* Copyright 2002 by Alton B. Harris and Andrea S. Kramer, all rights reserved. Mr. Harris is a partner inthe law firm of Ungaretti & Harris. Ms. Kramer is a partner in the law firm of McDermott, Will & Emery.They thank Brecken J. Cutler for her valuable assistance in preparing this paper.

(Available June 2003)

Corporate Governance: Pre-Enron, Post-Enron

By

Alton B. Harris and Andrea S. Kramer*

“Corporate governance” is theprocess by which a corporation’s man-agement is held accountable to itsresidual ownersthe stockholders. Be-cause of Enron and scores of othercorporations currently embroiled in ac-counting and managerial scandals, theNew York Stock Exchange (NSYE) andthe Nasdaq Stock Market (NASDAQ)have approved sweeping new listingstandards and the Congress has enactedwide-ranging federal legislationtheSarbanes-Oxley Act of 20021that willprofoundly affect the nature of and con-trol over corporate governance in theUnited States.

While the implosion of Enronwas unquestionably the decisive eventthat shaped the content and timing of thenew corporate governance paradigm,Enron’s significance in this regard can-not be fully appreciated except in thecontext of the changes in expectations asto “best practice” for corporate govern-ance over the prior 30 years. In thispaper, we examine the unique nature ofthe corporate governance problem, tracethe development of a “consensus” modelof “best practice” expectations, discussthe changes that the new listing stan-dards and Sarbanes-Oxley will force onmajor corporations, and finally offer afew tentative comments on the sensible-

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ness of the entire “best practice” enter-prise.

We wish to make clear that, inwhat follows, we touch only verybriefly2 on an alternative to the “consen-sus” model of corporate governance,what Henry G. Manne has called “themarket for corporate control.”3 We havechosen largely to ignore this alternativemodel not because of our personal viewsas to its potential effectiveness, but be-cause recent legislative and judicialdecisions have stripped it of much, if notall, of its usefulness as a managementcontrol mechanism. How and why thatcame about is an interesting and impor-tant story, but it is not the story we tell inthis paper. Our story is decidedly im-mediate and practical: What is thecurrent “consensus” model of “bestpractice” for corporate governance, howdid it become such, and is it likely to ac-complish its intended objectives?

I. Introduction

A. The Foreign Corrupt Prac-tices Act

The sea change in corporate gov-ernance now upon us did not begin withEnron4 or Cendant5 or Sunbeam6 or evenBausch & Lomb.7 Rather, it began witha series of corporate misadventures inthe 1970s that have an unsettling famili-arity to those of today. In 1973, theWatergate Special Prosecutor’s an-nounced that Lockheed, Northrop, GulfOil, and other prominent corporationsmay have used corporate funds to makeillegal domestic political contributions.8The Securities and Exchange Commis-sion (SEC) immediately commenced anextensive investigation, the result ofwhich was the revelation that scores of

American corporations had violatedUnited States election laws and hundredsmore had made payments abroad in cir-cumstances suggesting indifference orworse to domestic and foreign laws pro-hibiting bribery and other questionablemethods of securing business.9 Whenthe dust settled, many of the largest andmost respected United States corpora-tions were found to have used phonysubsidiaries and off-book accounts tochannel millions of dollars to govern-ment officials and others to influence thepurchase of goods and the awarding oflucrative contracts. All told, more than500 publicly held American companies,including 117 of the Fortune 500, wereeither charged by the SEC or voluntarilyconfessed to have engaged in seriousmisconduct, almost all involving ac-counting irregularities.10

For the SEC, the widespread oc-currence of questionable and illegalcorporate payments—facilitated by thefalsification of basic financial records—constituted evidence of a pervasive“frustration of our system of corporateaccountability.”11 For the Congress, itwas apparent that this seemingly epi-demic corporate misconduct had“erod[ed] public confidence in the integ-rity of the free market system.”12 InDecember, 1977, following specific rec-ommendations of the SEC, the Congressenacted the Foreign Corrupt PracticesAct (FCPA),13 which criminalized for-eign bribery and, for the first time inUnited States history, imposed on publiccompanies a federal obligation “tomaintain books and records that accu-rately and fairly reflect transactions anddispositions of [their] assets.”14 Shortlythereafter, the SEC adopted supplemen-tal rules making it illegal for anyone tofalsify (or cause to be falsified) any cor-porate accounting record or to

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misrepresent (or cause to be misrepre-sented) to a corporation’s independentaccountant any material fact.15

B. Harold Williams’ Three ActPlayIn 1978, in the midst of the pub-

lic and congressional outrage over“questionable and illegal payments,”then SEC Chairman Harold M. Williamsgave an extraordinarily prescient speechon the likely future course for corporategovernance. Williams began by outlin-ing what he referred to as a “familiar”three act play entitled “Federal Regula-tion of Business.” In Act I of this play, aseries of apparently isolated events in-volving corporate excess or insensitivityattracts press coverage under the rubricsof “scandals” and “flagrant abuses.”Next there are “thinly scattered commentby public interest types” and occasionalarguments that “the government shoulddo something to prevent these ‘outrages’from happening again.” The generalpublic, however is apathetic, and at thispoint the play’s plot seems weak, insig-nificant, and easy to ignore.16

Act II is the longest act in theplay. More corporate misdeeds occur,but at first only sporadically and in ap-parent isolation. After the passage oftimeunspecified as to durationtheoffending events begin to occur morefrequently and the sense of their sepa-rateness dissipates. Public sentiment isfanned by the multiplication of “scan-dals” and “flagrant abuses.” TheCongress then shows interest, and legis-lation is introduced “but [initially]attracts little support….” Act II, how-ever, closes with a bang. “[I]nflamed bya single dramatic and widely publicizedoccurrence,” the Congress is spurred “to

a full-blown and broadly based legisla-tive effort.”17

Act III is straightforward. TheCongress enacts legislation designed toprevent the reoccurrence of the corporatemisconduct at issue. “A chorus of busi-nessmen deplor[e] the furtherintervention of government into businessaffairs.” And the audience is left withthe moral that “it takes a law to get busi-ness to behave responsibly.”18

In outlining this “familiar” play,Williams reminded his listeners that overthe prior 10 or 15 years it had been fre-quently revived under a variety ofsubtitles including “auto safety,” “truthin packaging,” “occupational health andsafety,” “ERISA,” and, most recently,“questionable and illegal payments.”19

William’s concern was that without re-form of the mechanisms of corporategovernance itself, the next revival of thisplay was likely to be entitled “federallegislation on corporateaccountability.”20 Williams wanted toavoid such a revival, but he saw clearlythat if American’s public corporationswere to preserve their ability to controltheir own structures and governance,“they must be able to assure the publicthat they can discipline themselves….Mechanisms which provide that assur-ance must become structural componentsof the process of governance and ac-countability of the Americancorporation.”21 The point of Williams’exhortation was, thus, that the Americanbusiness community could not ignore,stonewall, or adopt a head-in-the-sandattitude toward the corporate governancecrisis if federal legislation was to beavoided.22

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C. Enron, WorldCom, and Fed-eral LegislationWhen Williams spoke in 1978,

he thought that the United States was in“the early stages of Act II” of the “fa-miliar” play.23 If that was the case, ActII was very long, indeed, lasting fromthe middle of the 1970s until earlier thisyear. But Act II ran its course just asWilliams had predicted. Toward its end,the revelations of “flagrant abuses” atEnron, following as they had on a seriesof accounting and managerial scandalsover the prior 10 years,24 resulted in theintroduction of federal legislation de-signed to impose significant federalcontrol over public accounting and thegovernance processes at all public com-panies.25 Public “outrage” at persuasivemanagement self-enrichment was high.26

Executive compensation by 2000 had, onaverage, reached 411 times the amountof the average factory worker’s salary,which was up from only 42 times in1982.27 Executive stock sales during thetelecom bubble had resulted in “one ofthe largest transfers of wealth from in-vestors—big and small—to corporateinsiders] in American history.”28 Ques-tionable and sometimes unapprovedloans by corporations to top executivestotalled billions of dollars.29 And in2000, executives at America’s 325 larg-est corporations had been awardedoptions worth 20 percent of their corpo-rations’ total pretax profit.30 Thepublic’s view of corporate managementseemed to be accurately captured byAlan Greenspan’s characterization of thebusiness community as having beengripped in the late 1990s and early 2000sby “infectious greed.”31

Within six months after Enron’scollapse, however, the “wave of enthusi-asm for overhauling the nation’scorporate and accounting laws ha[d]

ebbed and the toughest proposals forchange [were] all but dead.”32 Yet, justas Williams had predicted in 1978, ActII closed with a bang. WorldCom’s an-nouncement of a $3.8 billion accountingrestatement provided the “single dra-matic and widely publicized occurrence”that energized both the public and theCongress to undertake “a full blown andbroadly based legislative effort.”33

Act III then followed in straight-forward and predicted fashion. The“wave” of enthusiasm for overhaulingthe nation’s corporate and accountinglaws that only weeks before had been“all but dead” became an unstoppabletidal wave.34 Thirty-six days afterWorldCom’s first public announcementof its accounting irregularities, PresidentBush signed into law Sarbanes-Oxley,the most sweeping federal legislationaddressing public accounting and corpo-rate governance since the 1930s.

The play that Williams named“federal legislation on corporate ac-countability” has now come to an end.35

Its moral appears to be as predicted: “Ittakes a law to get business to behave re-sponsibly.”36 But the predictedbusinessmen’s chorus deploring gov-ernment intervention has been largelymissing. When President Bush signedSarbanes-Oxley, The Business Roundta-ble (BRT), unquestionably the mostprominent and outspoken defender ofprivate corporate prerogatives, did notdeplore government intervention in thearea of corporate governance, histori-cally left to contract and privateinitiative, but rather announced that it“welcomes these reforms and willquickly implement the changes tostrengthen our companies’ governance.We believe the law will go a long way

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toward establishing new higher stan-dards for America’s corporations.”37

A cynic no doubt would explainthe business community’s position onSarbanes-Oxley as a ploy designed todeflect public anger away from the“good” corporations. There is surelysomething to that explanation. Butwithout yet turning in our cynic mem-bership cards, we want to suggest thatthe business community’s attitude to-ward federal intervention in the area ofcorporate governance results, at least, inpart, from its realization as a result ofEnron, WorldCom, Tyco, and their fel-low travelers that relying on individualcorporations voluntarily to implementappropriate and effective corporate gov-ernance mechanisms has not and is notlikely to stop the corporate “scandals”and “flagrant abuses” that have been sodevastating for public confidence andcorporate prosperity. Indeed, there nowappears to be a general perception, evenon the part of the major corporationcommunity, that some form of collectiveaction is needed—whether direct legis-lation, mandatory listing standards, orotherwise—to assure that all corpora-tions behave responsibly toward theirstockholders. In what follows, we tracethe evolution, on the one hand, of the“consensus” view of the appropriatemechanisms for effective corporationgovernance and, on the other, of theagreement as to how those mechanismsare to be imposed.

II. Why Corporate Governance?

A. The Unique Status of Stock-holdersThe modern corporation has

many constituencies in addition to itsstockholders: employees, suppliers, con-

sumers, communities in which it oper-ates and that it can affect, the publicgenerally when the national interest isimplicated, and undoubtedly many oth-ers. At various times since the late1800s the corporation has been faultedfor its failure to fulfill its responsibilityto one or another of these constituencies.As the frequent revivals of Williams’“familiar” play makes clear, the federalgovernment periodically steps in to con-trol what is perceived to be corporate“greed,” to demand corporate attentionto an asserted “public interest,” or toprotect one or more of the corporation’s“vulnerable” constituencies. Whateverthe justification for any one of these in-terventions in particular or governmentintervention of this sort in general, suchlegislative efforts relating to one or moreof these corporate constituencies are notaddressed at corporate governance.

