THE CORPORATE GOVERNANCE OF NATIONAL SECURITY.

Author:Verstein, Andrew
 
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Abstract

At hundreds of companies, the government installs former spies and military officers to run the business without shareholder oversight, putting security before profits in order to protect vital projects from potentially treasonous influences. Through procedures I call "National Security Corporate Governance," corporate boardrooms have quietly become instruments of national defense, marrying the efficiency norms of corporate law and the protective ambitions of national security. How is this achieved, and how successfully? Using a variety of research approaches--including Freedom of Information Act (FOIA) requests, archival searches, telephone interviews, and in-person conversations with industry insiders--this Article illuminates a secretive government program and the challenging questions regarding the relationship between private ordering and public goals such as national security.

Table of Contents Introduction I. Contracting and its risks A. Information Security B. Industrial Security II. National Security Corporate Governance in Operation A. Who Implements National Security Corporate Governance? B. What Does National Security Corporate Governance Entail? 1. Outside Directors 2. Inside Directors 3. Proxy Holders C. Summarizing National Security Corporate Governance III. National Security Corporate Governance's Costs & Benefits A. Corporate Governance 1. Accountability 2. Shareholder-Centrism 3. Unity B. National Security C. Government Independence and Integrity IV. National Security Corporate Governance's Lessons A. How to Balance Security and Governance? B. When To Pursue Security Through Governance? C. How Should We Govern for Security? D. Should We Pursue Other Values through Governance? Conclusion INTRODUCTION

A central goal of corporate law is to make managers accountable to shareholders. (1) So it may come as a surprise that the federal government frequently compels companies to "effectively exclude the Shareholder ... from ... influence over the Corporation's business or management [...]" (2) Indeed, there is a federal agency whose principal work is to ask companies to entrench the board of directors, waive the duty of loyalty, and hire individuals with little business experience to run the company.

That agency is located in the Pentagon. The managers hired and entrenched are former spies, military officers, and law enforcement officials. They take the reins from the shareholders for reasons of national security, at companies completing secret projects or projects vital to military or espionage agencies.

This Article is about "national security corporate governance," a secretive government program of repurposing corporate boards as instruments of national security. National security corporate governance is born of the need to reconcile the two conflicting logics of security and efficiency. The closed culture of national security stultifies creativity and efficiency. This is why America has long outsourced much of its defense preparation and production to private contractors, where market dynamics encourage creativity and economy. (3) Yet these same market dynamics can undermine national security if companies feel their interests are better served spying on or sabotaging these important projects--perhaps because a major investor or another client has ties to a foreign state.

National security corporate governance attempts to focus private sector dynamism onto problems of national importance, without naively trusting that the national interest and private interests are identical. With national security corporate governance, government representatives commandeer the boardrooms of private companies for public purposes, where they intercept illegal or risky plans before they become corporate policy.

National security corporate governance is a widespread and important practice. Under its ambit are some of the nation's most pivotal security programs, such as civilian wiretapping (4) and the use of armed military contractors in combat zones. (5) Covered companies perform 5 percent of all classified government projects. (6) They include the U.S. operations of household names like Rolls Royce, BAE, and Siemens. (7) About 400 firms are currently subject to national security corporate governance, with one new agreement negotiated each week.* All it takes to fall under its scope is a classified project and a potentially influential foreign client or investor. (9)

The widespread use of national security governance means that the stakes are high. The program works by inverting the dictates of orthodox corporate governance wisdom. If this lowers accountability and efficiency at vital projects, then the nation will get far less security than it bargained for. (10) If vital projects remain at risk, then we may have missed the chance to take alternative protective steps.

The effectiveness of national security governance is not just important as a matter of national security; by repurposing corporate boards, it presents an important case study for central debates in corporate law, such as the appropriate degree of managerial accountability to shareholders. (11) Scholars have spilled much ink debating how and whether the boardroom should include non-shareholder priorities, such as employee or environmental wellbeing. (12) Although rarely discussed, national defense is a candidate for one of those competing priorities. (13) This Article contributes to the corporate law literature by presenting an actual instance of low-accountability, multiple-mandate boards that few imagined exist.

National security governance also bears on recent controversies in criminal, administrative, and constitutional law concerning the boundary between governmental and private action. (14) For example, should the government demand environmental or worker protections in connection with its bailout of automobile manufacturers? (15) Should companies get softer criminal penalties if they take a Department of Justice representative into the board room? (16) National security corporate governance raises similar questions but on a scale that is likely greater than all comparable programs combined. (17) Thus any discussion of administrative governance is necessarily incomplete without discussion of national security corporate governance.

This Article proceeds in the following manner. Part I describes the tensions--between efficient security contracting, information security, and industrial readiness--that lead us to try national security corporate governance. Special emphasis is given to the promise and peril of buying from firms owned in part by foreign nationals. Such firms are described in the law as being under foreign ownership, control, or influence (FOCI).

Part II turns to the law of FOCI and its mitigation through national security corporate governance. This Part describes the legal basis of national security corporate governance, the conditions for its application, and the government agency overseeing it.

Part III explores the costs and benefits of the national security corporate governance program. First, Part III(A) discusses the clash between national security corporate governance and the private ordering that corporate law normally prefigures. National security corporate governance requires firms to depart from the governance systems they would otherwise adopt. And there is reason to think that national security corporate governance creates costly inefficiencies as a result, which firms may pass on to their government customers.

Second, Part III(B) assesses national security corporate governance's effectiveness in addressing security risks. Although this should be national security corporate governance's vindication, the results seem mixed. National security corporate governance helps in some ways, but it is also easy to point to failures. This leads to a discussion of public choice theory, in Part III(C). While public interest surely motivates much of national security corporate governance, it also empowers government officials to engage in rent-seeking. We are, after all, dealing with the heart of the Military-Industrial Complex, and it is unsurprising that national security corporate governance facilitates a cozy relationship between the government and its contractors.

Part IV turns to theoretical and practical questions raised by national security corporate governance. Some questions are internal to national security corporate governance: given that we will sometimes use national security corporate governance, how can we best control and account for its cost? Some questions are external to national security corporate governance as a practice: what does this case study teach about the proper relationship between national security and corporate law, and about how best to resolve conflicts between legal regimes? Still other questions occupy a middle level: what light can national security corporate governance shed on other questions important to scholars of national security or corporate law?

To preview some tentative conclusions, the high cost of national security corporate governance makes it a poor choice much of the time. However, a number of contexts remain in which national security corporate governance may be a worthwhile policy. Indeed, it is even possible that we may wish to expand its utilization into new domains of domestic military contractors, foreign non-contractors, and domestic financial institutions. The use of national security corporate governance may prove interesting as a partial solution to problems of systemic risk created by Too-Big-To-Fail financial institutions.

Regardless, it is essential that when dissonant bodies of law vie for priority, as do national security and corporate law here, neither controls the result without due consideration of the contribution made by the other. We have a tendency to analyze problems solely from the vantage point of the more pressing body of law, often...

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