Publicly-Held Companies Are Prohibited From Making Loans To Corporate Officers And Directors, According To The Sarbanes-Oxley Act Of 2002
The Sarbanes-Oxley Act of 2002 (the "Act"), which was signed by President Bush on July 30, 2002, is intended to rein in corporate and accounting misdeeds by closely regulating corporate governance and reporting obligations and by holding the directors and officers of public corporations accountable for their actions. While the well-publicized reporting and certification provisions of the Act impose substantial new requirements on public corporations, the Act is also noteworthy because it prohibits loans to corporate officers and directors, effective July 30, 2002.
While the Act does not define "executive officer," it is widely presumed that the operative definition is derived from the Securities Exchange Act of 1934, and would include the president, vice-presidents in charge of a business unit, division, or function, and any other officer engaged in policy making.
The ban is far-reaching. Section 402 of the Act states that it is unlawful to directly or indirectly (even through a subsidiary) "extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit." Because the Act does not define what qualifies as a "loan," it is unclear what kinds of transactions may fall under the prohibition. In addition to the obvious personal loans to corporate officers and directors, the following types of transactions may now be illegal:
- mortgage assistance programs;
- split-dollar life insurance programs;
- cashless exercise of options;
- loans from the company's (or a subsidiary's) 401(k) plan (note however, that ERISA issues may arise from this interpretation);
- loans to family members of officers or directors;
- material modifications to any pre-existing loans (e.g., alterations of the interest rate and terms); and
- guarantees of loans by third parties to an officer or director.
The Act does not appear to apply to loans made for business reasons (e.g., business travel advances and company credit cards for business purposes). Absent interpretive guidance from the SEC, however, the scope of the Act will remain uncertain, and it is possible that even business-related expense advances could be viewed as personal loans if the amounts are excessive or are not promptly repaid by the executive officer or director. Accordingly, employers are advised to act with caution in this area and to review any policies which may be construed as a form of personal loan.
One of the more troubling aspects of the Act is its prohibition on "arranging" for loans through third parties. This prohibition effectively bans the receipt of certain benefits by directors and executive officers that previously had been commonly associated with high-level managerial employment, such as mortgage assistance programs, certain types of stock option exercises, and loans from the employer's 401(k) plan.
The prohibition on loans does not apply to loans maintained by the employer as of July 30, 2002 (the effective date of Section 402). Thus, it appears that all pre-existing loans (or other qualifying arrangements) are exempted, even if the transfer of money is not completed by July 30, 2002. However, such pre-existing loans or arrangements may not be materially modified on or after July 30, 2002 (by, for example, forgiving such loans).
There are also other limited exemptions to the Act. For example, companies that are regularly engaged in the consumer credit business may offer loans to officers and executive directors if certain criteria is met. Such loans must be of a type generally offered and made in the ordinary course of business, on the same terms offered to the public. In addition, the loan must be for home improvement (or manufactured homes); for consumer credit (although this category remains undefined in the Act); an open-ended credit extension (including charge cards); or, a margin loan by a registered broker or dealer (this exemption does not apply in certain circumstances). Finally, banks insured by the FDIC may make qualifying loans so long as the loans comply with the existing insider lending restrictions.
In light of the broad sweep of the Act and the absence of interpretive guidance from the SEC, employers should immediately review the legality of their policies relating to the benefits provided to officers and executive directors.