Corporate governance addressesa corporation’s relationship with onlyone of its constituencies: its residualowners or stockholders. However egre-gious a corporation’s “greed” or blatantits disregard of an asserted “public inter-est,” the conduct in question, in alllikelihood, has been pursued to enhancethe corporation’s profits and hence tobenefit (ill gottenly perhaps, but benefitno less) its stockholders. As PeterDrucker remarked about Lockhead andthe foreign bribery scandals of the1970s:

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Here was not a manage-ment looting a company; onthe contrary, what the man-agement did was intendedto advance the interests ofthe company and of its em-ployees—and, in respect tosales of military aircraft,even the interest of thecountry, of its foreign pol-icy and of its balance ofpayments.38

Harm to stockholders occurs forreasons different from harm to the cor-poration’s other constituencies. Whenharm to stockholders is alleged, it is notbecause of the corporation’s “greed” orthe corporation’s “indifference” tostockholder interests but rather becausecorporate management of the corpora-tion is shirking its responsibilities, hasfallen victim to extraordinary miscalcu-lation, or is pursuing its personal self-interest at the stockholders’ expense.Corporate governance, thus, is con-cerned with the control of corporatemanagers to assure that they do not en-rich themselves at the expense of thestockholders or act (as was surely thecase in the corporate bribery scandalsand, we believe, to a considerable extentin Enron) in such a grossly irresponsiblemanner as to seriously damage the cor-poration, if not wreck it entirely.

B. The Berle and Means Corpo-rationThe Modern Corporation and

Private Property by Adolf Berle andGardiner Means, published in 1932, con-stitutes the paradigmatic articulation ofthe reason that effective corporate gov-ernance is both so needed and so elusive.Berle and Means’ fundamental insight

was that “[t]he separation [in the moderncorporation] of ownership from controlproduces a condition where the interestsof owners [of the enterprise] and of [theenterprise’s] ultimate manager may, andoften do, diverge.”39 A mechanism toassure the attention and faithfulness ofcorporate managementthat is, an ef-fective scheme of corporategovernanceis needed if the divergenceof such interests is to be prevented or, atleast, the adverse consequences of suchdivergence minimized.

For Berle and Means, the largepublic corporation became in the 20th

Century “the dominant institution in themodern world.”40 As the wealth of in-numerable individuals was concentrated“into huge aggregates,” control over thatwealth shifted from the hands of its“owners” to the hands of those able toprovide a “unified direction” to thesenew corporate enterprises.41 This sepa-ration of ownership from controlconstituted a fundamental departurefrom the classic economic model underwhich the right of individual propertyowners to use their property as they sawfit could be “relied upon as an effectiveincentive to [the] efficient use of [that]property….” But as individual, self-interested, property owners moved fromactive market participants to passive in-vestors, their capacity to direct thedeployment and disposition of theirproperty “declined from extremestrength to practical impotence.”42 As aconsequence, owners are exposed to acontinual risk “that a controlling groupmay direct profits into their own pockets[and fail to run] the corporation… pri-marily in the interests of thestockholders.”43

Berle and Means saw the separa-tion of ownership from control as posing

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an extraordinarily difficult economicproblem, for the identification and im-plementation of mechanisms (beyondreliance on market forces and the good-will and ethical probity of managers)that will assure the alignment of the in-terests of those who control thecorporation with those who own it isneither obvious nor easy. Yet withoutthis separation of ownership from con-trol, there is no efficient solution to theproblems of decision making within alarge organization.44 The separation ofownership from control is, thus, a verysharp two-edged sword: Without theseparation of ownership from a central-ized management having virtuallyabsolute authority, the essential wealthenhancing corporate decisions essentialfor the growth and well being of ourcapitalist economy would not and couldnot be made; yet as a result of such sepa-ration, management holds “the power ofconfiscation of a part of the profitstreams and even of the underlying cor-porate assets….”45

Since at least the 1970s, the pre-sumed resolution of this dilemma hasbeen seen by a consensus of establish-ment lawyers, corporate representatives,and academics to lie in a system of cor-porate governance whereby, on the oneside, management, primarily in the formof a strong CEO, controls the directionand initiatives of the corporation, and, onthe other side, a board of directors, inde-pendent of management and the CEO,has the knowledge, incentive, andauthority to monitor management’s per-formance and curb its temptations foropportunism. 46 The formulation, sharp-ening, and testing of this “consensus”view of corporate governance over al-most 30 years sets the stage for approvalof the new NYSE listing standards andpassage of Sarbanes-Oxley.

III. Private Initiatives to ImproveCorporate Governance

A. The Strong Corporate BoardBecause of collective action

problems, free riding temptations, andthe so-called Wall Street Ruleit’s al-ways easier to sell than fightthemodern corporation’s stockholders haveneither the incentive nor the practicalability to act as the enterprise’s ultimatemonitors.47 Thus, the consensus viewthat has developed is that this monitoringfunction can be, and can best be, per-formed by the board of directors. Asone leading corporate scholar expressesthe point, the monitoring of managementis “of critical importance to the corpora-tion and uniquely suited for performanceby the board.”48 For William Allen, thenChancellor of the Delaware Court ofChancery, the basic responsibility of theboard is “to monitor the performance ofsenior management in an informedway.”49 And yet another prominent cor-porate scholar states flatly that “[t]heheart of corporate governance has beenthe imposition of the so-called monitor-ing model [on the board of directors].”50

In this “consensus” view, “bestpractice” for dealing with the problemscaused by the separation of ownershipfrom control, or, as contemporary corpo-rate scholars would put it, of reducingcorporate agency costs,51 is the estab-lishment of what is variously called a“monitoring board,”52 “certifyingboard,”53 or “empowered board.”54

However labelled, the basic characteris-tics of this strong board of directors havecome to be generally understood to in-clude directors that are all, or a majorityof whom, are independent; an activeaudit committee composed entirely ofindependent and adequately informed di-

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rectors; other specialized committees(nomination and compensation, in par-ticular) also composed entirely (oralmost entirely) of independent direc-tors; a formal charter setting out theboard’s authority and responsibility tomonitor the corporation’s performance,compliance and financial reporting; anda style of operation characterized by in-dependence from management,scepticism with respect to unsupportedassertions made to them, and doggedloyalty to shareholder interests.55

B. Evolution of the ConsensusThe “consensus” view that a

strong board of directors constitutes“best practice” with respect to corporategovernance is of relatively recent origin.When Myles Mace published his land-mark study of boards of directors in1970, he concluded that boards did notmanage corporations or monitor corpo-rate management but served solely asadvisors and counsellors to the CEO.56

And as Ira Millstein has observed, at thistime “[corporate] boards were the pars-ley on the fish . . . usually composed of agroup of friends or acquaintances of theCEO who could be counted on to sup-port management.”57 Audit committees,despite having been recommended bythe SEC in 194058 and the NYSE in193959 had spread slowly and had re-ceived relatively little public attention.60

Yet, between 1970 and 1980, the UnitedStates witnessed what can only be de-scribed as a revolution in the concept of“best practice” for corporate governance.

In May 1976, then SEC Chair-man Rodrick Hills wrote to then NYSEChairman Melvin Batten “suggesting”that the NYSE revise its listing standardsto require that all listed companies havean independent audit committee.61 The

NYSE accepted the suggestions, and ef-fective June 30, 1978, all NYSE listedcompanies were required to “main-tain…an audit committee comprisedsolely of directors independent of man-agement and free from any relationshipthat, in the opinion of the board of di-rectors, would interfere with the exerciseof independent judgement as a commit-tee member.”62

In November of that same year,the Subcommittee on Functions and Re-sponsibilities of Directors, of theCommittee on Corporate Laws, of theAmerican Bar Association (ABA) pub-lished the first edition of the CorporateDirector's Guidebook.63 Revised andadopted by the full ABA Committee onCorporate Laws seven days before theadoption of the FCPA, the Guidebookrepresented the establishment bar’s firstattempt to set forth “a structural modelfor the governance of a publicly-ownbusiness corporation.”64 At the heart ofthis model was a “board of directors[that] function[ed] effectively in its roleas reviewer of management initiativesand monitor of corporate performance”65

The effective performance of this rolerequired, in the ABA’s view, that “a sig-nificant number of [the] board’smembers should be able to provide inde-pendent judgment regarding theproposals under consideration.”66

Shortly thereafter, the BRT, aconsistent and steadfast defender ofCEO prerogatives, issued a statemententitled, The Role and Composition ofthe Board of Directors of the LargePublicly Owned Corporation.67 While,in hindsight, certain parts of this state-ment are embarrassingly defensive,68 theBRT’s statement is remarkably consis-tent with that of the ABA, particularly inits acknowledgement of the board’smonitoring role69 and its firm recom-

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mendation that all boards should have asufficient number of “outside” directors“to have a substantial impact on theboard[’s] decision process.”70

In 1980, when its Staff Report onCorporate Accountability was issued,71

the SEC saw

a new conse-sus…emerging withrespect to the vital moni-toring role to be playedby the board of directorsin the corporate account-ability process and themost desirable and ap-propriate composition andstructure of a board de-signed to play such anenhanced oversight role.The consensus is movingstrongly towards greaterparticipation by directorsindependent of manage-ment, currently calling fora board composed of atleast a majority of inde-pendent directors, withproperly functioning in-dependent audit,compensation, and nomi-nating committees, asessential to enhanced andeffective corporate ac-countability.”72

This “consensus” as to “best practices”for corporate governance included, ac-cording to the SEC, the following.

First, “a strong board of directorsis the key to improved accountability.”73

For this to occur, the “board’s primaryfunction [must be] to monitor manage-ment.”74 And if this monitoring processis to be successful, “the board of direc-tors [must be] an independent force in

corporate affairs rather than a passive af-filiate of management.”75

Second, because the traditionalboard dominated by insiders cannot ade-quately monitor the performance ofmanagement, “a majority of the board ofdirectors should be non-management di-rectors.”76 While corporations maydiffer as to the appropriate mix of insid-ers and outsiders on their boards, as wellas the affiliations of their outside direc-tors, “a majority of non-management,preferably independent, directors is nec-essary for the board to successfullyperform its monitoring function.”77

Third, while “there appear[ed] tobe an emerging consensus that those di-rectors with significant businessrelationships with the corporation shouldnot be considered independent of man-agement when…. determining if [theboard] has a sufficient critical mass ofindependence,”78 the primary emphasiswas on independence as “a state ofmind” rather than a formal specificationof affiliations that would disqualifysomeone from being viewed as inde-pendent.79

Fourth, because of NYSE re-quirements and AMEX and NASDrecommendations, a significant majorityof public companies had audit commit-tees. Although many of these auditcommittees had members that were not“independent,”80 the “consensus” viewwas that “audit committees should becomposed exclusively of directors inde-pendent of management.”81

Fifth, despite the recommenda-tions in the Corporate Director’sGuidebook,82 there was no consensusthat the audit committee should have theauthority to engage or discharge the out-side auditors. Likewise, despite theaudit committee’s “important role…in

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assuring the independence of the ac-counting firm,” very little evidenceexisted that this role was assumed byaudit committees generally.83

Sixth, the existence of a compen-sation committeecharged with reviewof compensation arrangements for seniormanagementcomposed of non-management directors some of whomwere “independent” of management wasviewed as desirable.84

To summarize, by 1980, thestrong corporate board had come to beseen by most observers as the criticaland only realistically available check onmanagement opportunism. Over thenext 20 years, this “consensus” viewgrew sharperthe concept of “inde-pendence,” for example, becameincreasingly specificand far less flexi-ble in its applicationone “size” ofcorporate governance was increasinglyseen to fit all corporations. Yet throughthis entire period the changes in the“consensus” view were by and largeevolutionary and incremental. Except,that is, in the crucial area of the appro-priate relationship between the strongboard and corporate management. Atthe end of the 1970s, the BRT, speakingfor the “consensus,” described that rela-tionship as appropriately one “of mutualtrust…challenging yet supportive andpositive…arm’s length but not adver-sary.”85 After Enron, the BRT, speakingnow for a substantially evolved “consen-sus,” described the board’s appropriateattitude toward management as one “ofconstructive skepticism [, of] ask[ing]incisive, probing questions and re-quir[ing] accurate, honest answers….”86

The story of the shift from “mu-tual trust” to “constructive skepticism” isalso the story of the ultimate failure ofHarold William’s hope that the response

of corporate America to the continuing“scandals” and “flagrant abuse” wouldeliminate the need for federal legislationon corporate accountability and avoidthe performance of Act III of the “fa-miliar” play.

