There are four key sources of corporate governance law and regulation in the United States: state corporate law (predominantly Delaware, in which over half of all US publicly traded corporations are incorporated); federal securities law, including the US Securities Act of 1933 and the US Securities Exchange Act of 1934, and the regulations of the US Securities and Exchange Commission (SEC) under those Acts; stock exchange listing rules (predominantly the New York Stock Exchange (NYSE) and the NASDAQ); and federal and state laws regarding particular areas of corporate practice (eg, regulations promulgated by the Federal Reserve and other federal and state agencies with respect to financial institutions, and by other similar regulatory bodies in other regulated fields). In addition to this mosaic of rules and regulations, US public companies are also influenced by institutional investors – especially the largest index funds – which yield significant influence and voting power and have increasingly sought to assert their views on a wide array of corporate governance issues. Together, these legal requirements and other influences make for a complicated and continually evolving environment.
Securities laws and regulations are enforced by the SEC, and the SEC reviews and may comment on important corporate disclosure documents (such as proxy statements and securities registration statements). Larger and older corporations with a history of securities law compliance are subject to fewer pre-clearance requirements and may in certain cases use abbreviated forms of disclosure. Investors may also bring actions under many provisions of the securities laws to recover damages for misstatements or omissions in public statements and in certain other circumstances. The Department of Justice prosecutes criminal violations of federal securities laws and SEC rules.
State law fiduciary duties of corporate directors and officers are predominantly enforced by private actions led by plaintiffs’ lawyers. These private actions generally fall into one of two categories: class-action suits on behalf of a particular group of the corporation’s shareholders (typically all shareholders who bought or sold during a particular period or all unaffiliated shareholders) and derivative suits, purportedly on behalf of the corporation itself. Class-action suits must satisfy the criteria under the Federal Rules of Civil Procedure or analogous provisions of state law before being permitted to proceed, designed to ensure the suitability of the claim to the class action process and the protection of class interests. Derivative suits under state corporate law permit shareholder plaintiffs, in theory, to represent the corporation in suing the corporation’s own board of directors or management, sometimes after complying with a ‘demand’ procedure in which the plaintiff must request that the corporation file suit and be rebuffed. In certain circumstances, especially when it can be shown that the board of directors is for some reason conflicted, this demand requirement is excused and the shareholder may pursue a claim without further enquiry.
The two primary US stock exchanges, the NYSE and the NASDAQ, each make rules with which corporations must comply as a condition to being listed on these exchanges. These listing rules address all aspects of corporate governance, including topics such as director independence, the composition of various board committees, requirements to submit certain matters to a vote of shareholders, regulation of dual-class stock structures and other special voting rights, publication of and topics covered by corporate governance guidelines, and even requirements relating to the corporation’s public website. These rules are enforced by the threat of public reprimand from the exchanges, temporary suspension of trading for repeat offences and permanent delisting for perennially or egregiously non-compliant companies.
In addition, of long-standing importance to the US corporate governance regime are the proxy advisory firms (predominantly Institutional Shareholder Services (ISS) and, with a lesser market share, Glass, Lewis & Co (Glass Lewis)), the influence those proxy advisers have on the institutional investor community, and the prevailing and evolving views of the institutional investor community. That community’s views have become particularly influential as the shareholder base of the vast majority of US publicly traded corporations consists of an overwhelming majority of institutional shareholders, including index funds, pension funds and mutual funds. As a result, major institutional investors are increasingly developing their own independent views on preferred governance practices.
Although proxy advisory firms are not a source of law, their guidelines figure significantly in the corporate governance landscape. These advisory firms exert pressure on corporations to conform to the governance standards they promulgate by issuing director election voting recommendations to each publicly traded corporation’s shareholders based on the corporation’s compliance with the advisory firm’s published standards. Proxy advisory firms wield outsized influence on corporate elections, especially among institutional investors such as pension funds.
One study found that a recommendation from ISS to withhold a favourable vote in an uncontested director election correlated with a 20.9% decline in favourable voting. In addition, a 2013 study sponsored by Stanford University found that companies were altering their compensation programmes to comply with proxy advisory firms’ ever-evolving policies. The US Congress, the US Department of Labor and the SEC have raised questions regarding fiduciary responsibility in the context of the outsourcing of proxy voting decisions to proxy advisory firms. In 2020, the SEC, led by former President Trump’s appointee chairman Jay Clayton, adopted amendments to the proxy rules governing proxy advisers, which were designed to enhance the accuracy and transparency of proxy voting advice provided by proxy advisory firms to investors. These reforms increased disclosure of material conflicts of interest in voting advice, provided an opportunity for review and feedback for the identification of errors in proxy voting advice and codifying that proxy adviser vote recommendations as solicitations subject to the anti-fraud provisions of Rule 14a-9.
