Corporate Governance and the SEC: The Impact of the Stimulus Bill (Part 1)

When the Exchange Act was adopted back in 1934, Congress intended to give the SEC a prominant role in the corporate governance process.  Congress mostly limited that authority to disclosure.  As the legislative history illustrates (and is set out in much greater detail in Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure) Congress mistakenly thought that governance problems (excessive compensation, management self perpetuation), would be corrected if shareholders received sufficient disclosure to remedy any abuse.  Congress did not take into account both the inherent benefits accorded management in the governance process (primarily the availability of the entire corporate treasury to win shareholder elections) or the diligence of Delaware in the race to the bottom and the willingness to change/interpret law in a manner that disadvantaged shareholders. 

Over time (particularly in the 1970s with the corporate bribery scandal), the SEC realized that accurate corporate disclosure could not be accomplished without regulating the substantive behavior of officers and directors.  It tried a number of methods to affect behavior, including the use of disclosure (meeting attendance disclosure is a good example) and enforcement proceedings (remember the paen to good corporate governance the the WR Grace case?).  The Commission tried to use the stock exchanges to implement substantive requirements but saw that approach damaged by the DC Circuit's decision in Business Roundtable.  None really worked.  As a result, disclosure became more precise and complex (look at executive compensation disclosure) while fiduciary duties continued to erode under the Delaware approach (Disney anyone?).

That approach changed in fairly dramatic fashion with the adoption of SOX.  SOX gave to the SEC substantive authority in the corporate governance area.  The SEC got the authority to define the duties of the board and officers with respect to internal controls.  Audit committees were largely put under the auspicies of the Commission.  The ban on loans to executive officers and directors were ensconced in the Exchange Act.

But the approach was patchwork and used less enforceable methods of implementation (imposing governance requirements as listing standards, for example).  Much of the Delaware approach to corporate governance remained unchanged.  Thus, the standards remained low and boards often engaged in little oversight, whether in assessing risk or determining executive compensation.  The likelihood that this would change seemed slight.  Indeed, VC Strine, one of the key players in the process of determining standards for board behavior, commented not long ago that "There's a lot of things that keep me up at night related to my work, but the possibility of [a federal corporate law] isn't one of them."

With that in mind, we turn to the Stimulus Bill.  The Bill amended TARP and included some strict corporate governance provisions.  The SEC received authority to implement the requirements.  In other words, the Agency historically consigned to disclosure as a means of affecting governance was now in the middle of the substantive debate on the topic.   We will look at a number of provisions over the next few posts.  Suffice it to say that if there ever was a time when it could be said, accurately, that the states regulated substance and the SEC regulated disclosure, those days are over.