C. The Market For CorporateControlBut before starting to tell that

story, it is worth pausing briefly to notethe United States’ flirtation with and ul-timate rejection of the “market forcorporate control” 87 as a model for con-trol of managerial opportunism. Theconcept, in brief, is that there is a highpositive correlation between corporatemanagerial efficiency and the marketprice of that corporation’s shares. Ifthere is a relatively unimpeded marketfor corporate control, inefficient andover-compensated management is, thus,subject to ouster through the mechanismof the hostile takeover. According toHenry G. Manne, “[o]nly the takeoverscheme provides some assurance ofcompetitive efficiency among corporatemanagers and [thus] strong protection tothe interests of vast numbers of small,non-controlling shareholders. Comparedwith this mechanism . . . [the benefits] ofa fiduciary duty concept [associated withindependent directors] seem small in-deed.”88

The merits of Manne’s claim thatthe “market for corporate control” pro-vides the best approach for resolving thedilemma confronting the Berle andMeans corporation, is provocative butcertainly arguable. For example, bothEnron and WorldCom declared bank-ruptcy within months of their stockstrading at what can only be regarded asextremely high multiples. Further, untilthey collapsed, these corporations were

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active acquirers rather than likely pros-pects for a hostile takeover.Nevertheless, whatever one’s view of thebenefits of a robust “market for corpo-rate control,” several developments haveimposed severe impediments to thismarket’s effective operation. First, fol-lowing over 100 hostile cash tenderoffers in 1966,89 the Congress passed theWilliams Act in 1968.90 This statutesignificantly limits the ability of a “cor-porate raider” to mount a hostiletakeover without advance warning to thetarget corporation and extensive disclo-sure of the “raider’s” intentions andfinancing.91 Second, as a result of a se-ries of highly publicized takeoverbattles, in 1985 the Delaware courts de-cided four cases that gave existingmanagement unprecedented power to re-sist hostile takeover attempts.92 Andthird, by 1992, under intense lobbyingfrom the BRT and other business groups,over two-thirds of the states had enactedhighly effective anti-takeover laws.93 Asa consequence of these developments,while hostile takeover activity continuesin various forms,94 by the early 1990sthe “market for corporate control” asManne had envisioned it had effectivelyceased to exist.95

D. The “Consensus” SharpensThe elimination of the hostile

takeover as a useful mechanism for pro-tecting stockholders from managementopportunism renewed interest in the roleand responsibility of the strong corporateboard. In 1992, the American Law In-stitute (ALI) completed its 14-yearproject, Principles of Corporate Gov-ernance: Analysis andRecommendations.96 While the gesta-tion of the ALI’s Principles was difficultand controversial,97 in the end, the Prin-ciples, at least in the areas with which

we are concerned, sharpened, but re-mained solidly within, the “consensus”tradition. Under the Principles, theboard is assigned “ultimate responsibil-ity for oversight”98 of “the conduct ofthe corporation’s business to evaluatewhether the business is being properlymanaged.”99 Public corporations with$100 million or more of total assets“should have a majority of directors whoare free of any significant relationshipwith the corporation’s senior execu-tives.”100 The audit committee should becomposed entirely of persons who arenot present or former employees, a ma-jority of whom should “have nosignificant relationship with the corpo-ration’s senior executives.”101 Andwhile the board itself should have re-sponsibility for determining “theappropriate auditing and accountingprinciples and practices” for the corpo-ration,102 the audit committee should“recommend the firm to be employed asthe corporation’s external auditor andreview…the external auditor’s inde-pendence.”103 In performing the latterfunction, the audit committee “shouldcarefully consider any matter that mightaffect the external auditor’s independ-ence, such as the extent to which theexternal auditor performs non-auditservices.”104

Two years after the ALI adoptedthe Principles, the ABA amended itsCorporate Directors Guidebook, empha-sizing “the board’s role as anindependent and informed monitor of theconduct of the corporation’s affairs andthe performance of its management.”105

The second edition of the Guidebookchanged the ABA’s original recommen-dation with respect to composition of theboard of directors from a “significantnumber” who are “non-management di-rectors” to “at least a majority” who are

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independent of management;106 formal-ized the concept of a board member’s“independence”;107 and changed the pre-vious ABA recommendation of a auditcommittee composed of “non-management directors, a majority ofwhom are unaffiliated non-managementdirectors”108 to a committee composedsolely of “independent directors.”109

And in 1997, the BRT publisheda white paper entitled, Statement onCorporate Governance.110 Sharpeningits 1978 recommendations, the BRT em-phasized that the board of directors musthave “a substantial degree of independ-ence from management,” and that themembers of the audit committee shouldmeet “more specific standards of inde-pendence…. ”111 While the BRT’sStatement is less specific in a number ofrespects than those of the ALI or ABA,its recognition that “[t]he absence ofgood corporate governance . . . may im-ply vulnerability for stockholders,” andthat the failure of “knowledgeable di-rectors . . . to express their views” placesa corporation at “risk,” gives the BRT’sStatement a decided air of serious practi-cality.112

The corporate governance rec-ommendations of the ALI, ABA, andBRT made in the 1980s differ in empha-sis, specificity, and tone, but by andlarge they all build on the earlier consen-sus in apparently constructive ways.Although only the ALI’s recommenda-tions continue to approximate the current“consensus” as to “best practice,” it is byno means an exaggeration to state that acorporation that had, in 1990, modelledits corporate governance mechanisms, inboth process and spirit, on any one ofthese sets of recommendations, wouldhave been a highly unlikely candidatefor a corporate governance “scandal” or“flagrant abuse.” Unfortunately, how-

ever, all of these “best practice” recom-mendations were just that,recommendations, and a sharpened“consensus” with respect to corporategovernance did not mean that most orany of the major corporations in theUnited States were following, in morethan form, “best practice.”

E. The Need for “CulturalChange” and the Blue RibbonCommitteeAlmost 20 years to the day after

Harold Williams had delivered hisspeech on the “familiar” three act play,Arthur Levitt, then Chairman of theSEC, gave another prescient commen-tary on the future course for corporategovernance. For Levitt, corporateAmerica had done too little to implementthe recommended corporate governancemechanisms for control of managerialopportunism. Levitt saw “[t]oo maycorporate managers, auditors, and ana-lysts [as] participants in a game of nodsand winks.”113 The managerial motiva-tion to meet Wall Street earningsexpectations was “overriding commonsense business practices.” Indeed, Levittwas concerned that “managing may begiving way to manipulation. Integritymay be losing out to illusion.”114 It ishard to imagine a harsher critique ofcorporate America, but Levitt, like Wil-liams before him, apparently stillbelieved that the situation could be cor-rected without government action ifthere was a voluntary re-examination by“corporate management and Wall Street[of] our current environment [and an]embrace [of] nothing less than a culturalchange.”115

On the same day that Levittspoke, the NYSE and the National Asso-ciation of Securities Dealers (NASD)

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announced that “in response to recentconcerns expressed by …Levitt aboutthe adequacy of the oversight of theaudit process by independent corporatedirectors,” the two self-regulatory or-ganizations were sponsoring a “blueribbon” committee charged with recom-mending ways to improve theeffectiveness of corporate audit com-mittees.116 In February, 1999, this BlueRibbon Committee issued its report with10 recommendations “geared toward ef-fecting pragmatic, progressivechanges…[in] financial reporting and theoversight process.”117 The Committeeacknowledged that the substantive mat-ters covered by its recommendations hadbeen “studied and commentedupon….for years,” but the Committee“anticipate[d]” that “this time” therewould be “prompt and serious consid-erations….”118 And, indeed, before theyear was over, the NYSE and NASD hadproposed, and the SEC had approved,significant changes to their audit com-mittee listing standards.119

Levitt had emphasized the needfor more reliable financial reporting toassure public confidence was maintainedin the integrity of corporate America.The Blue Ribbon Committee concludedthat this could be accomplished bymaking mandatory for listed companiesmore of the “consensus” model of corpo-rate governance. The Committee, as thevast majority of commentators over thepast 30 years, saw the board of directorsas having the responsibility “to ensurethat management is working in the bestinterests of the corporation and its share-holders” and the independence of amajority of these directors as “critical toensuring that the board fulfills [this] ob-jective oversight role and holdsmanagement accountable to sharehold-ers….”120 The most serious problem the

Committee found in the existing listingrequirements for publicly companies wasthat the standards for determining “inde-pendence” allowed for “too muchdiscretion and [, therefore,] should befortified.”121

Since 1978, the NYSE had re-quired that all listed companies have anaudit committee composed of at leastthree directors, all of whom “in theopinion of the board of directors” are in-dependent of management. Followingthe recommendation of the Blue RibbonCommittee, the NYSE amended its list-ing standards by specifying four specificcriteria for determining the “independ-ence” of audit committee members.Also on the recommendation of the BlueRibbon Committee, the NYSE amendedits listing standards to require that eachboard of directors adopt for its auditcommittee a formal written charter,which, among other matters, specifiedthat the board and audit committee havethe “authority and responsibility” to se-lect, evaluate, and determine theindependence of the outside auditor. Inaddition, the NYSE included in itsamended listing standards a requirementthat every listed corporation provide tothe exchange annually a written confir-mation (1) of “the financial literacy” ofall audit committee members, (2) that atleast one committee member “has ac-counting or related financialmanagement expertise,” (3) that thecommittee’s charter is adequate, and (4)that any board determination regardingdirector “independence has been dis-closed.”122

In approving the new NYSEaudit committee requirements, the SECstated that these requirements “will pro-tect investors by improving theeffectiveness of audit committees ….[and] enhance the reliability and credi-

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bility of financial statements…. bymaking it more difficult for companiesto inappropriately distort their true fi-nancial performance.”123 It would havebeen tempting in 2000 to believe thatwith the adoption of these amended list-ing standards, the sharpening of “bestpractice” recommendations by the ALI,ABA, and BRT, and the promulgationby the SEC of various new corporatedisclosure requirements,124 that corpo-rate governance for America’s publiccompanies had finally been gotten right,or at least, was about to be gotten right.As the BRT, somewhat immodestly,stated in its 1997 white paper:

The Business Roundtablenotes with pridethat…many of the prac-tices suggested forconsideration by TheBusiness Roundtablehave become more com-mon. This has been theresult of voluntary actionby the business commu-nity without new lawsand regulations …. TheBusiness Roundtable be-lieves it is important toallow corporate govern-ance processes tocontinue to evolve in thesame fashion in the yearsahead.125

Unfortunately, in 2000, corporategovernance was not even close to havingbeen gotten right, and the processes forits development were certainly not to beallowed to evolve “in the same [volun-tary] fashion” in the years ahead.Despite the recommendations of theBlue Ribbon Committee and the SEC’sbrave assurances that “the reliability andcredibility of financial statements[thereby] would be enhanced,” public

revelations of corporate “scandals” and“flagrant abuses” were to continue at anaccelerating pace.

