Legislative proposals for changing the General Corporation Law of Delaware have been submitted to the Corporation Law Section of the Delaware State Bar Association for approval. To the extent approved, they will be submitted to the legislature for approval. The expectation is that they will become effective on August 1, 2009.

We have examined one of the provisions, a sub rosa attempt to deprive shareholders of an emerging federal right to include nominees in the company's proxy statement. 

In addition, the proposed amendments would authorize bylaws that require the reimbursement of proxy expenses related to the election of directors.  The provision provides that reimbursement can be conditioned upon the number of directors nominated (limiting reimbursement to short slates, for example) and the amount can be conditioned upon the number of votes received by the nominee or the amount spent by the Company. 

The provision to some degree overturns the miserable reasoning by the Supreme Court in CA v. AFSCME.  In that case, the SEC certified to the Supreme Court (something that the SEC should disavow again; certification to an anti-shareholder court will only yield anti-shareholder decision, something the prior Commission presumably knew) a question about the legality of a shareholder proposal that would have required mandatory reimbursement of the costs of an insurgent's proxy contest where one or more directors were actually elected.  The Court took it, despite an apparent violation of its own rules, and held that without a fiduciary out, the bylaw was amended. 

In so holding, the Court ignored a number of pertinent issues (the issues were raised on brief or at oral argument), including that the bylaw only required "reasonable" payments and that reasonable did not contemplate payments made in violation of fiduciary obligations, that any concern about the reasons for the nomination were vitiated by the actual election of the directors, and that bylaws requiring violations of a board's fiduciary duties could be repealed.  Instead, the Court seemed to have a result oriented motive of making it clear that bylaws requiring board action or expenditures needed to have a fiduciary out.  Even if the proposed amendments to some degree overturn the actual holding of the case, the bad law about the need for a fiduciary out remains.  This is a legacy of the prior Commission. 

The CA decision, by cutting off a system of mandatory reimbursement, made the use of separate proxy statements much less likely.  In turn, the case increased pressure on the Commission to permit access to the company's proxy statements for shareholder nominees.  The proposed Section 113 allows companies to adopt bylaws that provide for mandatory reimbursement, subject to various conditions.  To that extent it overturns the CA decision and potentially makes direct access to the company's proxy statement for shareholder nominees less necessary, at least for companies that adopt the bylaws.

In the end, the reform (and it is a reform) is very modest.  Companies are not required to put the bylaws in place.  To the extent that they do, they can impose any set of legal limitations, including a fiduciary out, potentially making them useless.  Moreover, to the extent requiring a specified percentage of the vote, they effectively make payment uncertain.  Thus, shareholders funding proxy fights will likely still confront the risk that they will have to absorb the entire cost of their own solicitation.

In the end, the provision overturns a very poorly reasoned decision.  It does not, however, provide an adequate substitute for access.  Shareholders gaining access to the company's proxy statement for their own nominees at least know that those expenses will be borne by the company irrespective of the total number of votes received. 

We've copied the relvant provision below.  All of the proposed amendments are posted on the DU Corporate Governance web site.

Section 113. Proxy Expense Reimbursement.

(a) The bylaws may provide for the reimbursement by the corporation of expenses incurred by a stockholder in soliciting proxies in connection with an election of directors, subject to such procedures or conditions as the bylaws may prescribe, including:

(1) Conditioning eligibility for reimbursement upon the number or proportion of persons nominated by the stockholder seeking reimbursement or whether such stockholder previously sought reimbursement for similar expenses;

(2) Limitations on the amount of reimbursement based upon the proportion of votes cast in favor of one or more of the persons nominated by the stockholder seeking reimbursement, or upon the amount spent by the corporation in soliciting proxies in connection with the election;

(3) Limitations concerning elections of directors by cumulative voting pursuant to § 214 of this title; or

(4) Any other lawful condition.

(b) No bylaw so adopted shall apply to elections for which any record date precedes its adoption.

We discussed Steve Jobs’ health and the implications of his disclosure under Rule 10b-5 in prior posts.

Recently, the Financial Times printed an article on Jobs’ failing health and his directorship at Disney.  We discuss in this post whether Job's health issues would potentially be material to Disney.  This post looks at the materiality issue.  It does not look at the other elements of Rule 10b-5 or attempt to assess any exposure on the part of Disney.  It only examines whether, had Disney known of the health problems, the information would have been material to a shareholder of Disney.

Disney’s proxy statement states:

Steven P. Jobs, 53, has served as Chief Executive Officer of Apple Inc., a designer, manufacturer and marketer of personal computers, portable digital music players and mobile communications devices, since February 1997 and is a member of its Board of Directors. Prior to the Company’s acquisition of Pixar, Mr.Jobs also served as Chairman of Pixar from March 1991 and as Chief Executive Officer of Pixar from February 1986. Mr.Jobs has been a Director of the Company since the Company’s acquisition of Pixar in May 2006.

Disney disclosed the information about Jobs mandated by the proxy rules.  The explicit requirements are, however, a minimum. The antifraud provisions, whether Rule 10b-5 or Rule 14a-9 require additional information if necessary to make any public statement accurate and complete.  The misstatement or omission must, however, be material.

In TSC industries, Inc. v. Northway, Inc.426 U.S. 436 (1976), the Supreme Court, laid out the standard for materiality in a proxy setting:

An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote...there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. 426 U.S. 436, 496.

The Court expressly extended this standard to cases brought under Rule 10b-5 in Basic v. Levinson, 485 U.S. 224, 231 (1988).

As the CEO and face of Apple, Jobs is widely perceived as the impetus of its revival through the development of the iMac, iPod, and iTunes.  His health issues (and, as a result, his continued service as CEO) are likely to be important to a reasonable investors at Apple. The issue at Disney, however, is more complex.  He is only one of eleven directors at Disney, serving on a board that only met six times in 2008.   To the extent interchangeable with the other directors, Jobs continued tenure in office would not have a significant impact on shareholders.  Issues about his health would likely not be material.

Nonetheless, there is also an argument that Jobs is a unique director at Disney and his ability to serve on the board is a significant contribution to Disney.  His general reputation in the high tech area might suggest a unique contribution.  In addition, Jobs’ specific abilities in the film industry might be uniquely important to Disney.  He served as CEO of Pixar before the company was acquired by Disney.  The possible perception of Jobs as a director closely linked to the future success of Disney would mean that a reasonable shareholder would in fact find it important to know about his health issues (at least to the extent they suggest that he might cease serving as a director). 

