Sour Internet investments aren’t likely a top priority for benched basketball star Michael Jordan, who’s nursing a sore knee and reconciling with his wife.
But the wealthy MVP is the most famous of former Divine Inc. board members who accepted company loans to exercise stock options two years ago, four months before Divine’s public offering.
Divine’s shareholders effectively financed Jordan’s purchase of $1 million worth of Divine stock in March 2000. At the time, it was presumed Divine’s stock would rise in value to more than cover the borrowing costs.
Instead, the software company’s stock plummeted, and Jordan’s $1 million stake was worth about $37,000 at Friday’s market close–less than a single year’s accrued interest.
Two years after the Internet bubble burst, the costs of the late 1990s runaway stock market are still being reconciled as companies decide who should foot the bill when loans denominated in millions are secured by stocks trading for pennies.
Deeply-indebted CEOs such as WorldCom’s Bernard Ebbers and Adelphia Communications’ John Rigas have been ousted from their troubled enterprises partly because of outrage over the executives’ huge company-backed borrowings, including loans to buy stock.
The Rigas family resigned Thursday from the cable TV company’s board and agreed to turn over $1 billion in assets and $567 million in cash flow from other cable holdings to cover an estimated $3.1 billion in family debts for which Adelphia is liable.
The company is being investigated by federal securities regulators and grand juries in Pennsylvania and New York.
At companies where there are no allegations of wrongdoing, some boards are forgiving loans made to buy stock and writing off the losses.
– Priceline.com forgave a $3 million loan to departing chief financial officer Heidi Miller, now Bank One Corp.’s CFO, when Miller left after eight months in the fall of 2000.
– Compaq Computer last year agreed to forgive CEO Michael Capellas’ $5 million loan over a period of three years and gave him a $2.5 million loan to cover his taxes.
– Directors at Chicago’s CoolSavings Inc. last year voted to forgive themselves $3.7 million they collectively owed for pre-IPO stock purchases.
“These CEO loans are really just a way of disguising cash compensation. They’re calling it a loan, but it becomes pay for failure pretty quickly,” says Patrick McGurn, director of corporate programs at Institutional Shareholder Services. “It’s a terrible practice from a corporate governance standpoint.”
“It’s essentially a stock giveaway,” says Ann Yerger, director of research at the Council of Institutional Investors.
Even when debtors return stock when their loans are forgiven, she says, “These aren’t looking like great investments for the shareholders.”
Divine forgiveness
At Divine, the company’s board forgave $2.4 million in loans plus interest to three top officers including CEO Andrew “Flip” Filipowski. The executives gave back their stock.
“I wish I could do the same,” says Ronald Lachman, a former Divine director who, like Jordan, accepted a loan to buy pre-IPO stock. Although Divine forgave officers’ loans, it hasn’t done the same for the directors.
Company loans to executives are a time-honored perquisite, but the practice of awarding them to exercise options waxes and wanes with market booms and busts.
Compensation expert Judith Fischer, managing director of Executive Compensation Advisory Services, says the 1987 stock market crash prompted companies to scramble to put together loan packages for executives who couldn’t cover margin calls.
Buying stock on margin, with borrowed money, works well when prices rise. But when prices fall and the shares no longer are worth enough to secure the loans, brokers demand payment.
Rescuing executives from bankruptcy was the impetus for many companies’ stock-option loan programs in 1987, Fischer says. “The other issue is not wanting to see an executive dump a lot of shares on the market.”
A fresh impetus for stock loans came during the booming 1990s, amid a scramble for executive talent and an IPO mania that produced instant multimillionaires.
“The opportunity for big wealth was being dumped suddenly on many people who weren’t making enough money to afford the consequences,” Fischer says. “Companies created stock option plans with loan provisions so executives could exercise their options and pay the taxes.”
Stock options also were distributed among employees and unpaid directors at Internet start-ups such as Divine, where many anticipated a windfall. Instead, they’re stuck with debt.
Jordan’s do-right deal
Jordan’s $1 million option grant was part of a three-year consulting agreement under which the superstar was to have promoted Divine and chaired the board’s “do right” committee.
Divine says Jordan attended several board meetings. Jordan’s agent didn’t respond to questions about his loan or his consulting gig.
His 166,666 shares, held by Divine, are fully vested, and interest is accruing on his loan at 6.8 percent annually, according to Divine’s proxy statement. No payments are required until the principal is due in 2005.
At least three other former directors also borrowed money to exercise smaller option grants, according to Divine’s proxy. The filing lists $225,000 loans each outstanding to Lachman, a software entrepreneur; Mohanbir Sawhney, a professor at Northwestern University’s Kellogg School of Management; and FastHeat Inc. CEO Tim Stojka, founder of the former PlasticsNet.com.
Several former directors have asked for loan forgiveness, but none has been granted, says Divine spokeswoman Susan Burke.
Someone has to pay
“There’s no free lunch here,” notes another former Divine director. “Somebody’s got to take that loss.”
Fairness issues are complicated by the fact that many companies offered employees stock during the tech boom and lent them money for the purchases. In addition, some companies require senior managers to own stock.
Yet typically such loans aren’t forgiven when companies fail.
At bankrupt Comdisco Inc., 106 senior managers collectively owe $104 million for stock they bought voluntarily with company-guaranteed loans in 1998.
The company’s proposed Chapter 11 reorganization plan would give them some relief: discounts ranging from 20 percent to 80 percent when the company collects.
“We tend to look at stock options as windfalls, but they’re not,” says Fischer, the compensation expert. “They’re a highly risky gain that has enormous negative consequences when it doesn’t go right. You might as well go to Las Vegas. It’s a crapshoot, and a lot of executives lose.”
