Legitimacy and corporate law: the case for regulatory redundancy.

• Author: Jones, Renee M.

TABLE OF CONTENTS INTRODUCTION I. THE DEMANDS OF DEMOCRACY A. The Deliberative Model B. Critical Elements 1. Reasoned Debate 2. Participation 3. Transparency 4. Accountability C. Broadening Perspectives on Corporate Law II. THE PRIVATIZATION OF STATE CORPORATE LAW A. Delaware 1. The Delaware Bar Association 2. The Delaware General Assembly 3. The Delaware Judiciary B. A Note on The Model Business Corporation Act C. Limits on States' Claims as Corporate Regulators III. THE FEDERAL OVERLAY A. The Role of Congress B. The Example of Sarbanes-Oxley C. Constraints on Congress as a Corporate Regulator 1. Theoretical Difficulties 2. Congressional Dysfunction D. Congress's Pragmatic Posture Delegation to the SEC 1. The Rationale for Delegation 2. The SEC as Rulemaker 3. Agency Accountability 4. The Realities of Rulemaking E. Relative Advantages of Federal Rulemaking IV. THE DEMOCRATIC CASE FOR BROAD SEC AUTHORITY A. Balancing Independence with Democratic Accountability 1. General Principles of Judicial Review 2. Ossification Concerns B. The Destabilizing Threat of Aggressive Judicial Review 1. The Classic Case 2. Mutual Funds and Hedge Funds a. Mutual Funds b. Hedge Funds C. The Need for Greater Judicial Deference CONCLUSION INTRODUCTION

The impact of corporate law on citizens is often understated. We rely on corporate law to mediate the ever-present tension between authority and accountability which in turn determines whether those with the power to control a corporation's decisions will act with diligence or indifference when overseeing decisions that affect the interests of shareholders, creditors, employees, and the larger society. Corporate law rules often dictate whether the victim of an accident will receive compensation for an injury, or if workers lose their livelihoods when a plant is closed or jobs transferred overseas.

It therefore seems appropriate that citizens throughout the country have the ability to influence the substance of corporate law rules, just as we expect input on criminal and environmental laws. Our system of government, after all, rests on the principle that citizens should have a voice in shaping the substance of the rules that affect their lives. It is this guiding principle that confers legitimacy to the laws that govern our society.

Unfortunately, our system for crafting corporate law rules does not always comport with this democratic ideal. A significant portion of substantive law is set at the state level--and one small state, Delaware, dominates this process. Further, the task of drafting Delaware's corporate law is delegated to a small group of private lawyers, most of whom represent large corporate interests in their professional capacities. (1) Although many scholars have decried the democratic shortcomings of this arrangement, to date the analysis remains incomplete (2). To fully assess the democratic legitimacy of our corporate regulatory regime, we must also factor in the role of federal regulation which introduces important democratic safeguards to the system.

This Article is intended to fill a gap in the literature by broadening and sharpening the democratic assessment of American corporate law. It applies basic principles of contemporary democratic theory to an analysis of the structure of the corporate regulatory apparatus. It departs from prior analysis by looking beyond the state role to consider how regulation at the federal level shores up the legitimacy of the overarching structure. This focus on the federal role provides comfort on a democratic account, but also counsels caution with respect to current trends in the corporate regulatory landscape.

Although the base level of corporate law is crafted by states through statutes and common law decision making, the federal government provides a crucial regulatory overlay through federal securities laws administered by the Securities and Exchange Commission (SEC) and the various self-regulatory organizations (SROs) within its purview. (3) This regulatory redundancy, through which multiple regulators exercise authority over similar conduct, is a much maligned feature of our corporate governance regime. Yet, on a democratic analysis, such redundancy is properly seen as a critical element in a rulemaking system that allows certain centers of authority to function in secrecy, sheltered from public demands for accountability.

Because federal regulation helps compensate for the democratic deficiencies of state corporate law, the soundness of the entire regime depends upon the durability of each of its component parts. Attempts to dismantle or disable a component of the structure therefore threaten to strip the entire system of its integrity. Thus, to the extent that broad SEC authority helps to confer legitimacy to the corporate regulatory structure, judicial constraints on the SEC's administrative discretion risk undermining the legitimacy of the entire regime.

