10 of the 12 former outside directors of WorldCom Inc. have agreed in principle to pay $18 million out of their own pockets as a part of a $54 million settlement of the class-action lawsuit that WorldCom bondholders and shareholders brought against them in connection with the telecommunications company’s massive accounting scandal and resulting chapter 11 bankruptcy case. Paul Curnin of Simpson Thacher & Bartlett LLP in New York represents the ten former directors.
The directors’ liability insurers will pay the remaining $36 million of the tentative settlement. The $18 million that the former directors will pony up under the settlement represents about 20% of their combined personal net worth, excluding exempt property such as primary residences and retirement accounts.
WorldCom emerged from Chapter 11 bankruptcy protection last year and has changed its name to MCI. The reorganized company has an entirely different board of directors.
The tentative settlement is being watched closely be the business and legal community because it is precedent for expansion of the potential liability of outside directors whose companies commit accounting fraud. By way of comparison, the outside directors of Enron are currently attempting to settle similar litigation by using the remainder of approximately $200 million of the Enron officers and directors’ liability insurance while paying only 10% of their net Enron stock sales during the class period out of their own pockets.
As a general proposition, outside corporate directors have been among the most difficult defendants to tag in securities and accounting fraud litigation because of their lack of involvement in a company’s management and accounting processes. Although outside directors can face liability in such cases for oversight failures if their dereliction of duty is proven to both severe and demonstrable, the cases that have successfully proven such conduct are extremely rare. As a result, most cases against outside directors are settled by the directors’ liability insurer without the outside directors paying any portion of the settlement amount themselves.
The planned settlement comes about several months after Citigroup Inc.’s $2.65 billion settlement in the same lawsuit. Citibank — one of WorldCom’s leading bond underwriters — was one of 18 underwriters in the case, which also includes J.P. Morgan Chase & Co., Deutsche Bank AG and Bank of America Corp.
Update: Professor Ribstein provides his typically insightful analysis of the settlement here, and offers the following astute observation:

Well, the audit committee was independent, and at least one member did have the requisite expertise, but according to the complaint that didn?t prevent them from completely falling down on the job. Moreover, the complaint details disturbing governance failings at all levels ? executives, underwriters, accountants.
I believe an important lesson from all this is that our current model of corporate governance just isn?t working, and that we delude ourselves if we think that Sarbanes-Oxley is going to fix it.

So what?s the answer? First, we need high-powered market-based incentives that would be provided by the return of an active market for corporate control. Second, as I?ve been saying (e.g., here) we need to encourage alternative business structures that take near-absolute power over corporate earnings away from corporate executives and give it to the firm?s owners.
In other words, cases like WorldCom tell us that the answer to the corporate governance problems lies in getting rid of the corporation as the exclusive structure for business enterprise.