The Role of Stock Exchanges in Corporate Governance: The Matter of Enforcement (Part 8)

We are discussing The Role of Stock Exchanges in Corporate Governance, a report issued by the OECD.  As we noted in the last post, most exchanges eschew mandatory listing standards and instead rely on "comply or explain."  In these countries, a voluntary code of corporate governance exists and companies may "opt in" if they like. 

What about the issue of enforcement?  It turns primarily on the source of the listing standards.  To the extent governance requirements are also listing standards imposed by the exchange, there may be some exchange enforcement.  As the report notes:

• The most direct power of stock exchanges to enforce compliance obviously pertains to those standards which are also incorporated in the listing requirements. For instance, in the Australian model only those recommendations of the Code which are also part of the listing rules are subject to regular surveillance and enforcement by the ASX16, whereas other recommendations are to be observed on the CoE basis. The NYSE can also enforce compliance with its Corporate Governance Listing Standards through a letter of reprimand or de-listing as the Standards are mandatory for listed equities, having been approved by SEC. Likewise, the Six Swiss Exchange can impose a variety of sanctions when the listing requirements and its implementing provisions (including those dealing with governance issues) are not complied with.

Nonetheless, strict enforcement is apparently unusual.  The report notes that de-listing for breaches of governance codes "is extremely rare."  Indeed, breaches do not result in actions against the companies but in changes to any requirements for listing.  "On the contrary, anecdotal evidence suggests that instead of penalising non-compliance, exchanges have at times been induced to change their regulatory standards."  Certainly, the NYSE's confrontation with the one-share, one-vote standard in the 1980s is an example.  Rather than penalize General Motors for violating the standard, the NYSE opted to abandon the standard.  There are other examples.  See Report, at p. 16 ("An example quoted by some academic studies is the fact that Deutsche Börse has decided not to de-list Porsche, despite the latter's refusal to comply with the applicable disclosure requirements for over seven years.").

But that is not the global norm.  Where the requirements are not listing standards (which is the norm), the exchanges largely wash their hands of the compliance issue.  Non-compliance in this case might mean a failure to comply or explain or it might mean an inadequate explanation.  As the report notes:

• Euronext Paris is not equally empowered to take any enforcement actions given that the relevant governance recommendations are not part of its listing rules and have no legal status.

• As most governance recommendations remain in the form of contractual “soft” rules, punitive measures that can be adopted by exchanges in relation to breaches of governance requirements are limited in most cases. In instances of significant and continued non-compliance, a typical response by an exchange would be to forward the matter to the appropriate securities regulator. In the short run, the stock exchange in most cases has the option of disclosing its unease about any given company’s commitment to good practices of corporate governance. Following this, investors’ assessment of the situation can be reflected through the pricing mechanism.

Some exchanges view the matter as entirely up to shareholders.  "In the Netherlands, though listed companies are required to make annual disclosures on a CoE basis, it is up to the shareholders of the company to enforce adherence to 'material rules' and decide whether boards have provided 'sufficient explanation' in case of non-compliance. The Securities Regulator enforces transparency and examines the coherence of explanations."

In short, the exchanges in many instances are simply trading platforms that participate in the corporate governance process by influencing the standards but not by requiring or enforcing them.  In that sense, the exchanges in the US play a much more prominant role in the governance process.