Citizens United, speech and the corporate governance defence

A year ago, the US Supreme Court ruled that corporations could give as much money as they wanted to political campaigns. Any attempt by government to curb donations was an infringement of the right to free speech, which is protected absolutely by the first amendment to the US Constitution. The Supreme Court may have ruled, but that hasn't stopped commentators from exercising their right of free speech to keep the topic alive. The Citizens United case arose when the Federal Election Commission imposed a ban on the broadcast of a controversial documentary to thwart Hillary Clinton's attempt to win the Democratic Party's nomination for the presidency in 2007-08. Citizens United, an incorporated membership organization, had made the film with funding from a variety of donors. The narrow, 5-4 decision of the court didn't just overturn the issue of whether a documentary was different from, say, an advertisement. Instead it eliminated all restrictions on campaign donations by corporations.

The Citizens United website marked the anniversary with a remarkably balanced video about the case, giving critics of the ruling a lot of air time. The video suggested, without quite saying so directly, that the ruling led to the Democrats' heavy defeat in Congressional elections last November. The implication: corporate donations to Republicans turned the tide. More tellingly, it asserted that the decision meant President Obama would face the toughest campaign in history when he seeks re-election in 2012. Whatever the impact of the decision on the political process, the decision raises corporate governance issues that have not gone away.

To blunt the impact of the ruling, Lucian Bebchuk of Harvard Law School and Robert Jackson at Columbia have mounted what might be called the corporate governance defence. Corporations may have free speech, but the processes by which they decide what to say are a matter of corporate governance, they say. Boards of directors are fiduciaries for shareholders and decisions by boards could still be governed by processes involving even the legal rights – right established in law, by legislators – that constrain how boards act. Shareholders may well disagree with what the board decides. Bebchuk and Jackson point out that until now courts have found that political donations by companies, which have faced limits for the past century, have been treated as business decisions, as they would normally be made to achieve outcomes that would favour the company's business. Such choices are covered in corporate law by the so-called "business judgement rule" that limits shareholders' rights to sue directors over the decisions they reach, even if they turn out to be mistakes. But Bebchuk and Jackson, in an article for the Harvard Law Review, think political donations might be treated differently: "political speech decisions are fundamentally different from, and should not be subject to the same rules as, ordinary business decisions," they contend. They suggest that lawmakers could still adopt rules that:

• Give shareholders a voice: "provide shareholders a role in determining the amount and targets of corporate political spending";
  
• Give outside directors control: "require that political speech decisions be overseen by independent directors";
  
• Provide an opt-out: "allow shareholders to opt out of – that is, either tighten or relax – either of these rules"; and
  
• Demand disclosure: "mandate disclosure to shareholders of the amounts and beneficiaries of any political spending by the company, either directly or indirectly through intermediaries."

Theirs is not the only view, however. Larry Ribstein at the University of Illinois accepts that the court "did not wholly preclude regulation of corporate governance processes that produce corporate speech". But he contends that regulation of the corporate governance processes for authorising corporate speech still face significant first amendment obstacles. "These problems with the corporate governance rationale for regulating corporate speech suggest that protection of shareholders' expressive rights may be trumped by society's interest in hearing corporate speech and the First Amendment's central goal of preventing government censorship," he writes.

The Supreme Court ruling concerned political donations, yes, but it drew on a wide canvas, much wider than the one originally brought by Citizens United. There might well be other challenges to laws telling corporations what they may and may not say. Commercial speech – advertising and the like – has long operated under a variety of laws that prevent false claims for products. Corporate financial and non-financial disclosure is both required and constrained in law. Few legal scholars seem to think these limits on free speech would even be brought under the umbrella of the Citizens United decision, however sweeping it may have been. But for all practical purposes no one is seriously asking the question anymore about whether corporations are the sort of persons the founding fathers had in mind when they drafted the first amendment and wrote:

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

There weren't very many corporations in those days, of course. But there's a lot of case law since then that establishes that the legal person of the corporation is a person, come what may.

Shareholder value, stakeholder rights: It's worth considering, however, that the corporate governance defence that Bebchuk and Jackson promote depends upon a particular and fairly absolutist view of the role of boards. They say boards work in shareholders' interests. No further discussion. Supporters of a stakeholder-based approach to corporate governance contend that board have obligations to others who might be affected by the corporation's decisions. If you take away the link to shareholder supremacy, do you take away the corporate governance defence?

Source documents: The working paper "The First Amendment and Corporate Governance," by Larry Ribstein of the University of Illinois College of Law, is a 27-page pdf file. The pre-publication draft of the article "Corporate Political Speech: Who Decides?," by Lucian Bebchuk and Robert Jackson, runs to 42 pages.

