Paternalistic Regulation of Public Company Management: Lessons from Bank Regulation

Abstract

In this Article, I contend that Sarbanes-Oxley represents a significant step in the ongoing development of a paternalistic federal regulation of public firm management that is in certain respects comparable to the regulation of bank and bank holding company management by federal banking agencies. Federal regulation of bank management is all encompassing, covering bank officers and directors from the time a bank begins its operations onwards. The pervasive regulatory guidance and constant interaction, both informal and formal, between bank managers and regulators give the former notice of the regulators' expectations for their behavior and an early warning of regulators' concerns with it. The prescreening and ongoing monitoring thus justify the serious penalties that can be assessed against a bank officer and director by a bank regulator through an administrative proceeding or the courts or by a U.S. attorney in a criminal prosecution. By contrast, neither the Securities and Exchange Commission (the SEC) nor any self-regulatory organization (SRO) screens officers or directors of public companies. Although, at the direction of Congress, the SEC and the SROs increasingly specify standards of conduct for these officers and directors, they do not monitor on an ongoing basis officers' and directors' compliance with the standards, inspect the firms or interact informally or even formally, outside of enforcement and prosecutions, with them. Despite this approach, which reflects limitations on the SEC's jurisdiction, the SEC's disciplinary powers over public firm management have grown, as has criminal liability for officers and directors. Yet current corporate governance in public companies remains unsatisfactory. Despite improvements to the board over the last decades, including from Sarbanes-Oxley, directors do a poor job of monitoring executives. Boards of public firms often fail in their monitoring due to the formation in a public firm of a destructively cohesive group of senior executives, corporate advisors, and even some board members, led by the CEO. Social psychologists suggest that one way to prevent the formation of these perverse groups, or to break apart existing ones, is to involve in the monitoring of a group an outsider who is loyal and has a mission to an organization other than the group and who, as a result, can resist its attraction. While, as a theoretical and practical matter, the SEC and the SROs cannot replicate the prescreening, standard setting and oversight of management provided by bank regulators, in order to address the ongoing corporate governance problems in a way that uses the insights of social psychology, the Article proposes that the SEC appoint a corporate governance monitor for certain of the largest public firms who would have a role like that of an examiner of a large bank or financial holding company. The SEC would hire, train, and oversee the performance of, these monitors, who would be supervised by that part of the SEC's Division of Corporation Finance responsible for their firms and industry. A monitor would promote the development of professional standards in a board, assist the board in reviewing any conflicts of interest, look for red flags of serious management problems and convey to directors and executives, on an ongoing and informal basis, any SEC concerns about their conduct. Interaction with the monitor would give them an opportunity to address any problems in their behavior before the SEC instituted formal enforcement proceedings or the Department of Justice criminal action. The presence of the monitors in public companies would also enable the SEC to receive valuable information about companies and industries, which could improve overall company disclosure. The proposed reform would have the added advantage of balancing the enforcement orientation of the SEC's current paternalistic regulation of public firm management and the increasing criminalization of management's behavior.