It is a rare case that examines the corporate form with an exegesis that begins with the founding of the United States (or at least the adoption of the First Amendment).  Yet there is considerable history on this opinion, instigated by Justice Stevens and, to some degree, answered by Justice Scalia.  Whatever merits of the discussion for purposes of the case at hand, the discussion does show the significant evolution of corporations over the last 200 years.  

In those early days, corporations were not a creature of state statute but of state legislature.  As Justice Stevens noted: 

• Those few corporations that existed at the founding were authorized by grant of a special legislative charter. Corporate sponsors would petition the legislature, and the legislature, if amenable, would issue a charter that specified the corporation’s powers and purposes and “authoritatively fixed the scope and content of corporate organization,” including “the internal structure of the Corporation in the Law of the United States 1780–1970,pp. 15–16 (1970) (reprint 2004). Corporations were created, supervised, and conceptualized as quasi-public entities, “designed to serve a social function for the state.” Handlin & Handlin, Origin of the American BusinessCorporation, 5 J. Econ. Hist. 1, 22 (1945). It was “assumed that [they] were legally privileged organizations that had to be closely scrutinized by the legislature because their purposes had to be made consistent with public welfare.”

Of course, reliance on charters passed by the legislature also left open the possibility that the decision (including the terms in the charter) were determined by political rather than economic considerations.

He likewise notes that corporations were viewed with some suspicion.  After all, they could have an indeterminate life.  Again as Justice Stevens describes:

• The individualized charter mode of incorporation reflected the “cloud of disfavor under which corporations labored” in the early years of this Nation. 1 W. Fletcher, Cyclopedia of the Law of Corporations §2, p. 8 (rev. ed. 2006); see also Louis K. Liggett Co. v. Lee, 288 U. S. 517, 548–549 (1933) (Brandeis, J., dissenting) (discussing fears of the “evils” of business corporations); L. Friedman, A History of American Law 194 (2d ed. 1985) (“The word ‘soulless’ constantly recurs in debates over corporations. . . . Corporations, it was feared, could concentrate the worst urges of whole groups of men”). Thomas Jefferson famously fretted that corporations would subvert the Republic. General incorporation statutes, and widespread acceptance of business corporations as socially useful actors, did not emerge until the 1800’s.

Justice Scalia doesn't agree ("Despite the corporation-hating quotations the dissent has dredged up, it is far from clear that by the end of the 18th century corporations were despised.").  He notes properly that early suspicion may have arisen through "resentment towards corporations was directed at the state-granted monopoly privileges that individually chartered corporations enjoyed."  Yet these were the types of businesses that sought and received the corporate form.  It is not so easy, therefore, to separate opposition to the corporate form from opposition to the type of business they conducted. 

Finally, he notes that the corporate form in those early days was rare.

• Scholars have found that only a handful of business corporations were issued charters during the colonial period, and only a few hundred during all of the 18th century. See E. Dodd, American Business Corporations Until 1860, p. 197 (1954); L. Friedman, A History of AmericanLaw 188–189 (2d ed. 1985); Baldwin, American Business Corporations Before 1789, 8 Am. Hist. Rev. 449, 450–459 (1903). . . .  More than half of the century’s total business charters were issued between 1796 and 1800. Friedman, History of American Law, at 189. 

In short, the corporate form lacked anything close to widespread acceptance and dominant position held today.  Moreover, as discussion arises over increased legislative intervention into corporate affairs (mostly in the form of federal preemption of governance standards), it is important to remember that corporations began as creatures of the legislature.

The particular provision at issue did not involve restrictions on corporate contributions to political campaigns or prohibitions on expenditures that expressly advocated the election or defeat of a candidate.  Instead, the case inolved language added in 2002 that prohibited expenses for anything deemed to be an  “electioneering communication."  The term encompassed communications that referred "to a clearly identified candidate for Federal office” and was made 30 days before a primary or 60 days before a general election. See 2 U. S. C. §441b; see also 2 U. S. C. §434(f)(3)(A).  In short, corporations (and unions) could not pay for communications that referred by name to candidates just before an election. 

There are a number of topics that warrant examination.  First, there is an interesting discussion of the history of the corporate form in the United States.  Second, there is a suggestion that the best place to solve the corporate expenditure process is through resort to corporate governance.  We will discuss assertion.  Third, there is room for some regulatory intervention both by the Securities and Exchange Commission and Congress.  Finally, we will examine two places where the majority evidenced an activist approach in deciding the case.

Now it might be that this was intended as a compliment.  After all, Don Quixote has been labeled one of the greatest works of fiction in history.  Or perhaps it was meant as a criticism of Delaware and the Delaware courts, characterizing them as windmills.  Alas, neither is likely correct.  The reference was apparently to what Verret considers, shall we say, quixotic attacks on the Delaware model.  Dictionary .com kindly labels quixotic as "extravagantly chivalrous or romantic; visionary, impractical, or impracticable".  We suspect that Verret means the alternative definition, "impulsive and often rashly unpredictable". 

