As we pointed out previously, the only part of the consensus view of corporate governance that Sarbanes -Oxley enacted into federal law concerns the composition and authority of the audi
Trang 1the current corporate governance saga with a summary of the principal provisions of Sarbanes -Oxley and the new N YSE listing standards.
Sarbanes - Oxley Act
Most of the press coverage of Sarbanes -Oxley has focused on its creation
of a new Public Company Accounting Board188and its establishment of new standards of auditor independence.189One title of the Act, however,
is Corporate Responsibility, and four features of Sarbanes -Oxley’s approach
to corporate governance are worthy of careful note.
As we pointed out previously, the only part of the consensus view of corporate governance that Sarbanes -Oxley enacted into federal law concerns the composition and authority of the audit committee To an extent, this limited federalization of corporate structure is entirely un-derstandable Matters of internal corporate structure have been histori-cally the province of state law and private contracts, and Congress is surely correct to legislate in the area only with great deference Further-more, the impetus for the Act was the “recent corporate failures [that highlighted the need] to improve the responsibility of public companies for their financial disclosure.”190It was, therefore, logical for Congress
to have limited its incursion into the area of corporate governance simply
to assure that all public companies have “strong, competent audit com-mittees with real authority.”191
Nevertheless, despite the limited federalization of the consensus view
of best practice, Congress was prepared to ignore entirely such best prac-tice notions and rely on an entirely different model of corporate gover-nance model when it saw a clear need to control specif ic types of management opportunism Thus, for example, Sarbanes -Oxley:
1 Prohibits outright any publicly held corporation from making a loan to any of its directors or officers.192
2 Forces the CEO and CFO of any publicly held corporation that is required to file a financial restatement “due to the material non-compliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws” to re-imburse the corporation for any bonuses received or profits from stock sales realized during the 12 months following the filing of the inaccurate financial report.193
3 Requires CEOs and CFOs to certify that all f inancial statements filed by their corporations with the SEC “fairly present in all ma-terial respects the financial conditions and results of operations
of the issuer”194and makes it a federal crime to do so “knowing” that the financial statements do not.
Trang 24 Prohibits directors and executive off icers from selling company stock during benefit plan “blackout periods.”195
5 Makes it unlawful for any off icer or director to take any action
“to fraudulently inf luence, coerce, manipulate, or mislead” the corporation’s auditor.196
In the consensus view, a strong independent board can and will pro-tect stockholders from management’s temptation, in Berle and Means’ words, to “direct profits into their own pockets [and fail to run] the cor-poration primarily in the interest of the stockholders.”197But at least
in these five areas identified, Sarbanes -Oxley ref lects Congress’s serious doubts as to the ability of the board of directors, however independent, ef-fectively to perform that function.
In the audit committee area, Sarbanes -Oxley does follow the consen-sus model of corporate governance by requiring every publicly listed cor-poration198to have an audit committee composed entirely of independent
directors, defined as individuals who are not in any way affiliated with the corporation199or receive “any compensatory fee” from the corporation other than for serving on the board of directors.200Every public corpora-tion must disclose whether at least one member of its audit committee is
a “financial expert” and, if not, why.201The audit committee must be “di-rectly responsible for the appointment, compensation, and oversight” of the corporation’s outside auditor202and preapprove any “nonaudit ser-vices” that the outside auditor provides to the corporation.203The audit committee is required to receive from the outside auditor reports as to
“all critical accounting policies and all alternative treatments of f i-nancial information discussed with management.”204In addition, the audit committee must have “the authority to engage independent counsel and other advisors” and to compensate these advisors through such cor-porate funding as it determines appropriate.205
The method by which Congress chose to impose the new audit com-mittee requirements on publicly listed corporations is precisely that rec-ommended by the Task Force.206That is, Sarbanes -Oxley does not impose these requirements directly, but rather requires the SEC to direct the ex-changes and NASDAQ to “prohibit the listing” of a corporation that is “not
in compliance with these requirements.”207The signif icance of this ap-parently convoluted approach has generally gone unnoticed, but by struc-turing the audit committee requirements in this way, corporations, their boards of directors, and their audit committee members are not faced with liability in the event the audit committee requirements, for whatever rea-son, are not adhered to.208
Sarbanes -Oxley creates new financial crimes,209increases the crimi-nal pecrimi-nalties for many existing f inancial crimes,210 and gives the SEC
Trang 3substantial new enforcement authority.211It does not, however, except for extending the statute of limitations for fraud,212 in any way facilitate stockholders’ ability to sue for a breach of the securities laws or any new requirement imposed by the Act Indeed, as noted previously, even an in-tentional breach of the new audit committee requirements will not be ac-tionable because those requirements will be imposed by self -regulatory organization rules And enforcement of the new prohibition against fraud-ulently inf luencing an auditor is specifically limited to the SEC.213Thus, while Congress sought through Sarbanes -Oxley “to increase corporate responsibility,” it most clearly did not want to use increased stockholder litigation as a means for accomplishing that objective.
