Management and Control of Corporation - Essay Example

Management and Control of Corporation I. Introduction Historically, the regulation of business ‘has been split between corporate law and securities law; corporate law is contractual, enabling, and administered by the states; securities law is national, mandatory, and administered by the Securities and Exchange Commission and the self-regulatory organizations; accordingly, regulation of disclosure, the securities markets, and financial reporting are neither new nor, from a federalism perspective, particularly troubling; Sarbanes-Oxley, however, together with the increasing involvement of national regulators in the regulation of corporate governance, reflects a breakdown in this division of responsibility’ (Fish, 2004, 39). Moreover, Romano (1998, 2359) states that although ‘both the states and the federal government regulate securities transactions, the current regulatory arrangements are a far cry from competitive federalism; the federal securities regime, consisting of the Securities Act of 1933 and the Securities Exchange Act of 1934, applies to all publicly traded firms and is a mandatory system of disclosure regulation, bolstered by antifraud provisions; while the federal laws do not preempt all state regulation, states cannot lower the regulatory standards applicable to firms covered by the federal regime because its requirements are mandatory; they have also been prevented from raising regulatory standards on some occasions’. Moreover, in the summer of 2002, Congress ‘passed the Sarbanes-Oxley Act (2) in response to a barrage of corporate governance crises and flagging investor confidence in the securities markets’ (Song, 2003, 257). II. Historical development of proxy/ voting rules The historical background of the Securities legislation in U.S. (included the proxy rules) can be rooted in 1929. To a more analytical description of the main events related with their establishment, Burk (1992, 23) stated that ‘investment bankers in the 1920 s were driven by a desire to gain influence over others and to make huge fortunes off their influence; all of them were not, of course, but enough were to set the tone; they took advantage of the mass market for securities, created to sell war bonds during the First World War, by peddling corporate securities of questionable value at artifically high prices; The result was not a permanent prosperity, as some predicted, but a crash, which saw stock prices lose ninety percent of their value over the course of three years, and an economic depression, which lasted for the better part of a decade’. The above events led to the need for the creation of a series of legislative texts that could regulate the financial transactions, specifically the ones connected with the Securities industry in all their aspects. In this context and according to Burk (1992, 25) ‘three acts supplied the basis for federal securities regulation; the Securities Act, signed 27 May 1933, the Glass-Steagall Act, signed 16 June 1933, and the Securities Exchange Act, signed 6 June 1934; Passed within fifteen months of one another, the first two of these were enacted by the "hundred day" session of Congress with which Franklin Roosevelt began his tenure as President; All three acts document the frustration national leaders felt in trying to face and overcome the challenges posed by the dismal economic depression; Significant in themselves, these acts were also part of Roosevelt's first New Deal recovery program’. As for the reasons of the establishment specifically of the Securities Exchange Act of 1934, it has been stated that ‘Congress turned in the Securities Exchange Act to regulate the conduct of speculative trading; this regulation was to be achieved by three means; first, many practices -- wash sales, matched orders, dissemination of false or misleading information to raise or lower stock prices -- were simply barred outright, while others -- notably short selling -- were subject to closer supervision and rule; second, on the theory that price manipulation was facilitated by ignorance, registry and disclosure requirements applied to new securities offered under the Securities Act were extended to all securities listed on the stock exchanges; and, third, the Securities and Exchange Commission was established to take over the securities registration function from the Federal Trade Commission, to register stock exchanges, to monitor their rules’ (Burk, 1992, 26) The right of shareholders’ to appoint an agent to vote on their behalf at an annual meeting developed within the United States in the early 1800s; the right to proxy representation has since become an essential element in the progress of corporate democracy that has allowed for the tremendous growth in the size and number of publicly held corporations; This right is governed by state corporate law and the corporation’s charter documents, nearly all of which now permit proxy voting. State corporate law and provisions found in