Independent Directors: One Head, Two Hats - A Mismatch between Delaware Corporate Law and Federal Securities Law

Abstract

Although both federal securities law and Delaware corporate law have increasingly relied on independent directors in improving corporate governance, there is a fundamental mismatch between these two regimes. Federal securities law relies on independent directors to monitor the management of the corporation, while Delaware corporate law posits the independent directors as the ultimate decision-makers of the corporation, particularly in transactions in which insiders’ interests or incentives are in question. This mismatch emerged in the 1970s, when proponents of the “monitoring board” successfully campaigned for a board structure consisting of a majority of independent directors, in an attempt to transform corporate boards from ceremonial “advisory boards” to active monitors of management performance. While the SEC followed the monitoring board model, several key decisions of the Delaware courts beginning in the 1980s emphasized the decision-making function of the board, and in particular, the role of independent directors in fundamental transactions. This mismatch became salient after the Enron scandal and the 2008 financial crisis, as the SEC gained the authority to promulgate more stringent rules enhancing the independence of the board under Sarbanes-Oxley and Dodd-Frank. The mismatch may be explained either as a philosophical difference between securities regulators and Delaware judges or as an institutional difference between federal legislative bodies and common law courts. One consequence of the mismatch is that, because of the inherent tension between the monitoring and decision-making functions, independent directors are destined to under-perform both functions. I propose several solutions to reconcile the dueling functions of the board.