Since their inception, the accountability of independent regulatory agencies has been of concern to scholars of public law and political science. But whilst many decry the lack of accountability of regulatory agencies, others (albeit a minority) argue that accountability demands are counter-productive or subverted, prevent the agency from performing its role effectively or create cultures of blame.

The challenges of calling regulators to account are deep-rooted. The first key challenge is that of fluidity and ambiguity: the tension between independence, political control and political accountability creates an ambiguity in the responsibilities of the core executive and regulatory agencies which both, but particularly the executive, can seek to exploit. As a result, lines of responsibility and thus of accountability can be unclear, to say the least, particularly when things go wrong.

…continue reading: Calling Regulators to Account

At the center of the corporate wreckage of the past fifteen years — the accounting scandals, the outright fraud, the environmental disasters, the financial meltdown — sits the boards of directors. Their failure to choose the right CEO and to provide appropriate oversight on core risks and opportunities has, in my view, reflected a broad failure of the corporate governance movement and its reliance on directors to effectively to oversee the corporation and its business leaders.

Yet, the recent fall of Vikram Pandit, Citigroup CEO, underscores a basic truth: Independent boards of directors are still the best mechanism — or the least worst one — for holding business leaders accountable, even if many boards have failed in their attempts to do this, often in spectacular fashion.

Much of the Citigroup commentary has focused on the behind-the-scenes campaign of Citigroup board chair William O’Neil to oust Pandit and his stark ultimatum during a one-on-one confrontation: resign now, resign at the end of the year, or be fired.

Many have criticized O’Neil for his ham-handedness, saying this was rude to Pandit, demoralizing to essential Citi leaders, lacking in clear public rationale. A minority, however, has said such CEO separations are invariably messy, bringing to mind Lady MacBeth’s advice to her husband about murdering the king: “If it were done when ’tis done, then ’twere well, It were done quickly.”

But the tactics surrounding the decision should not obscure the potential importance of the decision itself. Are boards of directors now more than in the past focusing on their fundamental task — critically evaluating the leadership and the management of the CEO? Are they now much less hesitant to force changes at the top of the corporation due to performance on fundamentals, not just scandal or stock price variation?

…continue reading: Citigroup: A Symbol of Board Resurgence?

In the wake of its significant trading losses (now reportedly rising from $2 to $3 billion or more), JP Morgan can win back some of its lost reputation by transparently holding those responsible to account.

These individuals could include (but not be limited to) the London trader, Bruno Iksil (“The London Whale”); his London boss, Achilles Macris; their U.S. boss, Ina Drew, the former head of the bank’s Chief Investment Office (CIO); and CEO Jamie Dimon, who oversaw the CIO. Drew quickly retired after the losses, and Iksil and Macris are, according to news reports, leaving the bank.

Although the media has spoken loosely about a company “clawing back” pay, there are, in fact, different ways to hold responsible individuals to financial account. A “claw-back” seeks cash or equity already transferred to an individual. A “hold-back” cancels financial benefits which have been awarded but have not yet vested. A future compensation action would reduce 2012 variable benefits (bonus or equity awards) in absolute terms (or through a much slower rate of increase). Claw-backs or hold-backs of past awards could be appropriate for the departed employees. They could be appropriate for Dimon, but so could a compensation action about future variable comp.

…continue reading: Can JP Morgan Transparently Police Itself?

In the past few years, hedge funds have moved into the mainstream of the U.S. economy. Once restricted to a small number of super-wealthy “sophisticated investors,” they now receive hundreds of billions of dollars from public and private pension plans acting as fiduciaries for school teachers, truck drivers, construction workers, first responders and others whom we have lately come to call “the 99 percent,” who share little in common with fund managers stocking the Forbes 400 list. Surfing upon this incoming tide of money, some individual funds now manage enough assets to exert significant influence in the markets.

But the widespread acceptance of hedge funds among institutional investors has not been matched by commensurate improvements in their level of transparency, accountability and corporate governance. In recent months, we’ve witnessed the dismal result: a parade of inside-trading scandals evoking the fraud-riddled implosions of Worldcom, Tyco, Enron and Global Crossing that rocked corporate America a decade ago. It’s time for hedge funds to be brought into the 21st century and reflect their new broader role and fiduciary responsibilities. This means the legal regime that sets the rules for hedge funds must change.

Without question, the profile of the average hedge fund investor has changed in the past few years. Battered by the financial crisis that erased billions of dollars in stock market value just a few years before the first baby boomers were scheduled to retire, many pension funds started investing with hedge funds in the hope of making up lost ground by taking advantage of their customized, often quant-driven investing strategies and promises of “absolute returns” regardless of the markets’ direction.

…continue reading: Hedge Funds Need More Accountability

In our paper When the Government Is the Controlling Shareholder, recently made publicly available on SSRN, we analyze the ways in which existing corporate law structures of accountability change when the government is the controlling shareholder, and the extent to which federal “public law” structures substitute for displaced state “private law” norms.

As a result of the 2008 bailouts, the United States Government is now the controlling shareholder in AIG, Citigroup, GM, GMAC, Fannie Mae and Freddie Mac. Corporate law provides a complex and comprehensive set of standards of conduct to protect noncontrolling shareholders from controlling shareholders who have goals other than maximizing firm value, but are designed with private parties in mind. We show that when the government is the controlling shareholder, the Delaware restrictions are largely displaced, but hardly replaced, by federal provisions. When GM goes public again, government ownership of a controlling position will be a significant “risk factor.”

…continue reading: When the Government Is the Controlling Shareholder

The “clawback” of pay from high-level executives for malfeasance is a hot but complex topic. Designed properly, such a policy is a significant mechanism for corporate accountability.

