Investors Seek 'Restatement' of Bonuses

Troy Wolverton

Sanjay Kumar, Computer Associates' (CA Quote) recently deposed CEO, soon may be out of more than just his title. Irked shareholders are demanding that the executive repay the $3.2 million bonus he received in 2001.

Kumar and Computer Associates Founder Charles Wang -- who received $4.78 million in bonus pay in 2001 -- are the targets of what is becoming the latest corporate governance mantra: that executives repay bonus compensation for results that have been restated or are coming under close scrutiny.

"If you didn't earn it, if the financial results were [incorrect], as far as I'm concerned, you owe me money," said Duncan Stewart, a portfolio manager at Toronto-based Tera Capital. "Money received for profits that were not made should be paid back."

Forcing the boss to repay bonus cash for a performance that, in hindsight, never happened is a no-brainer for riled shareholders. But it is sending a chill through some of America's boardrooms. No one likes to give back money, and CEOs may decide to take the battle to court, a further expense to the company, especially if the CEO wins.

Corporate boards may not want to fight the CEO over past pay, even if it's for a bonus, but more firms are facing the issue. In recent weeks, three top executives at Nortel (NT Quote) were dismissed after the shake-up within the executive suite at Computer Associates that involved Kumar and Wang.

Nortel shareholders are already raising questions about whether the company's dismissed executives should have to repay their share of the $50 million worth of performance bonuses the company handed out last year. Nortel paid about $300 million in its "Return to Profitability" bonus program, The Wall Street Journal reported; recently dismissed CEO Frank Dunn received an estimated $5 million, although the company has yet to disclose actual figures.

But the issue is broader than the restatements at just Computer Associates or Nortel, and includes current efforts to have former New York Stock Exchange Chairman Richard Grasso surrender some of his $139.5 million pay package.

"The exposure of extreme abuses during the past couple years has gotten people extremely focused on rules and their enforcement," said Gary Lutin, an investment banker and shareholder rights advocate. "What they really have to focus on is the basics of fairness and integrity. That's what we're really getting to."

Requiring executives to repay those bonuses -- regardless of whether they directly or indirectly were involved in specious accounting -- is one of those simple issues of right and wrong, Lutin argued.

"If someone is overpaid, it should get adjusted," he said. "It's just basic fairness in business. You don't keep miscalculated payments. You don't ask if was it fraudulent or not."

That view, if widely adopted by investors, could have far-ranging implications. Public companies have restated hundreds of financial reports over the last several years. Last year alone, companies restated 206 annual reports, according to Huron Consulting Group, up from 183 in 2002.

And the pace of restatements shows no signs of abating. HealthSouth, which now trades on the pink sheets, announced earlier this year that it had detected up to $4.6 billion worth of improper accounting in its financial statements. On Friday, four executives, including former CFO Michael Martin, admitted to charges such as conspiracy to commit wire fraud and falsifying financial records, and have agreed to help prosecutors build a case against former CEO Richard Scrushy who is accused of orchestrating the fraud that dates back to at least 1996.

More than a dozen former HealthSouth executives have pleaded or agreed to plead guilty to fraud charges. Scrushy, who collected $24.5 million in bonuses and another $1.29 million worth of restricted stock from 1996 to 2001, has denied any wrongdoing; his trial is slated to begin in August.

Meanwhile, the bonuses can amount to sizable portions of companies' net income. The profit bonus at Nortel, for instance, actually helped turned the company's operating profit into a loss in the first quarter last year.

At Computer Associates, the $10.8 million in cash bonuses paid in 2000 to Kumar, Wang and four other top executives amounted to about 2 cents a share, before taxes. The company earned about $696 million, or $1.25 a share, that year.

Follow the Money

Demanding that executives repay part or all of their past bonuses is not a new issue. Two years ago, in his proposal for post-Enron reforms, President Bush called for executives to return bonuses given for reported financial results that were "grossly inaccurate," or the result of "serious misconduct." Under the Sarbanes-Oxley reform act, the federal government can force CEOs and CFOs to disgorge bonuses, equity compensation and the gains from stock sales made after a restated period, if "misconduct" was behind the misstated numbers.

There is some precedence for the idea of repaying compensation. In 2002, after Dollar General(DG Quote) announced that it would restate three years worth of results, Chairman Cal Turner repaid the company $6.8 million for bonuses and stock options he received during the affected years.

Gary Winnick promised to replenish the Global Crossing(GLBC Quote) workers' 401(k) fund with $25 million of his own money. He put the $25 million in an escrow account and last month agreed to pay investors and former employees $50 million to settle a securities fraud lawsuit.

