Corporate Governance

The Dodd-Frank Wall Street Reform Act and the Preemption of Delaware Law (Introduction)

By J Robert Brown Jr.

As the Dodd-Frank Wall Street Reform Act finally becomes law with the Senate's approval yesterday, we will discuss a number of the provisions, particularly in the realm of corporate governance.   These have largely been lost in the discussion over controversies raning from the new Consumer Bureau to the endu user exemption for trading swaps on an exchange.  Nonethless, they are important and deserve attention.

There has been a plethora of commentary over the Dodd-Frank Wall Street Reform Act in an effort to define the winners and losers.  One loser that has yet to be mentioned is the state of Delaware. 

This Blog has often criticized the approach taken by Delaware and the Delaware courts in determining the appropriate level of corporate governance.  Mostly, there has been an unwillingness to define duties of the board in a way that imposes meaningful obligations on directors.  Cases such as Citigroup suggest that the board has no role in risk management and cases like Amylin suggest that there is no affirmative duty of directors to inquire about contractual provisions that disenfranchise shareholders.  In a number of cases (ranging from Seinfeld to Axcelis), the courts have sharply limited shareholder access to information, making reasonable oversight all but impossible.  

The results have been obvious.  Executive compensation has no limits (discussed here) and directors have few specific oversight responsibilities.  Without board oversight, CEOs have much greater authority to act unilaterally, depriving him or her of what would often be sage advice that might warrant an alternative approach.  One wonders whether companies would have made many of the financial mistakes that led to the current crisis had top management consulted more often with the board about the appropriateness of the risks involved.

These weaknesses were not lost on Congress.  For the second time in a decade (SOX being the first), Congress stepped in and substantially rewrote the applicable governance requirements.  The approach taken by Congress can only be seen as a further preemption of the Delaware approach (and do a lesser extent a reduction in the authority of the stock exchanges).  The Commission, which in the 1990s had been told by the DC Circuit that it had no real role in the governance process (See Business Roundtable, discussed here), has now become, arguably, the dominant regulator in the governance process. 

In short, Delaware has seen its preeminence preempted.  Moreover, with Congress stepping in for the second time in a decade, it is clear that Delaware receives no particular deference in the reform process.  To the extent considered at all, it is simply one more interest group among competing interest groups in the determination of corporate governance standards. 

The reduction in Delaware authority has been rapid.  Back in 2008, VC Strine was quoted as saying: "There's a lot of things that keep me up at night related to my work, but the possibility of [a federal corporate law] isn't one of them."  Two years later, the very issue that wasn't keeping him up had largely come to pass.  Moreover, the decisions of the Delaware courts were largely responsible.  None of the provisions implemented by Congress would have been necessary had standards imposed under state law on boards been moderately more exacting.    

Over the next several posts, we will examine the areas where Delaware has been preempted by the Dodd-Frank Wall Street Reform Act. 

Full post as published by The Race to the Bottom on July 16, 2010 (boomark / email).