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Congress Shines Spotlight on Exec Comp

Nat Worden

A new investigation by Congress provides a rare glimpse into the workings of three top boardrooms in corporate America, raising serious questions about whether there is a widespread failure among executives and directors to live up to their fiduciary duties.

The report examines the compensation practices at Citigroup (C Quote), Merrill Lynch (MER Quote) and Countrywide Financial (CFC Quote), three companies that have become engulfed by massive losses related to the mortgage market.

Recent payments, stock purchases and retirement packages enjoyed by current and former CEOs at the three companies show a breakdown in corporate controls designed to protect the interests of shareholders.

On Friday, former Citigroup CEO Chuck Prince, ex-Merrill Lynch CEO Stanley O'Neal and Countrywide chief Angelo Mozilo will appear before the House Oversight Committee, chaired by U.S. Rep. Henry Waxman (D., Calif.), to answer questions raised by the report. Directors, including Time Warner(TWX Quote) Chairman Dick Parsons, who sits on the board at Citi, will also appear.

"Any alignment between the compensation of the CEOs and their shareholders' interests appears to break down in 2007," said the report, which was issued Thursday.

Despite precipitous declines in the performances of all three companies and their stock prices in 2007, all three chiefs were richly rewarded. Prince was awarded a $10 million bonus, $28 million in unvested stock and options and $1.5 million in annual perks upon his departure from Citi last year. O'Neal was allowed to leave Merrill Lynch with a $161 million retirement package. Mozilo received over $120 million in compensation and sales of Countrywide stock.

The companies defended the compensation awarded to Prince, O'Neal and Mozilo as fulfillment of contractual obligations that were put in place in an attempt by their employers to attract talent, years before the housing crisis struck, according to the report. They also argued that the pay packages aligned the executives' interests with those of shareholders.

While these cases are dramatic examples of a breakdown in corporate controls that are particularly outrageous, given each company's major role in the U.S. mortgage crisis, the report cites evidence that such runaway compensation packages are rampant throughout corporate America.

In 1980, CEOs in the U.S. were paid an average 40 times the average worker, according to the report. In 2006, the average Fortune 250 CEO was paid over 600 times the average worker. While CEO pay has soared, employees at the bottom of the pay scale have seen their real wages decline by more than 10% over the past decade.

Meanwhile, the report said, many experts believe there is a growing disconnect between CEO pay and performance. It cited a recent survey of more than 1,000 directors at large U.S. companies, in which 67% of the respondents said they believe boards are having difficulty controlling the size of CEO pay packages.

A Princely Sum, Stan the Man

When Prince left Citigroup last November, he was awarded performance bonuses of $10.4 million in cash and $28 million in unvested restricted stock and stock options.

"It is unclear how these decisions were related to Mr. Prince's performance or benefited Citigroup shareholders," said the report, which notes that Citigroup recorded more than $18 billion in writedowns related to subprime and other risky mortgages. Its stock dropped by 48%o from its five-year peak in December 2006. Neither O'Neal nor Mozilo received performance bonuses in 2007, amid similar performances at their companies.

After Prince left, Citigroup's board also gave him perks worth $1.5 million annually, which include an office, an administrative assistant and a car and driver for five years as well as a commitment to pay taxes on those benefits.

"Mr. Prince had no employment contract entitling him to these benefits upon his retirement from Citigroup," said the report.

After Prince's departure, Citigroup has continued to struggle because of the decisions made by the bank on his watch. Its stock recently made nine-year lows, and a Wall Street analyst is predicting that the company will report another $15 billion in mortgage-related writedowns in the first quarter, along with a loss of $1.66 a share.

At Merrill, O'Neal was awarded a retirement package worth $161 billion when he retired in October. That came in a year when the finance giant wound up with $18 billion in writedowns related to subprime and other risky mortgage investments. The company's stock dropped 45% from its five-year peak in January.

The biggest slice of O'Neal's farewell payout was the award of $131 million in unvested stock and options.

