SOX vs. Money: Which Is The Greater Motivator?

Last week I wrote this post on the occasion of Merrill's CEO, Stan O'Neal's departure. In it, I paid attention to O'Neal's outgoing compensation, and suggested that financial service company boards include a clause in a CEO's contract (under which, we have subsequently learned, neither O'Neal nor Citigroup's just-departed CEO Chuck Prince operated) to deny deferred compensation to a CEO who presides over serious losses. Specifically, I wrote of O'Neal,

"Here's a guy who presided over, and abetted, the loss of more than $8 BILLION this year, and he still walks with $160MM.

I don't care how that $160MM was earned, or over what time period. The truth is, the nature of financial service firms is such that a CEO, or, as I've written recently, here, any senior executive, can play the 'heads I win, tails you lose' game all too easily by risking the shareholders' equity.

In this regard, financial service companies are a bit different than those in most other sectors. Pumping growth at a financial services firm often leads to simply taking more risk.

In order to help a CEO own the responsibility for not allowing this to happen, why not simply make all deferred CEO compensation over an amount with which the board would not be embarrassed to have a loss-inducing CEO leave, subject to revocation and loss, in the event of certain conditions.

These conditions could include the occurrence of loss, as reported on financial statements, exceeding, either annually or cumulatively, a stated amount. Or perhaps a percentage decline in total return, adjusted for the S&P500 Index."

Consider Citigroup's Prince, who reportedly walks with $31MM, about which I wrote here last weekend. Citi is under fire for the SIVs it operates, but does not own. That is, it explicitly set up off-balance sheet vehicles which seem likely to cause large losses to the SIVs' lenders and 'senior note holders,' the latter being an equity-like class of investors in the vehicles.

Wasn't Sarbanes-Oxley supposed to end this sort of balance sheet slight of hand? Didn't the post-Enron environment cause Congress to pass SOX in order to prevent further financial statement abuses?

Guess it didn't work, did it? There's the nation's largest bank, by asset value, clearly engaging in off-balance sheet vehicle creation.

I contend that Congress, and investors, would get a whole lot more honesty and accuracy from CEOs and companies if the boards employed the type of deferred compensation reclamation for egregious losses that I suggested last week.

Clearly, SOX didn't stop Prince, nor his board, on which sat the former US Treasury Secretary, Bob Rubin.

Maybe I'm too cynical, but I'd bet that most CEOs will behave in ways calculated to preserve their tax-preferenced, deferred compensation wealth, SOX or no SOX. Moreover, I'd bet they'll be more motivated to protect their deferred fortunes than they will to avoid a SOX fine or penalty.

For a CEO to be stripped of his wealth, and 'retire' or be fired with as little as a few million dollars, is to add financial pain to shame. The latter might pass, but the former brings home much more viscerally the penalties of excessively risky behavior with shareholders' money.

Would Chuck Prince have been as cavalier in allowing the SIVs to be created, and so many structured investments assets be held, if he knew that engendering losses beyond some limit would strip him of nearly all of his $31MM exit package? He certainly didn't worry about SOX, did he?

Legal penalties for suspect corporate executive behavior is always going to be less certain than the result of a contractual agreement to forfeit assets under clear-cut conditions.

Ironically, using conditional deferred compensation clauses of the sort I am advocating might have provided less of a reason for Congress to have resorted to SOX in the first place.