Corporate governance in America: Principles, Paulson and piffle


New York, NY – Yesterday, Integrity Research Associates wrote a post discussing a Wall Street Journal article on the advantages and disadvantages of adopting a “principles-based” regulatory regime like the one currently in existence in the UK.  And while we admit that the ability of a regulator established on a “principles-based” foundation is capable of moving much more quickly and flexibly on various issues (the soft dollar issue is one prime example), this approach provides these regulators with few actual “teeth” to find and punish those who decide to break the rules and, in many cases, harm others.

The following article, written by a regular ResearchWatch reader, Peter D. Kinder, the co-founder and President of well-known ESG research provider, KLD Analytics addresses his concerns with adopting a “principles-based” approach to regulation.

———————————————————————————     US Treasury Secretary Hank Paulson recently opened a conference on corporate regulation post Sarbanes-Oxley with remarks that should trouble everyone concerned with corporate governance, shareholder rights, or a just society, writes Peter Kinder

Said Secretary Paulson at the recent conference in March: “Our goal should be better managed, more competitive corporations that earn investor confidence through sound leadership, thoughtful governance, and outstanding performance.

In my judgment, we must rise above a rules-based mindset that asks, ‘Is this legal?’ and adopt a more principles-based approach that asks, ‘Is this right?’

And we should consider whether our legal system appropriately protects investors or gives too much latitude to unscrupulous lawyers.

Since Secretary Paulson invoked the British phrase “principles-based,” it seems only fair to ask whether he was merely speaking piffle – an excellent bit of Britspeak – out of ignorance of what’s gone on in financial services during his working life or whether something more is in play here.

Is that right?

Start with “Is this legal?” vs. “Is this right?”

That distinction invites me to say to myself, “Well, of course, I’d do the right thing.” Maybe I would. But what about AIG’s Hank Greenberg? Hollinger’s Conrad Black? Or Enron’s Ken Lay? Many among us admired Enron’s statements of principle, codes of conduct, and corporate governance, etc.

No, these are sequential questions: what’s legal (what’s the minimum I have to do) followed by what’s right.

It’s this sequence of self-questioning that leads some executives to go beyond reporting, honestly, their numbers and to publishing, for instance, environmental and social performance reports.

A rhetorical wizard’s curtain?

The Treasury Secretary’s rules vs. principles line isn’t just piffle for audiences to nod through. It is the curtain concealing a “very bad wizard.”

Mr. Paulson says, “And we should consider whether our legal system appropriately protects investors or gives too much latitude to unscrupulous lawyers.”

Why, exactly, is there a trade off between protecting investors and restraining “unscrupulous” lawyers? Aren’t these distinct issues?

Consider the case the Justice Department has brought against the plaintiffs law firm, Milberg Weiss.

The Justice Department does not contest that the plaintiffs had a right to sue to protect themselves from the consequences of violations of the US Securities Acts.

Rather, Justice claims Milberg violated laws by rounding up the usual lead plaintiffs and paying them to serve.

Correcting lawyer misbehavior has no logical connection to my right as a shareholder or a consumer to seek compensation for corporate misfeasance that harmed me – financially or otherwise.

By damning the victim’s agent, the Treasury Secretary gets to blame the innocent victim with impunity.

Block that suit!

Mr. Paulson says nothing about who would answer the question, “Is this right?” Or how differing views of “right” might be resolved.

When connected to his recent anti-litigation efforts, his “unscrupulous lawyers” reference shows it won’t be shareholders or consumers making this call. It will be the corporations themselves.

And that brings me to Mr. Paulson’s goal: “better managed, more competitive corporations that earn investor confidence….”

So his plan is this: loosen corporation regulation, at least on securities issues, and protect companies from punishing shareholder lawsuits.

Then corporations will show that they’ve earned these privileges. It’s rewards first, performance later. I guess he’s never raised children.

The American experience?

We have been down this path before with disastrous results: The Securities Litigation Reform Act of 1995 followed by the sparkling corporate performance that led to Sarbanes-Oxley.

What we have in Secretary Paulson and his allies are history-deniers. And those who deny history condemn others to relive it.

In truth, American securities regulation is principles based.

It was the genius of the drafters of the 1933 and 1934 Acts to recognize that no agency or legislature could specify every possible way of fooling investors.

They left to court decisions and evolving administrative actions the meaning of “security” and “material.” A key instrument in this successful regulatory scheme was investor lawsuits.

Starting in the mid-1970s and continuing today, the corporate pleas for “securities litigation reform” and “tort reform” have focused on “unscrupulous” plaintiffs lawyers (and their coffee-burnt clients) preying on vulnerable companies.

Curiously, the campaign has rarely paid so much as lip service to cleaning up the plaintiffs bar. It has centered its efforts on keeping plaintiffs – even those represented by paragons – from winning or even bringing suits against corporations.

What’s in it for us?

When someone demands that you give up the right to protect yourself, history teaches us you better get something big in return.

So, the appropriate question to Secretary Paulson is, “What’s in it for us?” “What do we get for giving up our rights?”

On March 13, Mr. Paulson didn’t even acknowledge such questions.

Others have suggested benefits ranging from the promise of better companies to the possibility of shareholders being allowed to nominate a director or two to the hope of greater returns to shareholders due to reduced litigation expenses.

What’s on offer, then, to shareholders and consumers is piffle in exchange for the right to protect themselves. That is Secretary Paulson’s “principles-based” play here.

Peter D. Kinder, co-founder and president of KLD Research & Analytics, Inc., Boston, writes on corporate governance, fiduciary issues and socially responsible investing.

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