The Dodd-Frank bill, passed last month, mandated substantive clawback requirements for any company listed on a U.S. securities exchange if it has material financial restatements. Also in July, the European Parliament passed legislation requiring clawbacks , and the UK’s Financial Services Authority revised a proposed rule on remuneration, effective next January, which has a new provision that will define clawbacks. Prior to these regulatory developments, 212 of the S&P 500 had adopted a variety of “clawback” policies, but hundreds of public companies still don’t have such compensation recovery policies as required by Dodd-Frank.

…continue reading: Making Sense Out of “Clawbacks”

The issue of allowing shareholders of public companies to include their nominees for director in the company’s proxy materials (“Proxy Access”) has been the subject of heated debate for years. In 2003, when there were no state law provisions addressing the issue, and in 2007 (when only the North Dakota statute addressed Proxy Access), the Securities and Exchange Commission proposed rules that would facilitate such inclusion, only to abandon the proposals. In March 2009, Delaware added Section 112 to its General Corporation Law, effective August 1, 2009, to allow for bylaws that permit Proxy Access. It has been widely expected that many other states would follow Delaware’s lead and adopt similar statutes. In May 2009, the SEC announced that it would propose a new rule, Rule 14a-11, dealing with Proxy Access that would preempt key parts (but not all) of Delaware Section 112. Proposed Rule 14a-11 would differ in three important respects from the Delaware provision:

In its release announcing that it would propose Rule 14a-11, the Commission focused on enhancing director accountability. According to the Commission, the current economic crisis has created widespread concern about “whether boards are exercising appropriate oversight of management, whether boards are appropriately focused on shareholder interests, and whether boards need to be held more responsible for their decisions regarding such issues as compensation structures and risk management.” The Commission’s solution to the above problems is Proxy Access:

Because of these concerns, the Commission has decided to revisit whether and how the federal proxy rules may be impeding the ability of shareholders to exercise their fundamental right under state law to nominate and elect members to company boards of directors.

But the connection between effective director accountability and Proxy Access for shareholders is not obvious and depends on the validity of several implicit and intermediate premises. We believe that the SEC should address and make a strong case on each of the following premises.

Proxy Access, as a component of corporate governance, is a matter more properly dealt with under state law. We believe that the SEC, as a federal agency, should make a strong case before regulating in an area traditionally regulated by states. This is especially true with respect to Proxy Access, where state legislation is only in its infancy. It is likely that the states will develop a significant body of experience in a relatively short time and it will not be long before more resolving evidence emerges whether or not Proxy Access initiatives at the state level are or are not an effective means of dealing with the issue of director accountability. (We do not address in this alert the issue of whether the SEC has the power to enact Rule 14a-11, an issue that others have dealt with.)

Accordingly, we believe that it would be appropriate for the SEC to adopt a rule consistent with Rule 14a-11, if, but only if, it can make a strong case that the proposed rule is likely to enhance director accountability; that state initiatives such as Delaware’s Section 112 are not likely to increase director accountability; and that the current problems with director accountability are severe enough that we cannot afford to wait to see whether state-level regulation proves out. In making that case, it should address each of the premises discussed below.

…continue reading: Will proxy access enhance director accountability?

RiskMetrics Group recently released updates to its 2009 proxy voting policies, after an extensive process that included outreach to and input from hundreds of institutional investors and corporate issuers. RiskMetrics’ policies will be applied to all companies with shareholder meeting dates on or after February 1, 2009.

This year’s policy revisions reflect the unprecedented market turmoil that has sparked investor and regulatory focus on executive compensation practices, board accountability and oversight, and the quality of financial reporting. Accordingly, the three main areas of focus for the 2009 policy updates are executive pay, board structure, and audit practices.

Both issuer and investor respondents to RiskMetrics’s annual policy survey demonstrated little tolerance for outsized pay packages, with 70 percent of investors and 85 percent of issuers specifying pay relative to performance as “very important” in evaluating executive compensation practices. Thus, RiskMetrics’ policy guidelines on executive compensation have been expanded to examine practices that divorce pay from performance, such as tax gross-ups on severance payments and executive perks, and provisions that pay severance for voluntary departures following a takeover.

RiskMetrics has also harmonized assessment of company performance across several North American policies. As of 2009, corporate performance will initially be assessed using a relative, rather than absolute, measure of total shareholder return over 1- and 3-year periods. This assessment will result in greater scrutiny under several policies, including pay-for-performance evaluations, independent chair shareholder proposals, and director elections. Regarding the latter, the policy update addresses cases where lagging company performance is coupled with a governance structure that discourages director accountability and may lead to board and management entrenchment.

Additionally, RiskMetrics has updated its accounting policy guidelines to specify ongoing material weaknesses in Section 404 disclosures and misapplication of GAAP as triggers for in-depth analysis of a company’s accounting practices, and to recommend against audit committee members in the case of an adverse opinion from auditors.

Internationally, RiskMetrics revised its share buyback policy to reflect client feedback and regulatory developments in Europe. RiskMetrics’ policy on discharge of directors resolutions, common in several markets, will now accommodate recommendations designed to provide a “yellow card” warning to directors who may not be fulfilling their fiduciary duties. Director independence best practices in several European markets have also been incorporated into the 2009 policies. In Canada, RiskMetrics is introducing a Poor Pay Practices Policy to reflect the additional disclosure that is now available in that market.

The 2009 policy updates are accessible through RiskMetrics’ online Policy Gateway, which also contains FAQs and other informational resources to provide all market participants with a good understanding of how RiskMetrics formulates and applies its corporate governance policies. In addition to its own policies, the corporate governance policies and philosophies of leading market participants are also available via RiskMetrics’ Policy Exchange platform.