corporate charter documents are generally silent on disclosure requirements for proxies and proxy solicitation materials, and until the 1930s, the federal government did not involve itself in the proxy solicitation process; The federal government first became involved in the proxy solicitation process with the adoption of the Exchange Act in 1934; In the Exchange Act, Congress authorized and required the SEC to, among other things, design appropriate rules and regulations regarding the solicitation of proxies “in the public interest and for the protection of investors’. On the other hand, in response to the broad rulemaking authority provided in the Exchange Act, the SEC promulgated Regulation 14A, “Solicitation of Proxies,” and Schedule 14A, “Information Required in Proxy Statement”—the proxy rules’ [17] III. Description of current proxy regulations Shareholder voting has been considered [13] as ‘the primary means by which shareholders can influence the company's or mutual fund's operations, its corporate governance, and even activities of social responsibility that may fall outside of financial considerations; it is therefore very important for shareholders to participate in the voting and make their decisions based on a full understanding of the information and legal documentation presented to them’. On the other hand [13], ‘proxy voting is often the sole means by which investors can have a say in the business operations and societal activities of their company or mutual fund; shareholders need not attend an important meeting in person, but they certainly must make the effort to read and understand legal resolutions and use all available resources to make an educated vote based on their best knowledge and information’. In the above context [10], ‘investors should determine whether the Company permits shareowners to vote their shares by proxy regardless of whether they are able to attend the meetings in person because the ability to vote one’s shares is a fundamental right of share ownership; in some jurisdictions, Shareowners may find it difficult to vote their shares because the Company accepts only those votes cast at its annual general meeting, and does not allow them the right to vote by proxy or imposes other constraints; by making it difficult for Shareowners to vote their common shares, the Company limits a Shareowner’s ability to choose Board Members or otherwise to express their views on other initiatives that could alter the Company’s course. The procedure of proxy voting inside an organisational environment is as follows: ‘prior to the general meeting of a company or mutual fund, shareholders will receive a package in the mail containing a variety of documents that report financial data and operations results and announce important issues--such as proposals for changes to the company's share structure or mergers and acquisitions; These are all matters that shareholders or unit holders, the true owners of the company or mutual fund, will vote on at the general meeting; if, however, a shareholder is not able to attend an annual (or special) meeting, he or she can vote on proposals by means of a proxy, one of the documents that is included in the pre-meeting mailing package’ [13]. The proxy rules ‘do not apply to all proxy solicitations; The rules extend only to solicitations to holders of securities registered under Section 12 of the Exchange Act, regardless of whether such securities are actively traded at the time of the solicitation; Entities whose securities are exempt from registration under Section 12 of the Exchange Act are generally also exempt from requirements of the proxy rules; Such entities include any of the following entities that do not have equity or debt securities traded on any stock exchange or market: a) savings and loan associations (and similar institutions subject to state or federal supervision); b) specified foreign corporations; c) agricultural and other similar cooperatives; d) insurance companies; e) banks; and f) non-profit corporations’ [17]. On the other hand [24], in order ‘to enhance the quality of disclosures, the new rules require cash tender offer statements, cash merger proxy statements and going-private disclosure documents to begin with a short “plain English” summary term sheet that describes the material terms of the transaction. The current rules under the Securities Act already require a similar summary in registration statements relating to the securities being offered in business combinations’. At the same time, although the SEC ‘considered eliminating confidential treatment for preliminary merger proxy statements, confidential treatment will continue to be available where companies restrict their public pre-proxy statement communications to certain basic information about a transaction, such as the title and amount of securities offered, basic transaction terms and expected timing’ [24]. Table 1: Major Changes in Financial Market Law and Regulation in the United States (1990-2002), [11] Reform 1992 reform of SEC proxy rules allow shareholders to communicate about governance issues without filing proxy statements. 