Post-enron Corporate Governance Opportunities: Creating a Culture of Greater Board Collaboration and Oversight - R. William Ide

• Citation: Vol. 54 No. 2
• Publication year: 2003

Post-Enron Corporate Governance Opportunities: Creating a Culture of Greater Board Collaboration and Oversightby R. William Ide^*

I. Introduction

A. The Enron and WorldCom Failures

On October 16, 2001, one of the world's most acclaimed corporations, Enron, reported a shocking quarterly loss of $618 million. Within a week, CFO Andrew Fastow was fired, and on December 2, 2001, Enron filed for bankruptcy in the wake of revelations of overstated earnings and off-balance sheet frauds. Employees lost not only their jobs, but also their retirement funds, which had been invested in Enron stock. The damage to shareholders, innocent employees, vendors, and communities from this fraudulently caused failure was devastating.¹ Arthur Andersen, the venerable accounting institution, was convicted for obstruction of justice in connection with the destruction of documents relating to Enron, filed for bankruptcy, and, in less than a year, was out of business.²

Public shock was followed by anger and calls for action. By spring of 2002, over thirty Enron reform bills were pending in Congress; New York Stock Exchange ("NYSE") and Nasdaq Stock Market ("Nasdaq") task forces were proposing reforms;³ and the Securities and Exchange Commission ("SEC") gave notice of proposed tighter disclosure require-ments.⁴ Meanwhile, the Bush administration went on record calling for tough enforcement of existing laws and promising that indictments against senior managers would be forthcoming.⁵ The atmosphere became more charged with revelations that executives at Adelphia,⁶ Tyco,⁷ and other companies⁸ had egregiously usurped company assets for personal gains. In addition, companies were announcing restatements of earnings,⁹ and by early summer, the stock market had lost $7 trillion in value.¹⁰ Nonetheless, in the early summer, it looked as if the post-Enron reforms would be limited to (i) self-regulatory reforms by Nasdaq and the NYSE, (ii) tightened disclosure timelines and requirements by the SEC, and (iii) limited Congressional action in the regulation of accountants and the ERISA area.

Then came WorldCom. On June 25, 2002, WorldCom announced that it had improperly accounted for over $3.8 billion in expenses during the previous five quarters, resulting in the largest earnings restatement in business history.¹¹ On July 21, 2002, WorldCom filed for bankrupt-cy.¹² Congress heeded the pressure to move quickly. The dikes of containment that had been successfully maintained by corporate and accounting interests, using sound policy arguments of deference to SEC and state regulatory prerogatives, gave way. As a result, Congress passed the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley")¹³ with little opposition, a classic example of policy giving way to politics. Policy considerations were pushed aside in the rush to provide the public with evidence that Congress had done its part in fixing the problems. Consequently, the resulting legislation is in parts disjunctive, duplicati-ve, and lacking in regard for federalism considerations and distinctions between policy and administration.

In the months following the passage of the Sarbanes-Oxley legislation, the media attention and the political dynamics continued. The Bush administration pursued its pledge to punish the corporate wrongdoers and utilized the publicity of "perp walks" in making its arrests.¹⁴ President Bush personally met with all U.S. attorneys and Department of Justice leaders to urge more prosecutions of corporate wrongdoers.¹⁵

Meanwhile, the Attorney General of New York uncovered damning conflicts of interests by Wall Street firms in the use of analysts and their research reports to gain investment banking business and the allocation of initial public offering ("IPO") stock to CEOs for further business (referred to as "spinning").¹⁶ Public figure Martha Stewart was alleged to have profited from the sale of stock based on inside information.¹⁷ SEC chairman Harvey Pitt's style of managing his agency was not conducive to thwarting the politicalization of the corporate governance issue. On election day, the administration jettisoned Chairman Pitt, knowing that the press would be overwhelmed with other stories of greater magnitude.¹⁸ At the time of this writing, a successor has not been confirmed, leaving the SEC without a leader at a critical time.¹⁹

