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, butexpressed 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.
The Securities and Exchange Commission (SEC) is charged with maintaining fair and efficient markets, facilitating capital formation, and, like directors, protecting investor interests. This regulatory arm of the federal government has a significant impact on businesses, but many may not effectively understand the commission’s inner workings. Providing directors with an insider look at the SEC was a panel comprised of: Mark D. Cahn, former general counsel of the SEC’s Office of the General Counsel, and partner at WilmerHale; Thomas J. Kim, partner at Sidley Austin and former chief counsel and associate director of the SEC’s Division of Corporation Finance; Troy Paredes, senior strategy and policy advisor at PwC and former SEC commissioner; and moderator Kendra Decker, partner in Grant Thornton’s National Professional Standards Group.
The SEC has five commissioners, each of whom is selected by the president of the United States, and no more than three of them can be from the same political party. The president also selects one commissioner to serve as chair. The chair sets the agenda and makes senior hiring decisions; however, this does not create a hierarchy as that professional title might imply. The commissioners are like a board of directors, with each person maintaining their own, independent voice as they vote on the issues set before them.
“No one commissioner has the power to do anything,” Kim said. “They only have power by acting as a commission, just like a board must act as a collective body.” Although the SEC is generally thought of as a rulemaking entity, Cahn pointed out that it’s a relatively infrequent occurrence that commissioners actually cast a vote. The organization’s day-to-day workings are processed at the staff level—and, in turn, the division heads engage with the commissioners.
The panel also drew attention to challenges within the commission. For Cahn, the biggest challenge with regard to rulemaking is the Government in the Sunshine Act of 1976, which requires all commission deliberations to be carried out in public. “You end up with meetings of two commissioners with staff members to discuss issues when they could be much more productive to work out matters as a group.”
In addition, trying to pass a rule through a multi-member commission can turn into a game of chess, with each member making suggestions for changes up until the last minute. If a rule passes with a split vote, those dissenting opinions serve as a roadmap to potential litigants who want to challenge the rule—a factor that emphasizes the importance of unanimity within the commission. “I think it [speaks] well for the agency overall when there’s consensus,” Parades said. “But sometimes you can’t bridge those differences. Another aspect is, from time to time, chairs have had a norm where they wouldn’t go forward unless there was a norm of four. What that does, it forces people to compromise and it doesn’t allow those in the majority to say that ‘this is what we’re going to do, regardless.’”
Despite these complexities, Paredes stressed the critical importance of third-party engagement. “The SEC is able to better evaluate the consequences of their rulemaking if they are able to hear from the people their rules are going to impact,” he said. “If [SEC] folks aren’t hearing that through one mechanism or another, there are going to be serious blind spots.”
In these times, it is rare to be able to use the words “extremely successful” and “real estate investor” in the same sentence. So when I consider the utterances of my friend Joe, an extremely successful real estate investor, I often take heed. One of Joe’s key aphorisms has long been: “If we all had the same taste, we’d all be eating in the same restaurant.”
Those words, and their applicability to the choices and preferences of investors, regulators and directors, came to mind while on a recent two-week stretch in Singapore, the UK and the US. The range of attitudes and approaches in responding to rule-making and compliance was noteworthy, as it demonstrated the spectrum of approaches that can be employed in attempting to reach the goal of good, responsible governance.
Without getting enmeshed in long, generalized discussions about cultural differences and attitudes on ensuring compliance, I thought it might be interesting to offer a few quick snapshots of what is on the regulatory menu around the globe. Think of them as small “appetizers” from a number of cuisines, and please, disregard any old biases about English, Asian or American food. There are great chefs at work, and great meals to be had in each of these places.
In Singapore, regulators “name and shame” companies whose governance practices fail to measure up on specific requirements. One of the consequences of ignoring the mandate to have separated the chair and the CEO roles, is having the company name appear on a list of those “out of compliance”, and having that list well-publicized and broadly published. The newspapers and the financial press are ready consumers and promulgators of the list.
In the UK, the Financial Reporting Council (which is the principal corporate watchdog) has proposed a “comply or explain” requirement in a proposed UK Stewardship Code for the behavior of institutional investors as shareholders, matching the UK Corporate Governance Code which is already in place. In this case, for example, the goal is to bolster shareholder involvement in corporate governance. The code, as proposed, is not mandatory, allowing for the possibility of extenuating circumstances such as size or a specific investment strategy. At the same time, who adheres to the code, and who does not, becomes a matter not just of public record, but of public disclosure as well.
NACD Members, click here to access the complete Dodd-Frank Act webinar archives
So what’s the takeaway from all of this? Does it whet your appetite for more in the way of voluntary compliance? More in the way of mandatory compliance? More or fewer consequences for non-compliance?
In the arena of restaurant practices, there is wide variation. Some jurisdictions publicize the names of restaurants who have recently “failed” inspection, and why. Others make restaurants conspicuously post the most recent results of their inspections for cleanliness, with big colored signs carrying a letter grade or a test score.
Keeping in mind Joe’s views on peoples’ tastes, along with the global availability of venues in which to invest or manage, what do you want on the menu that will satisfy your appetite for good governance?