1995 Private Securities Litigation Reform Act grants institutional shareholders “lead plaintiff” status in shareholder litigation and raises pleading requirements in fraud suits. 1998 Securities Law Uniform Standards Act preempts state securities law and lawsuits to impose restrictions on securities litigation. 2000 Regulation FD (Fair Disclosure) bans selective disclosure of material information to favored institutions and analysts. 2002 Sarbanes-Oxley Act: Requires certification of corporate financial statements by CEOs and CFOs, with sanctions for material inaccuracy. Expands SEC authority over accounting industry rules & practices. Creates Public Company Accounting Oversight Board to draft accounting regulations. As of the theoretical description of ‘proxy’ it has been stated that the proxy rules [17] ‘contain a broad definition of proxy that includes any assignment of the power to vote or express consent or dissent with respect to any securities on behalf of the record owner of such securities; The proxy rules also define the term “solicitation” broadly in Rule 14a-1 of Regulation 14A to include any request for a proxy and any request to execute or not execute, or to revoke, a proxy; Thus, any communication requesting that shareholders execute, withhold or revoke a proxy will be treated as a solicitation within the meaning of the proxy rules. The definition of solicitation also includes any communication furnished to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy’. According to the study of Fish (2004, 39) ‘securities regulation has been a species of public law since at least 1934, when Congress established the Securities and Exchange Commission to administer the operation of the capital markets "in the public interest and for the protection of investors’. Moreover, it is stated that ‘recent regulatory reforms, particularly the adoption of the Sarbanes-Oxley Act of 2002, have led many commentators to argue that the federal government is improperly intruding into the traditional province of state law; similarly, recent reforms have been criticized for imposing excessive regulatory intrusions upon the structure and organization of business relationships, a matter traditionally relegated to private contract’. Table 2: Modified Governance Models and the Effects of Reform (1990 vs 2002), [11] Securities Law 1990 Proxy rules encumber shareholder activism by institutional investors Proxy rules (and state corporate law) give managers almost complete control over board nominations and elections; Accounting industry self-regulating; Accounting rules drafted by private industry body (FASB) 2002 Liberalization of proxy rules to strengthen governance role and power of institutional investors; Amended proxy rules to (modestly) increase the ability of shareholders to nominate and elect directors; Strengthened transparency regulation through more stringent disclosure, risk management, and executive certification of corporate accounts; Federal regulatory control over accounting rules by the PCAOB under SEC supervision IV. Enforcebility of the current rules – special reference on rule 14a-9 A very substantial issue regarding the examination of enforcement of proxy rules is the nature of the U.S. model of corporate governance. In this context, it has been stated that ‘corporate law is one small part of a complex U.S. corporate governance system comprising a wide array of complementary institutions, incentive structures, constraints, and practices that work together to create a whole that is greater than the sum of its parts’ (Paredes, 2004, 1063). It should also be noticed that the legislative framework of both the securities market and the corporate governance has been changed since the introduction of the Sarbanes-Oxley (SOX) Act of 2002, in which Congress ‘introduced a series of corporate governance initiatives into the federal securities laws, is not just a considerable change in law, but also a departure in the mode of regulation; The federal regime had until then consisted primarily of disclosure requirements rather than substantive corporate governance mandates, which were traditionally left to state corporate law; Federal courts had, moreover, enforced such a view of the regime's strictures, by characterizing efforts of the SEC to extend its domain into substantive corporate governance as beyond its jurisdiction. SOX alters this division of authority by providing explicit legislative directives for SEC regulation of what was previously perceived as the states' exclusive jurisdiction’ (Romano, 2005, 1521). Enforcement actions generally begin (Conahan et al., 2003, 1055) with ‘a preliminary investigation into a possible violation of federal securities law while leads on possible violations come from many sources, including SEC Division of Enforcement oversight, securities related organizations, and individual complaints filed