The provision in the Sarbanes-Oxley Act that bans loans to corporate executives has drawn public attention recently, as one major company took steps to comply with the rule while another company was accused by a shareholder research firm of skirting key provisions of the law.

In case you've forgotten, Section 402 of Sarbanes-Oxley prohibits public companies from extending credit "in the form of a personal loan" to any director or executive officer (see complete text at right).

Repaying Loans

Last week, $12 billion electric utility Dominion Resources disclosed a number of executives have exercised options so they can repay personal bank loans that are coming due in 2005 but can't be extended under Sarbanes-Oxley provisions. The Act specifically notes that issuers cannot "renew an extension of credit" in the form of a personal loan.

In fact, the company's board specifically authorized certain officers "to exercise options or sell shares through February 2005 for the purpose of paying off loans" under the company's stock purchase program. "The board lifted restrictions now to give the individuals a reasonable time to exercise their options and repay the loans," explains a spokesman for Richmond, Va.-based Dominion.

The loans were taken out in early 2000 to help the executives buy Dominion shares under the company's share ownership requirements.

The proceeds from any option exercises or sale of shares must be used to prepay loans and cover any related costs, the company stressed. The proceeds may also be used to acquire additional shares of Dominion.

And in fact a review of Form 4 filings for Thomas Capps specifically note that "net proceeds from the sale of shares and option exercise are to be used by Dominion's executive officer [Capps] to payoff a third party loan incurred to purchase shares under the Company's Executive Stock Purchase Program." (Sample Form 4 disclosure available from box above, right).

"This will enable officers to continue to maintain substantial share ownership in accordance with the intent of the company's ownership program and guidelines," the company stated in a press release.

According to a published report, Chief Executive Officer Thomas E. Capps has bought stock for about $32.6 million and sold it for $49.3 million over the past few weeks.

"I am exercising options for the purpose of loan retirement," he said in a statement. "I have not sold—and do not intend to sell—any Dominion shares. I am Dominion's largest individual shareholder and expect to maintain my share ownership position."

The company also said it will not extend its guaranty of personal bank loans to executives who borrowed money under the program, in accordance with Sarbanes-Oxley provisions. It also emphasized that the officers have been personally responsible for repaying the loans since the inception of the program.

The stock options were granted in 1999 under a shareholder-approved incentive compensation plan that requires officers to own from three to eight times their annual base salaries in Dominion shares. Officers will still be responsible for complying with share ownership guidelines after using proceeds from any stock and options sales to retire their loans, the company added.

Skirting The Provisions

Meanwhile, last week the Investor Responsibility Research Center accused the chief executive of $361 million FEI, of receiving a loan that contains many terms that led to the ban on such loans in the Sarbanes-Oxley Act.

The IRRC noted that in 1998, Vahe Sarkissian, then-newly appointed CEO of FEI, received a signing bonus of 50,000 shares of unrestricted common stock and the right to purchase about 150,000 shares of restricted stock. The company's 1995 stock plan permits the use of company loans to exercise options or purchase stock.

Under the plan, Sarkissian obtained a company loan for $1.1 million, due in June 2002, to purchase the 150,000 restricted shares, according to an IRRC report. He also borrowed $166,000 at that time to pay the taxes on his signing bonus.

In June 2002, Sarkissian asked for and received an extension of the due date on his restricted stock loan from June 2002 to June 2005, the IRRC added.

As of March 2004, Sarkissian owed $1.5 million on the restricted stock loan, including interest accumulated at 5.58 percent per annum from 1998 to June 2002 and 5.75 percent from June 2002 to the present. "The company passed up its right to repurchase Sarkissian's restricted shares at a price lower than the current price, and that right expired in June 2003," the shareholder advocacy group noted. "At that time, the company also forgave Sarkissian's tax-related loan."

In addition, at the May 20 annual meeting, the company asked shareholders to add another million shares to the 1995 plan. "The company has a history of adding shares to the plan almost every year since its inception," the IRRC asserted. "If that pattern continues, FEI's shareholders will again be asked to add more in the next year or two (the 1995 plan has no fixed termination date) and in doing so will have the opportunity to examine the plan's provisions relating to company loans."

The IRRC stressed that the Sarbanes-Oxley Act does not allow companies to extend new loans to named executive officers, but concedes that existing loans to those officers may remain on the books.

Sarkissian did not return phone calls seeking comment.

Restrictions And Modifications

Under the Sarbanes-Oxley Act, companies are not permitted to extend or maintain credit, or to arrange for the extension of credit, in the form of a personal loan to or for any director or executive officer. These restrictions do not apply to all other employees.

However, loans in existence on July 30, 2002, the date that the legislation was passed, are grandfathered so long as there is no material modification to any term of these loans, including any renewal.

In fact, according to a report published back in January by The Corporate Library, a number of companies were continuing to make loans "right up until the last possible minute," but that most organizations with outstanding insider loans are still waiting for them to be paid off, or forgiven.

The report, which randomly examined 115 proxies, found that 50 companies had outstanding loans during the 2003 and 2002 fiscal years. In addition, 23 offered split-dollar life insurance as a benefit, which Sarbanes-Oxley classifies as loans since companies typically pay premiums over a certain period and then, when the policy pays out, the cost of these premiums is reimbursed to the company, according to The Corporate Library.

"The other beneficiaries, the executives or their families, receive any remaining income," it elaborated. "In this way, the arrangements are seen as long-term loans, interest free, to the executives that pay their premiums.

Only 12 of the companies assured that the loans were totally paid off by year-end, it noted. This includes Intel, which The Corporate Library pointed out engages in best practices when it comes to compensation issues.

According to the report, on average the amount of indebtedness recorded by the 44 companies that disclosed amounts was more than $4.7 million. This compares with an average of $10.9 million in a report the Corporate Library had completed last year, which surveyed the 1,500 largest companies in the U.S.

Most of the companies in the new, limited and admittedly unscientific study are S&P 500 companies, where indebtedness was higher in the previous, larger study. "This suggests that loan amounts have fallen significantly," the report noted.

The company with the most owed to it was Union Pacific, which had nearly $40 million in outstanding loans to 62 executives under a stock purchase and loan program.

At the other end of the scale, Cisco Systems had just one loan outstanding—$200,000 during fiscal 2002—and it has already been repaid.

The largest proportion of loans was made for stock-related purposes, according to The Corporate Library. "These come under three different headings: stock option exercise, stock purchase and stock retention," it added.

The next largest number of companies made relocation loans, or loans related to relocation involving house purchase. This accounted for 14 of the companies. Another seven companies made loans for real estate purchases that were not associated with relocation.

And seven companies made loans where no purpose has been disclosed at all, according to the report.