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Article Excerpt
I. INTRODUCTION
II. SOME GOVERNANCE ISSUES IN THE UNITED STATES: AN OVERVIEW OF THE CORPORATE BOARD OF DIRECTORS III. THE SARBANES-OXLEY ACT AND ITS IMPLICATIONS ABROAD A. Corporate Auditing B. Provisions relating to CEO and CFO; Criminal Sanctions C. Audit Committee Independence D. Code of Ethics IV. CORPORATE TAKEOVERS, CONSTITUENCY STATUTES AND SHAREHOLDERS RIGHTS V. CONCLUSION
I. INTRODUCTION
While the exact definition of corporate governance should be specifically tailored to the requirements of each jurisdiction in which it is maintained, one concept utilized by both the United States and Europe is consistent: Corporate governance relates to some form of company "control." (1)
The European Union has very recently increased its list of member states from fifteen to twentyseven with the recent accession of Bulgaria, Cyprus, the Czech Republic, Estonia, Hungary, Malta, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia; and, with a total population in excess of 450 million, it is certainly a force in corporate governance to reckon with. (2) It is in the interest of other powerful industrialized nations, such as the United States, to monitor trends set by the European Union and for the country's corporate practitioners and academicians to monitor the trends in corporate governance and their implication for the United States. Not surprisingly, the European Union has been doing just that with respect to corporate governance trends in the United States. For example, the European Commission (the Commission) in May 2003, responding to recent corporate governance crises depicted by Enron and its progeny and the enactment of the Sarbanes-Oxley Act of 2002 in the United States (SOX or the Act), "presented a proposed 'Action Plan for Moderni[z]ing Company law and Enhancing Corporate Governance in the EU'."(3) This plan refers to some of the same corporate governance challenges faced in the United States, relating to such things as management responsibilities, composition, and operation of the board and its committees, shareholders' rights and how they can be exercised, derivative suits, takeovers and mergers, public auditing and public confidence in the audit profession, a reference to a code on corporate governance designated for use at national level, and so forth. (4) The European Union and the United States have identified basically the same broad problems and goals in corporate governance (the importance of good corporate governance for the investors and the economy); (5) however, unlike the Sarbanes-Oxley Act, which imposes mandatory provisions for U.S. companies (through a one-size-fits-all approach), the corporate governance initiatives proposed in the E.U. Action Plan are not intended to be mandatory. (6) The European Commission stated "it d[id] not believe that a European Corporate Governance Code would offer significant added value but would simply add an additional layer between international principles and national codes." (7) The Commission, in conceding that "a self-regulatory market approach based on non-binding recommendations" would be futile as sound corporate governance, especially "[i]n view of the growing integration of European capital markets," adopted in the Action Plan a "common approach covering only certain essential rules[.]" (8) This is typical of the European approach to corporate governance: self-regulation through corporate governance codes, with public companies then required to disclose whether or not they are in compliance with such codes. (9)
Consequently, a comparison of some of the corporate issues in these two systems in light of recent laws and regulations may not only be beneficial in understanding how each system functions, but may also be helpful in drawing lessons from the potential strengths and weaknesses of each system, thereby fortifying global corporate governance principles. For example, although the Sarbanes-Oxley Act of 2002 was drafted primarily with the U.S. regulatory market in mind, it also "regulates non U.S. companies doing business in the U.S. capital markets despite the fact foreign jurisdictions may already have their own corporate governance regulatory schemes in place." (10) Foreign companies doing business in the United States therefore would find it in their best interests to understand the implications of the Sarbanes-Oxley Act on their businesses. (11)
This Article will present a general overview of the aforementioned corporate governance issues and their regulation in the United States in Part II. Parts III and IV will critically analyze the new corporate laws and the issues raised by crossborder application of these laws in the European Union, highlighting the implications, similarities, and differences.