In short, while health problems of most outside directors would probably not be material in most cases, there may be a class of directors where this is not the case.  Where the market perceived a particular director as critical to the future of the company, health issues that might cause the director to depart could be material.  Jobs may be one such director.

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In In Re Digimarc Corporation Derivative Litigation, 549 F.3d 1223 (9th Cir. Or. 2008), shareholders alleged that the corporation’s officers and directors approved incorrect financial statements and filed suit against them for breaching their fiduciary duties. The shareholders argued that SOX Section 304 entitled them to file suit against the officers and directors of the company. The district court held that Section 304 did not contain a private right of action and the appellate court affirmed. The ruling eliminates a private right of action under SOX Section 304 to recover profits and bonuses from officers whose misconduct forced the company to restate its earnings.

In affirming the lower court’s ruling, the appellate court’s decision contained a thorough statutory analysis of Section 304. It quickly concluded that it did not contain an explicit private right of action and focused on whether Congress intended to provide one. The court rejected the plaintiff’s argument that Congress wrote Section 304 to resemble other language, which has been interpreted to create such a right. Moreover, the court examined the statute as a whole and found that analogous provisions expressly provided for private enforcement. This implied that where Congress intended to provide a private right of action within SOX, it would do so with express language.

The primary materials for the post are available on the DU Corporate Governance Website.

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When we did a series of posts on corporate governance agenda items for the new Commission, we strongly urged the Commission to consider action in the area of shareholder communications and voting.  Clearly, the Commission needs to simplify direct communications between shareholders and companies.  This means reform of the shareholder communication rules, rules that are currently a mess. 

In addition, however, we also recommended that the Commission move on the rule proposal submitted by the NYSE that would prevent brokers from voting uninstructed shares for directors.  Under NYSE Rule 452, brokers may not cast uninstructed shares on controversial matters.  This prevents these shares from having any significant influence on most matters of importance to shareholders.  There is, however, one significant exception. The provision applies to any matter that is "the subject of a counter-solicitation, or is part of a proposal made by a stockholder which is being opposed by management (i.e., a contest)" but does not apply to the unopposed election of directors.  In an era where unopposed directors must increasingly be elected by a majority of the votes cast, the broker votes can be outcome determinative. 

Back in 2006, after a study of the issue, the NYSE sent a proposed rule to the SEC to do away with discretionary voting in director elections by brokers.  The SEC sat on the proposal, inactivity the rule of the day.  We have learned from the Shareholder Communications Coalition that the NYSE has resubmitted the proposal and the SEC intends to take it up. 

It is an important albeit long overdue step in the governance area. 

For more on the problems of the shareholder communication rules, take a look at The Shareholder Communication Rules and the Securities and Exchange Commission: An Exercise in Regulatory Utility or Futility?

Section 111 of the Stimulus Bill requires the SEC to implement the say on pay provisions.  Senator Dodd wrote to the SEC setting out his views on the implementation of Section 111.  Specifically, he indicated a view that the Section did not require the implementation of say on pay for any TARP companies that had already filed a proxy statement (preliminary or final) with the SEC.  The SEC staff has provided guidance on the issue and responded to Senator Dodd.  We print the SEC response below.

 The Division staff is following the views expressed in Chairman Dodd's letter to Chairman Schapiro.

Question 1

Question: EESA Section 111(e)(1), as amended, is titled "Annual shareholder approval of executive compensation" and provides that any proxy or consent or authorization for "an annual or other meeting of the shareholders of any TARP recipient" shall permit a separate shareholder vote on executive compensation. Is a separate shareholder vote on executive compensation required for any meeting other than the annual meeting of shareholders for which proxies will be solicited for the election of directors or a special meeting in lieu of such annual meeting?

Answer: No. [Feb. 24, 2009]

Question 2

Question: EESA Section 111(e)(1), as amended, refers to the compensation of executives "as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the compensation discussion and analysis, the compensation tables, and any related material)." Smaller reporting companies are not required to provide compensation discussion and analysis under Item 402 of Regulation S-K. If a smaller reporting company is subject to the Act's say-on-pay provision, must the smaller reporting company provide compensation discussion and analysis disclosure?

Answer: No. [Feb. 24, 2009]

Question 3

Question: A company that determines to comply with EESA Section 111(e)(1), as amended, by including its own proposal to have shareholders approve executive compensation will be required to file a preliminary proxy statement pursuant to Exchange Act Rule 14a-6(a). If the company faces special circumstances and would like to request acceleration of Rule 14a-6(a)'s ten-day review period, how should it proceed?

Answer: The company should contact the Assistant Director of the office that reviews the company's filings to discuss the special circumstances the company faces and how the ten-day review period could be accelerated. [Feb. 24, 2009]

Question 4

Question: EESA Section 111(e)(1), as amended, states that the TARP recipient "shall permit a separate shareholder vote to approve the compensation of executives." Does this mean that the TARP recipient only needs to permit a shareholder vote if it receives a shareholder proposal on approving executive compensation?

Answer: No. The statute does not condition the requirement for a vote on the receipt of a shareholder proposal on approving executive compensation. Senator Dodd stated in his letter to Chairman Schapiro, "The law is intended to require a yearly vote by shareholders." [Feb. 26, 2009]

Question 5

Question: Can EESA Section 111(e)(1), as amended, be satisfied by a TARP recipient if it includes a shareholder proposal on "say on pay" in its proxy statement?

Answer: This provision calls for a shareholder vote on executive compensation as disclosed pursuant to the Commission's compensation disclosure rules. A shareholder proposal on "say on pay" that only asks the company to adopt a policy providing for annual shareholder votes on executive compensation in the future would not satisfy this requirement. The statute instead requires an actual, non-binding vote by the shareholders to approve executive compensation. [Feb. 26, 2009]

Back in the 1990s, shareholders challenged the compensation paid to Michael Ovitz.  As part of their challenge, they alleged that the board wasn't sufficiently independent.  In an extraordinary opinion, the Chancery Court found the board independent, a decision that entailed a finding of independence for a principal of a high school, a president of a college where Michael Eisner contributed $1 million and a director who's wife received contracts for her business.  While the court viewed it as independent, the market did not.  Business Week ranked it as the worst board (from a corporate governance perspective) two years in a row.  It demonstrated the myopic view.