with the SEC, and other divisions of the SEC; during these initial investigations the SEC does not have the authority to issue subpoenas or to compel testimony; if a preliminary investigation indicates that a violation occurred, the SEC then initiates a formal order of investigation to determine the validity of the accusations; a showing of probable cause is not necessary for the SEC to issue a formal order. Rather, the SEC need only demonstrate general non compliance with securities law; the formal order of investigation outlines the scope of the investigation and is deemed purely investigatory; upon initiation of a formal investigation, the SEC may use its subpoena power to compel testimony and the production of evidence’. One of the major problems for the Securities and Exchange Commission (SEC) is the control of insider trading (Kurtz et al., 1992, 691) as it ‘poses a serious threat to the integrity of the securities markets and investors' confidence in the markets; there is, however, no definition as to what conduct constitutes illegal insider trading in the securities laws; instead, insider trading is pursued under broad anti-fraud provisions with the courts determining, on a case by case basis, whether the conduct is illegal; consequently, the SEC has been able to broaden the type of conduct that it considers illegal insider trading’. Towards this direction, according to the study of Martin (1993, 725) ‘insider trading should be defined as "trading in the securities markets while in possession of material information (generally, information that would be important to an investor in making a decision to buy or sell a security) that is not available to the general public; neither this definition nor any other, however, has been enacted into law by Congress; nevertheless, Congress has put a high priority on eliminating insider trading in order to maintain public confidence in the integrity of the securities markets while the method chosen to achieve the goals of fairness and the public perception of fairness has been to rely on creative rulemaking by the SEC and broad construction by the courts of general antifraud provisions in the securities laws’. As for the specific legislative framework for the protection of the public’s interests, it has been stated that ‘probably the best known of these provisions is section 10(b) of the Securities Exchange Act of 1934. Pursuant to that section the SEC promulgated Rule 10b-5; although nowhere specifically prohibiting insider trading, these general antifraud provisions have been the primary bases for lawsuits against those who have bought or sold securities while in possession of material, non public information about those securities’. To the same direction Freid (2003, 455) stated that the primary mechanism ‘for regulating insider trading is the duty to "disclose or abstain," which arises under Rule 10b-5 of the Securities Exchange Act of 1934; under the duty to disclose or abstain, a person in knowing possession (or "aware") of material non public information must either disclose the information or abstain from trading when the other party to the transaction is entitled to know the information because of a fiduciary duty or other relationship of trust and confidence between them; although Rule 10b-5 prohibits insiders from trading while in possession of material non public information, it does not prohibit them from using such information to abstain from trading; thus, in certain cases Rule 10b-5 permits insiders to use material non public information to their advantage’. Moreover, according to Kurtz et al. (1992, 691) ‘section 14(e) of the Securities and Exchange Act of 1934 generally proscribes fraud in connection with tender offers and empowers the SEC to define and prescribe means to prevent acts and practices that are fraudulent; pursuant to this rulemaking power, the SEC promulgated Rule 14e-3, which creates a "parity-of-information" rule; however, the validity of this rule was recently raised in the case of United States v. Chestman; the district court held that Rule 14e-3 was valid; on appeal, however, the justices on the Second Circuit Court of Appeals panel could not come to a consensus; indeed, each judge reached a different conclusion; then, in what is a rare event in the Second Circuit, the full court reconsidered the case and held that Rule 14e-3 represents a valid exercise of the SEC's statutory authority’. Specifically for the rule 14e-3 it is stated (Choudhury et al., 2005, 881) that this Rule ‘prohibits anyone in possession of material, non-public information concerning a tender offer from trading on or "tipping" that information; this activity is criminal when the trading party knows the forbidden nature of the conduct; Rule 14e-3 imposes an absolute duty to disclose the confidential information or to abstain from trading, regardless of whether or not a trader obtained the information through a breach of a fiduciary duty; In O'Hagan, the Court ruled in a 7-2 decision that Rule 14e-3 