Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure

As the Securities and Exchange Commission prepares to hold roundtable discussions on the relationship between proxy rules and state corporation law, it might be worth considering the overall role of the Commission in the corporate governance process.  This is the subject of my recent essay, Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure, and a topic that will be discussed at The Race to the Bottom blog.

The Commission has traditionally been viewed as responsible for disclosure, with the substance of corporate governance left to the states, as if the two were distinct.  In adopting the Exchange Act, however, Congress expected disclosure to help reduce certain abusive managerial practices, including self-perpetuation in office and excessive compensation.  (The legislative history, and especially the discussion of disclosure requirements at pages 12-14 of the House Report recommending passage of the Act, make clear that Congress expected disclosure to rein in managerial abuses.)  In other words, from the outset, Congress expected the Commission to be involved in the corporate governance process. 

As the race to the bottom among the states continued, fiduciary obligations weakened, as I described in The Irrelevance of State Corporate Law in the Governance of Public Companies.  (This process was probably accelerated by the emergence of a more fulsome disclosure regime that eliminated much of the secrecy surrounding self-interested transactions.)  As fiduciary obligations weakened, the Commission became increasingly aware of the link between accurate disclosure and the substantive behavior of management.  The SEC sought to alter substantive standards through a variety of mechanisms–pressuring the exchanges to adopt tougher listing standards, using enforcement proceedings to set out the duties of the board, and adopting disclosure requirements designed to alter the substantive behavior of fiduciaries. 

It likewise became increasingly apparent that the disclosure process sometimes interfered with shareholder rights.  The proxy process largely rendered shareholder meetings a formality.  At the same time, the costs associated with solicitations effectively denied most shareholders access to the proxy process, eliminating the right to nominate directors or make shareholder proposals.  While Rule 14a-8 partially mitigated this effect, its exceptions–which permit companies to exclude shareholder proposals from the company’s proxy–often swallowed the Rule.   

The Commission’s efforts to improve corporate conduct met, at best, with modest success.  Disclosure in particular proved to be an inadequate substitute for direct regulation of substantive behavior.  Sarbanes-Oxley, of course, made the Commission’s role in the governance process less dependent upon disclosure.  Section 301 provides the SEC with the authority to regulate audit committees, albeit through the mechanism of listing standards.  Section 404 allows the Commission to define the responsibilities of management in establishing and maintaining adequate internal controls.

Given these developments, the debate is no longer about whether the Commission ought to have a role in the governance process but the extent and nature of that role.  Moreover, in considering the controversy over whether shareholders should be allowed to include proposals concerning the nomination of directors in management’s proxy statement, the SEC should understand that this is less about disclosure and more about the substantive rights of shareholders. 

Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure offers insights on all of these matters and more.  I welcome comments on the Essay as well as on this post.