A similar thing is taking place today with Citigroup.  The US Government has agreed to take a very large stake in the bank (36% according to published reports).  As part of the investment, the Government has demanded substantial changes in the board.  As the WSJ reported:

• The company will reconstitute its board to include a majority of new independent directors. It said of the 15 current directors, three will not stand for reelection and two will reach retirement age, and it will announce new directors soon.

• Citigroup Chairman Richard Parsons has been scrambling to lure new directors. That has proven an uphill battle, with two candidates Citigroup approached rebuffing the overtures, according to people familiar with the matter.

In other words, the Government views the existing board as having done an inadequate job.  At the same time this is occurring, the Delaware Chancery Court issued an extraordinary opinion involving Citigroup, the board, and allegations that the board did not adequately supervise the excessive risk taking by the bank.  We plan to post on this decision at length in the future. 

For now, though, suffice it to say that the shareholder suit was dismissed, that the court found nothing untoward in the board's behavior, and that it issued an opinion that all but accused the plaintiffs of doing little more than bring a suit because they were unhappy, in hindsight, with business deals that didn't work out.  The case contains a lecture largely defending the very system of governance that has resulted in the current turmoil. 

Disney in the 1990s showed how out of touch with reality the courts were, something that came home with a vengeance in the Enron era and resulted in the adoption of Sarbanes-Oxley, a law that largely preempted state law.  The Citigroup case is the poster child of the new millennium that shows just how little the courts are willing to make the boards responsible for the oversight of the company.  It demonstrates with equal force why more preemption is necessary.

Most of the primary materials on the Citigroup case can be found at the DU corporate governance web site.

The government is apparently about to provide AIG with access to another $30 billion.  As part of that deal, the government will convert previously issued preferred shares to a new class of Series E Non-Cumulative Preferred Shares on decidedly less advantageous terms for the government.  The main difference was that the preferred shares originally provided for a 10% dividend that would "cumulate," that is would accrue yearly if not paid.  The cumulated (unpaid) dividends must be paid before common stock holders can ever receive a dividend.  The new Series E shares do not cumulate.  If the 10% dividend is not paid in any year, the obligation disappears. 

Moreover, the term sheet pretends that the new Series E shares will pay a 10% dividend but that is highly unlikely to ever occur.  If AIG does not pay a dividend for any four quarters, even if not consecutive, it must cede to the government two positions (or 20%) of the board.  Even if that occurs and directors are inserted onto the board, they must resign whenever a dividend is paid "for four consecutive dividend periods following commencement of such right."

If by chance the dividend is not paid during a four quarter period, it is not clear that the government directors will ever actually get on the board.  The term sheet merely provides that the government gets the right "to elect" two directors.  This suggests the need for a shareholder meeting.  Since the term sheet does not say anything about the government's right to call a meeting, this presumably means the government must wait until the annual meeting of shareholders at which directors are elected.  This could be as long as a year away.  Moreover, the government's right to positions on the board terminates after four consecutive payments from the "commencement of the right" not the actual election of directors.  Thus, AIG could conceivably make the four dividend payments before the government actually elects the directors. Presumably once the right is terminated, AIG can then miss four more dividend payments before again having to worry about the directors. 

This effectively means AIG could pay no dividend one year (it then wouldn't cumulate), triggering the government's right to board seat then pay the dividend the next four quarters (eliminating the government's right to board seats).  The pattern could repeat, effectively meaning that preferred shareholders receive a 10% dividend every other year.

In addition, it is not good governance to provide that directors may sit on the board for a brief time and then resign automatically once certain dividend payments are made.

This aspect of the bailout means that the government is giving more and getting less.

So, was President Obama correct in his State of the Union of the following:

• And I intend to hold these banks fully accountable for the assistance they receive, and this time, they will have to clearly demonstrate how taxpayer dollars result in more lending for the American taxpayer. (Applause.) This time — this time, CEOs won't be able to use taxpayer money to pad their paychecks, or buy fancy drapes, or disappear on a private jet. Those days are over.

The amendments to TARP in the Stimulus Bill edge in this direction but do not guarantee that this will occur.  The legislation hardly touches fancy drapes and private jets.  It merely requires the boards of TARP participants to have a policy in place with respect to excessive expenditures in this area.  Nonetheless, as a practical matter, things are not as usual.  While boards could put in place policies that still allow for corporate aircrafts or expensive remodelings by the CEO, it is unlikely to do so.  The policies will likely be more restrictive than what is legally required (which, under Delaware law, is almost nothing). 

In other words, the practices will decline.  But to ensure that this occurs, the SEC needs to require companies to make those policies public.

As a final post in this series, we note some additional provisions in the Stimulus Act that do not specifically expand the SEC's authority but are worthy of comment.

In addition to a compensation committee consisting of independent directors, TARP dips directly into the governance process.  The compensation committee must meet at least semi-annually and must "discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans."  In other words, the legislation preempts state law by dictating the minimum number of meetings and by prescribing at least some of the tasks that must be undertaken by the committee.  This was done in SOX with respect to audit committees.  See Rule 10A-3, 17 CFR 240.10A-3. 

While these provisions are not as detailed as those required for audit committees, there is a profound difference in the regulatory approach of the two laws.  In SOX, the requirements were imposed as a listing standard.  Listing standards do not currently provide for a private right of action.  Moreover, the exchanges have historically had issues with enforcement of their own rules.  For a mix of posts on the subject, go here, here and here.  The topic is also discussed at length in Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.  The provisions in TARP are not listing standards but substantive requirements imposed directly by the statute.  The relevant federal agencies can enforce them.

In addition, TARP now requires that boards put in place a "company wide policy regarding excessive or luxury expenditures, as identified by the Secretary." The provision lists topics that "may" be included. The list is predictable and includes: "(1) entertainment or events; (2) office and facility renovations; (3) aviation or other transportation services; or (4) other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient." 

That federal law must dictate this demonstrates how little is required of boards under Delaware law.  If directors already had to do this under state law, there would be no need to have federal standards.  The provision, therefore, is a reflection of the utter lack of standards under state law.  The one irony of the requirement though, is that it might actually encourage remodeling and personal use of aircraft.  In identifying "excessive" expenditures, the board will, by definition, be defining a category of expenditures that are not excessive.  Thus, offices can be remodeled as long as they fall under the "excessive" standard.

