December 02, 2009
Other People’s Money: Interpreting the Fiduciary Duty to Monitor Enterprise Risk Management
Posted by Kristin Johnson

You may remember this story from last spring….

On a crisp Saturday morning in the spring of 2009, a somber group of citizens from the Connecticut towns of Bridgeport and Hartford boarded a tour bus.  The tour route did not pass through the lovely Hollywood Hills homes of Oscar-winning actors perched high above the sprawling city of Los Angeles, nor did the tour route pass through Manhattan’s historic and affluent upper east side to visit the brownstone where Carrie Bradshaw lived or the cupcake shop that she visited in a popular television series titled “Sex in the City.” Upon having loaded its passengers, the bus, flanked by national and international media – more journalists in fact than tour participants – took the road to Fairfield County, Connecticut to tour the homes of executives who work for the American International Group, Inc., a mammoth international insurance company with significant financial services operations in more than 130 countries. The bus tour group, organized by Connecticut Working Families, a coalition of community organizations, labor unions and neighborhood activists that lobby to impact issues important to working and middle class families, considered themselves emissaries of a nation frustrated by an economic crisis. As anticipation of a confrontation between the tour participants and the executives and their families grew, AIG executives like David Poling, recipient of a $6.4 million award, began renouncing their bonuses and enhancing their home security devices.

Sharpen your pitch forks and light the torches. Bonus distributions to executives at bailed-out firms made Americans mad. Moreover, the discovery of the role of credit defaults swaps in the crisis has fueled the rage. Justifiable national frustration suggests that federal rules may soon override state court precedent and legislation that protect directors from liability or at least big bonuses will be more closely watched and possibly denied by the exec comp czar. Possibly. Mark Roe has persuasively argued that the real competition in corporate law is not among the states but between the federal government and Delaware. An interpretation of fiduciary duty that excuses corporate management’s failed efforts to oversee enterprise risk management may offer further evidence to support Roe’s theory.

We have seen a flurry of activity to introduce federal oversight of executive compensation packages for companies that are recipients of the federal dole. (See David Zarig's post here.) In her November 1st blog on Jones v. Harris (here), Michelle Harner offered interesting insight into the issues of interestedness and independence in the context of fee structures. I see an easy application of these arguments in the context of executive compensation and parallels in arguments about effective enterprise risk management.

The consequences of a systemically significant institution’s failure to execute risk management policies with care reverberate through many constituencies. Ever increasing numbers of Americans own a broader array of stocks, even if only through mutual funds or retirement funds. In the absence of action on the part of the Delaware legislature or courts, the federal government might easily commandeer the regulatory stage.Federal preemption in the area of executive compensation may pave the road for preemption in other areas of governance, such as risk management. The poster child for this proposition: AIG. My prediction that we may see federal intervention into corporate governance on risk management is based on the brewing national debate on independence and interestedness.

The audit committee and independence standards and other corporate governance reforms adopted as part of SOX offer examples of ghosts from Christmases past. But additional intervention is appearing on the horizons. Congressional proposals for corporate-last-wills-in-testament, a requirements that companies explain in advance their policy for dealing with potential insolvency, present another example of the Feds pending foray into the corporate governance sphere. This funeral legislation, as it has been described, requires firms to state how they would unwind their businesses and gives the Treasury authority over initiating the unwinding of certain systemically significant institutions. Even lower federal courts seem to “want in” on the movement for a broader interpretation of directors’ fiduciary duties, as illustrated by Judge Rakoff’s rejection of the SEC v. Bank of America/ Merrill Lynch settlement negotiation. With all of the frustration we are left to wonder about future interpretations of directors fiduciary duties. 

Corporate Governance, Corporate Law, Delaware, Disney, Fiduciary Law, Financial Crisis | Bookmark

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