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Have Corporate Reforms Gone Too Far?

Every chief executive officer, chief financial officer, general counsel and director of a public company has been inundated with legal …

Every chief executive officer, chief financial officer, general counsel and director of a public company has been inundated with legal memos explaining the new rules of corporate governance promulgated under the Sarbanes-Oxley Act of 2002, revised New York Stock Exchange and Nasdaq regulations and general securities law paranoia. The goals include total financial statement transparency, more independent directors, disclosure committees and new auditing standards, all of which are positive in some respects. Arguably, these changes have, in part, helped to restore investor confidence in the capital markets and resulted in a resurgence in stock prices in the past year.

I believe, however, there is a hidden cost to these changes that is not being measured. CEOs and CFOs at some of the best U.S. public companies have spent the better part of the past three years looking over their shoulders to confirm, certify and reconfirm what they already knew: that their financial statements “fairly presented” the financial condition of the company. The required officers’ certifications, disclosure procedures, audit committee protocols, whistle-blower requirements, and redefined standards of independence for directors and auditors may encourage a limited number of companies to develop an infrastructure that actually provides better and more complete disclosure. But the majority of well-managed companies are not substantially improved by the enhanced regulations. Companies run by “bad actors” will not be remediated by the new requirements. And quality companies will still do the right thing by their investors, but at a higher cost.

Aggressive execution of creative strategic plans has always been the hallmark of the best public companies. Obviously, the stricter securities laws and the corporate governance requirements cannot be ignored in the pursuit of profits and higher stock prices. But there is an inherent risk involved. The pursuit of a perfect governance structure is causing management and boards of directors to subordinate the benefits of support, cooperation, vision and trust to a regulatory bias of control andlead, not where the regulatory system encourages second-guessing.

The obligation of a board is to “manage” the company consistent with the law and in the best interest of stockholders. The business judgment rule, a fundamental principle of corporate governance, generally provides that decisions made by a board that diligently analyzes its management’s decisions and that is not self-interested will not be second-guessed by the courts. This principle has always provided boards the protection necessary to support creative management in their efforts to aggressively pursue growth and profitability.

Sarbanes-Oxley and related NYSE and Nasdaq regulatory enhancements have clearly acted as a wake-up call to boards that had become complacent with respect to their oversight responsibility. But the reforms were not intended to fundamentally change the concepts of corporate governance. The business judgment rule is still the law in Delaware and every other enlightened jurisdiction I am familiar with. To the extent that the focus of a board of directors has become defensive and the concept of the board’s independence has created an adversarial relationship with management, the greatest assets of our corporate system-creativity and risk-taking-may be lost. The politicians won’t ever be able to measure that cost. Boards and advisors to boards should be cautious that their response to the new regulatory order doesn’t destroy management’s entrepreneurial spirit.


Louis J. Bevilacqua is a partner in the New York office of Cadwalader, Wickersham & Taft and chairman of the law firm’s corporate/ mergers and acquisitions department.

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