N YSE Lis t ing St andards
In February 2002, at the request of the chairman of the SEC, the N YSE appointed a special Corporate Accountability and Listing Standards Com-mittee (Accountability ComCom-mittee) to review the NYSE’s listing standards
in light of Enron On June 6, 2002, the Accountability Committee issued its report Although the report of the Blue Ribbon Committee had been completed less than three years earlier, the Accountability Committee saw
a need “in the aftermath of the ‘meltdown’ of significant companies due
to failures of diligence, ethics, and controls, [for] the NYSE once again [to use its authority] to raise corporate governance and disclosure stan-dards.”214Unlike the Blue Ribbon Committee’s recommendations, there is little conventional and nothing timid about the recommendations of the Accountability Committee These recommendations, which in all signifi-cant respects have been incorporated in proposed rule changes filed by the N YSE with the SEC on August 1, 2002,215are unquestionably the most far-reaching and rigorous expression of the consensus view of corporate governance ever promulgated.216A brief summary of certain key provi-sions of the new listing standards should illustrate their boldness.
The starting point is hardly surprising All listed companies must have a majority of independent directors.217Interestingly, a director does not qualify as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the cor-poration and that determination (and its basis) is “disclosed in the com-pany’s annual proxy statement.”218In addition, regardless of any board determination, no director may be considered to be independent until five years after he or she ceases to be an employee of, affiliated with the auditor for, part of an interlocking directorate involving, or a member of the immediate family of someone who is not independent of, the listed company.219
Trang 4It is, however, in the powers and authority of the independent directors that the recommendations of the Accountability Committee take the cor-porate governance paradigm of the strong board of directors to what must
be regarded as its apotheosis First, with the explicit objective of “em-power[ing] nonmanagement directors to serve as a more efficient check on management,” these directors must “meet at regularly scheduled execu-tive sessions without management.”220 Second, each listed company must have three committees composed solely of independent directors: a nom-inating/corporate governance committee, a compensation committee, and
an audit committee The nominating committee must have the authority
“to select, or to recommend that the board select,” the future director nominees and the responsibility to prepare a written charter addressing, among any other matters, “a set of corporate governance principles appli-cable to the corporation.”221 The compensation committee must “review and approve corporate goals and objectives relevant to CEO compensa-tion, evaluate the CEO’s performance in light of those goals and objec-tives, and set the CEO’s compensation level based on this evaluation.”222
With respect to the audit committee, no member of the audit committee may receive any compensation from the corporation other than director’s fees; the committee must have “the sole authority to hire and fire inde-pendent auditors; and it must preapprove any significant nonaudit rela-tionship with the independent auditors.”223 In addition, the audit committee is empowered “without seeking board approval” to “obtain ad-vice and assistance from outside legal, accounting, or other advisors.”224
The Accountability Committee’s report and the N Y SE’s actual pro-posed new listing standards contain many more specific requirements de-signed to “give the legions of diligent directors better tools to empower them and encourage excellence.”225 Indeed, it is hard to think how inde-pendent directors could be more empowered than they will be under the new NYSE standards without seriously interfering with the need for strong, centralized management capable of efficiently making the adaptive deci-sions necessary for the competitive operation of the modern corporation.226
The question, of course, to which we now turn, is whether the fully em-powered, independent board of directors will have the disposition, incen-tive, and resolution “to serve as a more effective check on management.”
