Boards: still not off the hook.

THE COLLECTIVE SIGH of relief from Walt Disney directors was audible from Tinseltown to Teaneck. Ruling on a shareholder suit that had dragged on for years, Delaware Chancellor William Chandler on August 9 determined that the Disney board did not neglect its duties when it awarded departing President Michael Ovitz a severance package worth $140 million in 1996. Ovitz had held the job for less than 18 months; the plaintiffs alleged that the board signed off on the generous package, which was recommended by Chief Executive Michael Eisner, without due diligence.

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If anything, the outcome has merely fueled the fury among another group of angry shareholders--those at Morgan Stanley, where CEO Phil Purcell's departure in June was accompanied by a slew of lucrative employment contracts for his top deputies. Billed as necessary to ensure management stability, the compensation packages contained exit clauses that guaranteed the executives' pay even if they quit. Stephen Crawford, for example, resigned in mid-July with $32 million in severance after serving as co-president for three months. CFO David Sidwell's contract guarantees him $10.5 million a year if he stays with the firm past October 15--but twice that amount if he leaves within the next 18 months.

Outrage among employees and stockholders was such that new CEO John Mack, the Morgan Stanley veteran who lost out to Purcell in a struggle for the top job in 2001, quickly amended his own $25 million-per-year contract in favor of a performance-based compensation package. Nevertheless, on July 19, the Central Laborers' Pension Fund filed a suit alleging the severance packages were excessive in light of the firm's performance and not in shareholders' best interests. (Morgan Stanley shares have underperformed those of Wall Street peers since 2000.) William Lerach, who represented Enron shareholders in suits against that company and its bankers and is now representing the pension fund, says he expects more plaintiffs to join the suit. And, he adds, "the outcome at Disney will not determine the outcome here."

At issue is whether directors fulfilled their fiduciary responsibility in approving the pay packages. To win, Morgan Stanley shareholders must prove that the board failed to spend enough time talking to independent lawyers and compensation consultants--in other words, that they simply rubber-stamped management's wish lists.

The Morgan Stanley case is "the final siren to board members that the days of getting together with your pals four times a year are over," says Brian Sullivan, chairman of New York-based executive search firm Christian & Timbers. "You have a responsibility to shareholders. If you like the CEO, God bless you, but it can't drive your decisions."

Although Chandler cleared Disney's board of negligence, his decision criticized its practices in blistering language. Eisner came under particularly harsh censure for his "Machiavellian (and imperial) nature as CEO."

"The takeaway [for boards] is pretty easy," says Sarah Wolff, head of litigation at Chicago law firm Sachnoff & Weaver, who specializes in executive liability and governance issues. "Directors have been told loudly and clearly that their job is to inform themselves and make reasoned decisions in a way that they can then explain them to shareholders, if need be."