This Article therefore questions efforts to limit the SEC's regulatory power through judicial challenges to its rulemaking authority. It argues that the SEC's ability to respond deftly to market crises and scandals has been hampered unnecessarily by a longstanding tradition of aggressive judicial review of agency decision making. This tradition, while rooted in concerns for preserving accountability, has undermined the very values it seeks to protect. Because the procedures for agency rulemaking comport well with democratic values, agencies deserve more deference than the courts have been willing to allow.

This pattern of intrusive judicial review drives agencies to rely more heavily on less formal modes of regulation that are free from the deliberative requirements Congress has wisely imposed on agencies. The lack of transparency for these more informal policies makes it harder for regulated parties to comply with the "rules" the agency prescribes. Greater judicial deference to SEC decision making would help restore the balance of authority that Congress has sought to maintain since the advent of the modern system of securities regulation.

This analysis has implications for current proposals to reform regulation of the national financial markets. (4) Although beyond the scope of this Article, proposals to diminish the SEC's role in financial regulation or to curtail the SEC's enforcement powers. (5) should give pause. It is the SEC's political independence that bolsters its ability to navigate the rough terrain of regulating the powerful industries within its jurisdiction. Incremental adjustment to the regulatory structure rather than a major overhaul seems a superior approach to achieving necessary improvements to the corporate regulatory system.

This Article proceeds in four parts. Part I lays the theoretical groundwork by proposing a set of ideals for a corporate lawmaking process that fairly reflects broadly accepted democratic values. Drawing on deliberative democracy theory, it identifies reasoned debate, broad public participation, transparency, and accountability as values that should be respected in an ideal corporate lawmaking process. Part 11 assesses the state lawmaking processes in Delaware and other states against these ideals and concludes that such procedures fall short. Part III examines the federal regulatory overlay by assessing corporate oversight mechanisms employed by Congress and the SEC. It concludes that Congress's traditional deference to state authority in corporate governance garners legitimacy only by reason of its concomitant broad delegation of power to the SEC. Part III also examines the SEC's rulemaking procedures and concludes that, in principle, such practices comport better with democratic values than state lawmaking traditions. Part IV argues that in light of the SEC's role in supporting the legitimacy of our corporate governance system, efforts to constrain SEC rulemaking through judicial challenges are misguided. It shows that such efforts and the judicial decisions that support them unwisely disregard the SEC's importance in shoring up the democratic legitimacy of our corporate regulatory regime.

1. THE DEMANDS OF DEMOCRACY

   When applied to corporate law, democratic principles would require that the methods for devising the rules that govern the relationship of corporations and their officials to shareholders, creditors, employees, and society should allow for the participation of all those with an interest in the substance of those rules. (6) Democratic accountability would also require mechanisms that allow citizens to provide feedback to their representatives and that facilitate continued debate on important policy issues, so policy adjustments can be made from time to time. (7) Because so much of U.S. corporate law derives from the state of Delaware, we immediately confront a democratic dilemma. (8) Most U.S. citizens are unrepresented in Delaware, thus our corporate governance system seems to fail the democratic test.

   Probing this apparent dilemma first requires some groundwork as to the principles we are seeking to uphold. This Article invokes deliberative democracy, an influential contemporary theory, as a guidepost for analyzing existing mechanisms for developing corporate law rules. (9) Deliberative democracy emphasizes the values of reasoned public debate and broad citizen participation. As such, the theory can help instruct us on what to look for when assessing the democratic nature of our corporate policymaking process.

   1. The Deliberative Model

      To stake a claim to legitimacy, American corporate law must be seen as democratic. (10) For it is democracy that provides "legitimacy" for collective decisions by which all citizens are bound. (11) According to most views, such legitimacy depends on some form of participation that allows citizens to have a voice in shaping the substance of laws they must obey. Political theorists (and ordinary citizens) vary greatly in their views of the purposes, potential, and...