Board communication – costly, biased and conformist

The board of directors is the forum where intelligent elites conduct serious discussions on matters of strategic importance, protecting the interests of shareholders, setting the "tone from the top", and respecting the rights of all those affected by its decisions. Right? That's the optimist's view of the board, and it's open to question. Few would dispute that directors are elites: being in the role makes them that, come what may. But the rest of those assertions are, as the scholar might say, empirical questions. According to a working paper from a scholar at Stanford University, the work of boards is somewhat different. Nadya Malenko starts with a different set of assumptions as she builds her model of board work. She sees the key features of board decision-making involving costly communication between directors, coloured by the presence of biases, and dominated by directors' concern for conformity.

• Costly communication: Directors meet only every once in a while so time is limited. It's difficult, therefore, to get you full opinion into the discussion. Board effectiveness depends upon good communication between directors, and that mean more frequent conversations and discussions outside the board meeting. For busy people, that's expensive and the cost is one that's easy to avoid by not communicating.
  
• Biases: Everyone is biased. We base our judgements on past experience, and we have only a limited range of experiences. Moreover, directors may act in their own interests. Collective decisions by boards seek to overcome that by having disparate voices and so a mix of biases in the discussion. That only matters if they are prepared to disagree.
  
• Conformity: Directors are often reluctant to disagree, even in private. "This reluctance can be due to several reasons, including the influence of the CEO and directors reputational concerns. For example, anecdotal evidence suggests that directors who oppose the CEO during the board meeting without support from other directors are likely to face retaliation and feel the pressure to resign," she writes.

The way to make things better is to improve communication. If directors can communicate more effectively, then both biases and concerns for conformity might improve the board's decisions because directors have a stronger motivation to convince others of their position. If she's right, then there are implications for the use of open or secret voting, the frequency of executive sessions of directors, board structure and the role of committees.

Source document: The working paper "Communication and Decision-Making in Corporate Boards," by Nadya Malenko of the Stanford Graduate School of Business, is a 63-page pdf file.

Harmonising financial regulation – the case against

The "solution" to the financial crisis is widely thought to lie in efforts by governments to bring about a harmonious global regime of financial regulation. That's what the Group of 20 countries set out to do. They called into being a new Financial Stability Board to coordinate the effort and made it the clearing house for ideas. Two years on from their London summit, and the G20 countries have largely gone their own ways. Banks in the US, for example, can still choose between a variety of regulatory regimes without having to move their headquarters to another state, let alone another country. The UK has taken a variety of steps to curb the discretion of bankers but avoided the really tough choices lest the bankers indeed move their headquarters to the US. Tax havens have signs a few protocols making it a little easier for authorities in the developed countries to prevent quite so much leaking from the system. But those agreements haven't put the havens out of business – far from it. You can still dodge taxes much the same as before, and there's more incentive to do so, now that tax rates are going up – but not evenly – in some – but not all – the G20 countries.

Financial regulation: It's on the regulatory side where the biggest, that is, the systemic issues arise. A large number of commentators have called for an end to regulatory arbitrage. That's what the European Union would like to achieve with its three new regulatory oversight boards for banking, insurance and securities, which opened for business in January. But from the US comes a voice of scepticism about the whole idea. Roberta Romano at Yale University is the woman who decried the "quack governance" of the Sarbanes-Oxley Act of 2002, and she's not convinced of the value of trying to rein in hedge funds now. "I contend that the move to regulate hedge funds is misguided because hedge funds were not a cause of the recent crisis, nor are they likely to cause a future one," she writes. The regulatory move on hedge funds can best be understood as hostility to short sellers, and it's directed at the wrong target. But she goes further, suggesting that the whole post-crisis emphasis on regulatory consolidation and harmonisation is just as misguided. Global harmonisation combined with any regulatory error can raise systemic risk, she contends. "When such strategies fail, they do so on a global basis, and can thereby precipitate a global financial crisis," she says. "Accordingly, regulatory arbitrage, a byproduct of regulatory diversity, provides a valuable, and little appreciated, hedge against systemic failure."

Source document: The working paper "Against Financial Regulation Harmonization: A Comment," by Roberta Romano of Yale, is a 21-page pdf file.