constituted a valid exercise of the SEC's rulemaking authority while there may be a simultaneous violation of Rules 14e-3 and 10b-5’. According to the Rule 14a-9: ‘a) no solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading; b) The fact that a proxy statement, form of proxy or other soliciting material has been filed with or examined by the Commission shall not be deemed a finding by the Commission that such material is accurate or complete or not false or misleading, or that the Commission has passed upon the merits of or approved any statement contained therein or any matter to be acted upon by security holders. No representation contrary to the foregoing shall be made’. Under the Rule of 14a-9 [21] ‘a nominating security holder or group would be liable for any false or misleading statements included in the notice provided to the company; A company would not be liable for the contents of the security holder's proposal or supporting statement that is included in the company's proxy materials; In addition, any information that is provided to the company in the nominating security holder's notice and then included in the company's proxy materials would not be incorporated by reference into any filing under the Securities Act or the Exchange Act unless the company determines to incorporate that information by reference specifically into that filing; Then, to the extent the company incorporates that information by reference, the SEC would consider the company's disclosure of that information as the company's own statement for the purposes of the antifraud and civil liability provisions of the Securities Act and Exchange Act’. The fraud related with misleading statements in proxies is punished by the law under the provisions of Rule 14a-9. The specific rule protects shareholder who receive fraudulent info in proxy stmt while it also offers him the option to get into federal court and to seek for compensation. There is also the possibility of the application of par. 32(a) related with criminal actions. SEC can also sue under 14(a) and 14a-9 and bring injunction actions and money damages, § 21 (d). Regarding the application of Rule 14a -1 and 14a-2 by the Courts, the following case can be used as an indicator of the method and the extension of enforcement of current regulation: In the Studebaker Corporation v. Gittlin (1966) case [22], ‘SH hoped to achieve changes on the B of D and wanted to solicit proxies for the Annual Meeting;  He tried to get a SH list but state law stated that one could only get one if one owned more than 5% or owned the stock for more than 6 months;  He obtained authorization from 42 other SH to get the list.  Ct found his actions to fall within the Proxy rules and that D had violated filing requirements;  The court reasoned that the solicitation of authorizations was part of a continuous plan intended to end in solicitation to prepare for the way to success.  Case seems harsh since D never got to the real solicitation;  Clark says not so.  He would have had to do these filing later anyway.  More importantly, the purpose of the rules is to ensure proper representation;  Gittlin presumably told other SH something when he obtained their authorizations and any misinformation spread at that time may have been hard to fix later’.  The issue of application of the Rule 14a-9 has also be examined by the Federal Courts. In this context, in the case of Virginia Banksares v. Sandberg   (SCT 1991) the Court decided the following [22]: ‘FABI owned 85% of Bank and wanted to get rid of the other SHs.  FABI and Bank thus entered into a merger agreement whereby Bank would be merged into a wholly owned subsidiary of FABI;  FABI called in investment bankers to give an appropriate price and they decided $42;  Bank’s board agreed to the $42. Bank’s minority SH were sent a proxy solicitation in which Bank’s Dirs. stated that they had approved the plan b/c it would give a high value and a fair price;  Most went for the deal; P did not.  P asserted that the shares were worth $60; The Qs before us are whether a statement couched in conclusory or qualitative terms purporting to explain director’s reasons for recommending certain corporate action can be “materially misleading” and whether causation of damages can be shown by a member of a class of minority SH whose votes are not required by law or bylaws to authorize the corporate action subject to the proxy solicitation; Directors argue that a statement of the reasons why the board was recommending could never be a statement with respect to material facts.  Ct says no and that SH often rely on the board’s reasoning;   A mere showing that the directors were not acting for the stated reason was not sufficient.  