With respect to these provisions, the SEC needs to improve disclosure.  The Commission should require all disclosure of the analysis employed by the compensation committee in connection with its review of the TARP requirements.  With respect to the excessive expenditures, the Commission should mandate disclosure of the policy.

For more on the subject, see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.

As a penultimate post in this series, we note some additional provisions in the Stimulus Act that do not specifically expand the SEC's authority but are worthy of comment.

The amendments to TARP also dipped a toe into changes to the process for determining executive compensation.  Section 111 required the creation of a compensation committee consisting entirely of independent directors (something already mandated for exchange traded companies).  The provision did not, however, define independent. 

There are three possible definitions:  The stock exchanges, state law and SOX.  With respect to state law and listing standards, there are substantial problems with the definition and reason to believe that they do not ensure director independence (there are plenty of posts on this Blog about that topic but much of the analysis can be found in Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty). 

What did the Bill mean when it referred to independent directors?  The Conference Committee says nothing, making one unhelpful and isolated reference to the provisions on compensation committees (see conference report on Division B at p. 219).  The case is strong that the most appropriate definition should be the one contained in SOX and codified in Rule 10A-3(b).  The provision, unlike the listing standards, prohibits directors from accepting any additional payments other than fees from the company.  Thus, the provision in the NYSE and Nasdaq listing standards that would allow directors to receive payments of not more than $120,000 and still maintain their independence would not apply. 

Moreover, to the extent that the listing standards become a benchmark, the requirement in the NYSE that directors not have a "material relationship" with the company (see NYSE 303A.02(a)) would be subject to federal enforcement.  Thus, the blind eye turned by the NYSE to the impact of directors' fees and whether they result in a "material relationship" (note the language in the 2007 Merrill Lynch Proxy Statement) would potentially no longer apply.  As a result, there may be a large number of directors considered treated as independent under the relevant listing standards who would not be under TARP.

For more on the subject, see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.

We are examining the changing role of the SEC in the corporate governance process and the recent changes included in the Stimulus Bill.

In addition to the restrictions on executive compensation, the amendments to TARP contained in the stimulus bill also required say on pay and required a certification by the CEO and CFO concerning compliance with the executive compensation provisions.  Both of the requirements were given to the SEC to enforce.  In addition, however, the Act builds in one very large but little noticed area for SEC involvement. We will discuss these in turn.

The provisions that are to be overseen by the Commission include the requirement of a certification of compliance.  Reminiscent of the certification requirement inserted into SOX (see section 302 of SOX and Rule 13a-14), the provision requires the CEO and CFO to provide a "written certification of compliance." The requirement only applies to TARP recipients and, for public companies, must be filed with the SEC. The Act specified an annual filing, presumably with the annual report on Form 10-K.

In the letter written by Senator Dodd to Mary Schapiro, the Senator indicated that the certification applied to "compliance with executive compensation and corporate governance standards that have yet to be established by the Secretary of the Treasury."  As a result, he asserted that the certification did not have to be filed until the standards had been established.

The Commission likewise received authority to implement say on pay. The Stimulus Bill provides that TARP companies "shall permit" a non-binding shareholder vote "to approve the compensation of executives." The matter to be voted on? Compensation, "as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the compensation discussion and analysis, the compensation tables, and any related material)." In other words, it's the Commission that gets to define the subject matter to be voted on. The Commission has a year to adopt rules implementing the provision.

In the letter from Senator Dodd, he noted that while the effective date of the legislation was Feb. 17, the provision "would not apply to preliminary (and the related definitive proxy even if filed after February 17) or definitive proxy statements filed with the Securities and exchange Commission on or before February 17, 2009, but would apply to proxies filed after."

The position is a reasonable one and designed to avoid hardship on companies well into the proxy process.  Having said that, it appears to be inconsistent with the statute.  The Stimulus Bill provides as follows:

• Any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding shall permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the compensation discussion and analysis, the compensation tables, and any related material).

The provision is keyed to the meeting, not the filing of the proxy statement.  It suggests, therefore, that it applies to any meeting of a TARP recipient held after the effective date of the meeting.  The SEC will, therefore, have to decide whether to require say on pay even for companies that have already filed preliminary/final proxy statements without having yet held the meeting or only those that have not yet filed their proxy statements. 

Finally, the less noticed example of Commission authority under TARP is the definition of senior executive officer.  The term is used to determine those who are subject to limits on bonuses and golden parachutes, among other things.  The term is defined as the persons within the top

• 5 most highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and nonpublic

In other words, it is the top five officers who appear annually in a company's proxy statement.  These persons are determined by rules adopted by the SEC.  Item 402 of Regulation S-K traditionally defined the officers subject to compensation disclosure as the CEO and the four highest paid executive officers.  When the Commission amended the provision in 2006, the formula was changed to the CEO, CFO and the three highest paid executive officers.  TARP, therefore, gives to the SEC the authority to define the particular officers subject to the restrictions on compensation.

All of this deeply interjects the SEC into the governance process.  With respect to say on pay, the SEC decides what is voted on.  In addition, however, the SEC may find itself in the middle of disputes between management and shareholders over substantive issues such as who gets to cast a vote on the matter.  With respect to certification, the SEC will accept the filings and, presumably, ensure their accuracy.  This may mean enforcement proceedings that explore the role of the CEO, CFO and the board of directors in connection with executive compensation.  Finally, the SEC is the one that gets to decide the officers subject to the compensation restrictions.

These provisions only apply to a small number of companies (TARP companies) and will expire when the companies no longer have TARP financing.  Nonetheless, they lay the groundwork for greater SEC involvement in the corporate governance process.  It is highly likely that the SEC will, in the future, see its substantive authority in the governance area continue to grow at the expense of the states, particularly Delaware.

For more on the subject, see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.

The Nacchio case came down yesterday and I received a call from Sara Burnett at the Rocky Mountain News for my thoughts.  It didn't earn me a quote but it resulted in a thoughtful, interesting conversation with someone who had followed the trial from the very beginning. 

Today, we have received in Colorado the sad news that the Rocky Mountain News will close, transforming Denver into a single newspaper city (the Denver Post is the survivor).  It is frustrating to see this happen with the inevitable loss of coverage that will result.  Moreover, newspapers often seem incapable of varying their model.  While advertising revenue is down (Craigs List and others have seen to that) and printing costs are up, there is a market out there for those willing to pay for thoughtful, unique coverage, delivered in a cost effective way (most likely over the Internet).  In time, there will hopefully be more rather than less coverage.  In the meantime, the closing of the Rocky is a great loss.

