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Old Corporate Loans Remain Despite Law
2006-02-25
Corporate loans to executives may seem like relics, remnants of the go-go years when executives such as WorldCom Corp.'s Bernie Ebbers and Tyco International Ltd.'s Dennis Kozlowski treated corporate coffers as personal piggy banks. But the loans haven't gone away. In fact, a handful of companies with shaky finances forgave millions of dollars in loans to their executives in recent years. Corporate reform law Sarbanes-Oxley made new loans by a company to its executives illegal. But loans made before the law went into effect July 30, 2002, were allowed to stand. The existing loan agreements cannot be modified in a "material" way, even if the modification benefits the company. Does forgiving a loan entirely count as a material modification? That "is and has been an open and debatable issue, one of the things lawyers scratch their heads about," said Bryn Vaaler, a partner in the corporate group of the Minneapolis office of the law firm Dorsey & Whitney LLP. There's no case law to settle the matter, so companies continue to forgive loans to their executives. For instance: • Silicon Graphics Inc., a technology company that has lost money for each of the past five years, in 2005 forgave $5,307,812 owed by Warren C. Pratt, its chief operating officer and executive vice president. The amount the company forgave included the loan, income on imputed interest and company reimbursements of Pratt's taxes in connection to the loan, according to the company's proxy. The loan was forgiven despite the fact that the company didn't have enough cash at the end of 2005 to support its operations, so it had to find new lines of credit, according to a quarterly report filed with the Securities and Exchange Commission. Its stock was delisted from the New York Stock Exchange in January when it failed to meet the exchange's minimum price requirement and now trades over-the-counter. The company did not return calls seeking comment. • Money-losing Wave Systems Corp., which makes digital distribution software, made a $250,000 loan in March 2001 to Gerard T. Feeney, its chief financial officer. The loan was originally due in March 2002, but was extended one year. In March 2003, the board's compensation committee approved a bonus in an amount equal to Feeney's debt and accrued interest. Feeney then repaid the loan. "The factors used in granting this bonus were the amount of the loan, the ability to repay the loan and the impact that non-repayment of the loan would have on Mr. Feeney's abilities to fulfill his duties for the Company," according to Wave Systems' proxy. Company spokesman David Collins said, "The company had two options, since he was unable to repay the loan immediately: To either demand his resignation and find a new CFO, or address the loan issue and enable him to serve the company." He added, "Mr. Feeney's subsequent bonuses have been substantially reduced, taking into account the bonus he received to address the loan outstanding." _Maxim Pharmaceuticals Inc., which develops cancer drugs, loaned Larry G. Stambaugh, its chairman and chief executive, $2.85 million in 2000. In an interview, Stambaugh said the loan came about after two events. First, when the company needed money in 1998 and 1999, the financing sources required him to buy more than 200,000 shares of the company's stock -- which cost more than his prior three years salary, so he had to borrow money. By late 2000, he had exercised some of his options and owned more company stock, which he used to secure a loan. Then he got a margin call. He told the board he would have to sell some of his stock. "That's when the board said they wanted to make the loan from the company so I didn't have to sell the stock," he said. In a meeting notice it filed with the SEC in 2005 before merging with another company, Maxim said, "The purpose of the loan was to avoid the necessity of Mr. Stambaugh selling Maxim stock during periods of market volatility and was viewed at the time to be in the best interests of Maxim and its stockholders." But Stambaugh was unable to repay the loan. "The board and I were faced then with the inability to work out the loan and I eventually became insolvent," he said. Maxim, a development-stage company that has lost money for each of the past six years, recorded $1.75 million in expenses on the loan, according to its filing. The company forgave the loan in August 2005, after Stambaugh forfeited the collateral securing the loan, including 203,333 shares of Maxim's common stock and 1.56 million options to buy the stock. "I gave up my stock, I gave up my options, I gave up some of my incentives and now I'm going to have to sell my home to pay the taxes on the loan forgiveness," Stambaugh said. According to property records, Stambaugh owns a five-bedroom house with a four-car garage and an assessed value of $2.54 million. "Everybody connected with this loan feels like it didn't work for me, for the board, or for the company," he said. "It didn't work for anybody. I didn't come out well." Maxim, which had a net loss of $27.69 million in 2005, merged with another drug company, EpiCept Corp., in January. Stambaugh, 59, does not work for the merged company. He said he's now looking for another job. "I've got no stock, no options, no home, no cash," he said. "I'd better get to work." Robert Cook, chief financial officer of EpiCept, said, "No management of the company (Maxim) was retained as a result of the merger.We look at this as a closed chapter in Maxim's history." What does the SEC say about forgiving loans? So far, not much. The SEC has pursued only one executive loan enforcement action since Sarbanes-Oxley passed. The December case involved Peter Goodfellow and Stamatis Molaris, officers of a Greek shipping company called Stelmar Shipping Ltd. The SEC said the two arranged loans for themselves, seemingly without the knowledge of the company's board. Both men were fined by the company. The SEC ordered them to cease and desist from violating the law; neither man admitted or denied the findings. Their company was acquired by another company in January 2005; its shares are no longer publicly traded.
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