Risk & Compliance

Executive Loans Can Run Both Ways

Even when such arrangements are properly disclosed, say experts, they may be legal and yet ethically troublesome.
Lisa YoonMarch 6, 2006

The Sarbanes-Oxley Act of 2002 may have outlawed loans by companies to their executives, but it says nothing about loans that are headed in the other direction.

That unusual situation arose last month when chief financial officer Robert P. Dowski extended his company, Washington, D.C.-based Allied Defense Group, a bridge loan of up to $2 million. The Washington Post, which first reported the Allied loan, wrote that the ammunition manufacturer is expanding a plant in Marshall, Texas, to attract more business from the Department of Defense. When negotiations fell through on a bank loan, Dowski reportedly stepped up to help with the financing.

According to a filing with the Securities and Exchange Commission, Dowski — who has advanced $1 million so far — will receive interest at an annualized rate of 12 percent as well as 1,000 shares of Allied stock for every $1 million the company borrows.

Allied had warned analysts earlier this year that it would report a loss for 2005, so in one sense, Dowski’s loan can be viewed as a sign of his confidence in the company. However, there’s also a less generous way of looking at the loan. Even when such arrangements are properly disclosed, say experts, they may be legal and yet ethically troublesome.

Benjamin Hermalin, a professor at the University of California at Berkeley’s Haas School of Business, would want a close look at the terms of the loan. “If the interest rate is exorbitant,” says Hermalin, that would raise an ethical issue: “Is the CFO gaining unfairly from the arrangement?”

Crystal Leiderman, director of investor relations at Allied, says the loan was an arm’s-length deal written by the company’s general counsel, chief operating officer, and chief executive officer; it was also reviewed and approved by Allied’s board of directors.

Based on last month’s $1 million loan — payable March 16, according to the SEC filing — Dowski stands to earn about $10,000 in interest and 1,000 shares; Allied closed at $22.90 on March 3.