Judge Henry wrote a separate dissent and suggested that the case would be back, with the courts having to resolve whether Nacchio received ineffective assistance of counsel.  As he noted:

• And, though I fear for today’s result, I do not believe this case is over. If “the district judge made clear his need for some proffer of data or literature underlying the expert’s assumptions and conclusions, [and] the defense offered practically nothing, despite repeated opportunities to do so,” Maj. Op. at 35, (citing United States v. Brien, 59 F.3d 274, 277 (1st Cir. 1995)), then defense counsel behaved inexplicably, which is to say they performed below the level expected of competent counsel. That means we will most likely see these issues return in the form of a § 2255 claim for ineffective assistance of counsel. The fact that a possibly meritorious § 2255 claim is waiting has no direct effect on what we do here now. Nonetheless, the majority’s scenario, which depends on a holding that counsel’s ineffectiveness possibly rose to a level of constitutional infirmity, suggests to me an alternative explanation: the district court simply was not clear, and it abused its discretion in excluding Mr. Nacchio’s expert.

Whatever the merits of the idea, Judge Henry predicates his views on the belief that counsel for Nacchio "behaved inexplicably" and, potentially, below the level of competent counsel. 

This is a hard argument to swallow.  Put aside that Nacchio received talented and skilled representation by five lawyers who seemed prepared at every turn.  There is also the possibility that the failure to submit additional information on methodology or request a hearing was actually beneficial to the defendant.  Had these things been done, its possible the evidence would still have been excluded, only this time on a more complete record that would have been harder to reverse. 

The actions of counsel at trial came within one vote of a new trial.  This hardly smacks of ineffective assistance.

The primary materials on this case have been posted at the DU Corporate Governance web site.

For a time, it seemed as if economic analysis (often bad economic analysis) was the sin qua non of legal analysis in the corporate law area.  There were plenty of scholars who wanted to see corporate and securities law become entirely a matter of contract.  The best way to police inefficient management was not by strengthening shareholder rights but by allowing the market for corporate control to exact the appropriate punishment.  In other words, let the market resolve everything. 

Those days have come and gone.  Certainly, the idea that the market can be counted on to correctly regulate behavior had taken a beating in the current economic turmoil.  Some degree of economic analysis can be useful depending upon the circumstances but it is but one more source of analysis, and sometimes a meager one at that.

In this particular case, Judge Holmes held that the reputation of Daniel Fischel, a preeminent scholar in the law and economics movement, and his track record of testifying in other cases was not of itself sufficient to establish his methodology.  In other words, it was not enough to repeat the mantra of economic analysis and present someone experienced and well known.  In effect, Judge Holmes held that economic analysis would receive no particular deference and, instead, had to meet the same standards that all other experts had to meet.      

Judge McConnell took great umbrage at the exclusion of Daniel Fischel and the perceived slight to the law and economics movement.  As he stated:

• Even more so, the judge must have been influenced by his conclusion that, quite apart from methodology, the evidence excluded was irrelevant and would be confusing to the jury. In his explanation of his disqualification ruling, Judge Nottingham articulated a contempt for expert economic evidence that raises serious questions about any exercise of his discretion in this matter. He described Professor Fischel’s proposed testimony—without knowing anything more about it than was described in the cursory “written summary” required under Rule 16—as “a waste of time” that would “mislead the jury” by “inviting the jurors to abandon their own common sense and common experience and succumb to this expert’s credentials.” Id. at 3919, 3920. He said, among other things, that the jurors had no need of expert evidence in determining whether Mr. Nacchio had an “economic incentive to trade or not trade on inside information here,” App. 3917; that analysis of the defendant’s trading patterns was “essentially irrelevant,” id.; that economic analysis “is within the common knowledge of the jury,” id. at 3918; that an analysis of whether Mr. Nacchio’s sales could be explained on the basis of the “economics of diversification” is “a piece of elucidation we really don’t need here,” id.; and that a comparison of Mr. Nacchio’s trades to those of other CEOs or Qwest directors at the same time, who lacked Mr. Nacchio’s inside information, is “almost preposterous.” Id. at 3919. He opined that expert evidence is no more necessary in a complex securities matter than in “a simple negligence case.” Id. at 3841. These statements are in sharp conflict with the advisory committee note to Federal Rule of Evidence 702, which describes “the venerable practice of using expert testimony to educate the factfinder on general principles,” specifically mentioning as an example “how financial markets respond to corporate reports.”

Perhaps this is a final chapter in the era of excessive deference to economic analysis.  Perhaps it means that economic analysis will be treated like any other, admitted where it is supported by a reasonable methodology, not admitted where it does not.     

The primary materials on this case have been posted at the DU Corporate Governance web site.

The case was decided by a 5-4 vote.  Nonetheless, there was a tenth judge involved in the decision making process, Judge Nottingham, the trial judge.  There is little doubt that his presence was felt by the dissenting judges in the en banc decision. 

Throughout the trial, Judge Nottingham and Judge Stern (Stern, counsel for Nacchio had once served as a federal district court judge in New Jersey) engaged in a constant tug of war, with the one with the gavel invariably winnning.  In addition, Judge Nottingham had a run of unsavory publicity in the aftermath of the trial, ultimately resigning from the bench. 

All of this seemed to have an impact on the deliberations.  Judge Holmes speaking for the majority disclaimed any impact of the trial judge on the appeal.      

• Mr. Nacchio is attempting to recast an unremarkable district court evidentiary ruling as an invidious act of judicial hubris. But it will not work. At bottom, Mr. Nacchio’s argument is no more than a run-of-the-mill lament of unfair surprise. We have rejected similar claims when, as here, the record belies them. Some of it was overt.

The dissent had a harder time of it.  Some judges didn't go to any great length to hide their annoyance at Judge Nottingham. 

During oral argument, Judge Kelly expressed almost palpable anger at Judge Nottingham, describing his ruling on Fischel as "the most simplistic thing I've ever seen." He seemed to confirm this attitude with a demonstration of favoratism toward counsel for the defense at oral argument.  Moreover, in his dissent in the en banc opinion, he specifically referred to "the tone of this trial," an obvious reference to his attitude towards Judge Nottingham. 

