Some interesting recent ‘settlements’ in America show that those with fiduciary responsibility to protect investors are finally paying a price for their failure.
Directors, lawyers, accountants pay the price for corporate fraud
By Sucheta Dalal
In the last few weeks, American investors who suffered massive losses in a spate of corporate scandals in 2002 have won significant victories that are likely to give new edge to corporate governance regulations.
Corporate governance codes around the world expect “independent directors” on company boards to guard the interests of minority shareholders. In practice, independent directors usually comprise friends of the promoters, who may be eminent personalities in their own right but are rarely willing to upset the management by asking uncomfortable questions.
Even in the war between the Ambani brothers, it is evident that none of the issues raised by Anil Ambani or the serious charges levelled by him (through media leaks) were ever discussed or questioned by the board – not even when a whopping Rs 10,000 crore investment in Reliance Infocomm gave them hardly any return or control.
However, a set of stunning “settlements” in class action litigation filed by American investors, could have repercussions around the world in forcing more responsibility on corporate boards and monetary consequences for directors, accountants and lawyers who fail to fulfil their fiduciary duty.
Consider this. Just over a week ago, 10 directors of the former WorldCom, (the telecom major which collapsed) agreed to pay $18 million of their personal funds to settle a class action suit in a $ 54 million settlement. WorldCom was caught in an $11 billion accounting fraud and its investors (who lost hundreds of million dollars) held that the directors couldn’t avoid responsibility for failing to do their job.
The settlement terms stipulated that the directors would have to pay from their personal funds; and in some cases, these former directors will part with as much as 20 per cent of their personal networth. That is not the end of the story. Investors are now chasing two more directors who have not participated in the settlement and 15 investment banks that were underwriters to WorldCom.
In the same week, 18 former directors of the notorious Enron Corporation agreed to pay $13 million of their own money in a $168 million settlement. This money is being recovered out of the profit made by directors made by selling their personal holding o Enron shares before it collapsed. Here too, shareholders have gone after the directors as well as investment banks that colluded with it. Enron’s investors claim that they lost a whopping $30 billion after its collapse.
A former Chairman of the Securities and Exchange Commission (SEC) told the New York Times that this personal penalty paid by the directors as a “watershed development” that has the “potential to change the rules of the game”.
A settlement of charges allows directors and others to pay up without specifically admit to or denying any wrongdoing. This may help them avoid certain punitive consequences, but not the financial damage or the stigma. The obvious question is, why would the directors pay, rather than take their chance at a legal trial?
The answer is simple. Public outrage over American corporate scandals of 2002 runs so high that a jury trial, which was the alternative, may have inflicted bigger damages on the directors – including jail terms or worse.
The trend of making companies and their retainers pay a price for fraud and negligence is not limited to the board of directors. In recent weeks, leading companies such as Monsanto have paid up $ 1.5 million to settle an investigation by the SEC and the Justice Department of the U.S. into illegal bribes that it have paid in Indonesia. And a law firm -- Jenkens & Gilchrist PC has agreed to pay $82 million in a class action (against it) for questionable advice regarding tax shelters. The case is expected to expand further and engulf the world’s leading law firms, banks and accounting firms.
In another unusual development, the executives of Nortel Networks agreed to voluntarily return hefty bonuses to the tune of $8.6 million over three years after an inquiry revealed that the accounts had been manipulated to show higher returns. Although the executives had no role to play in the manipulation, their bonuses had been calculated on the basis of fake and inflated performance figures.
All this points to a new trend where the net is closing in on companies, their employees, directors and support network of lawyers, bankers, accountants and investment bankers. They are not only being made to answer for their quiet collusion with management but to pay a price (in a settlement) for face the consequences of litigation. Over time, this trend is bound to have an impact in India as well. Already, the Securities and Exchange Board of India (SEBI) has barred, even the directors of DSQ Software from the capital market for a period of five years. Imposing monetary penalties on them could be next of the agenda.
It is of course another matter that the Indian system does not provide for monetary settlements on admission of guilt. But there is little doubt that the days of faceless directors who treat board meetings like coffee sessions may be over.