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Government Governance and the Need to Reconcile Government Regulation with Board Fiduciary Duties

By Lisa M. Fairfax. Full text here.

Corporate governance reforms strive to shore up directors’ roles, not only seeking to ensure that boards have sufficient incentives to engage in effective oversight, but also aiming to ensure that boards are held accountable for their oversight failures. The newest wave of reforms is no exception. The current financial crisis not only ushered in an era of significant government entanglement in the financial system, it also generated significant government involvement in corporate governance matters. That involvement ranged from the government becoming a shareholder of major corporations to the passage of a host of regulatory initiatives. Such involvement has clear implications for the board of directors, increasing their responsibilities in order to enhance the effectiveness of their oversight and thus meaningfully enhance board accountability and overall corporate performance.

However, this new wave of reforms appears to impose increased responsibilities on boards without reconciling those responsibilities with board functions and fiduciary law, at least as that law has been articulated by Delaware. The lack of rec­onciliation not only represents a missed opportunity to reconsider boards’ proper role and function within the modern public corporation, but also may undermine the effectiveness of reforms.

Part I of the article pinpoints some of the key reforms that have implications for board fiduciary duties. Part II and Part III then demonstrate what appears to be a fundamental disconnection between board reforms, on the one hand, and existing board structures and fiduciary law presumably necessary to support those reforms, on the other. Part II discusses this disconnection as it relates to existing board structures. First, Part II illustrates the manner in which the reforms may overburden boards in ways that not only may set them up for failure, but also may increase the likelihood that boards will engage in the sort of rubber stamping of managerial and agent decisions that reforms were aimed at counteracting. In this regard, Part II argues that the reforms may reflect unrealistic expectations about boards and their capacity. Second, Part II illustrates how the reforms may raise serious concerns about whether we can expect directors to have the expertise to tackle their new responsibilities, undermining the potential effectiveness of those reforms and once again increasing the likelihood that boards will unduly rely on managers or outsiders in a manner that could undermine their effectiveness.

Part III demonstrates the manner in which reforms may be incompatible with fiduciary duty norms. Those norms, at least as articulated under Delaware law, currently impose a relatively low risk of any personal liability for directors who may run afoul of their new responsibilities, particularly with respect to risk oversight and compensation. Part III, therefore, maintains that reforms raise questions about whether we can expect fiduciary duty law to hinder or support boards’ enhanced obligations. Part IV offers some concluding assessments.