Commissioner Paredes and His Anti-Governance Stance: Opposition Rather than Cooperation

Commissioner Paredes was appointed by President Bush, a compromise arrangement that also brought Commissioners Walters and Aguilar to the Commission.

As such, its no great surprise that he doesn't particularly favor the corporate governance agenda of the current Chairman and the Democratic Administration.  But even with the majority of democrats on the Commission, he confronts a choice in how he will proceed.  He can seek compromise, perhaps obtaining agreement on positions more favorable to management.  After all, the Commission in general prefers to operate by consensus.  The desire for consensus provides some negotiating room.

The alternative approach is to show no willingness to compromise, to oppose rather than cooperate.  The latter perhaps makes for good press but effectively renders his influence somewhere in the vicinity of zero.  From his recent speech to the "Shareholder Rights, the 2009 Proxy Season, and the Impact of Shareholder Activism," it is clear that he has opted for opposition over effectiveness.  The speech has been reposted on the Harvard Corporate Governance Site.

The Commissioner's message could perhaps have been predicted by the forum.  The conference may have been titled "Shareholder Rights" but it was sponsored by the Center for Capital Markets Competitiveness at the Chamber of Commerce.  This is an organization that has been at the forefront of trying to throw additional barriers in front of investor litigation against companies for securities fraud.  Moreover, the Chamber has staked out opposition to the Commission's access rule.  As one press release noted:

• This is a step in the wrong direction,” said David Hirschmann, president and CEO of CCMC. “The proposals issued today are a gift for activist investors and will weaken corporate governance and harm investors. The U.S. Chamber will continue to vigorously oppose any plan that allows groups to use the proxy process to promote narrow interests that do not serve the long-term goals of a company or its investors. Politicizing the boardroom would hurt millions of individuals who rely on these investments for retirement.”

The Chamber is also one name mentioned as a possible plaintiff to challenge the access rule when it is adopted.

Commissioner Paredes opened with a discussion of enabling versus mandatory rules in the governance area.  He is correct to note that the balance between the two can be a delicate one.  Unfortunately, his analysis shows none of the delicacy that he contends ought to be present.  First, he dislikes mandatory rules in general.  For Commissioner Paredes, the enabling approach is the only way to go.  As he noted:

• Mandatory corporate law forces a universal governance scheme on all firms without allowing a firm the flexibility needed to adapt based on its distinct circumstances. Recognizing that one-size-fits-all mandates are inappropriate for many businesses, the enabling approach defers to private ordering, spurred on by market discipline and competition, to determine how each firm should be organized to advance its particular needs and interests most effectively. The internal affairs of each corporation can be tailored to its own attributes and qualities, including its personnel, culture, maturity as a business, and governance practices. Simply put, the same corporate governance regime is not necessarily optimal for a struggling Midwest industrial manufacturer, a small-cap biotechnology company in Silicon Valley, and a dominant financial services firm in New York.

But what ensures that this enabling approach will in fact be beneficial for shareholders?  Back in the 1980s and 1990s, the answer was that corporate takeovers would ensure that the inefficient would be weeded out. That argument isn't heard much these days.  The very courts that Commissioner Paredes praises essentially eliminated hostile tender offers by allowing boards almost indiscriminate use of poison pills.

So what is the limit on this enabling approach?  Commissioner Paredes relies on the Delaware courts to police the acts of management.

• It is important to underscore that the enabling approach is not without legal standards governing behavior. State corporate law imposes upon directors and officers fiduciary duties of care and loyalty. Directors and officers are obligated to act in what they honestly believe is the best interests of the enterprise and its shareholders. More particularly, state corporate law, from which the shareholder vote originates, defends the shareholder franchise. The Delaware Chancery Court, for example, explained in the Blasius case that the standard of judicial review is especially demanding when boards act with the primary purpose of frustrating the right of shareholders to vote. Instead of being subject to the business judgment rule, a board "bears the heavy burden of demonstrating a compelling justification" when its principal intent is to compromise the vote.

The approach ignores the fact that the Delaware Courts have resolutely weakened the fiduciary obligations of the board.  No serious scholar would argue that the duty of care has any serious content.  Between the Disney case and waiver of liability provisions, the duty as a practical matter has been eliminated.  Likewise, the duty of loyalty has been turned into a mostly meaningless system of process.  For more on this, take a look at this article:  Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty.  As for the Blasius doctrine, the decision in Portnoy v. Cryo-Cell Int'l, Inc., shows the anti-shareholder evolution of that area of law.

In other words, he calls for an enabling approach but does not address the problem of no actual oversight of management's discretion when the enabling approach is employed.  In fact, when an enabling approach is used, the result can be a mandatory rule that, given management's domination of the process, favors management over shareholders.  This is the theme documented in Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom.  In other words, the phrase "enabling" is often code for mandatory, pro-management requirements. 

We will have a few more thoughts in the next post.