Statutory Reforms Post-Enron: Th e New Corporate Governance Model

• Author: Miriam Weismann
• Pages: 139-157

139

C 10

STATUTORY REFORMS

POST-ENRON

THE NEW CORPORATE

GOVERNANCE MODEL

I. The Failure of Credible Oversight

Credible oversight is a central component in achiev ing the goal of corporate gov-

ernance. Behavioral f inance literature, apply ing “rational choice theory,” explains

that “lure” more readily t ransforms into cri minal “opportun ity” where the corpo-

rate crimina l perceives the absence of “credible oversight.” It follows that credible

oversight increases risk for the cr iminally predisposed, resulti ng in a decrease in the

incidences of unlawf ul conduct. Congress , during the Enron hea rings, credited t he

absence of credible oversight as one of the principal c auses of the corporate failure. It

concluded that the traditiona l “corporate watchdogs failed to bark .”

Despite all of the rhetoric about the i mportance of credible oversight, there is

almost nothing i n the literature to expla in exactly what it is. T he failure to define

credible oversight leaves a substantial gap i n understanding how oversight should

operate in the corporate envi ronment and whether conclusions based on recent failed

expectations about t he quality of oversight are reasonable.

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140 Statutory Reforms Post-Enron

With the creation of the Secu rities and Exchange C ommission (SEC) in 1934,

pursuant to the Secur ities and Exchange Act, a c onscious policy decision was made

about the character of oversight that t he new regulatory body wa s to exercise over

issuers in the marketplac e. The model was premised on self-regulat ion by issuers,

a system of self-reporting under t he supervision of the regu lator. Here, supervision

did not vest responsibility in t he regulator to perform interna l corporate auditing

functions or other “ hands-on” supervision. It was never intended that the SEC would

become the issuer’s accountant. Instead, it wa s the job of the issuer to hire cred ible

third-part y professionals, such as accountants a nd lawyers, to perform audits, is sue

opinion letters, and assi st in the ful l and fair dis closure through a sy stem of docu-

mentary reporti ng to the SEC.

Simply, the regulator was to review a nd inspect only the is suer’s disclosure, to

confirm th at it was abiding by the rules . Critical to the model of se lf-regulation was

trust. The reg ulator was supposed to be able to rely on the report ing disclosures of

the issuer. That model also requi red the regulator to act ually look at the materia ls

being submitted by the issuer at least ever y three years to make such a determi nation.

Credible oversight in this context me ant a hands-off approach to issuers with, as for-

mer SEC Chairman a nd Supreme Court Justice Will iam O. Douglas descr ibed, the

“shot gun behind the door,” in the event an issuer engaged in i mproper or unlawful

behavior.

The SEC intended barebones reg ulation to avoid interference with natural mar-

ket forces. The notion that respected th ird-party professionals would not mainta in

their independence was not accorded much weight. In thi s way, issuers were bur-

dened with the obligat ion to provide corporate transparenc y and the regulator wa s

able to rely on the watchful eye of th ird-party professiona ls to ensure that the issuer

satisfied his bu rden. These third-par ty professionals were thought of as par t of a

class of corporate watchdogs, providing ac tual review a nd oversight. Indeed, the

belief was that the market place had a pack of such watchdogs, including not only

accountants and lawyers but a lso the self-regulatory organizat ions (SROs) such as the

stock exchanges, investment adv isors, banks, and market appraisers . Assuming each

watchdog performed its funct ions in a conf lict-free environment, t he risk or oppor-

tunity for corporate wrongdoing would d iminish.

There was nothing i n this legislat ive model that contemplated anythi ng more

than a superv isory approach with relia nce on information supplied by the issuer,

combined with the react ive power to punish in the event of a breach of trust. Peri-

odically, Congress considered inc reasing the powers of the regu lator, and various

statutes were added to the arsena l of regulatory enforcement tools. Yet the SEC

and Congress remained at a respec tful dist ance to avoid undue interference in the

marketplace. The regu lator was intended to supervise a s ystem of self-regulation

and enforce reactively in response to sel f-regulatory failure. T hat was the model of

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