II. SOME GOVERNANCE ISSUES IN THE UNITED STATES: AN OVERVIEW OF THE CORPORATE BOARD OF DIRECTORS
In the traditional model of corporate structure, the board of directors manages the business of the corporation. (12) Although boards generally do continue to maintain this central legal role, it is widely understood that the traditional managing model of the board is no longer accurate; rather, under modern corporate practice, the executives of the corporation hold the management function, not the board members. (13) Because the "managing model" is now an unrealistic description, especially in the last 25 years, the shift from a "managing model" to a "monitoring model" recognizes management function is exercised not by the board but by senior executives of the corporation. (14) Hence, in the classic governance theory with a separation of powers, the role of the board is to oversee and limit the exercise of power by the executive officers; the board is, in turn, accountable to the shareholders. (15) Consequently, "[b]y making executive officers responsible to directors and then making directors directly responsible to shareholders, the framework rests on the ability of the shareholders effectively to monitor and respond to the directors' oversight of the corporation." (16) This intended hierarchy between the board and management was commonly reversed in the past, however, with the directors' incentive to properly monitor management undercut by some factors. (17) "Today, the monitoring model of the board has been almost universally accepted and adopted [by] large publicly held corporations" in the United States. (18) It is inadequate to say that "the monitoring model of the board rests on its economic advantage in providing an additional system to monitor the efficiency of management--in particular, of the CEO." (19)
But looking at the board from either a managing or monitoring perspective, the board of directors is made up of individuals selected by shareholders of a company (20) and is the ultimate decision-making body of a company. (21) The board selects the senior management team, acts as the advisor and counselor to the senior management, and ultimately monitors its performance. (22) Hence, the directors and management are said to have a contract with the corporation. (23) In fact, the corporation is often described as an organization consisting of a nexus of contracts (24) involving the employees, suppliers, contractors, shareholders, directors, and the corporation. (25) The agreement between the directors and the corporation is the most important contract because it relates to the directors' duties and obligations to the corporation. (26)
A director's powers to act on behalf of the corporation are derived from the state of incorporation. This regulation of the corporation by the laws of the state of incorporation is often referred to as the "internal affairs doctrine." (27) Consequently, state law, among other things, defines the directors' powers over the corporation; (28) in this vein, corporations are said to be the '"creatures of state law[,]' and it is state law that is the font of corporate directors' powers." (29) Whether state regulation results in efficient corporate law rules has been a scholarly debate. Some scholars espouse the view that, because the grants of corporate charters result in state tax revenue, (30) states tend to adopt statutes that are management friendly at the expense of shareholders. (31) Companies incorporated in Delaware are often said to be involved in "a race to the bottom." (32) Regardless as to whether companies are racing to "the top" or to "the bottom," their state of incorporation determines how the board of directors, as the managing head of the company, is to exercise authority. This exercise of authority may, however, be subject to limitations placed by the shareholders in the articles of incorporation or bylaws. (33)
III. THE SARBANES-OXLEY ACT AND ITS IMPLICATIONS ABROAD
The unforeseen and shocking demise of companies--such as Enron, Adelphia Communications, WorldCom, Quest, and a few others--propelled Congress to approve the U.S. Securities and Exchange Commission's (SEC) recommendation to pass the Sarbanes-Oxley Act of 2002 as a means to boost investors' confidence. (34) "This failure of corporate governance, [compounded by] an enduring bear market, approaching mid-term elections and uncertainty about terrorism and war, placed the federal government under extraordinary pressure to act." (35) Hence, the passage of the Act was only natural. The Act has been said to be unprecedented because, in addition to regulating disclosure and securities trading, the traditional jurisdiction of U.S federal securities laws, (36) the law also addresses matters of substantive corporate governance and executive fiduciary responsibility. (37) These duties have historically been viewed as a prerogative of the states and self-regulatory organizations (SROs). (38) Whether these corporate scandals should call for more regulation is a scholarly debate between those favoring regulation and those favoring deregulation. (39) SOX has been said to have been significantly costly and the benefits elusive. (40) While the merits of the debate are significant, understanding the changes brought by the Sarbanes-Oxley Act is imperative to comprehending its broader impact beyond U.S. borders. This Article will now examine some of these changes.