CONC LUSION
Virtually all of the significant developments in corporate governance over the past 30 years f low from a paradigm shift in the general view of the role of the board of directors that occurred in the 1970s At the start
of that decade, boards of directors were seen as operating best through
Trang 5consensus, not conf lict, and the outside directors’ principal value was un-derstood to be that of experienced, constructive advisors to the CEO, of-fering knowledgeable and objective perspectives on the company’s competitive challenges As the decade progressed, however, scholarly and regulatory concern was increasingly expressed that such collegial, conf lict-avoiding boards were little more than rubber stamps for CEOs Thus, a con-sensus of establishment lawyers, academics, and business leaders developed that such boards should be replaced by monitoring boards, characterized
by independence, skepticism, and unf linching commitment to stockhold-ers’ interests As corporate scandals and f lagrant abuses continued through the 1980s and 1990s, this consensus view of the monitoring board as best practice spread and sharpened, culminating ultimately in Sarbanes-Oxley’s audit committee requirements and the N YSE’s new listing standards But the validity of the consensus view, in general, and of these recent corporate governance initiatives, in particular, rests on the assumption that increases in director independence and empowerment lead to de-creases in instances of management opportunism While it may be diffi-cult to disprove (or prove) this assumption,227we offer in closing some brief but skeptical comments on the wisdom of the apparently ever increasing public reliance on it.
First, boards of directors in the late 1990s and early 2000s were un-doubtedly far more independent than those in the early 1970s But surely
no one would argue that the managerial misdeeds leading to passage of the FCPA were worse than those leading to passage of Sarbanes -Oxley Enron, WorldCom, Adelphia, Tyco, and Global Crossing were all listed
on the N YSE or NASDAQ These companies were in full compliance, for-mally at least, with all applicable requirements for board and audit com-mittee independence, yet it would be hard to find any corporation in the 1970s whose management behaved with comparable piracy.
Second, if independent directors are to perform an effective moni-toring role, they need “to bring a high degree of rigor and skeptical ob-jectivity to the evaluation of company management and its plans and proposals.”228But these characteristics are likely to be far different from the characteristics of directors valued by a CEO for their strategic insights and business acumen At a minimum, therefore, the consensus demand for a monitoring board forces a tradeoff of strategic vision for skeptical objectivity—without any demonstration that a cost-benefit analysis favors
a monitoring versus counseling board More fundamentally, the success of the monitoring board would appear to depend on the recruitment of di-rectors with profiles very different from those of the didi-rectors that now oversee our major corporations Without exaggeration, the rhetoric used
by the N YSE’s Accountability Committee and the ABA’s Task Force—and
Trang 6the apparent objective of Section 301 of Sarbanes -Oxley—suggests that
in recruiting members for their boards of directors, public companies should be looking not for successful executives at other companies, in-vestment bankers with broad industry expertise, or professional consul-tants with detailed knowledge of business processes and operations, but rather, for former staff members of the SEC’s Division of Enforcement Surely, this cannot be right.
Third, if the premise of the monitoring board is correct, that is, if the stockholders are, in fact, to rely on the independent directors to prevent management opportunism, you would expect that when such a board fails to prevent such opportunism, through negligence or worse, it should
be possible to call the board to account for its failure But that is not the case “On the contrary many prominent features of corporate law [are] designed for the express purpose of making it difficult for share-holders to hold the board legally responsible, except in the most provocative circumstances [And it would be] dangerously optimistic [to] assum[e] that the level of judicial supervision of business can be dramatically increased without unforeseeable and incalculable conse-quences for the efficiency with which businesses make necessary adaptive decisions.”229Yet, as we assign more and more responsibilities to the in-dependent directors but do not in any way attend to the legal conse-quences of their negligent performance of these responsibilities, we are,
in effect, putting cops on the beat without supervision or risk of sanc-tion Neither Sarbanes -Oxley nor the N Y SE’s new listing standards ac-knowledge this anomaly, but surely the disconnect between director responsibility and director accountability is far too large to remain un-addressed.
Fourth, and finally, the consensus model of best practice in the area
of corporate governance represents an attempt to control corporate op-portunism through private initiatives, thereby avoiding federal interven-tion into matters of internal corporate organizainterven-tion and management Over the past 30 years, the pattern has been for the consensus to recom-mend independence on corporate boards to prevent further scandals or
f lagrant abuses When more scandals and f lagrant abuses occur, the con-sensus recommends even more independence, and then when scandals and f lagrant abuses continue, it recommends yet more independence, and
so on In Sarbanes -Oxley, Congress showed its impatience with this con-tinual ratcheting up of the standards for, and powers of, the independent directors by imposing federal bans on matters such as corporate loans to executives and forced executive repayments of bonuses and stock gains before corporate restatements In doing so, Congress was testing a new ap-proach to corporate governance.
