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Sarbanes-Oxley Case Studies

Worldcom MCI: Directors' Payoff Establishes New Legal Precedent.
Case Study of the Impact of Sarbanes-Oxley Act ("SOX")

According to various published reports, 10 of 12 former board members of WorldCom Inc. have tentatively agreed to pay $54 million to settle a class-action lawsuit brought by investors who lost billions when the original company entered bankruptcy following after admitting that it overstated profits by billions of dollars. The company emerged from bankruptcy last year, changing its name to MCI .

The 10 settling former outside directors are James C. Allen, Judith Areen, Carl J. Aycock, Max E. Bobbit, Clifford L. Alexander, Stiles A. Kellett Jr., Gordon S. Macklin, John A. Porter, Lawrence C. Tucker and the estate of John W. Sidgmore, (deceased 2003). The settlement excludes Bert Roberts and Francesco Galesi, who remain defendants in the lawsuit.

WorldCom's former CEO, Bernard Ebbers ("Bernie Ebbers"), is scheduled to stand trial this month on criminal charges that he oversaw the $11 billion fraud at the company, the largest corporate fraud in U.S. history.

The 10 directors agreed to pay a combined total of $18 million personally, with the remaining $36 million to be paid by the directors' liability insurance carriers. The specific allocation of each director's payment has not been determined.

As a Board of Director, why agree to the settlement ?

If the lawsuit were to proceed, the directors as defendants ran a high probability of being found criminally liable by a jury. Under those circumstances, insurance carriers would be not be responsible, leaving the directors facing complete responsibility of any award by the jury. Using the current settlement as a minimum guideline, would you rather be responsible for $18 million or $54 million? The directors clearly cut their losses.

What are the implications of this agreement?

Although the Sarbanes-Oxley Act currently does not specifically mention liability for Board of Directors, this settlement sets a legal precedent and a warning for all Board of Directors across all industries. If you are getting paid to serve as a Board of Director, you better take your job responsibilities seriously. While this may deter some individuals from wanting to serve as a board member of a publicly traded corporation, those that do choose to serve will be asking more questions and getting more involved. From my viewpoint, it's a step in the right direction.

Updates after February 3, 2005:

U.S. District Judge Denise Cote ruled that settlement agreement was invalid as it would potentially limit any liability that a jury award resulting from an ongoing trial would have against the directors.

The jury also has the responsibility for assigning the percentage each defendent was liable for the fraud. To illustrate, let's say the CEO, CFO and all the board of directors were found liable for fraud with an award to the plantiffs for $100 Million. The jury could have assigned the board of directors 90% of the liability, the CEO 5% and the CFO the remaining 5%. Using this formula, the board of directors would pay a total of $90 million, the CEO $5 million and the CFO $5 million.

Under the original proposed settlement, the board of directors liability would have been limited to $54 million instead of $90 million. This would have left the CEO and CFO to be held accountable for the remaining $46 million to get to the $100 million jury award to the plantiffs.

Based on this logic, Judge Denise Cole dismissed the original settlement.

Related article:
Worldcom's Ebbers faces $30 Million Fine and life in prison.

2005 Nelson Chin.

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