The law of unintended consequences?
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was enacted in response to perceived excesses and other dysfunction in the financial markets that precipitated the 2008 financial crisis. The public discourse surrounding the adoption and implementation of Dodd-Frank — including the notion that institutions deemed “too big to fail,” unless appropriately restrained, would take on excessive risks — permeates the more than 2,000 pages of the final act.
While much of Dodd-Frank was unrelated to corporate governance, portions of it directed rulemaking over matters usually in the purview of state law and private ordering. In broad terms, Dodd-Frank’s corporate governance provisions can be classified into two categories: executive compensation and accountability. Although the provisions may have been well intended, it is far from clear that they were necessary — and they may have stunted the organic progress that often occurs when market participants exert leverage and state courts apply more flexible principles of equity.
Dodd-Frank included three provisions geared toward compensation. First, it initiated the “say-on-pay” regime, which requires reporting companies to seek an advisory vote from their stockholders on executive compensation. Second, it initiated rulemaking from the SEC regarding independent compensation committees and compensation consultants. Third, it effectively mandated additional disclosure regarding executive compensation.
The intrusion of federal law into matters of internal governance that were once reserved for the states tends to discourage other corporate governance practices and policies. As a general matter, while it may not be unreasonable for management to consider stockholders’ views on executive compensation, the merits of “say-on-pay” remain subject to debate. Critics of “say-on-pay” have observed that the outcome of a vote may be difficult to decipher or respond to in a meaningful way and that it may be used as a means for stockholders to register dissatisfaction with the performance of the stock price, leading to a focus on short-term performance over the long-term best interests of stockholders. Likewise, while there may be nothing inherently objectionable about a compensation committee being composed solely of independent directors or having the power to engage consultants, it’s not clear that federal intervention was necessary to address matters that fall within the scope of state-law fiduciary duties. State courts, particularly in Delaware, are adept at assessing independence and disinterestedness, and they have proved to be effective in ferreting out advisor conflicts and other types of abuse or overreach. Their pronouncements tend to generate thoughtful changes in governance practices and procedures.
In addition to its focus on compensation, Dodd-Frank confirmed the SEC’s authority to implement proxy access and directed the SEC to mandate disclosure regarding whether the chairman and CEO positions are combined. Interestingly, Dodd-Frank’s foray into proxy access may have demonstrated, if anything, the important role of state law in driving corporate governance reform.
In 2009, with Dodd-Frank and activity around proxy access on the horizon, the Delaware General Corporation Law was amended to add Section 112, which permits bylaws requiring a corporation soliciting proxies for the election of directors to include in its proxy materials one or more stockholder nominees. While the statute included a non-exclusive list of the types of procedures and conditions that could be included, it made clear that “any other lawful condition” not expressly referenced could be adopted, giving corporations broad authority to design a proxy access regime appropriate to their unique circumstances. Few Delaware corporations rushed to enact proxy access bylaws after the adoption of Section 112. Indeed, with the backdrop of a federal regime that would supersede the area, client alerts from prominent law firms advised corporations to take a “wait-and-see” approach to proxy access bylaws. Although the SEC ultimately adopted final rules implementing a proxy access regime, these were vacated after a ruling that the SEC failed to take into account the economic implications. Now, according to Sidley Austin LLP’s 2019 report, The Latest on Proxy Access, proxy access bylaws have become widespread among large public companies, propelled by market participants relying on enabling statutes.
The provisions of Dodd-Frank dealing with the separation of the chairman and CEO were intended to require disclosure around board structure and not to mandate any particular method. That Dodd-Frank essentially required a summary of the rationale behind the decision, however, lays bare the underlying premise: If there were nothing suspect about having the same person serve as chairman and CEO, there would be no need to explain away the arrangement. While it may make sense for some companies to split the roles, it assuredly is not the case that every company would want to adopt that approach — or be subject to scrutiny for failing to do so.
The powers and duties that may be assigned to the position of chairman vary tremendously among companies. While the role frequently involves some level of coordination, it is by no means uniform. Moreover, it may make sense for some companies that have alternative governance structures, such as an active lead independent director, to maintain a dual chairman/CEO. Most important, however, is that if any particular governance structure is prone to fiduciary misconduct, those matters should be addressed at the state level.
State corporation law is sufficiently flexible to allow for multiple governance structures to emerge to address newfound concerns that may arise among investors. Moreover, the influence of market participants — coupled with the overlay of fiduciary and equitable principles enforced and developed through state courts — is generally sufficient to lead companies to appropriately address governance concerns. Federal law tends to intrude into state corporation law in response to specific crises through more a rigid framework. While some of the federal responses to the specific crises (or elements of those crises) may not be facially objectionable, they tend to be at once overbroad in the companies they capture and too narrow in their application. They also tend to thwart the development of principles of sound corporate governance that may otherwise emerge from common law or through other market forces.
President Barack Obama signs Dodd-Frank into law with U.S. Representative Barney Frank, Senator Chris Dodd, Senate Majority Leader Harry Reid and House Majority Leader Steny Hoyer. (Image: Shutterstock)