Governance Developments

March 2, 2010
Metropolitan Corporate Council
By Thomas Quaadman

For most of 2009, legislative and regulatory corporate governance developments were marching down a fairly predictable path at a steady rate of speed. However, as 2009 was ending, it seemed that a fog descended over the legislative and regulatory landscape obscuring corporate governance proposals and the prospect for success. The fog has only intensified with the passage of time and the process has slowed considerably as participants blindly grope in different directions. These developments and an ever-changing landscape have made it exceedingly difficult for the most seasoned observers to predict outcomes.

Financial Regulatory Reform

To quickly recap, H.R. 4173, the Wall Street Reform and Consumer Protection Act, passed the House on December 11, 2009 by a vote of 232-202. This bill included provisions for Say on Pay, independent compensation committees, regulation of incentive compensation for financial services employees and a grant of authority to the Securities and Exchange Commission ("SEC") to promulgate proxy access rules if it chooses to do so. House Financial Services Committee Chairman Barney Frank (D-Mass) stated that the House would consider a separate bill solely related to corporate governance. Of course, the SEC also released proposed regulations on proxy access last year and the initial comment period closed in mid-August.

In December, the SEC commenced a second comment period for the proxy access proposal, specifically requesting commentary on economic studies, as well as a report on private ordering. The second comment period closed on January 19, 2010. It is anticipated that the SEC will meet to formalize this proposal towards the end of March, five months after it was expected to be finalized. According to recent published reports, the SEC attempted to impose a proxy access regime on Bank of America as part of the Merrill Lynch settlement. Bank of America rejected this maneuver. It should be remembered that proxy access proposals have twice been rejected by the SEC and that the current iteration has been quite controversial. By using the enforcement process to create a proxy access precedent, some observers have viewed the SEC as acting out of weakness boosting the notion that the current proposal may not withstand a legal challenge.

In November, Senator Christopher Dodd (D-Conn.) released a proposed regulatory reform bill that included a modified version of the Shareholder Bill of Rights proposed by Senator Charles Schumer (D-N.Y.). As I noted at the time, the Dodd bill included majority voting for uncontested directors, proxy access, leadership structure disclosures, prohibiting of staggered boards and for financial institutions the establishment of risk management committees. In late November, 2009, Senator Dodd started a mark-up of his bill. However, because of serious concerns about the substance and process, this mark-up was quickly abandoned.

Senator Dodd and Senator Shelby (R-Al.) decided to scrap the original Dodd bill and began negotiations to draft a bi-partisan financial regulatory reform bill. This process included establishing five bi-partisan negotiating teams to attempt to resolve issues in the most problematic areas of the bill. The corporate governance negotiators were Senator Schumer and Senator Michael Crapo (R-Id.). While these discussions were private, it was widely assumed that Schumer and Crapo were on opposite sides of the issues.

As the negotiations started, Dodd held the ultimate trump card. With 60 Democratic votes, Dodd could push through a partisan bill if negotiations stalled. A partisan effort would be expected to have governance provisions that resembled the Schumer Shareholder Bill of Rights or Dodd's November effort. However with the election of Senator Scott Brown (R-Mass.) on January 19, 2010, the Republicans, with 41 seats, can now block any bill from reaching the Senate floor.

On February 5, 2010, the Dodd-Shelby negotiations broke down and Dodd announced that he would try to go it alone. Several days later Senator Bob Corker (R-Tenn.) announced that he and Dodd would attempt to revive the bi-partisan negotiations.

With these frantic developments it is unknown if a financial regulatory reform bill with corporate governance provisions will pass. What is known is that the clock is ticking and that the closer the calendar inches to the midterm elections, the prospects for a financial regulatory reform bill becoming law dwindles. The Senate Banking Committee must mark the bill up, the Senate must pass a bill, the House and Senate must have a conference committee to reconcile differing bills, and a conference report would have to pass both houses. This would probably all have to be accomplished by the end of July before the election season kicks into high gear. Doable - yes. Possible - increasingly problematic.

Free Enterprise Fund v. PCAOB

On December 7, 2009, the Supreme Court heard oral arguments in the case of The Free Enterprise Fund v. Public Company Accounting Oversight Board . This case involves the appointment provisions, contained in Sarbanes-Oxley ("SOX"), for members of the Public Company Accounting Oversight Board ("PCAOB"). Under SOX, PCAOB members are appointed by the SEC. The plaintiffs claim that the members of the PCAOB should be appointed by the President, subject to confirmation by the Senate. A decision in this case may be rendered as early as March, 2010.

Supreme Court observers believe this is a rare opportunity for the Justices to issue a ruling on the Constitution's appointment clause. Additionally, the case has a strange quirk because SOX lacks what is known as a severability clause. A severability clause, which is common in most major pieces of legislation, provides that an unconstitutional provision of a law is jettisoned and the rest of the law remains in place. Traditionally if one portion of a law is found to be unconstitutional, if there is no severability clause, the entire law is unconstitutional. Under such a scenario, all of SOX could be declared to be unconstitutional.

If the PCAOB loses this case, governance advocates may use potential legislative efforts to fix SOX or pass a SOX II, as an opportunity to push the Shareholder Bill of Rights. Pressure for legislative action will increase depending on the scope of the ruling. If SOX is declared unconstitutional, then Congress may be forced to act, and a second front in the governance wars may be opened.

This case is a sleeper and should be watched closely.

Twombly and Iqbal

Two bills have been introduced in the House and Senate, S. 1504 by Senator Arlen Specter (D-Pa.) and H.R. 4115 by Representative Jerrold Nadler (D-N.Y.) that would seek to overturn a pair of Supreme Court decisions, Bell Atlantic Corp. v. Twombly and Ashcroft v. Iqbal . These bills would radically alter well-settled legal standards governing how a complaint should be pled. The Twombly and Iqbal decisions endorsed principles long applied by the lower courts in determining the sufficiency of a complaint's allegations to defeat a motion to dismiss for failure to state a claim. Overruling these decisions would make it impossible for defendants to obtain dismissal of even frivolous complaints and allow for the proliferation of costly litigation discovery. Iqbal stands for an unremarkable proposition that is settled in the law: plaintiffs should not bring a lawsuit and subject a defendant to the costs and burdens of litigation if there is no plausible basis for their claims.

In the context of litigation against government officials sued in their individual capacity, such discovery would vitiate an important component of the officials' qualified immunity, even for claims seeking to impose personal liability on Cabinet-level officials for actions undertaken to prosecute wars abroad or to respond to national security emergencies at home.

Hearings have been held on these bills, and it is possible that further committee action can happen at any time.

The next 30-45 days should provide clarity as to the path corporate governance proposals will take, as well as the prospects for success or failure. Once events begin to move, they may move quickly, so be careful to watch for developments.