IV. Enron

A. The Run-UpWithin months of the issuance of

the Blue Ribbon Committee’s Report,Rite Aid Corporation, a more that $3billion dollar corporation listed on theNYSE, restated its operating results for1997, 1998, and 1999, eventually writingoff more than $2.3 billion in pretaxprofits. Before resigning, Rite Aid’soutside auditor publicly announced thatthe corporation’s financial controls wereso inadequate that it could not “accu-mulate and reconcile informationnecessary to properly record and analyzetransactions on a timely basis.”126

Eventually, the SEC charged four formerRite Aid’s executives, including its for-mer president, with “one of the mostegregious accounting frauds in recenthistory.”127

Three weeks after the SEC ap-proved the new audit committeerequirements, Cendant Corporation, an-other multi-billion dollar company listedon the NYSE, announced that it hadagreed to pay stockholders $2.8 billionto settle accusations of widespread ac-counting fraud.128 The SECsubsequently brought charges against sixformer executives, including Cendant’sformer Chairman, for “a long-runningfinancial fraud” that “originate[d] at thehighest level of [the] company.”129 Ac-cording to the FBI agent in charge of theCendant investigation, “[t]his case boilsdown to greed, ego, and arrogance.”130

On June 13, 1998, SunbeamCorporation, another NYSE listed com-

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pany, fired its then CEO, after the corpo-ration’s directors began questioning theintegrity of the reports they had beengiven on the financial condition of thecompany.131 On August 6, 1998, Sun-beam announced a restatement of itsfinancial statements back to 1996.132 TheSEC eventually charged the former CEOand four other former Sunbeam execu-tives with fraud,133 alleging that they had“orchestrated a fraudulent scheme tocreate the illusion of a successful re-structuring of Sunbeam [to] facilitate thesale of the company at an inflated price[with enormous gains for its execu-tives].”134

In February 1998, Waste Man-agement, Inc., yet another NYSE listedcompany, acknowledged that it had mis-stated its pre-tax earnings byapproximately $1.7 billion, the largestcorporate restatement in historyuntilthat time.135 In June, 2000, the SECcharged Waste Management with fraudand violations of internal financial con-trol requirements for its failure to“maintain effective and accurate billing,accounting and management informationsystems….”136 The SEC subsequentlycharged Waste Management’s formerCEO and five other former executiveswith perpetrating “a massive financialfraud lasting more than five years.”137

Waste Management, it appears, had useda veritable “catalog of ways to cook thebooks,” assuring the executives tens ofmillions of dollars in stock options andbonuses that would never have been paidout without the accounting fraud.138

Perhaps ultimately more impor-tant than any of these high profile“scandals” and “flagrant abuses” was thefact that in 2000, 156 public companiesrestated their financial statements in2000,139 compared with an average ofless than 50 per year over the previous

10 years.140 And of the 201 securitiesfraud class action law suits filed in 1999and 2000, over half were based on alle-gations of accounting fraud.141 Despitethese alarming developments, for corpo-rate governance the worst was yet tocome.

B. EnronAlthough by 2001 public belief

in the integrity of corporate managementand the ability of boards of directors tocontrol managerial opportunism was ex-tremely low,142 nothing had prepared thepublic, the regulators, or the Congressfor the spectacular implosion of, andrevelations of fraud by, Enron Corp, an-other NYSE listed company. Enron wasclassified as the seventh largest corpora-tion in the United States, with over $100billion in gross revenue and more than20,000 employees worldwide.143 For thesix years immediately prior to its col-lapse, Fortune Magazine had namedEnron the most innovative company inAmerica.144 And in February, 2001, En-ron’s then Chairman, Kenneth L. Lay,and its CEO, Jeffrey K. Skilling, wroteto stockholders:

Enron has built uniqueand strong businesses thathave tremendous oppor-tunities for growth….The10-year return to Enronshareholders was 1,415percent compared with383 percent for the S&P500….Our results put usin the top tier of theworld’s corpora-tions….We plan toleverage all of [Enron’s]competitive advantages tocreate significant valuefor our shareholders.…145

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Less than eight months later, En-ron announced a $544 million after-taxcharge to earnings and a $1.2 billion re-duction of stockholders’ equity, both theresult of transactions with an affiliatedpartnership that had been inappropriatelyaccounted for. On November 19, 2001,Enron filed a further restatement of itsfinancial statements with the SEC, whichamong other matters, reduced stockhold-ers equity by $258 million in 1997, $391million in 1998, $710 million in 1999,and $754 million in 2000. Three weekslater, Enron filed for bankruptcy protec-tion, the largest such filing in history –until then.146 Thus in “a span of lessthan two months during the autumn of2001, [Enron] fell from business idol tocongressional doormat, or somewhatmore importantly, from the new businessmodel to a model of business greed andultimate failure.”147

Discussions of Enron and itscollapse are now legion.148 According tothe report released by Enron’s SpecialInvestigation Committee of its Board ofDirectors, Enron’s Board of Directorshad “failed” in its duty of “oversight”with respect to “the related-party trans-actions” that brought the companydown.149 The Senate Permanent Sub-committee on Investigations found that“much of what was wrong at Enron wasnot concealed from its Board of Direc-tors….The Subcommitteeinvestigation…. found a Board that rou-tinely relied on Enron management andAndersen representations with little orno effort to verify the information pro-vided, that readily approved newbusiness ventures and complex transac-tions, and that exercised weak oversightof company operations.”150 And theBRT, hardly a corporate gadfly, ascribedthe Enron’s failure to “a massive breachof trust” involving “a pervasive break-

down in the norms of ethical behavior,corporate governance, and corporate re-sponsibility to external and internalstockholders.”151

Our concern is not the vehementdenunciations of Enron and its manage-ment, but the consequences of thismassive corporate fraud for the “consen-sus” model of corporate governance. Bylooking at the responses to Enron of theprincipal spokesmen on issues of corpo-rate governance, it may become easier tounderstand why Sarbanes-Oxley becamean inevitability, particularly, once theWorldCom “scandal” broke only sixmonths after Enron had filed for bank-ruptcy.

C. Two Responses to EnronWithin the four years immedi-

ately preceding Enron’s implosion, theBRT and ABA had each issued compre-hensive and confident recommendationswith respect to “best practices” for cor-porate governance. Yet within weeks ofEnron’s bankruptcy filing, both organi-zations convened task forces or specialcommittees to reassess and further refinetheir positions on “best practice” forcorporate governance.152 The first to doso was the BRT.

The BRT issued its restatementof the “guiding principles of corporategovernance” in May, 2002.153 Threethings are striking about the BRT’s newposition in its Principles of CorporateGovernance. First, although during2000-2001, more than 300 corporationshad restated their audited financialstatements, the SEC had filed over 200actions alleging financial fraud in 2000,and the five largest corporate bankrupt-cies in United States history had beenfiled in the previous 18 months, the BRTcontinued to insist that “[t]he United

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States has the best corporate governance[and] financial reporting systems in theworld.” As for Enron and its fellowtravellers, BRT characterized themmerely as “notable exceptions to a sys-tem that has generally workedwell….”154

Second, in its congressional lob-bing efforts, the BRT sought toemphasize “the inherently self-correcting nature of our market system[as evidenced by the fact that][c]orporate boards of directors are [al-ready] taking steps to assure….thatEnron-like failures will not occur at theircorporations.”155 The BRT’s pitch to theCongress was that before proceedingwith any new legislation, it should giveconsideration to the “SEC and privatesector initiatives already underway [in-cluding BRT’s] pending update [of] its1997 Statement on Corporate Govern-ance.”156

Third, despite its refusal to ac-knowledge a systemic problem incorporate governance and its initial (pre-WorldCom) opposition to federal legis-lation in its new Principles, the BRTrecommended a role and responsibilitiesfor the board of directors that wereclearly inconsistent with its 1978 state-ment and far beyond the position it hadtaken only five years earlier. For exam-ple, rather than urging a relationshipbetween the board and corporate man-agement characterized by “mutualtrust…[that is] challenging yet suppor-tive,”157 the BRT’s Principles describe“effective directors” as those that“maintain an attitude of constructiveskepticism [and] ask incisive, probingquestions and require accurate, honestanswers….”158 Further, in 1997 the BRThad called on corporations to have a“substantial majority [of directors whoare] outside (non-management) direc-

tors” but had left to each board the de-termination of the independence ofindividual directors independence basedon “individual circumstances rather thanthrough the mechanical application ofrigid criteria.”159 In its Principles, how-ever, the BRT explicitly stated that to beindependent, a “director should be freeof any relationship with the corporationor its management that may impair, orappear to impair, the director’s ability tomake independent judgments.”160 Andthe audit committee’s responsibilities,about which the BRT was silent in 1978,include, according to the Principles,“supervising the corporation’s relation-ship with its outside auditors…[and][b]ased on its due diligence…mak[ing]an annual recommendation to the fullboard about the selection of the outsideauditor.”161

On July 16, 2002, less than twomonths after the BRT issued its Princi-ples, a specially appointed Task Forceon Corporate Responsibility of the ABA(Task Force) issued its own PreliminaryReport.162 The two reports were polesapart. Unlike the BRT, the Task Forcedid not see Enron and its fellow travel-lers as aberrations. To the contrary, theTask Force forcefully acknowledged that“the system of corporate governance atmany public companies has failed dra-matically.”163 Evidenced by “thedisturbing series of recent lapses at largecorporations involving false or mislead-ing financial statements and misconductby executive officers,” it is apparent, inthe view of the Task Force, that “the ex-ercise by [independent directors andadvisers] of active and informed stew-ardship of the best interests of thecorporation has in too many instancesfallen short.”164 Despite the ABA’sthree editions of the Corporate DirectorsGuidebook, the ALI’s massive corporate

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governance project, the BRT and otherbusiness groups’ numerous recommen-dations, the NYSE’s listingrequirements, and the SEC’s jawboningover 20 years, the central feature of thecorporate governance “consensus” towhich all of these organizations sub-scribeda “monitoring” boardsufficiently independent of managementto control managerial opportunismhadtoo often, the Task Force believed, failedin practice because

many aspects of the out-side directors’ role havereflected a dependence onsenior management.Typically, senior man-agement plays asignificant part in the se-lection of directors, inproposing the compensa-tion for directors, inselecting their committeeassignments, in settingagendas for their meet-ings, and in evaluatingtheir performance. In ad-dition, directors oftendefer to management forthe selection of the keyadvisers to the board andits committees (e.g.,compensation consult-ants), as well as theoutside auditors for thecompany. Recommenda-tions to create activeindependent oversightmust address these reali-ties and bring aboutactual change.165

For the Task Force, therefore, the“solution” to the failure of independentdirectors to perform the role assigned tothem was a set of standards that will

“establish active, informed and objectiveoversight as a behavioural norm [and]create mechanisms that empower [di-rectors] to exercise such oversight . . ..”166 Specifically, all public corporations,in the view of the Task Force, shouldadhere to tough, new “standards of in-ternal corporate governance,” essentiallyidentical to the new listing standardsproposed by the NYSE and discussed inthe next section of this paper.

