August 10, 2005

Sigh of Relief in the Boardroom: Disney Directors Absolved of Personal Liability

Yesterday, Delaware Chancery Court Chancellor William Chandler delivered his long-awaited opinion in the Disney case by holding that the Disney directors didn’t violate their duties by ratifying Eisner’s decision to fire Ovitz in a way that entitled Ovitz to a huge severance package.

More analysis to come soon as there is an interesting discussion on good faith in the opinion. It’s important to remember that Chancellor Chandler was applying existing law to the facts in this case – the standard for personal liability was created last year in this Chancellor Chandler opinion when the case first survived a motion to dismiss.

We have posted a copy of the new 174-page opinion in the “Compensation Litigation Portal” on In addition, don’t forget that our “2nd Annual Executive Compensation Conference” will open with a panel on director duties featuring Delaware Supreme Court Chief Justice Myron Steele; Delaware Vice Chancellor Stephen Lamb; and Professor Charles Elson, Director of the U. of Delaware Center for Corporate Governance.

Tweaks to D&O Questionnaire for E&Y Independence

My good friend Linda Wackwitz of Quovadx informs me that she has learned that in connection with their settlement, E&Y is now required to scrutinize independence more closely than previously – so E&Y was going to require the Quovadx directors to complete a detailed E&Y independence questionnaire. Instead, Linda convinced E&Y to leverage off of the company’s existing D&O questionnaire by having the company add the following question to it:

“Do you or any member of your immediate family have any business relationships with Ernst & Young LLP or any of its affiliates or have an ownership interest in, or serve as an officer, director, or substantial stockholder of, any company (public or private) that has any business relationships with Ernst & Young LLP or any of its affiliates? If so, please specify the name of the person or entity that has the business relationship, a description of the business relationship, and the dollar amounts involved.”

Lessons Learned from WorldCom Mid-Manager Sentencing

Last week, Bruce Carton had the following interesting observations in his Securities Litigation Watch: Betty Vinson, a former WorldCom mid-level accounting manager who pleaded guilty in October 2002 to participating in the financial fraud at the company, was sentenced to five months in prison and five months of house arrest. Although her sentence won’t get even one-thousandth of the press coverage that Martha Stewart’s sentence did, it is far more important in terms of the impact it may have on deterring fraud in the future.

Vinson represents the typical “pawn” in a financial fraud–a lower or mid-level accounting person who by all accounts had no interest and no desire to commit fraud. Nonetheless, the fraud came to her. She was instructed by her boss, former CFO Scott Sullivan, to make improper accounting entries to make WorldCom’s numbers appear better than they really were, supposedly at the ultimate direction of CEO Bernie Ebbers. Vinson testified that “I felt like if I didn’t make the entries, I wouldn’t be working there.”

Vinson was deeply troubled by this instruction and went so far as to draft a letter of resignation in protest. But at this key juncture in her life, she did not quit. Instead, she stayed with the company and made many of the fraudulent accounting entries that enabled the financial fraud at WorldCom. She apparently did so for personal financial reasons and because of the personal appeals from Sullivan “not to jump out of the plane . . . [to] hang in there and help him get through the situation for the third quarter.” Vinson chose to believe Sullivan that this was a “one-time thing” that he would correct.

People placed in the excruciating position that Vinson found herself in need to know that the issue is not merely whether they should quit their job. They need to know that the consequences for participating in and enabling a financial fraud are severe–you may well go to prison as a convicted felon. As Judge Barbara Jones who sentenced her correctly observed,

“Ms. Vinson was among the least culpable members of the conspiracy at WorldCom,” Jones said. Still, she said, “Had Ms. Vinson refused to do what she was asked, it’s possible this conspiracy might have been nipped in the bud.”

Prison time for Betty Vinson was the right outcome, and public companies should be training their employees that prison is a realistic outcome for anyone–not just the ringleaders–who would betray the integrity of the company’s financial reporting.