Individual Settlement Contributions: When the Enron and WorldCom consolidated class action settlements were announced, much was made of the fact that individual directors and officers were compelled to contribute to those settlements out of their own assets without recourse to insurance or indemnity. This occasioned debate about whether the requirement for individuals’ settlement contribution represented a trend or was simply an attibute of the massive fraud involved in those particular corporate scandals. The debate continues, but it has been little noted that there was at least one significant subsequent settlement that also included this feature of individuals’ contributions out of their own funds without indemnity or insurance.

On January 12, 2006, Tenet Healthcare announced the settlement of the consolidated securities class action lawsuits and shareholders’ derivative lititgation that had been filed against the company and six present or former directors and officers, among other defendants. The company said that the monetary settlement would consist of a payment of $215 million by the company and/or its D & O insurers. In addition, two individual defendants agreed to contribute an additional $1.5 million to the settlement out of their own funds — Jeffrey Barbakow, Tenet’s former chairman and chief executive agreed to contribute $1 million, and Thomas Mackey, Tenet’s former chief operating officer, agreed to contribute $500,000. According to the Notice of Proposed Settlement sent to the class members regarding the settlement, “the sums contributed by [Barbakow and Mackey] shall not be reimbursed to them, by their insurance carriers or by Tenet or its agents.” A Wall Street Journal article discussing this settlement, including the individuals’ contributions, may be found here (via, subscription required).

First-Ever Patriot Act Enforcement Action: On May 22, 2006, the SEC announced its first-ever enforcement action under the Patriot Act. The enforcement action was brought against broker-dealer Crowell, Weedon & Co. under the anti-money laundering provisions of the Patriot Act that requires broker-dealers to implement and document identity verification procedures for all new accounts. The SEC alleged that Crowell, Weedon’s representatives were simply filing attestations that they had personal knowledge of each of then new account holders, rather than following the brokerage’s specified procedure to search public databases and review government issued identification documents. Crowell, Weedon did not admit to violations but agreed to enter a cease and desist order.

While the enforcement action against Crowell, Weedon relied exclusively on the specific Patriot Act provisions relating to broker-dealers, the Act’s anti-money laundering provisions generally apply to a very broad range of financial institutions and authorizes a broad range of sanctions for failure to comply with those provisions. Among other things, regulatory agencies are authorized to consider a financial insitution’s record of combating money laundering when reviewing applications in connection with a merger or acquisition, and financial institutions are subject to civil and criminal penalties of up $1 million for money laundering violations. The SEC may have pursued Crowell, Weedon to make an example, but it is far likelier that the SEC, energized by Congress’s March 2006 renewal of the Patriot Act, is newly motivated to add some enforcement teeth to the Act’s money laundering provisions. The D & O Diary expects to see more Patriot Act enforecement actions against a broader range of financial institutions.

Options Backdating and D & O Insurance: As The D & O Diary noted in its May 11, 2006 post, the plaintiffs’ class action lawyers have quick to try to capitalize on the growing options backdating scandal and have launched a number of securities class action lawsuits against companies caught up in the probe. This development is obviously of concern to directors and officers liability insurance carriers, and the May 24, 2006 issue of Business Insurance has an article entitled “Stock Option Probe Sparks D & O Concerns” (subscription required) discussing the possible impact of the options backdating story on the D & O insurance marketplace.

Talleyrand on Options Backdating: As the options backdating story has continued to unfold, some have questioned whether or not there is anything wrong with options backdating. For example, the law blog has a May 23, 2006 video post containing a debate between a business school prof and a CNBC reporter on the topic. Options backdating is obviously not harmless — the revelation of options backdating has already proven damaging to at least some of the companies caught up in the probe as they have had to restate their past financials to reflect their true compensation costs. But even beyond the restatement threat, there is a particular reason why the options backdating story has gained momentum in a way that stories about excecutives’ use of corporate aircraft or gold-plated pensions have not. The peculiar feature of the options backdating scandal is captured in the following epigramatic statement of Talleyrand:

If a gentleman commits follies, if he keeps mistresses, if he treats his wife badly, even if he is guilty of serious injustices toward his friends, he will be blamed, no doubt, but if he is rich, powerful and intelligent, society will still treat him with indulgence. But if that man cheats at cards he will be immediately banished from decent society and never forgiven.

The whole point of options-based compensation is to align executives’ financial interests with those of investors. Options-based compensation should subject executives to the same investment risk as investors. But back-dating options to ensure that executives gain in a way that investors cannot not only breaks the alignment between executives’ interests and those of investors, it unfairly stacks the deck in the executives’ favor. It is, in Talleyrand’s memorable phrase, cheating at cards, which no one will ever forgive. The D & O Diary believes the options backdating story has legs and has a long way to run.

For more about Talleyrand and Options backdating, see this post.

Thompson Memo Redux: Due to a technological snafu, subscribers to The D & O Diary did not receive an email feed for my May 23, 2006 post commenting on the Thompson memo. (Since the syndication service is free, I am hardly in a position to complain.)