The problem for the Task Forcewas whether and, if so, how such stan-dards should be imposed. In the thirdedition of its Corporate Directors Guide-book, the ABA had emphasized that“[n]o one governance structure fits allpublic corporations, and there is consid-erable diversity of organizational styles.Each corporation should develop a gov-ernance structure that is appropriate toits nature and circumstances.”167 Andthe BRT, only weeks before the TaskForce released its report, had asserted, asit had since its first statement on corpo-rate governance in 1978, that “[p]ubliclyowned corporations employ diverse ap-proaches to board structure andoperations, and no one structure is rightfor every corporation.”168 The TaskForce, however, rejected this position,concluding that “substantial uniformityof governance standards applicable topublic companies is desirable and wouldhave the greatest impact on reliable cor-porate responsibility.”169 The trick, ofcourse, was how to achieve that uni-formity.

The BRT’s approach of allowingcorporate governance mechanisms tocontinue to evolve through “voluntaryaction by the business community” 170

was now out of the question. And thenew listing requirements at the NYSE,by themselves, would not achieve uni-form “best practice” mechanisms for all

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public corporations. Therefore, the TaskForce suggested that the NYSE, theNASDAQ Stock Market, the AmericanStock Exchange, and the regional ex-changes jointly to appoint a new BlueRibbon Committee to recommend uni-form corporate governance standards foradoption by all exchanges.171 But theTask Force clearly recognized that if“the desired uniformity is not achievedthrough this approach,” “serious consid-eration” would have to be given tolegislation amending the Securities Ex-change Act of 1934 “to empower theSEC to amend the rules of a self-regulatory organization to assure uni-formity in listing standards with respectto corporate governance matters.”172

The Task Force saw the need fortough, uniform corporate governancestandards for all public corporations, ac-knowledged that federal legislationmight be necessary to achieve such uni-form standards, and even suggested thatthe Congress could achieve the neededuniformity through the intermediation ofthe SEC. And that is precisely whatSarbanes-Oxley did, at least with respectto audit committees. But one moreevent, what Harold Williams had called“a single dramatic and widely publicizedoccurrence,” was still needed to spur theCongress to the “full-blown and broadlybased legislative effort” that would re-sult in the passage of federallegislation.173

V. WorldComWorldCom, Inc. was the second

largest long-distance carrier in theUnited States. It had 20 million con-sumer customers, thousands of corporateclients, and 80,000 employees on sixcontinents.174 Its CEO, Bernard J. Eb-bers, was “an icon of the business

world….”175 Its common stock, listedon NASDAQ, had hit its high of $64.50in June, 1999, giving it a market capi-talization of $191 billion.

On April 22, 2002, WorldComreduced its revenue projections for 2002by “at least” $1 billion.176 Seven dayslater Ebbers resigned as President, CEO,and a director “under pressure from out-side directors frustrated with thecompany’s sinking stock price, contro-versy over Mr. Ebber’s $366 million [theMay 20, 2000, WorldCom Proxy State-ment revealed that the true amount was$408.2 million] personal loan from thecompany and the wide-range investiga-tion of the firm by the Securities andExchange Commission.”177 On June 25,2002, WorldCom announced that as aresult of an internal audit it had deter-mined that approximately $3.8 billion ofexpenditures were improperly capital-ized rather than expensed.178 What thenfollowed was the uncovering of “one ofthe largest accounting frauds in his-tory….”179 The day of theannouncement, WorldCom stock closedat $0.83, representing a decline from itshigh of over 98 percent and a loss of in-vestor wealth of more than $188 billion.The next day the SEC filed suit againstWorldCom alleging “a massive ac-counting fraud totalling more than $3.8billion.”180 On July 21, 2002, World-Com filed for bankruptcy protection,listing assets valued at $107 billion,making its filing by far the largest inUnited States corporate history. Enron,which had previously held that distinc-tion, had listed assets of only $63.4billion.181 On August 8, 2002, World-Com announced that its “ongoinginternal review of its financial state-ments” had uncovered an additional $3.3billion of “improperly reported earn-ings….”182 And on August 28, 2002,

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Scott Sullivan, the former CEO ofWorldCom, was indicted in New Yorkfor engaging “in an illegal scheme to in-flate artificially WorldCom’s publiclyreported earnings by falsely and fraudu-lently reducing…expenses.”183

But the accounting misadven-tures and managerial self-dealing atWorldCom and other corporations thatoccurred after July 30, 2000, are reallyirrelevant to our story, for on that datePresident Bush signed Sarbanes-Oxleyinto law. It took only 28 days forWorldCom to collapse after its manage-ment’s accounting fraud was discovered.It took only two days longer for the Sen-ate to pass the new reform legislation,the Conference Committee to reachagreement, both houses of the Congressto vote on the compromise bill, and thePresident to sign it. WorldCom was un-questionably the “bang” that Williamshad predicted would end Act II of the“familiar” play, and Sarbanes-Oxley isquite obviously the “federal legislationon corporate accountability” that he hadreluctantly predicted in 1978 wouldclose Act III.184

VI. Corporate Governance Post-Enron

A. OverviewHarold Williams’ “familiar” play

is now ended. Sarbanes-Oxley has beenenacted, the first direct federal regulationsince the 1930s of matters of internalcorporate governance–matters histori-cally governed by state law and privatecontract. Yet as this paper has tried tomake clear, this legislation did not comeabout, as Williams feared it would, be-cause the American business community(as represented by its most prominentspokesmen) ignored, stonewalled, oradopted a head-in-the-sand response to

the corporate accountability “scandals”and “flagrant abuses” of the past 30years.185 To the contrary, over that pe-riod a voluntary “consensus” view of“best practice” with respect to corporategovernance was continually promotedand refined. Indeed, Sarbanes-Oxley, tothe extent it addresses audit committeematters, is based directly on this “con-sensus” view and is an expression not ofthe Congress’ disagreement with the“consensus” recommendations but of itsfrustration with the corporate commu-nity’s inability voluntarily andcomprehensively to impose these “con-sensus” recommendations on itself.186

Yet, significantly, Sarbanes-Oxley imposes on all public corporationsonly a small part of the full set of “bestpractice” standards embraced by the nowcurrent “consensus” view that developedafter Enron. This view, expressed in theproposed new listing standards at theNYSE187 and endorsed by the TaskForce188 and the BRT,189 goes well be-yond the requirements in Sarbanes-Oxley and constitutes the most compre-hensive, specific, and rigorousarticulation to date of the “consensus”model of corporate governance “bestpractices.” But if the Task Force is cor-rect and “substantial uniformity ofgovernance standards applicable to [all]public companies is desirable…,190 thenSarbanes-Oxley will achieve that uni-formity for only certain key “consensus”standards – primarily with respect to thecomposition and authority of the auditcommittee. Left unaffected and decid-edly non-uniform are many otherimportant components of the new “con-sensus” view, including the composition,selection, and authority of the board ofdirectors as a whole, the compositionand authority of other board committees,and the development and content of

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codes of business conduct and commit-tee charters. In the last section of thispaper we discuss our overview of the ul-timate value of this “consensus model”and whether the SEC, which appears tobe so inclined, should expend significantresources to achieve uniformity in theseother areas as well. But before doing so,the current corporate governance saganeeds to be concluded with a summaryof the principal provisions of Sarbanes-Oxley and the new NYSE listing stan-dards.

B. Sarbanes-Oxley

Most of the press coverage ofSarbanes-Oxley191 has focused on itscreation of a new Public Company Ac-counting Board192 and its establishmentof new standards of auditor independ-ence.193 One title of the Act, however, isentitled “Corporate Responsibility,” andfour features of Sarbanes-Oxley’s ap-proach to corporate governance areworthy of careful note.

First, as we pointed out above,194

the only part of the “consensus” view ofcorporate governance that Sarbanes-Oxley enacted into federal law concernsthe composition and authority of theaudit committee. To an extent, this lim-ited federalization of corporate structureis entirely understandable. Matters ofinternal corporate structure have beenhistorically the province of state law andprivate contracts, and the Congress issurely correct to legislate in the areaonly with great deference. Furthermore,the impetus for the Act was the “recentcorporate failures [that highlighted theneed] to improve the responsibility ofpublic companies for their financial dis-closure.”195 It was, therefore, logical forthe Congress to have limited its incur-sion into the area of corporate

governance simply to assuring that allpublic companies have “strong, compe-tent audit committees with realauthority.”196

Nevertheless, despite the limitedfederalization of the “consensus” viewof “best practice,” the Congress wasprepared to ignore entirely such “bestpractice” notions and rely on an entirelydifferent model of corporate governancemodel when it saw a clear need to con-trol specific types of managementopportunism. Thus, for example, (1)Sarbanes-Oxley prohibits outright anypublicly held corporation from making aloan to any of its directors or officers;197

(2) it forces the CEO and CFO of anypublicly held corporation that is requiredto file a financial restatement “due to thematerial noncompliance of the issuer, asa result of misconduct, with any finan-cial reporting requirement under thesecurities laws” to reimburse the corpo-ration for any bonuses received or profitsfrom stock sales realized during the 12-months following the filing of the inac-curate financial report;198 (3) it requiresCEOs and CFOs to certify that all finan-cial statements filed by theircorporations with the SEC “fairly pres-ent in all material respects the financialconditions and results of operations ofthe issuer…”199 and makes it a federalcrime to do so “knowing” that the finan-cial statements do not;200 (4) it prohibitsdirectors and executive officers fromselling company stock during benefitplan “blackout periods;”201 and (5) itmakes it unlawful for any officer or di-rector to take any action “to fraudulentlyinfluence, coerce, manipulate, or mis-lead” the corporation’s auditor.202

In the “consensus” view, a strongindependent board can and will protectstockholders from management’s temp-

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tation, in Berle and Means’ words, to“direct profits into their own pockets[and fail to run] the corpora-tion…primarily in the interest of thestockholders.”203 But at least in the fiveareas identified above, Sarbanes-Oxleyreflects the Congress’s serious doubts asthe ability of the board of directors,however independent, effectively to per-form that function.

