Corporate Governance

The Financial Crisis, Reform, and the SEC: The Need For Access

By J. Robert Brown

With the current financial meltdown, Washington is overrun with calls for increased regulation, a far cry from a few years ago when the city seemed to be awash in efforts to repeal SOX.

The SEC has largely remained on the sidelines but it has been trying to get in the game.  Mostly it has done so through the effort to increase the regulation of short sales.  The agency imposed some emergency restrictions on short sales in connection with 19 financial institutions, restrictions that eventually lapsed.  With the latest turmoil, the SEC has rushed out new rules that would regulate short selling.   

But while some suspect that short selling has contributed to the current crisis, it is an unproven assumption.  The efforts are little more than an attempt to demonstrate the relevancy of the agency primarily responsible for overseeing the securities markets.

There is, however, an area that could actually contribute to fixing this problem.  One major source of the current problem has to be attributed to the board of directors.  The boards of these failed firms are often well paid.  They have not, however, played a significant role in reducing risk taking by the company.  Why?  Because they don't have to.  State law (read Delaware) does not impose meaningful standards on board behavior.  They can attend the six or eight meetings, deal with the issues that the CEO has put on the agenda and receive, in the case of Goldman Sachs, something in the neighborhood of $700,000. 

Boards are largely self perpetuating.  They are nominated by management and almost always elected without opposition.  Shareholders really have no effective say in the membership of the board.  As a result, boards have an economic incentive to act in the best interests of management rather than shareholders.  Moreover, state law shows no sign of increasing director duties or making shareholder elections easier.  The dismal, anti-shareholder decision in CA v. AFSCME illustrates the point clearly. 

It is time for a meaningful access proposal from the SEC, one that would give shareholders the right to insert their nominees in management's proxy statement.  The threat of a contest would likely focus the attention of directors on the interests of shareholders, improving management.  Moreover, the access proposals previously debated (one where shareholders can adopt a bylaw that allows them in the future to insert nominees in management's proxy statement) is not the right one.  The SEC should instead propose and adopt a rule that would allow certain shareholders to directly insert thier nominees into management's proxy statement. 

This is the reform that needs to occur.  Congress took the proxy process away from states in the 1930s because of the lack of effective regulation and the race to the bottom.  It is time for the SEC to finish the job and take away from Delaware control over the nomination process.  CA v. AFSCME and the current financial crisis shows that the issue is too important to be left to a pro-managment, non-diverse court in an otherwise unimportant state. 

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