Roles and Responsibilities of Other Corporate Governance Participants Chapter XI
Chapter Objectives: • Understand the advisory function of corporate governance normally provided by legal counsel, financial advisors, and investment banks. • Recognize the traditional role of legal counsel and how it has changed, as well as the lines of communication between legal counsel, the company, and its board of directors. • Identify the rules and regulations implemented by the SEC for corporate attorneys. • Understand the roles and responsibilities of financial advisors, specifically securities analysts. • Recognize the need for independence in research conducted by securities analysts and the inherent bias in any research. • Comprehend the five standards of best practices governing the relationship between corporations and their analysts.
Key Terms Association of Investment Management and Research (AIMR) Investment bank National Association of Securities Dealers (NASD) National Investor Relations Institute (NIRI) Regulation Analyst Certification (Regulation AC)
Legal Counsel SOX makes legal counsel an integral component of the internal processes of the corporate governance structure to monitor corporate misconduct. Corporate legal counsel should coordinate their activities and serve as counselors to the board, its committees, and directors in carrying out their oversight responsibilities and fiduciary duty; advisors to management in participating in the negotiation, development, process, documentation, and restoration of material business transactions; gatekeepers to ensure compliance with all applicable regulations; enforcement agents to evaluate risks associated with legal issues and to prevent violation of securities laws and engagement in corporate malfeasance, misconduct, and fraudulent activities.
Communication with Legal Counsel 1. Communication between general counsel and independent directors. The Task Force of the ABA recommends that public companies adopt a routine practice of having regular and periodic executive session meetings with their general counsel and an independent committee of the board of directors to discuss real and potential violations of laws and the actual or potential breach of fiduciary duties. 2. Communication between outside counsel and general counsel. The Task Force of the ABA recommends that the general counsel (1) establish policies and procedures for outside lawyers to communicate with the general counsel facts and cases where an officer or employee is engaged in material violations of law or fiduciary duty, and (2) require outside lawyers provide important information and analysis of legal matters to the general counsel where appropriate action can be taken.
Professional Conduct for Lawyers SEC rules for attorneys, established in August 2003, require corporate attorneys to report suspicions of fraud and violations of securities laws. SEC rules apply to any lawyer who is appearing and practicing before the Commission in the representation of an issuer. Up-the-ladder approach
Sarbanes-Oxley Section 307 andSEC Rule 205 • Up the Ladder Reporting • Legal counsel required to go “Up the Corporate Ladder” when violations were found and not properly dealt with. • Noisy Withdrawal • Created because of the need for lawyers to have a way in which to preserve attorney/client privilege , yet still alert the SEC to wrongdoing when Up the Ladder did not work.
Question 1: • How many people think lawyers should have the ability to use a noisy withdrawal to leave a situation that is legally controversial? Why?
Stanford Financial Ponzi Scheme • Sir Allen Stanford • Did most banking offshore in Antigua • Posted huge returns on Certificates of Deposit that were next to impossible • Defrauded investors of $7.2 Billion • (video)
Thomas Sjoblom • SEC Attorney for 19 years • Outside Counsel • Used SOX Section 307 and SEC Rule 205 to “lifeboat” out of the Stanford Situation • It is clear he had knowledge of the Stanford Ponzi scheme • Has no criminal liability
Responsibilities of Legal Counsel Legal counsel, either an in-house or outside lawyer, should: serve the integrity of the company aside from the personal interests of its directors, officers, employees, shareholders, or other stakeholders; be responsible for implementing an effective legal compliance system under the oversight of the company’s board of directors to ensure compliance with all applicable regulations; advise the board of directors or a board committee on special investigations and report directly to the board or the board committee; have appropriate rules of conduct in conformity with SEC and state attorney requirements and enforce these rules; be aware of adherence to their professional codes of ethics and responsibilities in their representation of public companies. If necessary, a special qualified legal compliance committee (QLCC) can be composed.
Financial Advisors Prosecutors are restricted but not prohibited from seeking corporate privilege waivers (in accordance with new guidelines for prosecutors issued by Deputy Attorney General Paul J. McNulty, of the U.S. D.J on December 12, 2006). Conflicts of interest may arise when the investment advisors have personal or business relationships with the company, its directors, or participants in proxy contents. The SEC, in addressing this potential conflict of interest, has adopted a rule that requires investment advisors to (1) establish policies and procedures to guide their proxy voting in the best interest of their clients, (2) disclose adequate information regarding the established policies and procedures and how they have voted their proxies, and (3) maintain proper records regarding proxy voting.
Securities Analyst Securities analysts are hired by brokerage firms to analyze financial performance of the corporations they follow, assess the quality of the company as an investment, and make recommendations for investment opportunities based on their analysis. A few facts about security analysts: They can directly or indirectly affect the quality and quantity of financial information dissemination by influencing investors’ investment decisions; Analysts are regulated by the NASD; Section 501 of SOX directs the SEC to issue rules addressing securities analyst conflicts of interest issues; SOX and Regulation AC address concerns regarding the independence of research from investment banking and the analysts’ perceived conflicts of interest; and Requirements of Regulation AC are consistent with and complement other rules governance conflicts of interest disclosure by research analysts mandated by the NASD Rule 2711 and NYSE Rule 472.
Ethical Guidelines between Public Companies and their Securities Analysts Was proposed by The Global Association for Investment Management and Research (AIMR) and the National Investor Relations Institute. The guideline’s standards are summarized as follows: Standard I: Information Flow assumes nondestructive free flow of information. Standard II: Analyst Conduct assumes that analysts’ research and recommendations are conducted with the utmost objectivity, independence, fairness, and unbiased opinion. Standard III: Corporate Communication and Access assumes equal information access. Standard IV: Reviewing Analyst Reports or Models assumes analysts, prior to the publication of their reports, may request that corporations review some portions of the report for factual accuracy. Standard V: Issuer-Paid Research Reports assumes that analysts may not receive any compensation in the form of corporate shares or anything related to future performance.
Conclusion • The advisory function of corporate governance is assumed by professional advisors, including legal counsel, financial analysts, and investment bankers who normally assist companies in evaluating legal and financial consequences of business transactions. • Traditionally, a lawyer’s role in corporate governance has been as the outside gatekeeper to promote legal compliance and to protect the interest of the company. • SOX makes legal counsel an integral component of the internal processes of the corporate governance structure to monitor corporate misconduct. • The board of directors should approve the appointment, retention, and compensation of the company’s general counsel. • General counsel should coordinate the activities of internal and outside lawyers.
Conclusion • Conflicts of interest may arise when investment advisors have personal or business relationships with the company, its directors, or participants in proxy contents. • Like accountants and lawyers, securities analysts have been subject to pressures and incentives to be biased toward corporations they follow, particularly when they are associated with firms that also do investment banking. • SOX and Regulation AC are intended to promote the integrity of research reports and investor confidence in those reports by properly disclosing conflicts of interest that are known or should have been known by securities analysts, brokers, or dealers to exist at the time of the appearance or the date of distribution of the report. • Professional advisors by virtue of their associations with public companies can influence corporate governance and financial reports.