Trang 7Berle and Means focused corporate scholarship’s attention on the risks of management opportunism given the separation of ownership and control Berle and Means, however, never suggested that a monitoring board was the solution to that endemic corporate problem At present, the consensus view as to corporate governance best practice is so dominant that it is difficult even to suggest that further empowerment of an inde-pendent monitoring board may not be the solution to the current round
of corporate scandals and f lagrant abuses Nevertheless, after watching in-dependence and empowerment ratcheted up and up and up for 30 years, our conclusion is that enough is now enough It is time to recognize that other best practice models of corporate governance need to be evaluated First, the costs and benefits of allowing an efficient market for corporate control to develop need to be reevaluated Second, members of the con-sensus and, particularly, the establishment business community need to
think seriously about the trade-offs between boards that counsel and boards that monitor And third, attention needs to be paid to other approaches to
controlling management opportunism While more direct federal prohi-bitions on specific types of management misconduct and more substan-tive corporate governance authority in the SEC are not particularly attractive on their own, they nevertheless may need to be explored once the impact of Sarbanes -Oxley is thoroughly analyzed More promising ap-proaches may be carefully tailored oversight of executive compensation, mandatory holding periods for options, and limitations on executive stock sales An increased role for trained internal monitors is not out of the ques-tion, and surely any number of other approaches could be explored The point is that by turning the corporate board into the “monitor” of corpo-rate management, we do not appear to have been able to stop the scandals and f lagrant abuses, and we may well be losing the vision, advice, and com-petitive perceptiveness that a good board should be providing the CEO Surely there must be better ways to deal with the consequences of the sep-aration of ownership from control in the modern corporation The time has come, we believe, to think outside the consensus box.
NOTE S
1 Pub L 107-204, July 30, 2002, available at http://frwebgate.access.gpo gov/cgi-bin/getdoc.cgi?dbname=107_cong_bills&docid =f:h3763enr.txt.pdf
2 Manne (1965), p 110
3 On October 16, 2001, Enron announced a $618 billion reduction in third quarter prof its and a $1.2 billion loss in shareholder equity (Hays, 2002)
4 In April of 1998, Cendant announced plans to restate its 1997 earnings because of major “accounting irregularities” that resulted in Cendant’s
Trang 8overstating income of up to $115 million “Cendant to Restate Results,”
CNNMoney, available at http://www.money.cnn.com/1998/04/15/companies
/cendant April 15, 1998
5 In 1998, Sunbeam Corp restated its 1996 and 1997 f inancials because of accounting discrepancies (Belstran and Rogers, 2002)
6 In late 1994, Bausch & Lomb announced that excess distributor invento-ries would reduce 1994 earnings by 54 percent (Maremont and Barnathan, 1995)
7 See Presidential Campaign Activities of 1972: Hearings Before the Select Comm on Presidential Campaign Activities, 93rd Cong., 1st Sess (1973).
8 See Activities of American Multinational Corporations Abroad: Hearings Before the Subcomm on International Economic Policy of the House Comm On International Relations, 94th Cong., 1st Sess 36 -37 (1976) (statement of Philip A Loomis,
Commissioner, SEC); SEC, Report of Questionable and Illegal Corporate Payments and Practices (May 12, 1976) (submitted to the Senate Banking, Housing, and Urban Affairs Comm.)
9 See S Rep No 114 (1977); H.R Conf Rep No 831 (1977), reprinted in
1977 U.S Code Cong & Admin News 4121; Note, Effective Enforcement
of the Foreign Corrupt Practices Act, 32 Stan L Rev 561 n.1 (1980)
10 SEC, 94th Cong., Report on Questionable and Illegal Corporate Payments and Practices (Comm Print 1976).
11 Unlawful Corporate Payments Act of 1977, H.R Rep No 95-640, 4 (Sep-tember 28, 1977)
12 Foreign Corrupt Practices Act, Pub L No 95-213, 15 U.S.C § 78dd et seq.
(December 19, 1977)
13 SEC, Regulation 13B -2, 44 Fed Reg 10970 (February 23, 1979)
14 Williams (1978), p 319
15 See note 14
16 See note 14
17 See note 14
18 See note 14
19 See note 14, p 327
20 See note 14, p 319
21 See note 14, p 320
22 Legislation was introduced in the House as H.R 3763 on February 14,
2002, and in the Senate as S 2673 on June 25, 2002
23 The chairman and CEO of Goldman Sachs said he “cannot think of a time when business overall has been held in less repute” (McGeehan, 2002,
p A1) See also Morgenson (2002, p C4), addressing a May CBS/Gallop poll f inding that “84 percent feel that [the accounting impropriety] issue
is punishing stock prices, ranking it ahead of conf lict in the Middle East and terrorism.”