Second, in the audit committeearea, Sarbanes-Oxley does follow the“consensus” model of corporate govern-ance by requiring every publicly listedcorporation204 to have an audit commit-tee composed entirely of “independent”directors, defined as individuals who arenot in any way “affiliated” with the cor-poration205 or receive “anycompensatory fee” from the corporationother than for serving on the board of di-rectors.206 Every public corporationmust disclose whether at least one mem-ber of its audit committee is a “financialexpert” and if not, why not.207 The auditcommittee must be “directly responsiblefor the appointment, compensation, andoversight” of the corporation’s outsideauditor,208 and pre-approve any “non-audit services” that the outside auditorprovides to the corporation.209 The auditcommittee is required to receive fromthe outside auditor reports as to “allcritical accounting policies…and all al-ternative treatments of financialinformation…discussed with manage-ment…”210 And the audit committeemust have “the authority to engage inde-pendent counsel and other advisers….”and to compensate these advisersthrough such corporate funding as it de-termines appropriate.211

Third, the method by which theCongress chose to impose the new auditcommittee requirements on publicly

“listed” corporations is precisely thatrecommended by the Task Force.212

That is, Sarbanes-Oxley does not imposethese requirements directly, but ratherrequires the SEC to “direct” the ex-changes and NASDAQ to “prohibit thelisting” of a corporation that is “not incompliance with these requirements.”213

The significance of this apparently con-voluted approach has generally goneunnoticed, but by structuring the auditcommittee requirements in this way,corporations, their boards of directors,and their audit committee members arenot faced with liability in the event theaudit committee requirements, for what-ever reason, are not adhered to.214

Fourth, Sarbanes-Oxley createsnew financial crimes,215 increases thecriminal penalties for many existing fi-nancial crimes,216 and gives the SECsubstantial new enforcementauthority.217 It does not, however, ex-cept for extending the statute oflimitations for fraud,218 in any way fa-cilitate stockholders’ ability to sue for abreach of the securities laws or any newrequirement imposed by the Act. In-deed, as noted above, even aninterventional a breach of the new auditcommittee requirements will not be ac-tionable because those requirements willbe imposed by self-regulatory organiza-tion rules. And enforcement of the newprohibition against fraudulently influ-encing an auditor is specifically limitedto the SEC.219 Thus, while the Congresssought through Sarbanes-Oxley “to in-crease corporate responsibility,”220 itmost clearly did not want to use in-creased stockholder litigation as a meansfor accomplishing that objective.

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C. NYSE Listing StandardsIn February 2002, at the request

of the Chairman of the SEC, the NYSEappointed a special Corporate Account-ability and Listing Standards Committee(Accountability Committee) to reviewthe NYSE’s listing standards in light ofEnron. On June 6, 2002, the Account-ability Committee issued its report.Although the report of the Blue RibbonCommittee had been completed less thanthree years earlier, the AccountabilityCommittee saw a need “in the aftermathof the ‘meltdown’ of significant compa-nies due to failures of diligence, ethics,and controls, [for] the NYSE…onceagain [to use its authority] to raise cor-porate governance and disclosurestandards.”221 Unlike the Blue RibbonCommittee’s recommendations, there islittle conventional and nothing timidabout the recommendations of the Ac-countability Committee. Theserecommendations, which in all signifi-cant respects have been incorporated inproposed rule changes filed by theNYSE with the SEC on August 1,2002,222 are unquestionably the most farreaching and rigorous expression of the“consensus” view of corporate govern-ance ever promulgated.223 A briefsummary of certain key provisions of thenew listing standards should illustratetheir boldness.

The starting point is hardly sur-prising. All listed companies must havea majority of independent directors.224

Interestingly, a director does not qualifyas “independent” unless the board of di-rectors affirmatively determines that thedirector has no material relationship withthe corporation, and that determination(and its basis) is “disclosed in the com-pany’s annual proxy statement.”225 Inaddition, regardless of any board deter-mination, no director may be considered

to be “independent” until five years afterhe or she ceases to be an employee of,affiliated with the auditor for, been partof an interlocking directorate involving,or a member of the immediate family ofsomeone who is not independent of, thelisted company.226

It is, however, in the powers andauthority of the independent directorsthat the recommendations of the Ac-countability Committee take thecorporate governance paradigm of thestrong board of directors to what must beregarded as its apotheosis. First, withthe explicit objective of “empower[ing]non-management directors to serve as amore efficient check on management,”these directors must “meet at regularlyscheduled executive sessions withoutmanagement.”227 Second, each listedcompany must have three committeescomprised solely of independent direc-tors: a nominating/corporate governancecommittee, a compensation committee,and an audit committee. The nominatingcommittee must have the authority “toselect, or to recommend that the boardselect,” the future director nominees andthe responsibility to prepare a “writtencharter” addressing, among any othermatters, “a set of corporate governanceprinciples applicable to thecorporation.”228 The compensationcommittee must “review and approvecorporate goals and objectives relevantto CEO compensation, evaluate theCEO’s performance in light of thosegoals and objectives, and set the CEO’scompensation level based on thisevaluation.”229 With respect to the auditcommittee, no member of the auditcommittee may receive any “compensa-tion” from the corporation other thandirector’s fees; the committee must have“the sole authority to hire and fire inde-pendent auditors; and it must pre-

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approve any significant non-audit rela-tionship with the independentauditors.”230 In addition, the audit com-mittee is empowered “without seekingboard approval” to “obtain advice andassistance from outside legal, accountingor other advisors.”231

The Accountability Committee’sreport and the NYSE’s actual proposednew listing standards contain many morespecific requirements designed to “givethe legions of diligent directors bettertools to empower them and encourageexcellence.”232 Indeed, it is hard to thinkhow independent directors could bemore empowered than they will be underthe new NYSE standards without seri-ously interfering with the need forstrong, centralized management capableof efficiently making the adaptive deci-sions necessary for the competitiveoperation of the modern corporation.233

The question, of course, to which wenow turn, is whether the fully empow-ered, independent board of directors willhave the disposition, incentive, andresolution “to serve as a more effectivecheck on management.”234

VII. ConclusionVirtually all of the sig-

nificant developments in corporategovernance over the past 30 years flowfrom a paradigm shift in the generalview of the role of the board of directorsthat occurred in the 1970s. At the startof that decade, boards of directors wereseen as operating best through consen-sus, not conflict, and the outsidedirectors’ principal value was under-stood to be that of experienced,constructive advisors to the CEO, offer-ing knowledgeable and objectiveperspectives on the company’s competi-tive challenges. As the decade

progressed, however, scholarly andregulatory concern was increasingly ex-pressed that such collegial, conflictavoiding boards were little more thanrubber stamps for CEOs. Thus, a “con-sensus” of establishment lawyers,academics, and business leaders devel-oped that such boards should be replacedby “monitoring” boards, characterizedby independence, skepticism, and un-flinching commitment to stockholdersinterests. As corporate “scandals” and“flagrant abuses” continued through the1980s and 1990s, this “consensus” viewof the monitoring board as “best prac-tice” spread and sharpened, culminatingultimately in Sarbanes-Oxley’s auditcommittee requirements and the NYSE’snew listing standards.

But the validity of the “consen-sus” view, in general, and of these recentcorporate governance initiatives, in par-ticular, rests on the assumption thatincreases in director independence andempowerment lead to decreases in in-stances of management opportunism.While it may be difficult to disprove (orprove) this assumption,235 we want to of-fer in closing some brief but skepticalcomments on the wisdom of the appar-ently ever increasing public reliance onit.

First, boards of directors in thelater 1990s and early 2000s were un-doubtedly far more “independent” thanthose in the early 1970s. But surely noone would argue that the managerialmisdeeds leading to passage of theFCPA were worse than those leading topassage of Sarbanes-Oxley. Enron,WorldCom, Adelphia, Tyco, and GlobalCrossing were all listed on the NYSE orNASDAQ. These companies were infull compliance, formally at least, withall applicable requirements for board andaudit committee independence, yet it

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would be hard to find any corporation inthe 1970s whose management behavedwith comparable piracy.

Second, if independent directorsare to perform an effective monitoringrole, they need “to bring a high degree ofrigor and skeptical objectivity to theevaluation of company management andits plans and proposals.”236 But thesecharacteristics are likely to be far differ-ent from the characteristics of directorsvalued by a CEO for their strategic in-sights and business acumen. At aminimum, therefore, the “consensus”demand for a “monitoring” board forcesa tradeoff of strategic vision for skepticalobjectivitywithout any demonstrationthat a cost-benefit analysis favors a“monitoring” versus “counselling”board. More fundamentally, the successof the monitoring board would appear todepend on the recruitment of directorswith profiles very different from those ofthe directors that now oversee our majorcorporations. Without exaggeration, therhetoric used by the NYSE’s Account-ability Committee and the ABA’s TaskForceand the apparent objective ofSection 301 of Sarbanes-Oxleysuggests that in recruiting mem-bers for their boards of directors, publiccompanies should be looking not forsuccessful executives at other compa-nies, investment bankers with broadindustry expertise, or professional con-sultants with detailed knowledge ofbusiness processes and operations, butrather, for former staff members of theSEC’s Division of Enforcement. Surely,this cannot be right.

Third, if the premise of themonitoring board is correct, that is, if thestockholders are, in fact, to rely on theindependent directors to prevent man-agement opportunism, then one would

expect that when such a board fails toprevent such opportunism, through neg-ligence or worse, it should be possible tocall the board to account for its failure.But that is not the case. “On the con-trary…many prominent features ofcorporate law [are] designed for the ex-press purpose of making it difficult forshareholders to hold the board…legallyresponsible, except in the most provoca-tive circumstances….[And it would be]dangerously optimistic [to] assum[e] thatthe level of judicial supervision of busi-ness can be dramatically increasedwithout unforeseeable and incalculableconsequences for the efficiency withwhich businesses make necessary adap-tive decisions.”237 Yet, as we assignmore and more responsibilities to the“independent” directors but do not inany way attend to the legal consequencesof their negligent performance of theseresponsibilities, we are, in effect, puttingcops on the beat without supervision orrisk of sanction. Neither Sarbanes-Oxley nor the NYSE’s new listing stan-dards acknowledge this anomaly, butsurely the disconnect between directorresponsibility and director accountabilityis far too large to remain unaddressed.

Fourth, and finally, the “consen-sus” model of “best practice” in the areaof corporate governance represents anattempt to control corporate opportunismthrough private initiatives, therebyavoiding federal intervention into mat-ters of internal corporate organizationand management. Over the last 30years, the pattern has been for the “con-sensus” to recommend “independence”on corporate boards to prevent further“scandals” or “flagrant abuses.” Whenmore “scandals” and “flagrant abuses”occur, the “consensus” recommendseven more “independence,” and thenwhen “scandals” and “flagrant abuses”

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continue, it recommends yet more “in-dependence,” and so on and so on. InSarbanes-Oxley, the Congress showedits impatience with this continual ratch-eting up of the standards for, and powersof, the independent directors by impos-ing federal bans on such matters ascorporate loans to executives and forcedexecutive repayments of bonuses andstock gains before corporate restate-ments. In doing so, the Congress wastesting a new approach to corporate gov-ernance.

Berle and Means focused corpo-rate scholarship’s attention on the risksof management opportunism given theseparation of ownership and control.Berle and Means, however, never sug-gested that a monitoring board was thesolution to that endemic corporate prob-lem. At present, the “consensus” viewas to corporate governance “best prac-tice” is so dominant that it is difficulteven to suggest that furtherempowerment of an independent, moni-toring board may not be the solution tothe current round of corporate “scan-dals” and “flagrant abuses.”Nevertheless, after watching “independ-ence” and “empowerment” ratcheted upand up and up for 30 years, our conclu-sion is that enough is now enough. It istime to recognize that other “best prac-tice” models of corporate governanceneed to be evaluated. First, the costs andbenefits of allowing an efficient “marketfor corporate control” to develop need tobe re-evaluated. Second, members of

the “consensus” and particularly the es-tablishment business community need tothink seriously about the trade-offs be-tween boards that “counsel” and boardsthat “monitor.” And third, attentionneeds to be paid to other approaches tocontrolling management opportunism.While more direct federal prohibitionson specific types of management mis-conduct and more substantive corporategovernance authority in the SEC are notparticularly attractive on their own, theynevertheless may need to be exploredonce the impact of Sarbanes-Oxley isthoroughly analyzed. More promisingapproaches may be carefully tailoredoversight of executive compensation,mandatory holding periods for options,and limitations on executive stock sales.An increase role for trained internalmonitors is not out of the question, andsurely there are any number of other ap-proaches that could be explored. Thepoint is that by turning the corporateboard into the “monitor” of corporatemanagement, we do not appear to havebeen able to stop the “scandals” and“flagrant abuses,” and we may well belosing the vision, advice, and competi-tive perceptiveness that a good boardshould be providing the CEO. Surelythere must be better ways to deal withthe consequences of the separation ofownership from control in the moderncorporation. The time has come, we be-lieve, to think outside the “consensus”box.