His defense of the Delaware model is an appropriate topic to debate, although with additional federal preemption coming, there will be less of it to debate.  Moreover, with executive compensation as an indication of the consequences of the model, it is not an easy case to make.

Yet his analysis is, in the end, weakened by gratuitous and overbroad slaps at those in academia who have cause to criticize Delaware's approach to corporate governance ("I’m proud to say that Lucian has forgotten more about corporate governance than most of the anti-Delaware critics who have followed in his footsteps."), not to mention excessive praise for himself ("I will, however, offer that my viewpoint is far more informed than most of Delaware’s critics."). 

It is reminiscent of the days when law and economics controlled legal analysis in the corporate area and shouted down anyone who did not agree with their reasoning.  In the end, personal attacks, much like saying it again louder, do not advance the debate.  Verret would have been more convincing had he stuck to the legal issues and avoided the personalities.  Otherwise, as Don Quixote said, "[b]y a small sample we may judge of the whole piece."  

Plaintiff Deloitte LLP is a Delaware limited liability partnership that provides audit, consulting, financial advisory, risk management, and tax services to clients.  Plaintiff Deloitte & Touche LLP is a Delaware limited liability partnership that provides audit and risk management services to clients.  Defendant Flanagan, a Certified Public Accountant, was a partner of one or both of the Partnerships for 30 years until his resignation on September 5, 2008.  As a partner of Deloitte, Flanagan was required to sign a Memorandum of Agreement with each of the Partnerships (“MOAs”) setting forth his rights and obligations as a fiduciary.  The MOAs require that partners not engage in any activities inconsistent with Deloitte’s rules and policies, one of which prohibits partners and employees of Deloitte from owning any securities in the firm’s “Attest Clients.”  Deloitte defines Attest Clients as clients for whom Deloitte performs audits, reviews of financial statements, or other “agreed upon procedures or engagements.”  The policies also require partners to disclose all information regarding investments held by them so that Deloitte can track any unauthorized holdings.  The policies further require that partners make annual representations to the Partnerships that they complied with these policies.   

Flanagan consistently made annual representations that he was familiar with the policies, that he had accurately and completely disclosed all investments he held, and that at no time did he have a financial interest in a restricted entity.  Deloitte’s Complaint asserted that, notwithstanding Flanagan’s representations, he did in fact trade in the shares of Deloitte clients in more than 300 instances over several years.  Deloitte requested partial summary judgment as to the question of liability on its claims for breach of fiduciary duty, breach of contract, common law fraud, and equitable fraud. 

The court focused on a subset of trades for which Flanagan did not offer a defense and which appeared to violate Deloitte’s policies.  According to the complaint, Flanagan received an 85% gain from trading call options of Allstate Corporation shortly after he reviewed a draft of the insurer's upcoming earnings release.  Flanagan then purchased and sold call options of Best Buy Company for a 31% return, after he directly provided audit services and learned of the company’s earnings prior to their public announcement.  Lastly, Flanagan received a 1,400% return by improperly trading in options of Motorola Corporation, another of Deloitte’s clients with whom he had worked, not long after receiving an e-mail that included a statement from the company's CEO about the Corporation’s recent performance. 

The court held that Flanagan’s misrepresentations with respect to his holdings constituted a breach of his duty to be “just and faithful to the Partnership,” therefore the court granted Deloitte’s motion for summary judgment on its breach of fiduciary duty claim.  For the breach of contract claim, the court stated that Flanagan was on actual notice that these three entities were clients of Deloitte since he personally provided them audit services.  As a result, his trading in these entities and his failure to report his trades to Deloitte constituted a breach of the MOAs.   The court also granted summary judgment for the equitable fraud claim because the court stated that Flanagan had an obligation to accurately report his trading on the Annual Representation form and to maintain an accurate and complete list of his holdings in Deloitte’s Tracking and Trading system.  Flanagan failed to fulfill either of these obligations.

Lastly, the court granted Deloitte’s motion for summary judgment on liability with respect to the common law fraud claim.  The standard for scienter in common law fraud requires committing the misstatement recklessly or with intent.  The court found that the magnitude of Flanagan’s unauthorized trades, the discerning trading in those clients for which Flanagan had material nonpublic information, and his misuse of the Tracking and Trading system established that Flanagan acted with requisite scienter. 

In summary, the court granted Deloitte’s motion for partial summary judgment as to liability.  Vice Chancellor John Noble left the determination of damages for a later hearing.

The primary materials for this case may be found on the DU Corporate Governance website.