A. Corporate Auditing
One of the major innovations of the Act was the creation of a Public Company Accounting Oversight Board (Oversight Board), a quasi-public accounting board that oversees audits of public companies that are subject to the securities laws. (41) The principal purpose of the Oversight Board is to protect the interests of investors and to engage public interest in the "preparation of informative, accurate, and independent audit reports." (42) This is a sort of a new federal "watchdog" for regulation of the public accounting profession. "Although the [Oversight Board] is not technically a government agency, it is closer to a full government agency than to a [SRO] or industry-based group such as the American Institute of Certified Public Accountants, which ha[s] been performing the standard-setting function since 1939." (43) The Oversight Board's specific responsibilities include: "the registration and inspection of all 'public accounting firms that prepare audit reports' for public companies; the adoption and modification of 'auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports' for public company audits; the investigation of registered firms for violations of rules relating to audits; and the imposition of sanctions for such violations." (44) Likewise, SOX contains some auditor-independence provisions that affect auditors, audit committee members, executives, and directors of public corporations; hence, an auditor for an issuer is prohibited from providing a list of nonaudit services. (45) In the same vein, rotation of an audit partner is required every five years, and anyone who was employed by an auditor for an issuer within a one-year period is prohibited from becoming the CEO, controller, CFO, or chief accounting officer of the issuer. (46)
While the Oversight Board's proposal has been generally hailed as appealing to resolving accounting problems in public corporations, it is not without its own shortcomings. The Oversight Board standards require external auditors to consider audit committee effectiveness as part of their overall review of a corporation's internal control over financial reporting. (47) According to Professor Cunningham, the Oversight Board reveals a flaw in the corporate governance system as a result of a mixture of state and federal law regulations. (48) He contends that, although audit committees are essential, no one other than boards and, after the fact, shareholders and courts should have the power to oversee them. (49) However, according to him, what SOX did was simply mandate characteristics and functions, while SEC and SROs mandated characteristic reports. (50) The disclosure to the Oversight Board requires auditors to include an audit committee review as part of the auditors' more general assessment of the company's internal control over financial reporting. (51) Cunningham asserts this results in major problems: First, it highlights the tension between state and federal law, as state corporation law empowers the board to choose the appropriate management tools for a corporation, while federal law mandates specific parameters of the audit function. (52) In this case, neither of these is complete, and even when combined, are still incomplete. (53) Second, the issue of how to monitor the monitors becomes imminent. The federally-prescribed audit committee is directed to supervise the external auditor, and the Oversight Board proposes to have the external auditor evaluate the audit committee. (54) While these evaluations may be feasible, it remains to be seen how they fit in squarely with state law. (55)
In sum, SOX provided the SEC the authority to restructure corporate audit committees: (56) the SEC may authorize the SROs to change their listing rules to meet certain standards, and mandate them to require a public company to disclose whether its audit committee includes a financial expert or explain why it does not. (57) This specific grant of authority to the SEC to regulate the structure and duties of the audit committee and the substantive standards contained in SOX affected entrenched governance norms by taking authority away from management and placing it in the hands of the audit committee. (58)
The next issue to consider is how these requirements and regulations affect foreign companies. As expected, foreign companies and countries doing business in the United States did not necessarily welcome the application of SOX, (59) and some took steps to put their own corporate governance reforms in place, possibly to preempt Enron-like occurrences. (60) The government of the United Kingdom, for example, "initiated a series of reviews, primarily under the auspices of the Department of Trade and Industry (DTI) to examine whether changes were necessary to regimes for the regulation of the UK audit and corporate governance." (61) In the same vein, The House of Commons Treasury Committee initiated its own inquiry: the Higgs Report, (62) the Smith Report on corporate governance, (63) and the Coordinating Group on Audit and Accounting Issues (CGAA) were all welcomed and considered. (64) In particular, the 2003 CGAA report not only considered the issues of auditor independence, corporate governance, audit firm transparency, financial reporting standards and enforcement, and monitoring of audit firms; it also identified twentyseven conclusions and recommendations supporting initiatives including, inter alia, audit partner rotation by the Institute of Chartered Accountants in England and Wales (ICAEW), a principlesbased approach to financial reporting and auditing standards by the Accounting Standard Board (ASB) and, at an international level, by the International Accounting Standard Board (IASB) and the International Auditing and Assurance Standard Board (IAASB). (65) Other related reports on corporate governance include: the Greenbury Report, which focuses on disclosure of director pay; (66) and the Hampel (67) and Turnbell Reports, which review companies' approaches to internal controls. (68)
Likewise, the Canadian securities regulators in keeping abreast with the spirit of SOX (boasting investor's confidence) and aligning their corporate governance rules with those of the United States, unveiled initiatives in 2003 with regard to auditor oversight, officer certifications in companies' reports, and audit committees. (69) The Chairman of the Ontario Securities Commission requested the Canadian Institute of Chartered Accountants to address issues of audit independence and rotation of engagement partners and firms. (70)
The European Union Commission was concerned that European company issuers and auditors would be unfairly treated (because they were already subject to stringent measures in their home markets) and that added...
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