The Board of Directors and a Review of Corporate Disclosure

When the Commission inked the settlement with Bank of America (yet to be approved by Judge Rakoff), it included some corporate governance reforms.  One of them was to require the audit committee to retain disclosure counsel who would review the company's disclosure and report to the audit committee.  As the settlement disclosed:

• IT IS HEREBY FURTHER ORDERED, ADJUDGED, AND DECREED that within forty-five (45) days of the entry of this Final Judgment, the Audit Committee of BAC's Board of Directors ("Audit Committee") shall retain disclosure counsel with expertise in disclosure issues ("Disclosure Counsel") for a period of three (3) years after entry of this Final Judgment. The Disclosure Counsel shall report solely to the Audit Committee. BAC shall require that the Disclosure Counsel: (i) review drafts of all of BAC's public disclosure statements, including all quarterly reports, annual reports, proxy statements, and current reports containing financial information; and (ii) confer, in executive session, with members of the Audit Committee at all regularly scheduled meetings of the Audit Committee, separate and apart from the nonindependent members of BAC's Board of Directors, to discuss the adequacy of BAC's disclosures in its public disclosure statements. BAC shall also require that the Disclosure Counsel, for the period of engagement, not enter into, directly or indirectly, any other employment, consulting, or other professional relationship with BAC or its affiliates, directors, officers, employees, or agents without obtaining the consent of the Commission's staff.

The approach is an interesting one.  SOX substantially beefed up the obligations of the audit committee, at least for Exchange traded companies.  See Section 301 of SOX.  The committee was given the direct authority to supervise and to hire/fire the outside auditor.  The committee was also given the authority to hire counsel without full board approval.  The approach essentially amounted to the preemption of state law by redefining the duties of the audit committee (taking them away from the full board) and by treating a sub-category of the board (a single committee) as a separate entity with its own jurisdiction and funding authority.  The approach has raised interesting ethical questions, particularly whether the privilege rests with the board or with the committee.

In the proposed settlement with BofA, the SEC is seeking to augment the authority of the audit committee one more time.  The Commission is giving to the audit committee (not the full board) the authority to hire counsel.  Counsel must not only review filings but must discuss possible deficiencies with the audit committee in executive session, without the presence of the non-indpendent directors.  The latter restriction is significant. 

While the three committees required by the exchanges (nominating, compensation, and audit) must consist entirely of independent directors, there is no requirement that they meet in executive session or otherwise exclude the non-independent directors.  Indeed, one would say that the compensation committee usually consults actively with the CEO over compensation issues.

To the extent approved by Rakoff, the change can be characterized as another example of the SEC dipping into the corporate governance debate and setting out what it thinks are good governance principals.  

The primary materials, including the proposed settlement, can be found at the DU Corporate Governance web site.