First, of course, it is, to some degree, a clear victory for the judge.  He rejected a $33 million dollar settlement that did not address the failure to disclose the mounting losses by Merrill in connection with shareholder approval of the acquisition.  Moreover, the original settlement harmed existing shareholders by imposing a penalty without providing them with any benefits.  This settlement not only involves a substantially increased penalty ($150 million) but contains corporate governance provisions that ought to benefit existing shareholders.  It is a much improved deal.

Second, Bank of America strenuously argued that it had done absolutely nothing wrong in connection with the first settlement.  The settlement therefore looked like government extortion, the price Bank of America had to pay for getting rid of an overbearing government.   BofA has not admitted the allegations in the settlement (it merely acknowledged "having been served with the Amended Complaint", entered a general appearance and "admits the Court's jurisdiction over it and over the subject matter of the
Actions.").  Nonetheless, the rougher settlement provides greater assurance that the matter was resolved on the merits and not as a result of government coercion.

Third, the failure of the SEC to address the losses by Merrill Lynch in the first case (the complaint only involved issues around the representation that the bank had not approved the bonuses for Merrill when, it was alleged, they in fact had) and the confusion of the reliance on counsel argument suggested that the Agency had not been thorough in its investigation, lending credence to the suggestion by BofA that this case was best explained through government coercion.  The SEC has now added in claims about the losses and conducted extensive discovery, including taking depositions of officers and lawyers involved in the matter.  The increased thoroughness provides greater assurance that the matter is being decided on the merits and is not a product of government coercion. 

In rejecting the first settlement, Judge Rakoff indicated a number of concerns, including the failure to charge individuals.  While the Judge may be disappointed in this failure (although the individuals have now been charged by the New York Attorney General), it will not be enough to stop the settlement.  The SEC provided its reasons for not charging the individuals and, given the greater effort and thoroughness of the Agency, not to mention the depositions taken of counsel, the Judge will not hold up the settlement on this basis. 

These include enhanced auditor review of disclosure procedures and expanded certification requirements for the CEO and CFO (now applicable to the proxy statement).  The undertakings require greater involvement of the audit committee of the board in the disclosure process (through the requirement to hire special counsel). 

A series of undertakings are also designed to affect the compensation process.  The independence requirement for members of the compensation committee have been enhanced (subjecting them to the same standards as the audit committee independence requirement that was adopted in SOX), as has the requirement for the compensation consultants.  Shareholders are to receive an advisory vote on compensation (say on pay) and on changes in compensation policies. 

The description of the undertakings below comes from the memorandum filed by the SEC (and which will be posted eventually at the DU Corporate Governance web site).   We'll venture a prediction on what Judge Rakoff will do in the next post.

• Audit of Internal Disclosure Controls.  Under Section 404 of the Sarbanes-Oxley Act, 15 U.S.C. § 7262, Bank of America must establish internal controls and procedures for financial reporting and have its outside auditor attest to, and report, on management’s assessment of their effectiveness. Although Bank of America is also required to establish controls and procedures for disclosure-related matters and evaluate their effectiveness each quarter, see 17 C.F.R. § 240.13a-15, such disclosure controls and procedures are not required to be audited by an external auditor. This undertaking requires Bank of America to retain an independent auditor to perform an annual assessment and attestation of the Bank’s internal disclosure controls, similar to a Section 404 audit, and to include the attestation report in its annual report to shareholders and filings on Form 10-K.

• Certifications of Annual and Merger Proxy Statements.  Pursuant to the Sarbanes-Oxley Act, Bank of America’s Chief Executive Officer and Chief Financial Officer are required to certify the accuracy of the Bank’s quarterly and annual reports under the Exchange Act. See 17 C.F.R. §§ 240.13a-14(a), 240.15d-14(a). No certification is required, however, with respect to proxy statements. This undertaking requires Bank of America’s CEO and CFO to provide certifications of all annual and merger proxy statements similar in form to the certifications required for quarterly and annual reports under theSarbanes-Oxley Act.

• Special Counsel to Audit Committee. This undertaking requires the Audit Committee of the Bank’s Board of Directors to retain special counsel with expertise in disclosure issues who will report to the Committee and review the Bank’s public disclosures. The disclosure counsel is required to confer with members of the Bank’s Audit Committee in executive session at all regularly scheduled meetings, separate and apart from the non-independent Board members, to discuss the adequacy of Bank of America’s public disclosures.

• “Super-Independence” of Compensation Committee.  The members of Bank of America’s Audit Committee are prohibited, under the Sarbanes-Oxley Act, from accepting consulting, advisory or other compensatory fees from the Bank or its affiliates other than routine compensation for serving as a Board member. See 15 U.S.C. §78j-1(m)(3)(B). This standard of independence, commonly referred to as “super-independence,” is not required for compensation committee members. This undertaking requires Bank of America to adopt a super-independence requirement for members of the Compensation Committee of its Board.

