Let's just say that you went to prison. Let's just say that you pled guilty to, say, pension and income tax felony charges and got sent up the river for about 18 months.
What would be the chances that your current job would be waiting for you when you returned?
No, I'm serious, stop laughing.
Here's the next question: For the three of you who do not play in the NFL and answered that your job would still be there, how much of a bonus would you expect to receive while you were incarcerated?
Would $2 million be enough?
This is how Fog Cutter Capital (NASDAQ:FCCG) has penalized its Co-CEO Andrew Wiederhorn, who began an 18-month prison sentence on Monday for tax- and pension-fraud-related crimes. Fog Cutter, a financing company that operates disparate businesses such as the Fatburger restaurant chain, George Elkins Mortgage Banking, and Strouds, a linen retailer, claims that Wiederhorn's continued participation is needed because of his unique skills. There are other reasons, which we'll get to in a moment.
Let's just play patsy and assume that this argument is true, that Wiederhorn's contacts and skills are so specialized that Fog Cutter's shareholders would be massively harmed without him in the captain's chair, that no one else could possibly serve in this role over the long term. Is it completely outside the realm of possibilities that someone who owns 32.5% of the entire company wouldn't be motivated to help the company move forward even had he not been paid while he was in prison? Inmates are not allowed to engage in any business affairs while they are incarcerated -- by law there's nothing that Wiederhorn can do for the company for the next year and a half (15 months for good behavior). What possible justification could there be for the company to pay him?
Perhaps we should start by noting why Mr. Wiederhorn is going to jail. He formerly ran a company known as Wilshire Financial Services, which specialized in the secondary mortgage loan market, among other high-risk instruments. In 1998 the financial turmoil in Russia and Asia torpedoed Wilshire, causing Wiederhorn to turn to another financial company, Capital Consultants, for a $160 million loan to protect the company. Capital Consultants, for its part, was playing a shell game and collapsed, vaporizing the assets of several pension funds. That's thousands of retirement accounts that vanished into thin air.
Victim of circumstance, correct? Well, it gets better. Wilshire, which had borrowed the money from Capital Consultants to shore up its assets, had made personal loans to Wiederhorn of about $64 million. In June 1999, according to documents from the AFL-CIO, Wiederhorn, in his role as Wilshire CEO, signed documents forgiving the loans to, well, Wiederhorn. Wilshire defaulted on its loans from Capital Consultants, and Capital Consultants collapsed.
In 2001, Wiederhorn received notice from the U.S. Attorney's office that he was a target of an investigation into the failure of Capital Consultants. This culminated with his guilty pleas in June of this year. Wiederhorn was convicted of paying an illegal gratuity to Capital Consultants CEO Jeff Grayson in 1998 when he waived a $6 million personal guarantee Grayson had made on a bad loan Wiederhorn had assumed from Capital Consultants. He also pled guilty to tax evasion stemming from claiming losses on his 1998 tax return that did not have economic substance.
That's the basic story, the chief of a financial company up to his eyeballs in a really nasty financial situation that cost thousands of pensioners millions of dollars. For this he is going to jail, but the board of his new company, Fog Cutter, has determined that not only are they going to keep paying him, but also they're going to pay him a bonus that just so happens to match exactly the $2 million fine he must pay the state. What could they possibly be thinking?
Fortunately the board has helped us out here, producing a "white paper" that explains its actions and rationale for paying Wiederhorn and keeping him ensconced in the role of CEO even while he's in the big house. The composition of this board is also noteworthy: Along with Mr. Wiederhorn are three other directors who also served on the Wilshire board. Another member of the board is Donald Berchtold, Mr. Wiederhorn's father-in-law. He was appointed in March to take over for Robert Rosen, who suddenly resigned as president of the firm and as a director. These aren't exactly bulldogs; they're Wiederhorn's longtime associates. One might have hope for a mistrusting father-in-law, but fat chance: He's in management at the company.
So grotesque have been Fog Cutter's board decisions that Ernst & Young recently resigned as auditors, and Nasdaq is rapidly moving to delist the company's shares. Keep in mind that Nasdaq didn't delist Steve Madden (NASDAQ:SHOO) when its eponymous founder went to jail in 2001, though he continues to receive salary, nor does it seem that the NYSE will move against Martha Stewart Living Omnimedia (NYSE:MSO) even though its now-"founding editorial director" faces a stint as a ward of the state -- with pay.
The board gave four "whys" as to its decision to pay Wiederhorn while he's in jail. First, the company sees his continued interest in the company as a business necessity. The directors note that Wiederhorn is the only person who is intimately familiar with all facets of the company's business. It also notes that its 2002 agreement to acquire 51% of George Elkins Mortgage stipulates that if Wiederhorn leaves his positions that the minority shareholders have a right to repurchase Fog Cutter's stake at prices substantially below current values. I have one question -- the board knew in 2001 that Wiederhorn was at risk for substantial prosecution, and yet it allowed such a condition to be attached a year later, at odds with the interests of Fog Cutter shareholders. Why would a board of even reasonable competence agree to such a cockeyed and high-risk stipulation? That's crazy.
The second "why" is the nature of the charges against Mr. Wiederhorn and that he didn't commit these crimes in any capacity at Fog Cutter. That provides scant justification for retaining him as CEO; it is no reason at all to compensate him while he is in jail.
Third is that Wierderhorn's decision to settle allows Fog Cutter to look ahead rather than remain under the cloud of a protracted criminal battle. Again, this is at best justification to consider leaving him in place as CEO, not for payments while he's in the slammer.
And fourth, and slimiest: Mr. Wiederhorn let Fog Cutter's board know that he believed that his employment agreement entitled him to certain rights and remedies should the board terminate his employment, and as such the board would be best served to avoid litigation and the potential claims that might be higher than those payable under the Leave of Absence agreement. That's right -- he owns 32% of the company, but he'd sue 'em blind if they dared not pay him while he's in jail.
Granted, his employment contract, which is available for public review, does have these things built in. But the board approved a revised contract for Wiederhorn in 2003 -- two years after the criminal investigation began. What sort of unrefined mouth-breathers agree to such stupid terms under those circumstances? Fog Cutter says its board believes the company would prevail if Wiederhorn sued. But how in the world did the board members allow themselves even the possibility of having to pay should Wiederhorn go to jail, when they had the knowledge that this was a distinct possibility?
I have two theories. Either these board members are so deeply unconcerned about their fiduciary duty to minority shareholders that they allowed Wiederhorn to negotiate these terms both with George Elkins Mortgage and with his own employment with the knowledge that conditions in both put shareholder value deeply at risk, or they're a bunch of morons.
Either way, the head of a financial company sits in jail at this moment, guilty of financial crimes. That this isn't an ironclad sufficient cause for termination under any employment contract negotiated by rational individuals who are looking out for shareholder interests is baffling. Fog Cutter chose to pay Wiederhorn rather than fight. It deserves every ounce of the bad publicity and negative consequences it has received to date. This is corporate governance at its most rotten.
Bill Mann would like to learn Amharic. He holds shares in none of the companies mentioned in this story. Fog Cutter tends to turn up on variously constructed value screens, but a look under the hood shows why it seems so cheap. For some real value ideas, you have a chance to be a charter member of the Motley Fool's newest investing service: Inside Value. Try a free 30-day subscription today!