24 Klinger et al (2002), p 1
25 See Berman (2002)
26 See Lublin and Sandberg (2002)
Trang 927 See Wing (2002), p 4.
28 Greenspan (2002) “If the past thirty years have demonstrated anything, it
is that the avarice of America’s corporate leaders is practically unlimited, and so is their power to run companies in their own interest” (Cassidy, 2002,
p 76)
29 Labaton and Oppel (2002)
30 See Williams (1978), p 319
31 See Labaton and Oppel (2002)
32 Sarbanes -Oxley was signed into law on July 30, 2002
33 See Williams (1978), p 320
34 BRT Strongly Supports President Bush’s Signing of Accounting and Financial Re-form Law ( July 2002), available at www.brtable.org/press.cfm/748.
35 Drucker (2001), p 113
36 Berle and Means (1991), pp 6 –7 Adam Smith made much the same point
a little over 150 years earlier In discussing joint stock companies, Smith wrote: “The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be ex-pected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it Negligence and profusion, therefore, must al-ways prevail more or less, in the management of the affairs of such a com-pany” (Smith 1976/1992, vol 2, p 741, Chapter v.i.e.)
37 See note 36, p 313
38 See note 36, p 4
39 See note 36, p 131
40 See note 36, p 293
41 See Arrow (1974), pp 68–70
42 See Berle and Means (1991), p 219
43 By opportunism, we mean not only management’s pursuit of its self -interest
at the expense of the stockholders, but also (1) what is generally referred
to in the economic literature as the temptation for “shirking,” that is, man-agement’s tendency to avoid responsibility, negligently perform assigned duties, and free ride on the efforts of others, and (2) the likelihood of sys-tematic deviation from rationality when managers attempt to deal in com-plex situations and are “erroneously conf ident” in their knowledge and underestimate the odds that their information or beliefs will be proved wrong See Bazerman and Messick (1996)
44 Clark (1986), pp 390 –392, and Alchian and Demset z (1972), p 777
45 See Eisenberg (1976)
46 Allen (1992)
47 Bronson (2002)
48 Jensen and Meckling (1976)
49 See Eisenberg (1976), pp 140 –148
Trang 1050 Millstein (1993), p 1485.
51 Lorsch (1995)
52 See, for example, Gordon (2002), Monks and Minow (2001), and Lipton and Lorsch (1992)
53 Mace (1970)
54 Millstein (1993)
55 SEC, Accounting Series Release No 19 (December 15, 1940)
56 Report of the Subcommittee on Independent Audits and Procedure of
N Y SE Committee on Stock List (1939), p 7
57 Maut z and Newman (1977)
58 Letter from Hills to Batten, Exhibit D to 1976 Report (May 11, 1976)
59 NYSE Company Manual A-29 (1980).
60 American Bar Association (1978)
61 See note 60, p 1619
62 See note 36
63 See note 36
64 BRT (1978)
65 For example, “ We enumerate all these legal, regulatory, and political con-straints on U.S business organizations with some mixed emotions because
a number of them impose excessive and unnecessary costs [and] impair the effectiveness of U.S business in a world increasingly characterized by trans-actional markets and transtrans-actional competition.” See note 64, p 293
66 See note 64
67 See note 64, p 310
68 Staff Report on Corporate Accountability, 96th Cong 2d Sess Senate
Commit-tee on Banking, Housing and Urban Affairs, (Comm Print, September 4, 1980)
69 See note 68, pp 8–9
70 See note 68, p 428
71 See note 68, p 431
72 See note 68, p 428
73 See note 68, p 437
74 See note 68, p 442
75 See note 68, p 448
76 See note 68, p 469
77 See note 68, p 495
78 See note 68, p 494
79 See American Bar Association (1978), p 32
80 Staff Report on Corporate Accountability, 96th Cong 2d Sess Senate
Commit-tee on Banking, Housing and Urban Affairs, (Comm Print, 1980), at 499
81 See note 80, p 519
82 See note 64, pp 304, 312, 315
83 See BRT (2002), p 3
84 Manne (1965), p 110
85 See note 84, p 113