• “Super-Independent” Compensation Consultant.   Pursuant to this undertaking, Bank of America will maintain a consultant to advise the  members of its Compensation Committee, who will also be subject to “super-independence” standards.

• “Say on Pay”.  As a former recipient of funds under the Troubled Asset Relief Program (TARP), Bank of America until recently was required to hold a non-binding shareholder vote to approve executive compensation. See 17 C.F.R. § 240.14a-20. Because the Bank has recently repaid the government the TARP funds it had received, it is no longer subject to this requirement. Thisundertaking requires the Bank to continue holding a non-binding shareholder vote on executive compensation for three years from the entry of judgment.

• Disclosure of Compensation Principles and Advisory Shareholder Vote on Any Changes.  Pursuant to this undertaking, Bank of America will implement and maintain incentive compensation principles and procedures and post a description of them in a prominent place on its website at www.bankofamerica.com. Unless a change in the principles is required by law, Bank of America can change them only after first informing its shareholders and placing any proposed change to the shareholders for an advisory vote.

Women are, or are soon to be, over 50 percent of our nation’s workforce.  They are 50 percent of the middle managers.  Yet females make up only 8 percent of the corporate officers and 3 percent of the CEOs, despite constituting over 30 percent of the MBA and law graduates since the 1970s (40 percent since the 90s).

Why the disparity?  Undoubtedly a glass ceiling still allows women to see but not obtain jobs on the highest rungs on the corporate ladder.  Yet, whether it exists, or doesn’t, any ceiling is more permeable, with many cracks in it (18 million, according to Hillary Clinton, numbering the votes she received in the presidential primaries).

Today the trick for women who aspire to upward progress is to find out where the cracks might be:

            Go Where They Aren’t.  This is the twenty first century.  Fields that were not open to women even 20 years ago are today.  CEOs Susan Ivey (Reynolds America), Pat Woertz (Archer Midland Daniels), Paula Rosport Reynolds (ex-CEO of Safeco Insurance), Lynn Elsenhans (Sunoco), and Ellen Kullman (Dupont) spent most of their careers in, respectively, tobacco, oil and gas, public utilities, petroleum, and chemicals.  Beyond training in business and accounting, none of these women began their careers with specialized technical knowledge.

            Be Financially Literate.  Many women who have reached the very top have done so in sales, or marketing (one, Anne Mulcahy at Xerox, in human resources) rather than in “line” jobs, those with bottom line profit and loss responsibility.  Male CEOs and board members, in particular, emphasize the absolute necessity of line experience for women.  Line experience or not, a CEO will always have plentiful support in finance and accounting.  But as the careers especially of women CEOs whom corporate boards have ousted, such those of Jill Barad at Mattel or Carleton Fiorina at Hewlett-Packard, demonstrate, possession and application of some grounding is essential -- no matter what pathway led to the top or how much staff support one has.  No substitute exists for a basic familiarity with corporate finance, managerial accounting, and capital markets.

            Have Style.  The existing advice books, or most of them, are flat wrong when they suggest that women should act like their male counterparts (“lower your voice,” “take up golf,” “watch Monday Night Football”).  Aggressive or assertive behavior, imitating what they perceive many males do, may well derail a woman’s career, even if after a promotion or two.  The days of “shoulder pad feminism” and Armani pants suits are gone. In the ranks of upper management, corporations want executives, men or women, who represent their corporations well, anywhere and at any time.  Diplomacy, the ability to think strategically, and the ability to show a team oriented approach have supplanted the dated 1970s advice, if it was ever good anyway.

            Develop a Reputation as a Problem Solver.  At Avon Products, CEO Andrea Jung evolved a strategy to retain hundreds of thousands of loyal Avon reps despite the relegation of “Avon calling” home sales to the whip and buggy era.  Charged with masterminding methods for making use of Dupont’s products safer, Ellen Kullman had Dupont spawn an entire new division, Safety, that is Dupont’s largest today. While at Chevron, Pat Woertz oversaw completion, on time and under budget, of an oil pipeline from Northern Alberta to Northern California.

Despite statistics (3 percent) that show only a glimmer of progress, closer examination of the careers of 21 women who have actually become CEOs demonstrates that many more routes than used to, or that readily meet the eye, lead toward the corner office.  

Douglas M. Branson is the W. Edward Sell Chair in Law at the University of Pittsburgh.  His newest book, The Last Male Bastion - Gender and the CEO Suite at America’s Public Companies,” has been published by Routledge Press early in 2010.

