Uncle Sam as Shareholder and Regulator

The regulatory burden on U.S. public companies continues to increase and the government’s role has expanded from that of just regulator to, in some cases, shareholder. That might leave some directors wondering how far into the boardroom Uncle Sam can reach.

A panel of financial industry and government experts convened last fall to discuss the influence of the federal government when it acts as either a shareholder or a regulator. The Clearing House Association and the University of Delaware’s John L. Weinberg Center for Corporate Governance facilitated the discussion with a program called The Government as Regulator and/or Shareholder—The Impact on Director Duties, which  included the following speakers and panel members:

• Rolin P. Bissell, partner, Young Conaway Stargatt & Taylor LLP
• Amy Borrus, interim executive director, Council of Institutional Investors
• Laban P. Jackson, Jr., director, JP Morgan Chase & Co.
• Peter A. Langerman, CEO, Franklin Mutual Advisers, LLC
• Giovanni P. Prezioso, partner, Cleary Gottlieb Steen & Hamilton LLP
• Gregg L. Rozansky, managing director, The Clearing House Association
• Mary Schapiro, former chair, U.S. Securities and Exchange Commission (SEC)
• Collins J. Seitz, Jr., justice, Supreme Court of Delaware

Charles M. Elson, director of the Weinberg Center and professor of finance, moderated the discussion.

The panel offered a wide range of perspectives, but a few common themes emerged that are applicable to directors across a variety of industries.  

Most panelists agreed that the 2010 Dodd-Frank Act was a response proportional to the 2008 global financial crisis, but expressed frustration with certain government bailouts and the political motivations influencing them. Several panelists indicated they felt uneasy about the broad scale of intervention that the federal government made into the private sector to bail out failing companies. The panelists cited the example of the U.S. Federal Reserve Bank’s $85 billion bailout of American International Group (AIG) to illustrate how far agencies reached—even in the face of the internal corruption at the company. AIG’s credit default swaps lost the company $30 billion and are often blamed as a major reason the company collapsed in 2008. Controversy swirled when in March 2009, publicly disclosed information revealed that after the bailout, employees of AIG’s financial services division were going to be paid $218 million in bonuses. A June 2010 report by the Congressional Oversight Panel (COP)—a five-member group created by Congress in 2008 to oversee the U.S. Treasury’s actions—concluded that the Federal Reserve Board’s close relations to powerful people on Wall Street influenced its decision to help AIG.

While the panelists were critical of the bailouts, they agreed that Dodd-Frank was a reasonable response to help prevent future failure of companies. Directors’ bandwidth, however, to address their corporation’s most important strategic matters, including emerging risks, may be limited by the need to spend time ensuring compliance with Dodd-Frank. Most agreed that they do not expect a lessening of regulations in the near future.

Panelists also agreed that the Delaware court system—one of the most powerful legal arbiters of U.S. corporate governance—is not designed to address scenarios in which the federal government acts as an investor. When the federal government intervenes by investing in a company to salvage it, the government becomes a shareholder with greater legal privileges than a traditional, human shareholder who might challenge corporate decisions in the Delaware courts. In the event that the government challenges a company in the federal court system, the federal government would be tried in legal institutions where the ultimate power of appeal is granted by its own founding documents. Challenges to federal sovereign immunity and the federal government as shareholder would be difficult, if not impossible, to navigate.

The line between the government as a stockholder and regulator could be blurred when the regulatory influence over the company is pervasive. This issue may be particularly acute for wholly owned subsidiaries of public companies when the government closely reviews company decision-making and expresses views on what is in the best interest of the subsidiary.

Relationships between regulators and directors—though once strained by mistrust after the financial crisis—are beginning to improve. A panelist observed that, in several global markets, relationships between regulators and directors have steadily normalized over the past year and a half, in contrast to more tense interactions of previous years. As global regulatory standards are established, markets recover and stabilize, and businesses and regulators deepen their understanding of each other.

Forming relationships with regulators should be a strategic priority for directors. Most panelists insisted that good relationships with representatives from regulatory agencies are essential. Boards should aim to keep a level of candor with regulatory contacts that could be helpful when pushing back against regulatory action and when directors have suggestions for upcoming regulations. Directors should also acknowledge that regulators have an important function to carry out in a high-pressure, multi-stakes market environment that is a challenge to navigate for regulators and companies alike. A “kicking and screaming” approach to relationships with regulators was frowned upon, as it is not productive and is insensitive to the fact that developing or implementing regulation is demanding and complex.

Directors seeking to strengthen their oversight of corporate compliance and ethics programs can access the National Association of Corporate Directors’ (NACD) publication Director Essentials: Strengthening Compliance and Ethics Oversight. The guide provides an overview of the board’s role in compliance oversight and offers practical insights about fulfilling regulatory expectations.