Judge Henry in his dissent in the en banc case also had a few digs to make at Judge Nottingham, although they were at least a bit less personal. As he described:"Yet, the district court, seemingly driven by some internal time schedule, deprived Mr. Nacchio of his key expert witness, Professor Daniel Fischel."  Whatever he means by "timetable," its clear that he viewed the ruling as somehow motivated by something other than Judge Nottingham's view of the law and the adequacy of the defendant's submissions.

Finally, Judge McConnell wrote a 44 page dissent.  Rather than discuss the trial judge in neutral terms (Judge Holmes referred to the decision maker interchangeably as the trial judge or the district court),  Judge McConnell singled out Judge Nottingham by name, mentioning him 33 times, as if the reference to the specific individual would somehow strengthen his argument.  We haven't studied the opinions written by Judge McConnell in any great detail but suspect that it would be unusual for him to criticize a specific judge by name in an opinion to the extent done in his dissent in the Nacchio en banc.  The opinion, therefore, has a very personal feel, one judge chastising another by name.  It doesn't help that Judge McConnel used some occasionally harsh language in describing the rulings of Judge Nottingham ("In his explanation of his disqualification ruling, Judge Nottingham articulated a contempt for expert economic evidence that raises serious questions about any exercise of his discretion in this matter.").   

One does have to wonder whether the presence of a different trial judge would have changed a vote or two among the dissenters.     

The primary materials on this case have been posted at the DU Corporate Governance web site.

As we more or less predicted, the full court vacated the panel opinion which had overturned the verdict of Joe Nacchio and ordered a new trial.  The effect of the en banc opinion is to reinstate the conviction.  The majority opinion was written by Judge Holmes who also wrote the dissent in the panel opinion.  His opinion is a lengthy discussion showing that Nacchio had plenty of notice and opportunity to make a stronger case for the admission of Daniel Fischel, the excluded experts. 

Judge Holmes made it very clear that the case was not about the personality of the judge or his hubris in the courtroom.  As he noted:  

• Mr. Nacchio is attempting to recast an unremarkable district court evidentiary ruling as an invidious act of judicial hubris. But it will not work. At bottom, Mr. Nacchio’s argument is no more than a run-of-the-mill lament of unfair surprise. We have rejected similar claims when, as here, the record belies them.

Judge Holmes further noted that Nacchio had not sustained his burden on the methodology used by Fischel.  While Fischel could rely on his "experience," the defendant needed to offer something more than simply taking the expert's word for it.    

• Mr. Nacchio considered his revised Rule 16 disclosure to be a submission on Professor Fischel’s methodology. Aplee. Supp. En Banc App. 50. This filing indicated that Professor Fischel was basing his opinion on analysis of, inter alia, market- and stock-related information. These assertions indicate that Professor Fischel was applying his experience to material that he reviewed to formulate an opinion. An expert witness’s testimony can rely solely on experience. When that is the case, however, “the witness must explain how that experience leads to the conclusion

  reached, why that experience is a sufficient basis for the opinion, and how that experience is reliably applied to the facts.” Fed. R. Evid. 702 advisory committee’s note (2000). Mr. Nacchio did not offer any of this additional information. “The trial court’s gatekeeping function requires more than simply ‘taking the expert’s word for it.’” Id. “[N]othing in either Daubert or the Federal Rules of Evidence requires a district court to admit opinion evidence that is connected to existing data only by the ipse dixit of the expert.” Joiner, 522 U.S.  at 146.

Although conceding that Fischel had testified in the past, the expert's past experience and general expertise was not a substitute for a description of the proposed methodology.

• It appears that Mr. Nacchio relied on Professor Fischel’s qualifications to tip the balance in favor of the admissibility of his expert testimony.  In doing so, Mr. Nacchio ignored the precept that when assessing expert testimony, “the question before the trial court [i]s specific, not general.” Kumho Tire, 526 U.S. at 156. Although Professor Fischel generally has been permitted to testify in the past, and a district court might well respect his credentials, the court had an obligation to assess the methodology that Professor Fischel had employed in the case at hand. See id. at 153-56; Rodriguez-Felix, 450 F.3d at 1122. Mr. Nacchio could not assume that his expert’s testimony would be admitted because other courts had allowed it in; he had to carry his burden of demonstrating the admissibility of Professor Fischel’s testimony in this particular case. Mr. Nacchio, however, failed to satisfy the district court that Professor Fischel’s testimony was reliable. Thus, the district court was well within its discretion in excluding it. See Rodriguez-Felix, 450 F.3d at 1125 (finding no abuse of discretion when the district court excluded testimony based on the “woefully inadequate” report regarding proffered testimony).

The opinion ended by sending the case back to the panel to address some remaining unresolved issues, including those centering around sentence enhancement and asset forfeiture.  These are relatively modest issues that do not go to the underlying merits or the need for a new trial.  For Nacchio to have any meaningful hope of reversal, he will have to go up the ladder with the decision.  

The primary materials on this case have been posted at the DU Corporate Governance web site.

As an initial matter, we offer the following comments from John Holcomb at the Daniels College of Business.  John has commented considerably on this case and attended the trial. 

• As several predicted, the en banc panel has reversed the 3-judge panel and reinstated the Federal District Court ruling and verdict. In that sense, it is a red-letter day for criminal justice and vindication for Qwest shareholders and retirees, as well as vindication for Judge Nottingham in his careful rulings on the exclusion of Fischel as an expert witness.

• Though it is a narrow 5-4 ruling, the majority decision is a thorough rebuke of the claims made by the defense and the analysis of the three-judge panel. It even adopts some of Judge Nottingham’s language that the defense report to qualify Fischel as an expert witness was “woefully inadequate” or “woefully insufficient.” It is clear from the majority opinion that any mistakes made were by defense counsel and not by Judge Nottingham.

• The en banc opinion deferred to Judge Nottingham’s discretion and the procedures used in excluding the expert testimony and ruled that he had not been arbitrary or capricious, but rather careful in his rulings. The defense had received plenty of notice that Nottingham would rule on the government’s crucial motion that the expert testimony be excluded as not meeting Daubert standards, and the defense had numerous opportunities to request an evidentiary hearing and failed to do so.

• The court has remanded to the 3-judge panel for a decision on sentence enhancement and forfeiture issues, where Nottingham was again careful and restrained in his rulings. Hence, any reversal or modification of the sentence is highly doubtful.