But few others have followed the lead of Turner or Winnick.

"If it's happened, it's not happened very publicly at this point," said Pat McGurn, special counsel at proxy adviser Institutional Shareholder Services.

Part of the problem companies face is a likelihood of a potential legal brawl. Executive contracts are often vague about the financial-performance targets the company needs to hit to trigger bonuses, notes Gary Friedman, who heads the employment law practice in the New York office of Mayer, Brown, Rowe & Maw. Additionally, if executives receive bonuses often enough -- or if the bonuses they receive represent a significant portion of their total pay -- state laws and some courts might hold that the bonuses are really part of executives' normal pay, Friedman said.

"Unless the individual himself is responsible for the misstatement of the profits, I think companies have significant hurdles" in trying to recover bonuses paid for restated periods, Friedman said.

But companies may be reluctant to pursue illegitimate bonuses simply because they are following what they've done in the past, McGurn suggested. Many boards and compensation committees have taken the position that restatements will be factored into future compensation packages, rather than making any attempt to recover past payments, he said.

"I don't think that's good enough," McGurn said. "While the act of making a check out [to repay a bonus] is somewhat symbolic, that's what needs to be done, not some hypothetical haircut [in pay] that they take in the future."

But boards may soon change their ways. New leadership at Nortel and Computer Associates is studying the issue of recovering bonuses from ousted executives.

That should be a no-brainer, said Greg Taxin, CEO of San Francisco-based Glass Lewis.

"Executives that are thrown out of their jobs for cause ought to be forced to repay any compensation that was tied to performance that didn't actually occur," Taxin said. "That seems like the bare minimum starting place."

Meanwhile, the recent upsurge in shareholder activism and proposed rules that would open up corporate proxies to dissenting shareholders could put pressure on directors to go after past payouts and set new rules to make it easier for corporations to recover future bonuses.

Stewart said he would take into account the boards' actions in deciding whether to vote for individual directors at Nortel and Computer Associates, both of which he holds long positions.

"This is something that boards need to consider to be within the four corners of their fiduciary responsibility to shareholders," McGurn said.

Payback's a Glitch: Executives garnered huge rewards for now-tainted results
Restatement/Accounting Irregularity	Response	Executive Bonuses*
Company: Computer Associates
Restated results for 2000 and 2001. The company prematurely booked $2.2 billion in revenue.	Sanjay Kumar resigned as CEO and chairman; former CFO Ira Zar and former vice presidents of finance David Rivard and David Kaplan pleaded guilty to obstruction of justice and securities fraud; company fired nine other employees in its legal and finance departments.	-- Founder Charles Wang received a $4.78 million bonus, $7.17 million worth of restricted stock and 1 million stock options in 2000. He received no such incentive pay in 2001. -- Kumar received a $3.2 million bonus, $4.74 million worth of restricted stock and 750,000 stock options in 2000. He received no such incentive pay in 2001. -- Zar received an $800,000 bonus and 900,000 stock options in 2001. Zar received a $950,000 bonus and 500,000 stock options in 2000.
Company: Nortel
In the process of restating results for 2000 through 2003.	Fired CEO Frank Dunn, CFO Douglas Beatty and Controller Michael Gollogly "for cause."	-- Dunn received a $1.01 million bonus and 12,480 shares of restricted stock in 2000; 2.95 million stock options between 2000 and 2002; reportedly received $5 million in 2003 as part of a "return to profitability" bonus program. -- Other four highest-paid executives received a combined $4.18 million in bonuses and 46,080 shares of restricted stock in 2000; 6.51 million stock options between 2000 and 2002.
Company: HealthSouth
Detected up to $4.6 billion worth of improper accounting entries in its past statements. The misstatements are thought to go back to at least 1996, but may date back further.	Revamped board, brought in new management; former CEO Richard Scrushy has been indicted on charges of securities fraud and conspiracy; more than 12 former executives, including two former CFOs, have pleaded guilty to fraud charges.	-- Scrushy received $24.5 million in bonus pay, 7.35 million stock options and $1.29 million worth of restricted stock between 1996 and 2001. -- Former CFO Michael Martin received $2.75 million worth of bonuses, 1.3 million options and $1.29 million worth of restricted stock between 1996 and 1999. -- Other top executives received at least $8 million in bonus pay, 5.29 million stock options and $5.18 million worth of restricted stock between 1996 and 2001.
Source: Company proxy filings, TheStreet.com. *Nortel has not disclosed executive compensation figures for 2003. HealthSouth has not disclosed its executive compensation figures for 2002 or 2003.

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