Doug received his B.A. from the University of Notre Dame and his J.D. from Northwestern University. He has also earned an LL.M. from the University of Virginia, specializing in corporate law and securities regulation. Before joining the faculty at the University of Pittsburgh, Professor Branson taught for more than 20 years at Seattle University. He holds a permanent faculty appointment at the University of Melbourne, Australia, in its Masters of Law Program.  As an elected member since 1981, he had an influential role in framing the American Law Institute’s recommendations for corporate governance.  Most recently, he has been a USAID consultant to the Ministries of Justice in Indonesia, Ukraine, and Slovakia advising on corporate law, capital markets law, corporate governance, and securitization issues.  Currently, he is the Condon-Falknor Distinguished Visiting Professor at the University of Washington in Seattle.

We welcome him to The Race to the Bottom.

Goldman’s 2007 proxy statement (“Proxy”) was prepared according to Schedule 14(a) and Item 402 of Regulation S-K.  Item 402 required Goldman to disclose the value of stock option grants to its CEO and its four highest compensated officers.  Goldman elected to value stock option grants using grant date present values.  SEC regulations in effect at the time required that Goldman make additional disclosures if it used a variation of common option pricing models to calculate grant date present value.  Required additional disclosures included, among other things, a description of the pricing model and any model adjustments for non-transferability or risk of forfeiture. 

Although Goldman allegedly used an alternative pricing model, its Proxy did not contain a description of the pricing model employed.  In addition, its Proxy did not contain any model adjustments.  Furthermore, Bader alleged option values contained in the Proxy understated the true value of the option grants by approximately 50%.  Consequently, he commenced this action and alleged the grant date present values set forth in the Proxy were materially false, in violation of Section 14(a) of the 1934 Act and SEC Rule 14a-9.  Moreover, Bader alleged that the miscalculations were due to Blankfein’s negligent actions.  Importantly, however, Bader failed to make a pre-suit demand on Goldman’s Board of Directors before commencing this action. 

Blankfein moved to dismiss the case because Bader failed to make a pre-suit demand.  The trial court granted Blankfein’s motion.  On appeal, Bader argued, among other things, (1) “there is no pre-suit demand requirement for shareholder derivative suits under section 14 of the 1934 Act because proxy misstatements are not a product of business judgment”; and (2) “in the alternative, demand was excused . . . as futile because [Goldman’s] directors were either interested or not independent.”

First, Bader argued that there was no pre-suit demand requirement because SEC regulations at issue required “full disclosure,” which is not a product of directors’ business judgment.  The court, however, held that disclosure of stock option values is a product of business judgment, and thus, pre-suit demand is required in an action brought under Section 14 of the 1934 Act.  Specifically, SEC regulations at issue implicated a business judgment because Blankfein decided what option pricing model to use and what disclosures were required.  Put another way, “[t]he information [regarding option valuation that was] required to be disclosed could not have been done automatically or without thought.”  Therefore, Bader should have made a demand upon Goldman’s Board of Directors prior to commencing the Section 14 derivative action at bar.  

Second, Bader argued pre-suit demand would have been futile because Goldman’s Board of Directors were interested or not independent.  In rejecting this argument, the court deferred to the lower court’s judgment: Bader’s “‘complaint[,] [even if amended, would] not create a reasonable doubt that the majority of the directors are disinterested and independent, and therefore fails to establish that it would have been futile to make demand upon Goldman’s Board of Directors prior to commencing this action.’”  Because Goldman’s Board of Directors were clearly disinterested and independent, a pre-suit demand was required before Bader commenced the action at bar. 

In sum, the U.S. Second Circuit Court of Appeals affirmed the lower court’s order dismissing Bader’s suit because Bader failed to make a pre-suit demand on Goldman’s Board of Directors before bringing a Section 14 derivative action, and because Bader failed to show that a pre-suit demand would have been futile. 

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

• There is undoubtedly a constituency that is interested in, and has long pressed the Commission to require, more extensive disclosures on environmental issues in order to drive particular environmental policy objectives. The issuance of this release, however, at a time when the state of the science, law and policy relating to climate change appear to be increasingly in flux, makes little sense.

As for the legal effects of the release, Commissioner Casey oddly opposed it because it reflected a statement of the law as it currently existed.

• Legal requirements and reputational pressures relating to climate change issues are, fundamentally, no different than those that arise in other regulatory contexts, albeit climate change is currently a “hotter” and more controversial political topic than most other regulatory issues.  . . . Nevertheless, the disclosure guidance in this release relating to legal requirements and reputational pressures would apply with equal force to any other legal and regulatory regime affecting public companies.

In other words, she did not object to any of the legal principles in the release, only that it was written in the context of climate change disclosure.  In other words, "there is no credible reason to single out climate change issues for discussion."

Its a strange criticism.  While it is true that the release applies a broad set of requirements to a specific type of disclosure, there is nothing new with that.  Moreover, to the extent it brings all of the existing requirements into a single place, there is a certain convenience factor that results.