The change in administrations in the United States in 2021, and the resulting reshuffling in the leadership of the SEC, was accompanied by changes in the SEC’s goals and priorities. In particular, while the SEC during the Trump Administration sought to loosen the regulations applicable to US public companies, the SEC during the Biden Administration has announced plans to scale up certain disclosure requirements, including ESG and proxy voting. In November 2021, the SEC proposed two further amendments to the proxy rules governing proxy advisors, to scale back certain of the changes enacted in 2020 in response to concerns expressed by investors and others that the new rules may impair the timeliness and independence of proxy voting advice and subject proxy advisors to undue litigation risks and compliance costs. Significantly, certain major institutional investors, such as BlackRock, Inc (which invests more than $9.5trn in client assets) and the Vanguard Group (which invests more than $7.2trn in client assets) employ internally developed guidelines to reach voting decisions, independent of proxy advisory firms, and have sought to engage directly and pragmatically with companies. These major institutions are positioned uniquely to reduce reliance on proxy advisory firms. Importantly, these major institutions are converging on a more stakeholder-focused, and less shareholder-focused, vision of corporate governance.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), signed into law in July 2010, was passed in response to corporate governance practices perceived by some to have contributed to the 2008–10 economic crisis. The Dodd-Frank Act requires additional disclosure in corporate proxies and non-binding shareholder votes on various questions of corporate governance (notably, concerning executive compensation), and contemplates greater access for shareholder-proposed director nominees to the company proxy. In the latter regard, most S&P 500-listed companies now afford shareholders with expanded proxy access rights to facilitate director nominations if certain requirements are met. In more recent years, the SEC has adopted rule amendments to streamline disclosure requirements, reduce duplicative or overlapping disclosure obligations and update the periodic disclosure requirements relating to a company’s business, human capital resources, legal proceedings, risk factors and management’s discussion and analysis of business trends and uncertainties. These changes seek to encourage flexible, principles-based disclosure and permit increased use of summaries, cross-references and hyperlinks to reduce repetition.
Outlook and developments
Corporate governance in the United States has changed dramatically during the past 30 years and will undoubtedly continue to evolve in significant ways. In particular, the SEC has increased its focus on proxy plumbing, including with respect to the accuracy, transparency and efficiency of the voting process; shareholder communications and retail participation in the voting process; and misalignment of voting power and economic interests, including through empty voting strategies involving purchasing voting securities and then hedging away the economic exposure with derivatives. The SEC has indicated that it is continuing to review the role of proxy advisory firms such as ISS and Glass Lewis in the voting process; in light of ISS’s substantial influence in the evolution of corporate governance norms during the past several decades, this review may have significant implications. The SEC has also received many proposals for the reform of the Regulation 13D reporting regime, including to encompass additional forms of economic interests and to close the ten-day reporting window that raiders have used to facilitate stealth acquisitions of control blocks without paying a premium. The SEC has also expressed an interest in improving market transparency in respect of beneficial ownership reporting, derivative ownership and short selling. Similarly, the SEC has expressed concerns with manipulation, information asymmetries in securities trading and transparency and, in 2021, released for public comment a pair of proposals that, if adopted, would reshape the disclosure and corporate policy landscape with respect to issuer share buybacks, trading by corporate insiders and the use of Rule 10b5-1 plans as an affirmative defence against liability for insider trading.
At the state level, the courts of Delaware have been refining the fiduciary duty rules applicable to conflict transactions and the review of merger and acquisition proposals, often to increase the scrutiny that directors will face in connection with such transactions and, more generally, to recalibrate the relative power of shareholders and directors.
Spurred on by the accounting scandals of the early 2000s, the financial crisis in 2008-10 and the Covid-19 pandemic, the political and public appetite for corporate governance remains strong. Recently, however, we have seen a heightened awareness of short-termist pressures in the markets and their effect on boards of directors charged with guiding a company’s strategy to achieve long-term value creation. The Business Roundtable’s statement on the purpose of the corporation exemplifies the widespread acceptance by companies and institutional shareholders that corporations must consider the interests not only of shareholders but also those of employees, customers, suppliers, the environment, communities and other constituencies that are critical to the success of the corporation. Indeed, there is an on-going awakening to the idea that corporate governance is not just about the allocation of decision-making authority and accountability as between corporations and shareholders; instead, corporate governance is being reconceived in light of the broader purpose and role of corporations as engines of the economy, ladders of socioeconomic mobility, innovators of technological progress and key stakeholders in environmental sustainability.
Shareholder engagement practices have evolved significantly as well, with the frequency and depth of engagement increasing alongside a more fundamental rethinking of the nature of relationships with shareholders and the role of these relationships in supporting – or undermining – board efforts to take long-term perspectives. A central aspect of the continuing debate is whether initiatives styled as governance reforms operate to shift the locus of control over the corporate enterprise from those with direct knowledge, involvement in and fiduciary responsibilities for the enterprise towards entities lacking those attributes, and whether imposing some form of duties, regulations or mandated best practices on those entities is needed.
In many respects, the relentless drive to adopt corporate governance mandates seems to have reached a plateau in the United States, with essentially all the prescribed best practices – including say-on-pay, the dismantling of takeover defences, majority voting in the election of directors and the declassification of board structures – having been codified in rules and regulations or voluntarily adopted by a majority of S&P 500 companies. It remains to be seen whether this portends a new era of more nuanced corporate governance debates, in which the focus has shifted from ‘check the box’ policies to more complex questions, such as striking the right balance in recruiting directors with complementary skill sets and diverse perspectives, and tailoring the board’s role in overseeing risk management to the specific needs of the company.
Continued debate about, and the evolution of, US corporate governance rules and practice thus appear likely.