"If the Merrill Lynch board had terminated Mr. O'Neal for cause, he would have forfeited these stock and options because they had not yet vested," said the report. "Allowing Mr. O'Neal to retire instead of terminating his employment for poor performance significantly inflated the value of Mr. O'Neal's retirement package. It is unclear why this decision was in the interests of Merrill Lynch shareholders."

Moreover, the report notes that Merrill's board made a last-minute decision to cut the duration of O'Neal's non-competition clause, which he signed in 2004, in half and to shorten the list of companies to which it applied.

"Only one board member raised an objection to this revision in the agreement," said the report.

'Maximum Opportunity' at Countrywide

Mozilo's case is particularly egregious, because he sold almost $150 million in Countrywide stock from November 2006 through the end of 2007 at a time the company was taking on $1.5 billion in fresh debt to repurchase its overpriced shares. During that period, Mozilo made three revisions to his stock trading plan, increasing the amount of stock he was authorized to sell each time.

"The Countrywide board knew of the changes to Mozilo's stock trading plan but did not act to prevent Mr. Mozilo's sales," said the report. "Several board members also made large stock sales during this period."

In 2007, Countrywide announced a $1.2 billion loss in the third quarter and an additional loss of $422 million in the fourth quarter. By the end of the year, its stock had plummeted 80% from its five-year peak in February. During the same period, Mozilo was paid $1.9 million in salary, and he received $20 million in stock awards that were contingent on performance.

But the questions don't end there. In Mozilo's 2001 compensation contract governing his pay from 2002 through 2006, Mozilo received total compensation of $185 million in cash, stock and stock options. In 2004, the company hired a compensation consultant, Pearl Meyer, who raised concerns about payments Mozilo stood to receive after his planned retirement as CEO at the end of 2006.

"The board appears to have accepted some of Pearl Meyer's recommendations and rejected others," said the report. "It then ended its relationship with the consultant."

In 2006, a new compensation consultant, Exequity, raised new questions about Mozilo's compensation. The firm said his contract was based on a flawed "peer group" of companies that inflated his pay and inappropriately placed him at the top of the peer group in terms of salary and bonus.

In response, Countrywide's board reduced Mozilo's compensation when it renegotiated and extended his contract in the end of the year, but it came nowhere near the reductions recommended by Exequity. For that contract, Countrywide's management hired a second compensation consultant, Towers Perrin, to review Exequity's proposal.

"Although the company retained Towers Perrin, internal emails show that the consultant appeared to serve as Mr. Mozilo's personal advisor with the goal of achieving 'maximum opportunity' for Mr. Mozilo. The final contract was significantly more generous to Mr. Mozilo than Exequity originally recommended," according to the report.

Furthermore, the report raised other issues with the renegotiated contract. For instance, the "change in control" provisions entitled Mozilo to a severance payment of $36 million in cash on top of benefits. The terms gave Mozilo the right to collect the payment if the board took an action that "results in the diminution of executive's status, title, position and responsibilities" or that "results in the executive not being able to travel by private aircraft at company expense." The board could get rid of Mozilo without paying him severance only if he were convicted of a felony or acted in "bad faith."

The new contract gave Mozilo $10 million in restricted stock units to compensate him for payments he would have received under his retirement plan if he had retired at the end of 2006.

"It is unusual to include compensation for not retiring in the pay package of an actively employed CEO," said the report.

It also entitled him to a cash bonus calculated as a percentage of the company's annual net income provided that Countrywide's return on equity exceeded 10%. At the time the contract was negotiated, Countrywide was regularly logging a return on equity more than doubled that rate, so it effectively handed him a bonus even if he performed badly.

"I can't believe how low the ROE measures are," said a Countrywide official in an internal email, according to the report. "[S]hareholders or newspapers might comment all over this evident fact."

On Jan. 11, Bank of America(BAC Quote) announced plans to acquire Countrywide. On Jan. 28, after the committee called Mozilo as a witness to the hearing to be held Friday morning, the CEO forfeited severance and benefits totaling $37.5 million.