Commissioner Casey's real objection seems to be the belief that by restating the requirements, they will in fact put pressure on companies to make more and better disclosure in the area.  As she notes:  "Nevertheless, this guidance assumes that man-made global warming and climate change are occurring as a result of greenhouse gas emissions and are likely to result in physical effects that will affect the businesses of registrants."

That may be true.  But whatever the cause, disclosure only needs to occur, presumably, where the change in the climate will have a material effect on the company's business.  There may be difficulties in quantifying the consequences and in the precise cause of the climate change, but shareholders ought to be informed about the impact of these changes if they will be material.

Paredes objected to several things (including his belief there were more pressing priorities before the Commission and, as a result, "now is not the time for this agency to consider climate change disclosure.").  One of them was this statement in the release:

• Depending on the nature of a registrant's business and its sensitivity to public opinion, a registrant may have to consider whether the public's perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition resulting from reputational damage.

He contended that the requirement would "foster confusion and uncertainty about a company's required disclosures'"  His main objection?  That "reputational damage . . .  can be quite speculative."  The result will encourage disclosures "that are unlikely to improve investor decision making and may actually distract investors from focusing on more important information."

The claim that disclosure can result in excessive amounts of information has been raised by Commissioner Paredes before.  See Statement by Commissioner Paredes at Open Meeting to Adopt Amendments Regarding Proxy Disclosure Enhancements, Dec. 16, 2009 ("Even as we add new disclosure requirements today, it is important to consider whether other mandated disclosures should be more narrowly focused or otherwise scaled back if they are no longer sufficiently useful to investor decision making").  Moreover, the risk that new requirements will result in boilerplate is always present. 

But the substance of the claim is misplaced.  Without the benefit of the entire release, there may be more to the statement than is in the remarks by Commissioner Paredes.  Yet it looks to be nothing more than an application of qualitative materiality.  Moreover, while the statement refers to reputational damage, it specifically indicates that this will only be important where it will have an adverse effect on business operations or finances.  In other words, this is about reputational harm that will hurt the bottom line.  

To the extent that this was the main objection (there was also one on the impact of disclosure relating the "physical effects of climate change"), it seems like a remarkably small issue that could have been readily clarified by the staff.  This suggests that in fact there were other motivations for opposing the guidance.  A hint of what that might have been appears in a later paragraph.  As Commissioner Paredes notes: 

•  Also problematic are the interpretive release's introductory and background discussions on climate change and its regulation. To me, the effect of the discussions is to find the Commission joining the ongoing debate over climate change by lending support to a particular view of climate change. Although the release does not expressly take sides, the release emphasizes the "concerns" and potential harms of climate change and discusses a range of regulatory and legislative developments, along with international efforts, aimed at regulating and otherwise remedying causes of climate change. . . . While the release stresses the risks of climate change and ongoing efforts to regulate greenhouse gas emissions in the U.S. and abroad, the release fails to recognize that the climate change debate remains unsettled and that many have questioned the appropriateness of the regulatory, legislative, and other initiatives aimed at reducing emissions that the release features. In short, I am troubled that the release does not strike a more neutral and balanced tone when it comes to climate change — an area far outside this agency's expertise.

Yet whatever the tone, disclosure apparently is limited to climate change matters that have a material effect on a company's business.  In other words, the SEC is not entering the debate on climate change as much as it is telling companies that material, quantifiable consequences of climate change must be disclosed.

Commissioner Paredes apparently views accurate disclosure as something that should be sidelined when the matter is controversial.  

• Impact of Legislation and Regulation: When assessing potential disclosure obligations, a company should consider whether the impact of certain existing laws and regulations regarding climate change is material. In certain circumstances, a company should also evaluate the potential impact of pending legislation and regulation related to this topic.

• Impact of International Accords: A company should consider, and disclose when material, the risks or effects on its business of international accords and treaties relating to climate change.

• Indirect Consequences of Regulation or Business Trends: Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for companies. For instance, a company may face decreased demand for goods that produce significant greenhouse gas emissions or increased demand for goods that result in lower emissions than competing products. As such, a company should consider, for disclosure purposes, the actual or potential indirect consequences it may face due to climate change related regulatory or business trends.

• Physical Impacts of Climate Change: Companies should also evaluate for disclosure purposes the actual and potential material impacts of environmental matters on their business.

Mostly the release (as evidenced by the press release) emphasizes the need for companies to disclose the impact of enviornmental/climate change legislation/regulations (and treaties) whenever they can have a material effect on the company.  In short, the release looks like little more than a reiteration of the already existing requirement that material effects on business need to be disclosed.  If no other place, this would be required disclosure as a trend in the MD&A. 

Indeed, the release stressed that the obligations would not "create new legal requirements nor modify existing ones, but are intended to provide clarity and enhance consistency for public companies and their investors." 