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End Notes

1 Pub. L. 107-204, July 30, 2002, available at <http://frwebgate.access.gpo.gov/ cgi-bin/getdoc.cgi?dbname=107_cong_bills&docid =f:h3763enr.txt.pdf>.

2 See Section III C, below.3 Manne (1965), p. 110.4 On October 16, 2001, Enron announced a $618 billion reduction in third quarter profits and a $1.2 billion

loss in shareholder equity. Hays (2002). 5 In April of 1998, Cendant announced plans to restate its 1997 earnings due to major “accounting irregulari-

ties” that resulted in Cendant overstating income of up to $115 million. “Cendant to Restate Results,” CNNMoney<http://www.money.cnn.com/1998/04/15/companies/cendant> April 15, 1998.

6 In 1998, Sunbeam Corp. restated its 1996 and 1997 financials due to accounting discrepancies. Belstranand Rogers (2002).

7 In late 1994, Bausch & Lomb announced that excess distributor inventories would reduce 1994 earnings by54 percent. Maremont and Barnathan (1995).

8 See Presidential Campaign Activities of 1972: Hearings Before the Select Comm. On Presidential Cam-paign Activities, 93d Cong., 1st Sess. (1973).

9 See Activities of American Multinational Corporations Abroad: Hearings Before the Subcomm. on Interna-tional Economic Policy of the House Comm. On International Relations, 94th Cong., 1st Sess. 36-37 (1976) (statementof Philip A. Loomis, Commissioner, SEC); SEC, Report of Questionable and Illegal Corporate Payments and Practices(May 12, 1976) (submitted to the Senate Banking, Housing, and Urban Affairs Comm.).

10 See S. Rep. No. 114 (1977); H.R. Conf. Rep. No. 831 (1977), reprinted in 1977 U.S. Code Cong. &Admin. News 4121; Note, Effective Enforcement of the Foreign Corrupt Practices Act, 32 Stan. L. Rev. 561 n.1(1980).

11 SEC, 94th Cong., Report on Questionable and Illegal Corporate Payments and Practices (Comm. Print1976).

12 Unlawful Corporate Payments Act of 1977, H. R. Rep. No. 95-640, 4 (Sept. 28, 1977).13 Foreign Corrupt Practices Act, Pub. L. No. 95-213, 15 U.S.C. § 78dd et. seq. (Dec. 19, 1977).14 See note 9, above.15 SEC, Regulation 13B-2, 44 Fed. Reg. 10970 (Feb. 23, 1979).16 Williams (1978), p. 319. . 17 Ibid.18 Ibid.19 Ibid.20 Ibid.21 Ibid, p. 327.22 Ibid, p. 31923 Ibid, p. 320.24 See Section IV.A. below.25 Legislation was introduced in the House as H. R. 3763 on February 14, 2002, and in the Senate as S. 2673

on June 25, 2002.26 The chairman and CEO of Goldman Sachs said he “cannot think of a time when business over all has been

held in less repute.” McGeehan (2002), p. A1. See also Morgenson (2002), p. C4, addressing a May CBS/Gallop poll

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finding that “84 percent feel that [the accounting impropriety] issue is punishing stock prices, ranking it ahead of con-flict in the Middle East and terrorism.”

27 Klinger, Scott, Hartman, Chris, Anderson, Sarah, Cavanagh, John, and Sklar, Holly, Executive Excess2002, Ninth Annual CEO Compensation Survey, Institute for Policy Studies and United for a Fair Economy, p. 1(August 26, 2002)

28 See Berman (2002).29 See Lublin and Sandberg (2002).30 See Wing (2002), p. 4.31 Greenspan (2002). “If the past thirty years have demonstrated anything, it is that the avarice of America’s

corporate leaders is practically unlimited, and so is their power to run companies in their own interest.” Cassidy, John,The Greed Cycle, The New Yorker, Sept. 23, 2002 at 76.

32 Labaton and Oppel (2002). 33 See Williams (1978), p. 319. 34 See Labaton and Oppel (2002).35 Sarbanes-Oxley was signed into law on July 30, 2002.36 See Williams (1978), p. 320. 37 BRT, Strongly Supports President Bush’s Signing of Accounting and Financial Reform Law (July 2002).

www.brtable.org/press.cfm/748. 38 Drucker (1981), p. 113.39 Berle and Means (1991), pp. 6-7. Adam Smith made much the same point a little over 150 years earlier.

In discussing joint stock companies, Smith wrote: “The directors of such companies, however, being the managersrather of other people’s money than of their own, it cannot well be expected, that they should watch over it with thesame anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stew-ards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easilygive themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail more or less,in the management of the affairs of such a company.” Smith, Adam, An Inquiring Into the Nature and Causes of theWealth of Nations, Vol. 2, p. 741, Chapter v.i.e., General Editors R.H. Campbell and A.S. Skinner, Textural EditorW.B. Webb Todd, Clarendon Press, Oxford 1976.

40 Ibid, p. 313.41 Ibid, p. 4.42 Ibid, p. 131.43 Ibid, p. 293.44 See Arrow (1974), pp. 68-70.45 See Berle and Means (1991), p. 219.46 By “opportunism” we mean not only management’s pursuit of its self-interest at the expense of the stock-

holders, but also (1) what is generally referred to in the economic literature as the temptation for “shirking,” that is,management’s tendency to avoid responsibility, negligently perform assigned duties, and free ride on the efforts of oth-ers, and (2) the likelihood of systematic deviation from rationality when managers attempt to deal in complex situationsand are “erroneously confident” in their knowledge and underestimate the odds that their information or beliefs will beproved wrong. See Bazerman and Messick (1996).

47 Clark (1986), pp. 390-392, and Alchian and Demsetz (1972), p. 777. 48 See Eisenberg (1976). 49 Allen (1992). 50 Bronson (1983). 51 Jensen and Meckling (1976). 52 See Eisenberg (1976), pp. 140-8.

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53 Millstein (1993), p. 1485. 54 Lorsch (1995).55 See, e.g., Gordon (2002), Monks and Minow (2001), and Lipton and Lorsch (1992). 56 Mace (1970). 57 Millstein (1993). 58 SEC, Accounting Series Release No. 19 (Dec. 15, 1940).59 Report of the Subcommittee on Independent Audits and Procedure of NYSE Committee on Stock List

(1939), p. 7. 60 Mautz and Newman (1977). 61 Letter from Hills to Batten, Exhibit D to 1976 Report (May 11, 1976).62 NYSE Company Manual A-29 (1980).63 “Corporate Directors' Guidebook” (1978).64 Ibid., p. 1619.65 Ibid.66 Ibid.67 BRT (1978). 68 For example, “We enumerate all these legal, regulatory and political constraints on U.S. business organi-

zations with some mixed emotions because a number of them impose excessive and unnecessary costs [and] impair theeffectiveness of U.S. business in a world increasingly characterized by transactional markets and transactional compe-tition.” Ibid, p. 293.

69 BRT (1978).70 Ibid., p. 310.71 Staff Report on Corporate Accountability, 96th Cong. 2d Sess. Senate Committee On Banking, Housing and

Urban Affairs, (Comm. Print, Sept. 4, 1980). 72 Ibid, pp. 8-9.73 Ibid., p. 428.74 Ibid. at 431.75 Ibid., p. 428.76 Ibid., p. 437.77 Ibid., p. 442.78 Ibid., p. 448.79 Ibid., p. 469.80 Ibid., p. 495.81 Ibid., p. 494.82 See “Corporate Directors' Guidebook” (1978), p. 32.83 Staff Report on Corporate Accountability, 96th Cong. 2d Sess. Senate Committee On Banking, Housing and

Urban Affairs, (Comm. Print 1980), at 499. 84 Ibid., p. 519.85 See BRT (1978), pp. 304, 312, and 315.86 See BRT (2002), p. 3. 87 Manne (1965), p. 110.

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88 Ibid., p. 113.89 House Interstate and Foreign Commerce Committee, House Report No. 1711, to Accompanying S.510,

90th Cong. 2d Sess. (July 12, 1968) Reprinted in 1968 U.S. Code Cong. & Admin. News, Vol. 2 at 2812.90 Pub. L. 90-439, July 29, 1968.91 See, Securities Exchange Act of 1934 at Sections 13(d) (1) and 14(d).92 In Smith v. Van Gorkom, directors were given the authority to make takeover-related decisions based not

on a corporation’s market value, but on its “intrinsic value.” Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). InUnocal Corp. v. Mesa Petroleum Co., takeover defenses were permitted provided they were “reasonable in relation tothe threat posed” test. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). In Revlon v. MacAndrews &Forbes Holdings, directors were held to have a duty to maximize the short-term value of the corporation once the deci-sion had been made to sell, but they were under no duty to make the corporation available “for sale” at all times.Revlon v. MacAndrews & Forbes Holdings, 506 A.2d 173 (Del. 1986). And, in Moran v. Household International,Inc., board authority to adopt “a poison pill” was affirmed, effectively blocking any takeover attempts unless share-holders replaced the directors with a takeover-friendly board. Moran v. Household International, 500 A.2d 1346 (Del.1985).

93 Bainbridge (1995). 94 See Lipton, Martin and Steinberger, Erica H., Takeovers & Freezeouts, Vol. 1, 1-5 to 1-10.1, Law Journal

Press, New York, New York (2001).95 Manne (2002).96 American Law Institute (1994). 97 See generally, Symposium on Corporate Governance, The Business Lawyer 48 (Aug. 1993), p. 1267. 98 See American Law Institute (1994), at § 3.02(c).99 Ibid. at § 3.02(a)(2).100 Ibid. at § 3A.01.101 Ibid. at § 3.05.102 Ibid. at § 3.02(a)(4).103 Ibid. at § 3A.03.104 See American Law Institute (1994), at vol. 1, p. 117. 105 American Bar Association (1994), p. 15. 106 Ibid., p. 16.107 Ibid.108 American Bar Association (1978), p. 1627.109 See American Bar Association (1994), p. 27.110 BRT (1997). 111 Ibid., pp. 10-11. 112 Ibid., p. 1. 113 Levitt (1998). 114 Ibid. While there were a number of accounting “scandals” that predated Levitt’s speech, perhaps the most

notorious was reported in 1994 when auditors discovered that Bausch & Lomb’s Hong Kong division had inflated saleswith a scheme of phony invoices and hidden inventory. Later in the same year, an SEC investigation revealed that thecompany’s contact lens division inflated 1993 profits by offloading enormous amounts of unwanted inventory to dis-tributors at year-end under delayed payment plans. After these issues surfaced, Bausch & Lomb announced that excessdistributor inventories would slash 1994 earnings by 54 percent. Further investigations disclosed a pattern of corporatemisdeeds, including funneling products onto the “gray market;” threatening distributors unless they agreed to take ex-cess inventory; pre-shipping products without obtaining orders and recording them as sales; and providing customersunusually long payment terms. See Maremount and Barnathan (1995). SEC investigations found that Bausch & Lomb

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had overstated income by $17.6 million. The company later settled a shareholder lawsuit for $42 million. See “Ac-counting Failures…” (2002).