• In his dissent, Chief Judge Henry suggests the case is not over, and if the majority is correct about the mistakes made by defense counsel that Nacchio might file an appeal based on “ineffective assistance of counsel.” That likely will not fly, in spite of the numerous criticisms of counsel Stern’s advocacy. In the slight chance it would fly, it would be quite a blemish on Stern’s reputation.

• This is a great ruling and a very careful and convincing majority opinion by Judge Holmes, who dissented from the 3-judge panel decision. He carefully weaves through every precedent, showing how they dictate the result in this case and how any contrary rulings do not apply and can be readily distinguished. His footnotes are well crafted and provide tremendous support for his analysis. Given his earlier dissent from the three-judge panel and his majority opinion for the en banc court, he will be the hero to Qwest shareholders and to those who will be glad to see Nacchio in prison.

The 10th Circuit has affirmed the conviction of Joe Nacchio by a 5-4 vote.  We will have commentary on the case later.

We are examining the changing role of the SEC in the corporate governance process.

The Leviathan that is the Stimulus Bill included some corporate governance provisions on p. 402 in Part B, Title VII.  Section 111 of the Act contains most of the operative restrictions on executive compensation.  At least some of the language came directly from Senator Dodd.  We have attached a copy of Section 111 in this post.

Section 111 repeats some of the provisions from earlier iterations.  TARP companies must limit the use of compensation incentives that encourage executive officers to "take unnecessary and excessive risks that threaten the value" of the company.  There may not be any compensation plan that encourages "manipulation of the reported earnings . . . to enhance the compensation of any of its employees."

The provision also continues the restriction on payments under golden parachute agreements for the highest paid employees but goes deeper. The restriction applies to senior executive officers (the five highest paid officers included in the proxy statement) and the next 5 most highly-compensated employee.

The most interesting provisions are those related to bonuses.  The Act continues to employ a clawback with respect to bonuses but expands the number of people subject to the requirement.  TARP now provides that TARP companies shall have a provision that provides for the recovery of any bonus paid to to any senior executive officer (the five highest paid officers included in the proxy statement), as well as the next 20 most highly paid employees to the extent "based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate." 

Most restrictive is the prohbition on bonuses and other incentive compensation.  Bonuses can be paid but only if in the form of long term restricted stock and in an amount not more than one-third of total compensation and bonus must be paid with restricted stock (an undefined term).  The number of people in each company subject to the limitations varies with the amount of TARP funds accepted.  For the smallest amounts (those companies receiving $25 million or less), the restriction only applies to the most highly compensated employee.  For those accepted between $25 and $250 million, the restriction applies to the five most highly compensated employees.  Those receiving $250 - $500 million, the restriction extends to the ten most highly compensated employees.   Over that amount, the number is 20.

Most of these provisions are expected to be implemented through regulations adopted by the Department of Treasury.  Nonetheless, Section 111 reserves an important role for the SEC.  We shall examine those provisions in the next post.

SEC. 111. EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE.

(a) DEFINITIONS.—For purposes of this section, the following definitions shall apply:

(1) SENIOR EXECUTIVE OFFICER.—The term ‘senior executive officer’ means an individual who is 1 of the top 5 most highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and nonpublic
company counterparts.

(2) GOLDEN PARACHUTE PAYMENT.—The term ‘golden parachute payment’ means any payment to a senior executive officer for departure from a company for any reason, except for payments
for services performed or benefits accrued.

(3) TARP RECIPIENT.—The term ‘TARP recipient’ means any entity that has received or will receive financial assistance under the financial assistance provided under the TARP.

(4) COMMISSION.—The term ‘Commission’ means the Securities and Exchange Commission.

(5) PERIOD IN WHICH OBLIGATION IS OUTSTANDING; RULE OF CONSTRUCTION.—For purposes of this section, the period in which any obligation arising from financial assistance provided under the TARP remains outstanding does not include any period during which the Federal Government only holds
warrants to purchase common stock of the TARP recipient.

(b) EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE.—

(1) ESTABLISHMENT OF STANDARDS.—During the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, each TARP recipient
shall be subject to—

(A) the standards established by the Secretary under this section; and

(B) the provisions of section 162(m)(5) of the Internal Revenue Code of 1986, as applicable.

(2) STANDARDS REQUIRED.—The Secretary shall require each TARP recipient to meet appropriate standards for executive compensation and corporate governance.

(3) SPECIFIC REQUIREMENTS.—The standards established under paragraph (2) shall include the following:

(A) Limits on compensation that exclude incentives for senior executive officers of the TARP recipient to take unnecessary and excessive risks that threaten the value of such recipient during the period in which any obligation arising from financial assistance provided under the TARPremains outstanding.

(B) A provision for the recovery by such TARP recipient of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of the TARP recipient based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.

(C) A prohibition on such TARP recipient making any golden parachute payment to a senior executive officer or any of the next 5 most highly-compensated employees of the TARP recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding.

(D)(i) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any prohibition developed under this paragraph shall not apply to the payment of longterm restricted stock by such TARP recipient, provided
that such long-term restricted stock—

(I) does not fully vest during the period in which any obligation arising from financial assistance providedto that TARP recipient remains outstanding;

(II) has a value in an amount that is not greater than 1⁄3 of the total amount of annual compensation of the employee receiving the stock; and

(III) is subject to such other terms and conditions as the Secretary may determine is in the public interest.

(ii) The prohibition required under clause (i) shall apply as follows:

(I) For any financial institution that received financial assistance provided under the TARP equal to less than $25,000,000, the prohibition shall apply only to the most highly compensated employee of the financial institution.

(II) For any financial institution that received financial assistance provided under the TARP equal to at least $25,000,000, but less than $250,000,000, the prohibition shall apply to at least the 5 most highlycompensated employees of the financial institution, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

(III) For any financial institution that received financial assistance provided under the TARP equal to at least $250,000,000, but less than $500,000,000, the prohibition shall apply to the senior executive officers and at least the 10 next most highly-compensated employees, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

(IV) For any financial institution that received financial assistance provided under the TARP equal to $500,000,000 or more, the prohibition shall apply to the senior executive officers and at least the 20 next most highly-compensated employees, or such higher number as the Secretary may determine is in the public interest with respect to any TARP recipient.

(iii) The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.

(E) A prohibition on any compensation plan that would encourage manipulation of the reported earnings of such TARP recipient to enhance the compensation of any of
its employees.

(F) A requirement for the establishment of a Board Compensation Committee that meets the requirements of subsection (c).