The defense’s motion claimed that Robin Szeliga’s (“Sleliga”) deposition testimony to the SEC two years after the conclusion of the trial created recognizable “new evidence” which was sufficiently significant to grant a new trial. 

During the 2007 criminal trial, Szeliga testified about communications between herself and Nacchio concerning Qwest’s 2001 financial target shortfalls.  Qwest kept two sets of revenue targets.  The first was an internal target unknown to the investing public and the second was public.  Szeliga learned in 2000 that there was a $1 billion shortfall risk in Qwest revenues.  She also testified that she communicated this billion dollar risk to Nacchio.  Confusion ensued during Szeliga’s trial testimony on whether she told Nacchio the billion dollar shortfall related to the internal or public targets.  If the risk related to internal targets it represented 1.4% of Qwest’s revenues, while if the risk corresponded to the public target it was 4.2% of Qwest’s revenues.  During Szeliga’s SEC deposition testimony two years after the trial she seemingly testified about the billion dollar shortfall relating to the internal and not public figure.  In her deposition, however, she continually cautioned SEC attorneys that her recollection was vague and that she needed to look over documents to refresh her memory. 

Nacchio contended in his motion that Szeliga’s deposition was new evidence that confirmed the billion dollar risk related to the internal targets, representing 1.4% of Qwest’s revenues.  In particular, Nacchio claimed this affects the materiality of the communications, thereby requiring a new trial.

A motion for new trial under Federal Rule of Criminal Procedure 33 based on the discovery of new evidence requires: “(1) the evidence was discovered post-trial; (2) the failure to discover the evidence was not caused by the defendant’s lack of diligence; (3) the new evidence is material to the principal issues involved; (4) the new evidence is not merely cumulative or impeaching; and (5) the new evidence would probably produce an acquittal in a new trial.”  The court focused its analysis on the last two elements. 

New evidence cannot be merely cumulative or impeaching.  As explained by the court, cumulative evidence simply confirms or corroborates evidence already established by other evidence.  Impeaching evidence simply calls a witness’ credibility into question.  The court noted Szeliga’s trial testimony thoroughly examined her communications with Naccio and the existence of a substantial risk shortfall.  Both the prosecution and defense had ample time to explore these issues in their direct, cross examination, and redirect.  In fact, it was these exhaustive examinations which lead to the confusion about whether the billion dollar risk applied to the internal or public targets.  The court held Szeliga’s SEC deposition could only be cumulative or impeaching.  The deposition added no new information and did not recant her trial testimony.  Notably, Szeliga continually told SEC attorneys that she was having trouble recollecting specifics about their questions.  Her deposition would only corroborate that her statements to Nacchio about the billion dollar risk did apply to the internal targets or would simply undermine her credibility, nothing more. 

Lastly, the court stated the deposition testimony continued to demonstrate Szeliga’s inconsistent testimony about which financial target her communications with Naccio concerned.  For the court, the deposition testimony fell well short of demonstrating reasonable probability of resulting in an acquittal.

Accordingly, Judge Krieger dismissed Nacchio’s Motion for New Trial.  The Race to the Bottom will continue its coverage of the Nacchio saga as it develops.  

The primary materials in this case can be found at the DU Corporate Governance web site.    

The difficulty in reaching consensus can be worsened by the existence of representation of both parties on the body.  The five person commission is prohibited by law from having more than three persons of the same party.  See 15 USC 78d ("Not more than three of such commissioners shall be members of the same political party, and in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable.").  Ordinarily, therefore, the party in the White House gets three seats (and a majority) and the party out of power receives the other two (although there have been cases where the non-majority slots went to independents). 

Of course, its possible to have appointees who represent both parties but have the same philosophical approach to regulation.  In other words, party affiliation isn't by itself a guarantee of diverse viewpoints.

The current Commission, however, does have a diversity of viewpoints that break down along party lines.  The Commission currently has a full complement.  Schapiro, Walter and Aguilar sit in the democratic slots; Paredes and Casey occupy the republican ones.  Four of the current appointees were put on the Commission by President Bush.  President Obama has only had a single appointment so far, the chair, Schapiro. 

Particularly in the area of corporate governance and corporate disclosure, it looks as if any pretense at consensus no longer exists at the Commission.  More decisions seem to be made by a 3-2 vote.  Examples?  The Amendments to Rule 452 of the NYSE to prohibit discretionary voting by brokers in uncontested elections for the board of directors; the proposed rules giving shareholders the right to access.  The most recent is the interpretive guidance on climate change disclosure.    

Note that the two dissenting commissioners (always Paredes and Casey) have done so in rules sought by the self regulatory organization (the amendment to Rule 452), rules that were merely proposals  (access), and interpretive guidance.  Commentary suggests that the interpetive guidance on climate control merely repeats what lawyers already tell their clients.   In other words, the two in opposition felt the need to object to a release that largely reiterates rather than changes the law.

