Corporate Governance

Corporate Governance, the Bailout and a Lost Opportunity (Part 3)

By J. Robert Brown

So what could Congress have done in the Bailout Bill?  The model already exists.  The approach might be labeled "SOX Plus." 

Congress could have mandated that the boards of all companies participating in the bailout form a committee designed to assess risk (something that could be assigned to the audit committee).  The committee would consist entirely of independent directors (using the stricter definition as in SOX rather than the weaker definitions of the stock exchanges) and have at least one "risk specialist" as a member.   

Companies should be required to have in place procedures designed to assess financial risks (most probably already have these procedures).  The key, however, would be to assign accountability for the standards.  First, the certifications by the CEO and CFO could be expanded to require that they certify the existences and efficacy of risk standards and procedures.  Second, the procedures would need to be assessed by management and reviewed by outside experts.  In other words, duplicate the process in Section 404 of SOX. 

The procedures would require regular reports to the board and reports any time the risk procedures were not met.  Thus, whenever Bear Stearns exceeded its internal limits on mortgage securities, a report would have to be made to the relevant board committee.

Reports about risk and violations of risk standards would still be left to the discretion of the board.  Nonetheless, even under the anemic regime in Delaware, directors on notice of potential problems would likely have a duty to at least investigate and to respond to the problem.  In other words, the most immediate solution is to make sure the board knows about the standards and any noncompliance process.  If directors did not act, they would risk personal liability which might mean the obligation to pay a judgment out of their own pocket.  Moreover, a failure to act implicates the duty of good faith under Delaware law and, as a result, waiver of liability provisions would not be applicable.

These types of reforms would not be necessary if Delaware already required boards to be more involved in risk assessment as part of their fiduciary duties.  But, alas, it does not.  A federal solution is the only solution.   

Full post as published by The Race to the Bottom on October 06, 2008 (boomark / email).