(4) CERTIFICATION OF COMPLIANCE.—The chief executive officer and chief financial officer (or the equivalents thereof) of each TARP recipient shall provide a written certification of compliance by the TARP recipient with the requirements of this section—

(A) in the case of a TARP recipient, the securities of which are publicly traded, to the Securities and Exchange Commission, together with annual filings required under
the securities laws; and

(B) in the case of a TARP recipient that is not a publicly traded company, to the Secretary.

(c) BOARD COMPENSATION COMMITTEE.—

(1) ESTABLISHMENT OF BOARD REQUIRED.—Each TARP recipient shall establish a Board Compensation Committee, comprised entirely of independent directors, for the purpose of reviewing employee compensation plans.

(2) MEETINGS.—The Board Compensation Committee of each TARP recipient shall meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans.

(3) COMPLIANCE BY NON-SEC REGISTRANTS.—In the case of any TARP recipient, the common or preferred stock of which is not registered pursuant to the Securities Exchange Act of 1934, and that has received $25,000,000 or less of TARP assistance, the duties of the Board Compensation Committee under
this subsection shall be carried out by the board of directors of such TARP recipient.

(d) LIMITATION ON LUXURY EXPENDITURES.—The board of directors of any TARP recipient shall have in place a companywide policy regarding excessive or luxury expenditures, as identified by the Secretary, which may include excessive expenditures on—

(1) entertainment or events;

(2) office and facility renovations;

(3) aviation or other transportation services; or

(4) other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient.

(e) SHAREHOLDER APPROVAL OF EXECUTIVE COMPENSATION.—

(1) ANNUAL SHAREHOLDER APPROVAL OF EXECUTIVE COMPENSATION.—  Any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding shall permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the compensation discussion and analysis, the compensation tables, and any related material). 

(2) NONBINDING VOTE.—A shareholder vote described in paragraph (1) shall not be binding on the board of directors of a TARP recipient, and may not be construed as overruling TARP recipient to enhance the compensation of any of its employees.

(F) A requirement for the establishment of a Board Compensation Committee that meets the requirements of subsection (c).

(4) CERTIFICATION OF COMPLIANCE.—The chief executive officer and chief financial officer (or the equivalents thereof) of each TARP recipient shall provide a written certification of compliance by the TARP recipient with the requirements of this section—

(A) in the case of a TARP recipient, the securities of which are publicly traded, to the Securities and Exchange Commission, together with annual filings required under the securities laws; and

(B) in the case of a TARP recipient that is not a publicly traded company, to the Secretary.

(f) REVIEW OF PRIOR PAYMENTS TO EXECUTIVES.—

(1) IN GENERAL.—The Secretary shall review bonuses, retention awards, and other compensation paid to the senior executive officers and the next 20 most highly-compensated employees of each entity receiving TARP assistance before the date of enactment of the American Recovery and Reinvestment Act of 2009, to determine whether any such payments were inconsistent with the purposes of this section or the TARP or were otherwise contrary to the public interest.

(2) NEGOTIATIONS FOR REIMBURSEMENT.—If the Secretary makes a determination described in paragraph (1), the Secretary shall seek to negotiate with the TARP recipient and the subject employee for appropriate reimbursements to the Federal Government with respect to compensation or bonuses.

(g) NO IMPEDIMENT TO WITHDRAWAL BY TARP RECIPIENTS.— Subject to consultation with the ppropriate Federal banking agency (as that term is defined in section 3 of the Federal Deposit Insurance Act), if any, the Secretary shall permit a TARP recipient to repay any assistance previously provided under the TARP to such financial institution, without regard to whether the financial institution has replaced such funds from any other source or to any waiting period, and when such assistance is repaid, the Secretary shall liquidate warrants associated with such assistance at the current market price.

(h) REGULATIONS.—The Secretary shall promulgate regulations to implement this section.

For more on the subject, see  Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.

When the Exchange Act was adopted back in 1934, Congress intended to give the SEC a prominant role in the corporate governance process.  Congress mostly limited that authority to disclosure.  As the legislative history illustrates (and is set out in much greater detail in Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure) Congress mistakenly thought that governance problems (excessive compensation, management self perpetuation), would be corrected if shareholders received sufficient disclosure to remedy any abuse.  Congress did not take into account both the inherent benefits accorded management in the governance process (primarily the availability of the entire corporate treasury to win shareholder elections) or the diligence of Delaware in the race to the bottom and the willingness to change/interpret law in a manner that disadvantaged shareholders. 

Over time (particularly in the 1970s with the corporate bribery scandal), the SEC realized that accurate corporate disclosure could not be accomplished without regulating the substantive behavior of officers and directors.  It tried a number of methods to affect behavior, including the use of disclosure (meeting attendance disclosure is a good example) and enforcement proceedings (remember the paen to good corporate governance the the WR Grace case?).  The Commission tried to use the stock exchanges to implement substantive requirements but saw that approach damaged by the DC Circuit's decision in Business Roundtable.  None really worked.  As a result, disclosure became more precise and complex (look at executive compensation disclosure) while fiduciary duties continued to erode under the Delaware approach (Disney anyone?).

That approach changed in fairly dramatic fashion with the adoption of SOX.  SOX gave to the SEC substantive authority in the corporate governance area.  The SEC got the authority to define the duties of the board and officers with respect to internal controls.  Audit committees were largely put under the auspicies of the Commission.  The ban on loans to executive officers and directors were ensconced in the Exchange Act.

But the approach was patchwork and used less enforceable methods of implementation (imposing governance requirements as listing standards, for example).  Much of the Delaware approach to corporate governance remained unchanged.  Thus, the standards remained low and boards often engaged in little oversight, whether in assessing risk or determining executive compensation.  The likelihood that this would change seemed slight.  Indeed, VC Strine, one of the key players in the process of determining standards for board behavior, commented not long ago that "There's a lot of things that keep me up at night related to my work, but the possibility of [a federal corporate law] isn't one of them."

With that in mind, we turn to the Stimulus Bill.  The Bill amended TARP and included some strict corporate governance provisions.  The SEC received authority to implement the requirements.  In other words, the Agency historically consigned to disclosure as a means of affecting governance was now in the middle of the substantive debate on the topic.   We will look at a number of provisions over the next few posts.  Suffice it to say that if there ever was a time when it could be said, accurately, that the states regulated substance and the SEC regulated disclosure, those days are over.