[Congressional Record (Bound Edition), Volume 149 (2003), Part 2]
[Senate]
[Pages 2823-2826]
[From the U.S. 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

[[Page 2824]]

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 
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.

[[Page 2825]]

  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.
       Issues 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 
     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

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     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.

                          ____________________