115 Ibid.116 SEC, News Rel. 98-96 (Sept. 28, 1998).117 NYSE and NASD (1999).118 Ibid., p. 4.119 SEC, Rel. No. 34-42231 (Dec. 14, 1999); SEC, Rel. 34-42233 (Dec. 14, 1999).120 NYSE and NASD (1999), pp. 20, 22.121 NYSE and NASD (1999), p. 23.122 NYSE Company Manual § 303.01. The NASD made similar but not identical changes to the NASDAQ

listing standards. 123 See SEC, Rel. No. 34-42233 at 9-10; See SEC, Rel. No. 34-42231 at 12.124 See, for example, revisions to the proxy rules relating to disclosure of executive compensation (SEC,

Regulation 14A, Item 10) and audit committees operations, (SEC Regulation 14A Item 7(d)). 125 See BRT (1997) at Foreword. 126 Norris (2000). 127 SEC, Litigation Release No. 17577 (June 21, 2002). 128 Treaster (1999). 129 SEC, Litigation Release No. 16910 (Feb. 28, 2001). 130 Norris and Henriques (2000). 131 Fields (1998). 132 “Dunlap to Leave Sunbeam Board” (1998). 133 SEC, Litigation Release No. 17001 (May 15, 2001). 134 Norris (2001). 135 SEC, Litigation Release No. 17435 (March 26, 2002). 136 SEC, Release No. 34-42968 (June 21, 2000). 137 SEC, Litigation Release No. 17435 (March 26, 2002). 138 Eichenwald (2002). 139 Min (2001). 140 “Heard on the Street” (2002). 141 PriceWaterhouseCoopers Securities Update 2001. 142 In December 2000, 30 percent of Americans had no, or very little, confidence in large corporations and

only 9 percent had a great deal of confidence. By comparison the comparable percentages for the Congress were 24percent and 10 percent. NBC News/Wall Street Journal Poll conducted by Hart-Teeter. online.wsj.com/documents/poll-20020724.html.

143 Enron Corp., Form 10-K for Fiscal Year Ended 2000. 144 Barroveld (2002). 145 Enron Corp. (2001). 146 Powers et. Al. (2002). 147 Clayton, Scroggins, and Westley (2002).

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148 In addition to materials cited elsewhere in this paper, see Fusaro and Miller (2002), International Swaps

and Derivatives Association (2002), Bratton (2002). News stories, court developments, reports, and SEC filings withrespect to Enron are available at <http://news.findlaw.com/legalnews/lit/enron/index.html>.

149 See Clayton, Scroggins, and Westley (2002), p. 148. 150 The Role of The Board of Directors in Enron’s Collapse, Report prepared by the Permanent Subcommit-

tee on Investigations of the Committee on Governmental Affairs United States Senate, 107th Congress 2d Session,Report 107-70 (July 8. 2002).

151 BRT Press Release, The Business Roundtable Calls Enron Failure “Massive Breach Of Trust”; Task ForceChair Raises Outlines Principles for Corporate Governance Before House Panel, March 3, 2002.

152 The BRT and the ABA were by no means the only organizations that issued statements on corporate gov-ernance. See, in addition, March 2002 Financial Executives International, Observations and RecommendationImproving Financial Management, Financial Reporting and Corporate Governance; Council of Institutional InvestorsCorporate Governance Policies available at <http://www.cli.org/corp_governance.htm>. On June 4, 2002, InstitutionalShareholder Services announced the release of its “corporate governance quotient calculation” to “assist institutionalinvestors in evaluating the quality of corporate boards and the impact their governance practices may have on perform-ance.” ISS, Press Release, available at >http://www.issproxy.com/Press_ Release_CGO_launch%20_Final.htm>.

153 BRT (2002), p. iv. 154 Ibid., p. iii. 155 The Business Roundtable, “Statement of BRT on the Corporate and Auditing Accountability, Responsi-

bility and Transparency Act of 2002 (H.R. 3763),” submitted on March 20, 2002 to the Comm. On Financial Services,H. of Rep., at 2.

156 Ibid., p. 9. 157 BRT (1978). 158 BRT (2002), p. 3. 159 BRT (2002), p. 11. 160 BRT (2002), p. 10. 161 Ibid., pp. 13-14. 162 American Bar Association (2002). 163 Ibid., p. 6. 164 Ibid., pp. 3 and 10. 165 Ibid., p. 13. 166 Ibid. 167 American Bar Association (2001). 168 See BRT (2002), p. 9. 169 American Bar Association (2002).170 See BRT (1997), at foreword.171 See American Bar Association (2002), p.15.172 Ibid., pp. 14-15.173 See Williams (1978). 174 WorldCom, Form 10-K for the fiscal year ended December 31, 2001. 175 Blumenstein and Jared (2002). 176 Young (2002). 177 Blumenstein and Jared (2002).

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178 WorldCom Announces Intention to Restate 2001 and First Quarter 2002 Financial Statements, WorldCom

Press Release, June 25, 2002. 179 Sandberg, Blumenstein, and Young (2002). 180 SEC, Litigation Release No. 17588 (June 27, 2002). 181 Young, Mollenkamp, Sandberg, and Sender (2002). 182 WorldCom Announces Additional Changes to Reported Income For Prior Periods, WorldCom Press Re-

lease, August 8, 2002. 183 United States of America v. Scott D. Sullivan and Buford Yates, Jr., Indictment ¶ 20. 184 WorldCom not the only corporate scandal to follow Enron. The Task Force cites the following: (1) On

June 25, 2002, Adelphia Communications filed for bankruptcy protection three months after revealing that it hadguaranteed loans of $2.3 billion to members of the Rigas family, Adelphia’s controlling shareholders. Treaster (2002),p. C2. Adelphia’s common stock, which had reached a high of nearly $28 per share in December, 2001, was nowessentially worthless. Lauria (2002). (2) The market capitalization of the stock of Tyco International has fallen by some$100 billion in 2002, after the indictment of its former CEO on charges of state sales tax evasion, and by concernsabout the use of corporate funds for the personal benefit of the CEO and the general counsel of the company. See Ber-enson (2002). (3) Gary Winnick, the former head of Global Crossing Ltd., sold over $700 million of his stock from1999 (when the price reached $60 per share), through the end of 2001 shortly before the company’s bankruptcy filing.Global Crossing’s revenues were alleged to be inflated due to swaps without economic substance. See Stewart (2002).Before these companies, went into bankruptcy, their common stock was traded on the NYSE or the NASDAQ NationalMarket.

185 See Williams (1978), p. 319. 186 Sarbanes-Oxley also contains provisions–blanket prohibitions of loans to corporate executives, recapture

of profits from stock sales in the event of an earnings restatement, executive certification of financial statements, andprohibition of executive stock sales during “blackout periods”–that reflect substantial skepticism with respect to the“consensus” view that strong boards of directors can effectively control management opportunism. See Section VII,below.

187 Corporate Governance Rule Proposals Reflecting Recommendations from the NYSE Corporation Ac-countability and Listing Standards Committee as Approved by the NYSE Board of Directors, Aug. 1, 2002, available at<www.nyse.com>. On August 21, 2002, NASDAQ’s Board of Directors approved a comprehensive package of corpo-rate governance reforms that basically tracks the NYSE’s new listing standards. Because the full text of the NASDAQproposals are not yet available, we will cite hereafter only to the NYSE Standards. A summary of the NASDAQ Cor-porate Governance proposal is available at<http://www.NASDAQnews.com/about/corpgov/Corp_Gov_Summary082802.pdf>.

188 See American Bar Association (2002), pp.16-21. 189 The Business Roundtable Praises the New Listing Standards of the New York Stock Exchange, BRT Press

Release, Aug. 1, 2002, available at <http://www.brtable.org/press.cfm/751>. 190 See American Bar Association (2002), p.14.191 See note 1, above. 192 Ibid. at Title I. 193 Ibid. at Title II. 194 See text accompanying notes 188, 189, and 190. 195 Public Company Accounting Reform and Investor Protection Act of 2002, Report of the S. Comm. On

Banking, Housing and Urban Affairs, to accompany S. 2673, 107th Cong., 2d Sess., Rep. 107-205, 23 (July 3, 2002). 196 Ibid. 197 See note 1, above at § 402. This provision could well have far reaching implications for several well es-

tablished corporate employee benefit programs. See Rozhon and Treaster (2002), and Treaster and Rozhon (2002).198 See note 1, above, at § 304. Presumably, this provision can be enforced in the same manner as the current

prohibition on short-swing profits in Section 16(b) of the Securities Exchange Act of 1934, that is, through stockholderderivative action.

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199 See note 1, above, at § 302. The SEC has now adopted rules implementing section 302 of Sarbanes-Oxley

as well as imposing extensive additional requirements regarding internal controls for both disclosure and financial re-porting. SEC, Rel. No. 33-8124, Certification of Disclosure in Companies’ Quarterly and Annual Reports, August 29,2002.

200 See note 1, above, at § 906.201 Ibid. at § 306.202 Ibid. at § 303.203 Berle and Means (1991), pp. 6-7. 204 This is a narrower universe than that of all public corporations because it includes only corporations

“listed” on NASDAQ or and exchange. 205 This is a defined term and includes any person directly or indirectly controlling, controlled by, or under

common control with the corporation. See Securities and Exchanges Act of 1934, § 3(a)(19).

206 See note 1, above at § 301. 207 Ibid. at § 407.208 Ibid. 209 Ibid. at § 202. 210 Ibid. 211 Ibid. at § 301. 212 See American Bar Association (2002).

213 See note 1, above, at § 301. 214 The generally accepted legal doctrine is that there is no private right of action for violation of rule of a

self-regulated organization.

215 See note 1, above, at §§ 802, 807, 1102, and 1107. 216 See note 1, above, at §§ 902, 903, 904, and 1106.

217 See note 1, above at §§ 305, 602, and 1105. 218 Ibid. at § 804. 219 Ibid. at § 303. 220 See note, above, at 1. 221 Report of New York Stock Exchange Corporate Accountability and Listing Standards Committee (June 6,

2002). 222 Corporate Governance Rule Proposals Reflecting Recommendations from the NYSE Corporate Account-

ability and Listing Standards Committee as Approved by the NYSE Board of Directors August 1, 2002, available at<www.nyse.com>.

223 While the NYSE’s actual proposed rule changes were approved by its Board after enactment of Sarbanes-Oxley, the Corporate Accountability Committee’s recommendations on which they were based were made almost twomonths before the Act was signed into law and several weeks before Senator Sarbanes’ Senate Banking Committee re-ported the bill. The Nasdaq Stock Market has proposed somewhat similar requirements. NASDAQ Press Release,June 5, 2002.

224 See note 222, above, at ¶ 1. The NYSE had previously only required a listed company to have three inde-pendent directors, all of whom were to serve on the audit committee. NYSE Listed Company Manual, § 303.01(B)(2)(a).

225 See note 222, above, at ¶ 2(a) and Commentary. 226 Ibid. at ¶ 2(b).

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227 Ibid. at ¶ 3. 228 Ibid. at ¶ 4. 229 Ibid. at ¶ 5. 230 Ibid. at ¶ 7(a). 231 Ibid. at ¶ 7(b)(ii) (E) and Commentary. 232 Ibid., at 1.233 See Arrow (1974). 234 See note 221, above, p. 8. 235 But see Bhagat and Black (1999). “[Evidence suggests] the opposite−that firms with super majority-

independent boards perform worse than other firms, and that firms with more inside than independent directors performabout as well as firms with majority (but not super majority) independent boards.”

236 Langevoort (2001).

237 Dooley (1992).