PwC finds UK non-executives are busier than ever

Nobody doubts that non-executives directors are busy people. According to research by the accountants at PricewaterhouseCoopers, their busy now even if they're serving on fewer boards. Regulatory requirements mean their time commitment has grown by 20 per cent in the last few years, while their fees have changed very little. Nonetheless, 63 per cent found the role more attractive. These gluttons for punishment may be enjoying – if that's the right word – the task of working their way through the most difficult economic circumstances in decades. PwC asked 110 non-executive directors and company secretaries from the top 350 companies for their experiences and opinions. They found:

• Committee duties: The biggest burden on regulation has affected the chairman of the audit committee, according to almost half the respondents. Remuneration committee chairs come a close second.
  
• Obstacles: The list of difficulties associated with the job is topped by regulatory requirements, but it includes lack of time for debate, uncooperative executive directors and a lack of information.
  
• Executive pay: Remuneration committees face their biggest difficulties in determining how to create the right target, aligning them to strategy and then designing the right incentives. No surprise there.
  
• Director fees: None of the respondents thought non-executives were paid too much. No surprise there, either. A bit more than half thought non-execs were paid well enough, though.
  
• Board evaluation: 90 per cent of the top 100 companies had annual board evaluations; 79 per cent of the next 250 did. Almost everyone thought they were useful.

"While the economic outlook is still uncertain, many companies have emerged from the crisis in relatively good shape and are ready for the upturn," PwC said. "The fact that so many companies survived and are generally well governed is often overlooked by the critics of the current board structure, who call for increased regulation and compliance."

Source document: The can register to receive the PwC survey results.

'Completeness' and 'reasonableness' needed in audit reports – FRC

"Shareholder engagement" and "stewardship" are much in the air now, but when it comes to the guts of it, corporate governance still has a lot to do with monitoring, controlling and reporting. As part of its drive to facilitate the "stewardship" of institutional investors over their investments in equities, the UK Financial Reporting Council wants to see companies produce an enhanced report from their auditors. A report contains seven key recommendations, among them:

• Audit committee reports: Audit committees should provide fuller reports to shareholders, particularly in relation to the risks faced by the business.
• Auditor report on the audit committee: The auditors' report should include a new section on the "completeness" and "reasonableness" of the Audit Committee report, particularly in relation to the dialogue between them and the Committee.

The FRC proposes that the whole of the annual report and accounts should be balanced and fair, including the chairman and chief executive reports. Isn't that the way it's always been? Well, no, just specific parts of it needed to be balanced and fair. At the moment, the rest of the annual report can, by implication, be imbalanced and unfair. "While the best annual reports continue to improve, research by the FRC shows that some companies fall short of fulfilling their Companies Act requirements. Of 50 companies studied, a half to two thirds fell short in some areas, including in their reporting of principal risks," it said.

Stephen Haddrill, FRC chief executive, said:"Annual reports are more than marketing documents: they are a vital source of narrative and financial data which are used by shareholders to make investment decisions." It plans to create a new market participants group to spot market developments and identify best practice and to form a "financial reporting lab" to test financial reporting opportunities and enable trials to take place to encourage greater innovation in the market.

Source document: The FRC statement, "Effective Company Stewardship: Enhancing Corporate Reporting and Audit," is a 23-page pdf file.

When boards intervene, news coverage matters

If you listen to top managers, the story you hear is that it's bad news when the board hits the headlines. Boards are supposed to be the wise counsellors behind the scenes. The chief executive is the face of the corporation. A study in Germany suggests a rather more nuanced view. German companies, of course, have two-tier boards, with a supervisory board of non-executives and representatives of the workforce. They oversee the work of management boards, with their chief executives and senior management teams. When the supervisory board intervenes, you would think it's a sign of serious discord, and ought, therefore, to be bad news indeed. Two academics at the University of Tübingen looked at the effect of supervisory board interventions on the value of publicly listed firms in Germany between 2000 and 2006. "Looking at companies receiving low media coverage, we find a negative and significant effect of supervisory board interventions on firm value," their study says. But the picture is different for companies that are always in the news. Supervisory board interventions "have a positive effect on stock prices which is also significant when returns are cumulated over several days".

Source document: The study "Stock Price Reaction to Supervisory Board Interventions: Empirical Evidence from Germany," by Karin Vetter and Philipp Sturm at the University of Tübingen, is a 27-page pdf file.

Did good governance help in the banking crisis?

Yes, at least a bit. That's the conclusion of a study by a pair of academics in Finland, looking at the share price performance of 67 large, publicly traded US banks. The "bit" is the speed of recovery from the crisis. "Our empirical findings on the effects of corporate governance on bank performance are mixed," they acknowledge, in line with previous studies that showed ambiguous links between measures of corporate governance and various aspects for firm performance. "Although the results suggest that banks with stronger corporate governance mechanisms were associated with higher profitability in 2008, our findings also indicate that strong governance may have had negative effects on stock market valuations of banks amidst the crisis." Nevertheless, strong corporate governance practices were related to substantially higher stock returns in the aftermath of the market meltdown.

