Corporate Governance

Reform, the Presidential Campaign, and Oversight of the Financial Markets: The Delaware Responsibility

By J. Robert Brown

The massive unrest in the financial markets has caught the attention of the two presidential candidates. Both essentially call for increased oversight of the financial markets and the streamlining of the regulatory system.  As the Journal noted:

• Despite the rhetoric, both candidates are looking at generally similar solutions. They both say the government must do a better job of monitoring financial institutions that deal in complex securities, such as those based on subprime mortgages that triggered the market unrest last year.

• The Obama team reiterated steps Sen. Obama outlined in a speech in March after Bear Stearns Cos. collapsed and the Federal Reserve opened its lending facility to investment banks. He says the Fed should have supervisory authority over any institution with access to its funds, and that regulators should set standards for how much liquidity financial institutions have, not just how much capital.
  

Hard to argue with this approach to regulation, although the devil is, as always, in the details.  But what the approach ignores entirely is the role of the board of directors in the crisis and the role played by Delaware in allowing this to happen.

Boards have fiduciary duties.  The duties require that they act in the best interests of shareholders.  But in fact the board typically has an economic incentive to act in the best interest of the CEO.  This translates into excessive deference to the CEO and the failure to provide adequate oversight.  This can happen because, under cases such as Caremark, the board had little affirmative obligation to seek out information about what is happening in the company and take steps to exercise effective oversight.  The area of law is, as one commentator on this Blog described, a "failed revolution." 

The problem is much larger than this single post can properly address.  But in all of the proposed reforms, the burden of oversight should not simply be placed in the hands of a regulatory body.  It should be shifted back to the board of directors.  As in SOX with the need for internal controls and management supervision, any federal regulation should impose on the board the affirmative duty to monitor risk related issues in the financial sector.  In other words, there needs to be federal preemption of state law.  That should be part of any reform package adopted by either campaign.

Full post as published by The Race to the Bottom on September 18, 2008 (boomark / email).