Corporate Governance

Chairman Levitt, Director Self Interest, and a Challenge to the Delaware Model

By J. Robert Brown

Earlier today, we comment on Alan Greenspan's testimony.  In it he more or less took the position that the Delaware approach that excessive deference to management was the best way to protect shareholders.

We turn to the views of Arthur Levitt, the former Chairman of the SEC.  He gave a thoughtful view on the future of securities regulation in an opinion piece published in the WSJ.  He called for a merger of the SEC and the CFTC, a separation he rightfully described as antiquated.  He also had this to say about the mission of the SEC

• For most of its nearly 75-year history, a strong SEC has been the investor's advocate. It has succeeded in maintaining investor confidence, helping to make our markets the envy of the world. Unhappily, over the past few years, the SEC has failed in this mission.

In addition for calling for self financing, the new agency would have some additional authority.  As he described:

• This new agency should be given an old mission with new powers. The SFC's mission should be investor protection, built upon tough enforcement and ensuring efficient financial markets. Its new powers should include enhanced authority over hedge funds, OTC products and rating agencies. For investment banks, the SFC should supervise their global business lines and be able to establish appropriate capital standards.

Chairman Levitt also called for longer terms for the chairman (seven years) and an elimination of the political party requirement for appointments. 

We could not agree more with the proposed reforms.  But consistent with the views of Alan Greenspan and this Blog, we would in addition call for a strengthening of the pro-investor, pro-shareholder role of the agency.  Chairman Levitt noted that the Commission should have a "formal advisory board consisting of representatives of investor groups to hel it maintain a focus on investors and their issues." 

In addition, however, the Commission needs expanded authority to define board standards, particularly those pertaining to supervision, and to determine accountability for these oversight functions.  Section 404 of SOX was a start requiring management to set out and review internal controls.  The provision in the end was too narrow.  It applied mostly to financial reporting.  This latest round of financial turmoil demonstrates that boards were asleep at the switch when it came to assessing risk.  In other words, state standards (read Delaware) proved entirely inadequate to protect shareholders.  The same is true with the determination of executive compensation. 

These matters ought not to be left to states that have an economic self interest in devising a regulatory scheme that favors management.  Greenspan has acknowledged that the pro-management standards underpinning the current economic system have been inadequate to protect shareholders. 

Meaningful standards are necessary.  Delaware won't impose them.  The Commission should be given the statutory authority to fill the gap left by the Delaware courts.  Only then will the Agency be able to fulfill its mission to protect the interets of shareholders and investors.

Full post as published by The Race to the Bottom on October 24, 2008 (boomark / email).