During the spring and summer of 2002, significant potential self-governance reforms took place. The NYSE and Nasdaq, as self- regulatory organizations ("SROs"), published their governance re-forms.²⁰ Corporate America, through its professional associations, the Business Roundtable, and the Conference Board, also recommended progressive corporate governance reforms.²¹ At the same time, civil lawsuits were filed against management, directors, accountants, lawyers, and Wall Street firms, alleging participation in the frauds, conflicts of interests, violations of fiduciary duties, and violations of new theories of liability for corporate officials and their "gatekeepers."²² Further criminal suits and SEC enforcement actions are unfolding under new and more aggressive theories.²³

B. Navigating Sarbanes-Oxley, SEC Rules, State Law, and SRO Requirements to Create the New Paradigm for Corporate Governance

The biggest question about the many reform actions that have been and are being taken is whether they will truly make a positive difference. Advances in a civil society usually occur with laws following the will of the people in the particular area of concern. Sarbanes-Oxley and SEC regulations do provide new structure, but they do so as a political reaction to give assurance to the public that the relevant problems have been fixed. The resulting reactions to this hastily drawn legislation and the corresponding regulations are likely to be driven by an attitude of doing what is required to comply with the law and nothing more. An opportunity now exists, however, for a more positive result that could form a new paradigm for how public companies manage their affairs.

The SRO proposals are based on carefully considered proposals for better governance that institutional investors and other thoughtful leaders have been advocating over time²⁴ and are reflective of a will by some leaders in corporate America to embrace a culture of strong board involvement. This potential for self-reform offers the greatest promise for a new and stronger culture of protecting shareholder (and indeed stakeholder) interests.²⁵

Claims are being made that the Enron reforms will provide the greatest change in corporate governance since the enactment of the Securities Act²⁶ and Securities Exchange Act²⁷ in the 1930s. That potential does currently exist, but not because of Sarbanes-Oxley or SEC regulation. The public approach to Enron reforms is: "Do what it takes to make sure that these frauds and abuses cannot happen again." Sarbanes-Oxley and SEC actions to date respond to that approach by mandating financial reporting requirements with which management and directors must comply, by assuming jurisdiction over accountants, and by requiring lawyers to disclose fraud up the chain of command in the corporation. The overall tone of the legislation and corresponding regulations is one of directing and prohibiting actions to prevent fraud and abuse rather than improving the internal structure of governance. As a result, Sarbanes-Oxley's approach misses the dynamic of empower-ing independent directors to prevent abuses and also to make better decisions to increase shareholder value. If anything, some of the Sarbanes-Oxley and SEC requirements may burden the governance process and produce no corresponding value other than some minimal increase in deterrence.

On the other hand, one can sense that within the public company sphere there is a feeling that too many corporations have developed a "CEO-centric" culture, where the CEO is not subject to meaningful oversight. Consistent with this attitude, the new listing standards and "best practices" proposed by the SROs take the positive approach of seeking to set a culture of empowerment for independent directors to provide greater oversight on behalf of the shareholders. If there is sufficient commitment by directors and management to this approach, then there is indeed potential for a new positive dynamic in the boardrooms of listed companies.²⁸ The independent director empowerment approach could lead to more valuable business decisions and oversight that will in turn create greater public trust and shareholder value.

In our free market system of capitalism, it is essential that corporations have the flexibility to take risks and to fail if they are wrong.

Regulations should be balanced on a risk/reward scenario. In the corporate world, governance has been the province of state corporate law and subject to public scrutiny under the disclosure requirements of the federal securities laws. Parts of the Sarbanes-Oxley legislation and resulting regulatory efforts by the SEC are helpful additions to the disclosure requirements, but other parts are cumbersome intrusions into areas in which state law has greater expertise and abilities. It is the view of this Article that state corporate laws should be amended to provide that publicly traded corporations are subject to the SRO-advocated principles reflecting the empowerment of independent directors to act on behalf of shareholders in providing oversight of management. As discussed below, some of the best practices advocated by the SROs and business groups should be mandatory requirements of state law while others should be tools for measurement by the SROs, institutional investors, and state courts.²⁹

The key to meaningful reform of corporate governance is the replacement of the CEO-centric mindset, under which the board and senior managers are caught in an atmosphere of guarded acquiescence, with a new culture of true independent director oversight and collaboration with management.

This...