David Brooks, DHB, and the Problem of Excessive Compensation

Last week, David Brooks, a former CEO and founder of DHB Industries (Point Blank Solutions), "a major supplier of body armor to the US military and law enforcement agencies," was sued by the SEC and indicted by the United States. The SEC complaint (32 pages) set out a myriad of charges, primarily related to the filing of false periodic reports and proxy statements from 2003 to 2005. In addition, the Complaint painted Brooks as a relatively unpleasant figure.

• Brooks exercised absolute control over every aspect of DHB's business, using the company's weak corporate governance and almost nonexistent internal controls to facilitate and hide the financial fraud he directed through Schlegel and Hatfield. Because Brooks knew any real examination of DHB's books and records would uncover the fraudulent scheme, he ruled the company through intimidation and abuse of those who questioned him and rewarded loyalty with extravagant bonuses and perks.

That wasn't all of it. As the complaint further noted: "When anyone questioned the accounting and financial practices underlying the fraud at DHB, Brooks became furious and threatening."

This Blog doesn't emphasize fraud cases. For our purposes, the more interesting sections of the complaint dealt with what the SEC described as the use of the company by Brooks as his own "piggy bank." Specifically,

• He used DHB checks and corporate credit cards to divert company funds to his private entities and pay for millions of dollars in personal expenses, including luxury cars, jewelry, art, real estate, vacations, personal aircraft usage, horse training, designer clothing and accessories from Hermes and Louis Vuitton, among other high fashion retailers, and $122,000 for iPods included in gift bags for guests at his daughter's multi-million dollar bat mitzvah.
• Brooks owned a jet through a private entity he controlled, and from 2003 through 2005 he had DHB pay for numerous personal trips he made to Las Vegas, Aspen, Mexico, St. Barthelemy, and St. Maarten, among others.

The indictment contained other details. It turns out that he is alleged to have "caused DHB to pay more than $1 million of the expenses of his personal horse business, including trainers’ salaries, the cost of feed and vitamins for the horses, stable fees and veterinary and legal fees," $20,000 for leather bound invitations to his son's Bar Mitzvah, $11,240 for acupuncture treatments for his family, and $101,500 Armored Vehicle for personal use.  Some of the other expenses included $10,300 summer camp for Brook's children, a $12,835 gold bracelet with diamonds, and a $101,190 belt buckle studded with diamonds, rubies and sapphires.

While the case paints a picture of largess (not unlike the picture painted in connection with Dennis Kozlowski at Tyco), the truly unfortunate thing about the expenses is that the error (assuming there was one) was the failure of Brooks to get the compensation committee to approve the expenses.  In that case, they would not have been illegal but either legitimate business expenses or additional compensation.  The armored car could be necessary to ensure the CEO's security; the Bar Mitzvah expenses and gifts could be necessary to entertain business associates and partners.  And, under Delaware law, approval by an independent compensation committee would be enough.  

Sound far fetched?  There are plenty of proxy statements disclosing that officers receive personal use of the corporate jet (sometimes for family members), a personal driver (for security reasons), home improvements such as the installation of a security system, free tickets to sporting events and other entertainment, and merchandise discounts (a short step away from free merchandise).   In other words, almost any degree of largess is permitted as long as approved by an independent board or committee. 

If Delaware had in place a more meaningful standard of review, one that required examination of the "fairness" of the transaction (rather than merely requiring adequate process, without consideration of the terms of the transaction), such extreme examples of corporate largess would become less common and perhaps people like David Brooks would be less likely to use the company treasury as a piggy bank.