Liability can only be premised on a statement with respect to material facts;  “We hold disbelief or undisclosed motivation, standing alone, insufficient to satisfy the element of fact that must be established under 14(a);  Instead, P must show proof by objective evidence that the statement also expressly or impliedly asserted something false or misleading about its subject matter”; Here, P showed that the price was not high or fair;  However, P loses anyway b/c she was part of a group of minority SH whose consent was not needed;  Ct felt that to allow a group to recover for misstatements when their consent was irrelevant would give rise to speculative claims;  Ct adds though that loss of a state right is automatic causation’.  V. Conclusion Shareholder voting has been considered [13] as ‘the primary means by which shareholders can influence the company's or mutual fund's operations, its corporate governance, and even activities of social responsibility that may fall outside of financial considerations; it is therefore very important for shareholders to participate in the voting and make their decisions based on a full understanding of the information and legal documentation presented to them’. On the other hand, ‘proxy voting is often the sole means by which investors can have a say in the business operations and societal activities of their company or mutual fund; shareholders need not attend an important meeting in person, but they certainly must make the effort to read and understand legal resolutions and use all available resources to make an educated vote based on their best knowledge and information’ [13]. On the other hand, it has to be noticed that the new rules that SEC introduced, have faced a controversial reaction. More specifically [23] ‘shareholder activist groups have argued that the nomination and election framework under the existing proxy rules is dysfunctional, and denies shareholders any meaningful ability – short of a full-scale proxy contest – to influence the membership of the boards of directors of the companies in which they invest; Thus, these groups argue that changes are necessary to provide shareholders with greater access to the nomination process and the ability to exercise their rights as “owners” of the corporation’. The above presented issues prove that the introduction of amendments regarding the proxy voting Rules as first appeared in the 1934 Securities and Exchange Act was a necessary initiative as there were details which needed clarification in order for the rights and the interests of the shareholders to be protected. In this context, the procedure of voting by proxy can be considered as fully covered as of its legal aspect and the relevant procedure should remain one of the fundamental tools for the corporate governance. References Burk, J. (1992). Values in the Marketplace: The American Stock Market under Federal Securities Law. Aldine De Gruyter, New York Choudhury, M. S., Johnson, D. R., Vashista, A. (2005). American Criminal Law Review, 42(2): 877-932 Conahan, J., Loaisiga, J., Nolette, P., Young, A. (2003). Securities Fraud. American Criminal Law Review, 40(2): 1041-1099 Cox, J. D., Kiku, D., Thomas, R. S. (2003). SEC Enforcement Heuristics: An Empirical Inquiry. Duke Law Journal, 53(2): 737-765 Damnann, J. (2005). A New Approach to Corporate Choice of Law. Vanderbilt Journal of Transnational Law, 38(1): 51-91 Fisch, J. E. (2004). The New Federal Regulation of Corporate Governance. Harvard Journal of Law & Public Policy, 28(1): 39-46 Fried, J. M. (2003). Abstention. Yale Law Journal, 113(2): 455-479 Kurtz, J. M., Sleeper, B. J. (1992). Fraud Liability for Outsider Trading: SEC Rule 14e-3 in Limbo. American Business Law Journal, 29(4): 691-730 Martin, S. L. (1993). SEC Rule 14e-3 Is Valid: A Rebuttal. American Business Law Journal, 30(4): 725-744 Paredes, T. A. (2004). A Systems Approach to Corporate Governance Reform: Why Importing U.S. Corporate Law Isn't the Answer. William and Mary Law Review, 45(3): 1055-1105 Romano, R. (1998). Empowering Investors: A Market Approach to Securities Regulation. Yale Law Journal, 107(8): 2359-2430 Romano, R. (2005). The Sarbanes-Oxley Act and the Making of Quack Corporate Governance. Yale Law Journal, 114(7): 1521-1597 Sanchirico, C. W. (2004). Evidence Tampering. Duke Law Journal, 53(4): 1215-1289 Song, D. (2003). The Laws of Securities Lawyering after Sarbanes-Oxley. Duke Law Journal, 53(1): 257-280 Vancea, M. D. (2003). Exporting U.S. Corporate Governance Standards through the Sarbanes-Oxley Act: Unilateralism or Cooperation? Duke Law Journal, 53(2): 833-864 Walker, D. I. (2005). The Manager's Share. William and Mary Law Review, 47(2): 587-635 Winkler, A. (2004). Corporate Law or the Law of Business: Stakeholders and Corporate Governance at the End of History. Law and Contemporary Problems, 67(4): 109-129 Zacharias, C. A. N. (2000). New Rules, New Responsibilities. Journal of Accountancy, 190(2): 53-56 Cases United States v. O'Hagan, 521 U.S. 642, 667 (1997) (holding Rule 14e-3 constituted a valid exercise of the SEC's rulemaking authority) Carpenter v. United States. 484 U.S. 19, 24 (1987) Chiarella v. United States, 445 U.S. 222 (1979) Studebaker Corporation v. Gittlin (1966) Virginia Banksares v. 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