Deutsche Bank (DB) CEO Josef Ackermann will look back at the year 2006 with relief: he avoided conviction in his re-trial over breach of fiduciary duty during the Mannesmann/Vodafone (VOD) takeover battle by settling for a paltry EUR 3.2 million without admitting guilt. The re-trial was not going well for Ackermann and the settlement provided him with a last-minute exit strategy. He had announced he would resign if he were convicted.
Recall that Mannesmann was sold to Vodafone in the midst of the internet boom after an extended hostile takeover battle. Mannesmann’s share price rose from EUR180 to EUR 350 during the showdown, an aggregate increase of EUR 80 billion. Approximately EUR 50 million were paid to a number of executives as bonuses as part of the takeover. Somehow, prosecutors got wind of the unusual way in which these bonus payments had been handed out, and this led to a criminal trial of six Mannesmann executives and board members for breach of fiduciary duty.
In their defense, Ackermann and his co-defendants initially argued that the bonuses were meant to reward Mannesmann CEO Klaus Esser and other executives for their shrewed negotiations during the hostile takeover that raised the value for shareholders by EUR 50 billion. In addition, they stressed, multi-million dollar bonus payments are common in the U.S. (not surprisingly, the Dusseldorf judge dismissed salary levels in other countries as irrelevant to a defense against criminal charges)
During the retrial, Ackermann suddenly changed his defense:
“I wanted to maintain the value that had been created, I was concerned with stabilizing the present in the interest of the future.”
This describes a retention bonus in a flowery CEO lingo not typical for hard-hitting investment bankers. However, a retention bonus is news to anyone who has followed the first Mannesmann trial. Why didn’t Ackermann bring it up before? His shifting defense can be only be explained by the appeals court’s ruling – the one ordering the retrial – that criticized the absence of benefit to Mannesmann from the bonus payments. Hence, Ackermann’s sudden discovery of retention as a reason for bonus payments.
Why would the outgoing board be concerned about executive retention? This would normally be in the interest of the buyer, and sellers regularly incorporate executive retention arrangements at the request of the buyer. But apparently, Vodafone made no such request. And clever retention payments should be structured to keep managers in the firm. Clearly, a one-time lump sum payment won’t do the trick. Esser joined private equity firm General Atlantic Partners as a partner soon after the merger. Thanks to the lump-sum bonus he had nothing to lose from jumping ship.
The Mannesmann Six settled charges for a total of EUR 5.8 million: Josef Ackermann, Joachim Funk, Klaus Esser, Dietmar Droste , Klaus Zwickel and Jürgen Ladberg.
The first trial was a success for Ackermann and his co-defendants on two fronts: not only were they acquitted on the basis of the weak argument that they were unaware of the illegality of their conduct, but they also won the support of much of the business press. The trial was portrayed as a clash of cultures between provincial government bureaucrats and international executives who deserve multi-million dollar salaries. Just recently, the Wall Street Journal carried the headline “German retrial highlights perils of importing US pay practices,“ as if Richard Grasso’s (NYX) troubles or Michael Ovitz’s eight-year Disney (DIS) legal battle had not happened. Lost in translation was the actual substance of the trial: accusations of breach of fiduciary duty. It was not primarily the level of bonuses that was on trial, it was the dubious way in which they were awarded.
The amounts in question are indeed in line with golden parachutes typical in the U.S., and also in Europe. But a closer look at the circumstances under which these bonuses were awarded suggests that they would have little chance of holding up to scrutiny in U.S. courts.
In the Mannesmann case, there is practically no documentation that supports the bonus decision, and the courts have to rely on witnesses. The secretary who has prepared all board minutes since 1975 found the ready-typed minutes of the bonus board meeting on her desk one morning. Were it not for that morning surprise, she would not even have known that a board meeting took place. Ironically, the minutes had been typed on letterhead normally reserved for letters of condolence. In the following weeks, she was asked more than 20 times to make changes to these minutes. The meeting and its minutes continue as a red flag because they show that board member Funke approved his own bonus. At the time, this was a serious enough issue to trigger auditors KPMG to question the legality of the bonuses. It is easy to picture how this testimony alone could determine the outcome of a jury trial in the U.S.
Other aspects of the bonus award procedures remain equally murky. The key event is a late-night meeting between Esser and Vodafone’s CEO Chris Ghent in Esser’s office. Suddenly, an unexpected visitor arrives: Canning Fok, CEO of major Mannesmann shareholder Hutchison Whampoa (HUWHY). Fok seeks to enter Esser’s office, but a Morgan Stanley banker alleged played bouncer and refused to let Fok in. Fok eventually negotiated his way into the meeting, allegedly uttering the phrase “we need to do this the Chinese Way.” What he meant remains a mystery. It has been suggested that he proposed the bonus payments as a bribe, but this assertion has never been confirmed by the court. Other pay practices at Mannesmann also raise eyebrows. In early 2000, the chairman of the supervisory board promised Esser a car and chauffeur for life. Esser later “sold” that benefit back to Mannesmann for EUR 2 million. Not bad for a benefit that was meant to be “non-cash”.
In comparison to regulations and best practices in the U.S., Mannesmann’s boardroom antics were unprofessional, or even illegal. High salary levels are common in the U.S., but at least they have to be approved by shareholders. NYSE and NASDAQ require shareholder voting on all equity-based compensation of companies listed on these exchanges. Even the government gets involved. As in many other areas where direct government interference is politically infeasible, tax deductibility is used as an indirect but effective tool. Section 280G of the Internal Revenue Code requires shareholder approval for golden parachutes, while section 162(m) eliminates deductibility of executive compensation above $1 million unless shareholders approve the compensation plan. Mannesmann shareholders were never given the opportunity to vote but had to part with EUR 50 million of their assets.
The good news for Deutsche Bank shareholders is that the trial is over and Ackermann no longer needs to spend one day per week in court. He can now concentrate fully on steering Deutsche to new highs. We hope he will perform in 2007. The bad news is that unless governance reaches U.S. standards and pay packages continue to be determined in the same arbitrary way, Ackermann may well find himself in front of a judge soon again.
Disclosure: The author and the Pennsylvania Avenue Event-Driven Fund [PAEDX] do not hold long or short positions in any companies mentioned in this article.