Source document: The working paper "Did Good Corporate Governance Improve Bank Performance During the Financial Crisis?" by Emilia Peni and Sami Vähämaa at the University of Vaasa in Finland, is a 30-page pdf file.

Risk dominates sustainability reporting – US, UK, Canada study

Sustainability is clearly on the corporate agenda, just not the agenda that activists might like to see. According to a study by accountancy organisations in the US, UK and Canada, compliance and regulatory risk dominate the decisions of companies when they report on sustainability issues. Although the introduction to the findings states that "profitability and other strategic factors are also significant", that sentiments doesn't come through quite so strongly in the numbers:

• Large companies: 34 per cent identified compliance as the top ranked critical driver; 32 per cent identified managing reputational risk as second.
  
• Small companies: 24 per cent identified compliance as most critical; 19 per cent identified cost cutting and efficiency as next most.

Large companies have more robust sustainability capabilities than small companies, with 79 per cent of larger ones reporting that they have a formal sustainability strategy, compared with only a third of the smaller ones. Another quarter say they'll have one, though, in the next two years. The study was undertaken by the Chartered Institute of Management Accountants, the American Institute of CPAs and the Chartered Accountants of Canada.

Source document: The joint report, "Evolution of corporate sustainability practices: Perspectives from the UK, US and Canada," is a 24-page pdf file.

UK, US agree plan for audit inspections

Ever since Enron, the regulators' eyes have been trained on audit. The Sarbanes-Oxley Act of 2002 created a new accounting regulator in the US with a mandate to inspect auditors anywhere in the world if they so much as breathed on the accounts of any company with securities listed on US capital market. Almost nine years on, the US and UK have struck a deal to share information. According to the UK's Financial Report Council, the authorities have signed an information sharing agreement aimed at increasing the level of cooperation on the oversight and inspection of audit firms. The protocol between the UK’s Professional Oversight Board and the Public Company Accounting Oversight Board of the United States paves the way for joint work on inspections, including exchanges of information and interviewing firm personnel. Dame Barbara Mills, chair of the Professional Oversight Board, said: "This will both strengthen and streamline the process of audit market inspections, increasing the efficiency and effectiveness of the oversight regime." You can count on it!

Source document: The protocol is an eight-page pdf file.

Analyst fined for fast fingers

The UK Financial Services Authority has fined an analyst, now dismissed from the investment bank MF Global, for a hasty and suggestive message to clients that caused a big movement in the price of the shares of Enterprise Inns. Christopher Gower sent a "Hot Off The Press" alert via an instant messaging service to the bank's clients about a meeting he had had with the CEO of a competitor, Punch Taverns. The report sounded like inside information. It wasn't. It was just public information repeated and definitely reheated. The FSA said: "This instant message did not accurately reflect the conversation Gower had had. It gave the impression of containing inside information although, in fact, Gower had no such information. The message was misleading and inaccurate…. Gower gave no apparent consideration to the consequences to the market of his message. His conduct was careless and fell below proper standards of conduct in the circumstances." It fined him £50,000.

The decision is one of a seeming flood of market abuse-related cases. An investment banker and his wife pleaded guilty to insider trading and a string of people were banned from working in financial services or ordered to cease trading since the start of the year. There was a time when these sorts of cases seemed hard to prove. Is the information better, or just the attitude of the enforcers?

Source document: The FSA statement gives further details of the case in a 12-page pdf file.

And right under their noses!

Transparency is the best way to improve governance, right? And what better way is there than the internet to do it? The development of website for corporations and government agencies has vastly expanded the information investors and citizens alike have. With that information we can hold executives and government officials to account. It just takes time to sort through all the data. So perhaps it isn't too surprising that the US Securities and Exchange eventually came across this nugget:

"SEC Charges Government Website Provider and Four Executives With Failure to Disclose CEO Perks." That was the headline of the item that detailed a case of a public company called NIC Inc., which managed websites for the government. NIC failed to disclose that it had paid the bills "for wide-ranging perks enjoyed by former CEO Jeffrey Fraser, his girlfriend, and his family – including vacations, computers, and day-to-day personal living expenses". NIC didn't say that it paid thousands of dollars per month for Fraser to live in a Wyoming ski lodge and commute by private aircraft to his office in Kansas. NIC falsely told investors that Fraser worked virtually for free from 2002 to 2005, and then continued to materially understate the perks that Fraser received in 2006 and 2007.

Source document: The SEC news release gives the details.