Antidisestablishmentarianism! Remember that old word? In this Congress, it’s taking on new meaning. At the turn of the century, the Grand Old Party’s laissez-faire, free market economics were the “establishment.” Then liberal Democrats wrought “disestablishment” through heavy rulemaking in the early Obama years. Now, today’s neoconservatives are trying to undo that regulatory regime. If this isn’t “antidisestablishmentarianism, we don’t know what is!
A group calling itself Tea Party Patriots gathers for a “Reclaiming the Capitol” rally in Washington, D.C., on election day.
Yes, this “A factor” makes one’s head spin, but so does Washington. In following the changing moods of the Capital City, directors got used to self-governance in response to market signals (remember all those voluntary governance guidelines?), then mandated conformity to myriad rules and now a possible return to less government. The U.S. Chamber of Commerce succeeded in halting proxy access through court action and we are hearing vows to overturn many of the new laws. While most of these pledges pertain to broad national laws, such as healthcare reform (aka “Obamacare”), some pertain to governance changes.
Here’s a look at the state of the A-factor from the executive, legislative and judicial branches of our ever-changing government.
Executive Branch
The Securities and Exchange Commission is forging full speed ahead as it implements Dodd-Frank. The SEC’s 2011 to-do list includes finalizing rules on “say on pay” and whistleblowing, and proposing new rules on compensation committee and advisor independence, executive pay clawbacks, uninstructed broker votes on “other issues,” hedging by employees and directors, pay for performance and (perhaps extending into 2012) pay ratios of CEOs to workers. As the year starts, the SEC staff is reviewing more than 1,000 comment letters it has received on its proposed whistleblowing rule, including NACD’s. The antiwhistle backlash may cause the SEC’s rule to limit the scope of the rule significantly, or face a technical correction to this part of the Dodd-Frank law, courtesy of the new Republican majority.
In coming years, the A-factor may cause reallocation of SEC funds from punishment to education—possibly changing the director’s job from scapegoat to communicator. Currently, more than half of the SEC’s operating budget is devoted to enforcement rather than prevention. In a recent lecture at the American Enterprise Institute (AEI), attorney Peter J. Wallison took issue with this allocation. “If… the SEC [were] more interested in giving advice and solving problems rather than collecting scalps there might be more candor and voluntary disclosure. But when the SEC only seems interested in bringing enforcement actions it’s inevitable that bad conduct will be hidden until the scheme simply collapses of its own weight.” The AEI lecture series is named after the late A. A. Sommer Jr., a former SEC commissioner who served on the board of NACD during its formative years, and in 1999 chaired the first NACD Blue Ribbon Commission on the Audit Committee. Sommer’s moderate positions on the issues of his time have had a lasting impact on governance and the culture of NACD.
The Federal Bureau of Investigation could come knocking on more boardroom doors, alleging that a particular business practice engaged in was “criminal” and will merit jail time. According to the FBI, white-collar crimes are categorized by “deceit, concealment or violation of trust” and are not dependent on the application or threat of physical force or violence. Such acts are committed by individuals and organizations “to obtain money, property, or services; to avoid the payment or loss of money or services; or to secure a personal or business advantage.”
Among other business practices, the FBI investigates allegations of securities and commodities fraud, fraud against the government, copyright violations and telemarketing, healthcare and bank fraud. In healthcare, the FBI says it targets systemic abuses, such as large-scale billing fraud. In banking, the FBI pursues financial institution fraud involving $100,000 or more.
Could officers and directors be implicated in criminal investigations even if they had no criminal intent? Over time, the definition of crime has expanded to include a wide range of behaviors, to the point where mere noncompliance may be criminalized.
More facts: The number of agents investigating “corporate and other securities, commodities, and investment fraud cases” has increased 47 percent, from 177 in 2001 to more than 250 today, according to the enforcement agency. Since 2007, there have been more than 1,700 corporate, securities, commodities, and investment fraud cases, an increase of 37 percent since 2001. FBI special agents work with investigators from the SEC and other government agencies, including the Treasury’s Financial Crimes Enforcement Network, targeting what it calls “sophisticated, multi-layered fraud cases that harm the marketplace and threaten our economy.” It’s enough to keep audit committee members up at night.
Legislative Branch
The House Committee on Ways and Means is likely to lower the tax rate—but investors may still panic at the high rates they now face. While the top statutory capital gains rate in 2011 is 20 percent, the top effective rate will actually be 22 percent. For dividends, while the top statutory rate will be 39.6 percent in 2011, the top effective rate will actually be 41.6 percent. But because of the additional, hidden tax rate increases (buried in the new health law) the top effective rate on capital gains and dividends in 2013 will be 25.8 percent and 45.4 percent, respectively.
The nearly 50-percent levy on investors’ dividend income may put more pressure on investors to achieve short-term returns through their portfolios. Boards need to put shareholder relations (and corporate pension-fund management) high on their list of agenda items.
Meanwhile, the Internal Revenue Service will be requiring companies to report “uncertain tax positions” on their tax returns. The time is now for audit committees— and perhaps boards—to inquire about this issue.
Judicial Branch
The Supreme Court has decided or heard three cases on arbitration in recent months. The topic is of natural interest to boards, since corporate directors are likely to experience a conflict at some point in their years of service and arbitration outcomes can be more moderate than court outcomes.
In a ruling in April in Stolt-Nielsen S.A. v. Animal Feeds Int’l Corp., the Supreme Court said that if an arbitration agreement is silent on the subject of class action, such an action cannot be imposed on parties to the agreement. Imposing class arbitration on parties who have not agreed to authorize such arbitration, the Court said, is inconsistent with the Federal Arbitration Act. In the pending case of Rent-A-Center, West Inc. v. Jackson, the question is who gets to determine claims of unconscionability— the court or an arbitrator. AT&T Mobility v. Concepcion, also still pending, concerns whether the Federal Arbitration Act preempts states from conditioning the enforcement of an arbitration agreement on the availability of particular procedures. If you have any existing arbitration agreements or plan to sign any, ask counsel to help. In these changing times, it’s more important than ever to stay current.
To read NACD comment letters on the proxy system, proxy access, shareholder votes on executive compensation and golden parachutes, and most recently, whistleblowing, visit sec.gov or email a request to resources@ nacdonline.org.