This sort of divisiveness is, it seems, increasingly common in the political realm.  Now, apparently, it is becoming increasingly common in the administrative realm.  One of the consequences is, ironically, a reduction in influence for the dissenters.  In shaping access or repealing the limits in Rule 452, a consensus approach would likely give the dissenters influence on the final terms of the regulation.  Yet by objecting, particularly at the onset, the dissenters largely make themselves irrelevant to the shaping of the final product.  As for the length of time on the commission, Casey's term expires in 2011.  Paredes has until 2013.

Encouraging Observations: The Good Guys and Gals
The most encouraging observation is that there appear to be several Senators, House Members, and a President who are concerned about repeating the mistakes of the past. 

1. Senate: There are some very engaged Senators and staffers on the Banking Committee who want to prevent future financial crises. The one who stands out is Senator Jeff Merkley (and his fabulous staffer, Andy Green) from Oregon. A close second is Senator Kohl from Wisconsin, due to his stellar staffer, Harry Stein.
2. House Legislation: I am encouraged that the House did pass by a vote of 223- 202, H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009. Quite simply, there are at least 223 people looking out for the taxpaying middle class. The general topics this bill covers were identified earlier in this series.  You might want to see who supported this bill. Here’s the roll call for the vote. It is worth noting that there was not a single Republican “aye” vote and there were 27 Democrats who voted “no.” There were nine who did not vote at all. If you want to know the name of your Representative in the House, check here. 
3. House Hearings on Executive Pay: Moreover, at the House Financial Services Committee hearing on “Compensation in the Financial Industry,” many in attendance (at least one Republican and at least a half dozen Democrats) were very concerned about the way Wall Street is using the bailouts and back-door subsidies to the record of $140 billion in bonuses for 2009. One expert witness noted that some banks that received bailout funding (TARP) returned the money even though it lead to a decline in stock value. The implication is that the CEOs of those banks did this so that they would be able to make more money personally at the expense of their own shareholders.
4. Obama “Volcker Rule”: It was encouraging that the President heard the message that the public is frustrated with the slow progress on financial regulatory restoration, and though not as expansive as one would hope, the proposal does require action to be taken to help prevent the gambling and speculation at too-big-to-fail banks to avoid another massive economic crisis.

Causes for Concern

1. Taxpayers to Fund the Next Bailouts: I am not kidding you. It is true. The Senate plan is for taxpayers to fund the next bailout. In some Orwellian double speak, we heard from both Warner's and Corker's staff that no one wants another bailout, but that the funding to resolve a failing giant bank will come from the Treasury, capped to some degree, but open for Congress to increase the funding.
2. The Warner- Corker Bankruptcy Approach: As noted in detail in an earlier part in this series, bankruptcy instead of pre-funded receivership-type resolution is (1) not new; (2) not a resolution; and (3) not the free market approach, but just another taxpayer funded bailout.
3. Lack of Preventative Measures:  It was alarming to hear the staffer for Tennessee Senator Bob Corker (R) inform us that no preventative regulation was needed other than some transparency, and that she doubted that we would ever again have a situation where another large financial institution became insolvent. This was stated in the context of questions we raised about funding a resolution. In other words, this reflects a view, perhaps of her boss, Senator Corker, that transparency and the presence of more regulators with oversight (such as the Fed’s current oversight of investment banks that are now bank holding companies) would be enough to prevent a future debt-fueled asset bubble.
4. Power of the Big Banking Lobby: It was extremely distressing to find out that the lead Democratic Senator on the systemic risk/too-big-to-fail legislation appears more committed to satisfying the big banks than taxpayers, consumers, or the 5,000 community banks. This was evident, as noted above, when his lead legislative aid chose to meet with the President of the American Bankers Association instead of keeping the appointment with us. Indeed, the  banks may be okay with the ban on proprietary trading because they can easily get around the ban, according to former Goldman Managing Director, Nomi Prins.
5. The Obama proposal freezes firms as they are, but does not address their existing scope, scale, concentration or interconnectedness. Finally, many of the important measures for improving corporate governance (including shareholder empowerment), enhancing consumer protection, ending predatory lending, reforming credit rating agencies, creating transparency in the asset-backed securities markets, requiring registration of advisers of hedge funds, and other private pools, are not being addressed in the Senate. They are outside of the Warner-Corker team's scope or the President’s proposal. And, many excellent suggestions such as those by SAFER, Shareowners.org, and AFR are relevant and not yet being considered.

Open Questions

The Volcker Rule: The president declared that “Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers.” There seems to be uncertainty as to what qualifies as “proprietary trading for their own profit, unrelated to serving their customers.” That might appropriately include all trading activities other those under which the bank has a “fiduciary duty." Expect this definitional space to be where the lobbying begins.