The SEC and the Erosion of Corporate Governance

BNA reports that the SEC has approved a rule change by the NYSE in connection with corporate governance requirements. The changes would eliminate the need for an opinion of counsel in connection with any application to list securities. The opinion mainly attested to the legality of the shares and the qualification to do business. The requirement would be replaced with the submission of legal opinions filed in connection with recent stock offerings or, if none where available, a certificate of good standing from the state of incorporation.

More importantly for purposes of this blog, the Exchange proposed eliminating the opinion that effectively attested to the company's compliance with the corporate governance requirements of the Exchange. The reasons for the change? A race to the bottom. As the Exchange described: " No other major exchange requires as a condition to listing an opinion with respect to the issuer’s compliance with the exchange’s corporate governance requirements."

The Exchange took the position that there were two other "sources of assurance that, at the time of initial listing, a company is in compliance with the Exchange’s corporate governance requirements." The first was that an authorized officer had to execute a listing application attesting to the fact that he/she had “read and understood the Exchange’s Listings Rule, and fully believes itself to be in compliance with, and, if approved for listing, intends to continue to be in compliance with, the Exchange’s listing and corporate governance rules and requirements, . . .”

In addition, the company must provide at the time of listing a written affirmation that it is in compliance with the director independence requirement. The NYSE promised to amend the written affirmation to have it include "compliance with the Exchange’s nominating and compensation committee independence requirements and thereby comprehensively covers the Exchange’s corporate governance requirements."

There are several problems with these substitutes. First, the requirements are legal in nature.  While a board could in good faith attest to compliance, nothing about the process ensures legal involvement.  Thus, for example, in determining whether directors are independent, they may not have a "material relationship" with the company.  Legal advise on the meaning of the phrase is necessary for appropriate application.  Yet the NYSE rule proposal is essentially eliminating a required role for counsel.

Second, the whole approach of SOX was to recognize that boards function better when there are gatekeepers looking over the shoulders of management.  Thus, Section 404 required management to assess the company's internal controls but further mandated that the outside auditor attest to the findings.  In other words, the auditors had to review management's opinion.  The rule change by the NYSE is eliminating a gatekeeper role in the process.   It is doing so despite the existing problems of enforcement.

The NYSE has an incentive to propose the change.  The other exchanges don't do it and it adds a cost to the listing process.  This is a tough thing to require in a competitive environment.  But that is no excuse for the SEC to improve what is an obvious weakening in corporate governance standards administered by the SROs.