed to repay and still owes the company about $7
million. The Subcommittee concluded that the Enron board had
failed to monitor or halt abuse by Mr. Lay of his multi-
million-dollar, company-financed credit line.
Enron, of course, is not alone in having experienced
corporate loan abuses. Similar abuses by corporate executives
given company-financed loans for millions of dollars have
taken place at other U.S. publicly traded companies. At the
time of Worldcom's collapse, for example, Board Chairman and
CEO Bernard Ebbers was found to have outstanding company-
financed loans exceeding $400 million. Apparently, most of
these loans had been provided to enable him to purchase
Worldcom stock. At Tyco International, Board Chairman and CEO
Dennis Kozlowski and other executives apparently managed to
secure not only multi-million-dollar personal loans using
company funds, but to arrange to have these loans deemed
``forgiven'' in amounts allegedly totaling more than $100
million. Apparently these loans were to pay for employee
relocation expenses, including the purchase of expensive
residences. Numerous other publicly traded companies have
also provided troubling, multi-million-dollar, company-
financed loans to corporate executives, including
Adelphia, AMC Entertainment, Dynegy, FedEx, Healthsouth,
Home Depot, Kmart, Mattel, Microsoft, Priceline.com,
SONICblue, and more.
Given the extent of insider abuse in this area and the lack
of effective Board or management oversight, the Subcommittee
recommended in its July report that Board members at publicly
traded companies bar the issuance of company-financed loans
to company directors and senior officers. Later that same
month, Senator Charles Schumer offered on the Senate floor
the amendment that led to inclusion of the Section 402
prohibition in the final corporate reform law.
Media reports indicate that some companies may be pressing
the SEC to narrow the scope of the prohibition or otherwise
weaken it through regulation, guidance, or other means. These
media reports suggest that opponents want exemptions, for
example, for company loans used by executives to purchase
company stock, exercise stock options, obtain insurance,
relocate for work, or pay taxes. But the legislative history
provides no basis for creating these exemptions or otherwise
weakening the provision. To the contrary, the statutory
prohibition makes it clear that publicly traded companies are
not supposed to be using company funds to provide personal
financing to company directors or officers for any reason;
financing is to be provided instead by lenders, credit card
operators, or other third parties engaged in the ordinary
course of business.
In light of the abusive record compiled by the Permanent
Subcommittee on Investigations among others, the
Subcommittee's bipartisan recommendation to bar company-
financed loans to corporate directors or officers, and the
plain language of the statutory prohibition itself, the
Commission should continue to resist efforts to weaken this
significant post-Enron reform. Congress enacted and the SEC
must enforce this bright-line measure to end corporate loan
abuses by top executives.
Thank you for your attention to this important matter. If
your staff has any questions or concerns about this letter or
would like additional copies of the Subcommittee report,
please have them contact Elise Bean, Subcommittee Staff
Director, at (202) 224-9505 or Kim Corthell, Minority Staff
Director, at (202) 224-3721.
Sincerely,
Susan M. Collins,
Ranking Minority Member.
Carl Levin,
Chairman.
____________________