Dan Boxer's Business Law Seminar

BUSINESS LAW SEMINAR:

GOVERNANCE,
ETHICAL ORGANIZATIONS, STAKEHOLDER RESPONSIBILITY AND

CORPORATE SOCIAL RESPONSIBILITY

COURSE OUTLINE AND MATERIALS FALL SEMESTER 2011 University of Maine School of Law

Prof. Dan Boxer

Summary of Contents

Part One: What Governance is all About …………………………………………………1 Part Two: Stakeholders and Shareholders (all kinds)…………………………………98

Part Three: Corporate Social Responsibility, Sustainability, Accountability; What’s Included? Where does Governance Fit in; Definitions…………………….121

Part Four: Ethics in Business and Other Organizations…………………………….157

Part Five: Governance and Other Lessons From the Financial Crisis……………185

Part Six: Gatekeepers-Obligations and Issues;
Lawyer as Business Conscience; Lawyer as Board Member ……………….201

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Section 4: Governance Trickles Down…………………………….24

A. The Trickle Down Theory of Governance…………………………………26 1. Good practices are good practices whether required or not……………26 2. A Good Example of Trickle Down Governance–The Sarbanes-Oxley

Act………………………………………………………………………27

Section 5: Deeper Dive into the Board’s Substantive Duties……30

A. But First: Boards Not Knowing Their Role………………………………..31

B. Drilling into the “List” of Board Duties……………………………………31

1. Strategy……………………………………………………………….32
2. Risk ………………………………………………………………. 35
3. Financial……………………………………………………………………….43
4. Compliance, Ethics, Culture, Social responsibility …………………………….45
5. Hiring The CEO, Executive Compensation and Performanceand
6. Succession Planning, Human Resources………………………………………50
7. Board Operations, Improvement and the Assessment of Performance………..57
8. Advice, and Mentoring of Management……………………………………….60

Section 6: Deeper Dive into the Structural Aspects of Governance; Driving Governance With Disclosure and Federal Mandates …..64

A. Overview……………………………………………………………………64 B. NYSE Listing Standards. ……………………………………………………………65

C. The SEC’s Enhanced Disclosures and More………………………………70 D. Dodd-Frank ………………………………………………………………..74 E. Diversity Issues and Board Governance……………………………………78

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Section 7: The Relational and Behavioral Elements of Governance…………………………………………………………..81

A. Impediments to Better Boards; Behavioral Psychology; Group Dynamics..81 1. Overview………………………………………………………………81

2. A Few Stage Setters……………………………………………………83

3. A Sampler of Some Legal (mostly) Learning on Board Psychology….84

B. Independence as Behavior: Beyond Structure – into Bias and Conflict……87 1. Independence issues are multi-faceted; A Bit More on the NYSE…….87 2. The Law………………………………………………………………..89

3. Independence , Groupthink and Conflicts …………………………….91 4. Some Independence Issues……………………………………………..91 5. Maine Law for Nonprofits and Board Independence…………………..93 6. IRS Getting into the Act………………………………………………..93

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Part Two: Stakeholders and Shareholders (all kinds)

Section 1. For Whom is the Corporation Run? …………………….98

A. Introduction to Shareholder and Board Primacy and Stakeholder Theory; Concepts and Confusions………………………………………98

1. Lots of Ways to Look at Issues; Not Much Consensus……….98 a. ASamplingofLegalisticApproachestoStakeholderAnalysis……..98 b. Good Management or Business Stakeholder Considerations……….101

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c. CorporateResponsibility,Social,Moral,EthicalandGlobal Stakeholder Imperatives……………………………………………102

2. Some Legal History; More Context to the Board-Stakeholder- Shareholder Primacy Debate…………………………………102

3.Stakeholder Governance, Constituency Statutes and B and Benefit Corporations……………………………………………………105

Section 2. Who Are The Shareholders; Short Termism………….107

A. Shareholders Come in All Sizes…………………………………………107 1. Many Conflicting Interests; No Monolithic Shareholder…………….107

2. Government Autoworker Shareholders and Politicians Calling the Shots; Shadow Boards and Sovereign Funds…………………………………..110

B. Short and Long-Termism……………………………………………….112

C. Shareholder Activism and Motivation; Socially Responsible Investing (SRI)………………………………………………………………………..115

1. Shareholder Activism in its Many Forms……………………………..115 2. Socially Responsible Investing………………………………………..119

Part Three: Corporate Social Responsibility, Sustainability, Accountability; What’s Included? Where does Governance Fit in; Definitions

Section 1. Concepts, Definitions, Frameworks and Convergence..121

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1. A Few Basics; Ethics and Compliance are not the Same Thing……158 2. Some Definitions of Ethics…………………………………………161 3. Ethical schools of thought………………………………………….162

B. Definitions May Be Simple, Assuring Ethical Behavior is Hard

1. Situations Always Present Issues…………………………………164
2. Most Business Ethics Situations Don’t Involve Front Page News.166
3. Most Don’t Make the News, But Some Do………………………169

Section 2. Codes of Ethics and Conduct; Do they do Much Good?

A. Background………………………………………………………..170 B. Do Codes Accomplish the Intended Purpose?……………………………172 C. Looking at Some Codes……………………………………………174

Section 3. Ethics is a Problems and Not Just for the Business World

A. In the Business World; Rays of Hope?……………………………………..179 B. The MBA Oath; Doubtful…………………………………………180 C. A Bit on Nonprofits and Ethics……………………………………182

Section 4.Who is Out There for Further Guidance on Organizational Ethics?……………………………………………………………..185

A. Only Half the World—Blogs, Websites, etc……………………….185

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Part Five: Governance and Other Lessons From the Financial Crisis

Section 1. The Financial Crisis…………………………………….185

A. Background ………………………………………………………………..186 B. What Caused The Financial Crisis?……………………………………………………..186

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1. Lots of study but Probably No One Knows; Or Agrees………………….187

C. The Financial Crisis Finger Points at Least in Part, at Governance………….191

1. One Side of the Governance Debate—It Was Responsible……………..192 2. Another Side—Blame Government and its Policies……………………..195

4. Does it all Come Down to Greed, Temptation, Human Weakness, Lack of Ethics and Failures of Culture? ……………………………………………..196
5. Are the Responsible being Held responsible?………………………………………….198

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Part Six: Gatekeepers-Obligations and Issues; Lawyer as Business Conscience; Lawyer as Board Member

Section 1. Gatekeepers…………………………………………201

A. B. C.

Overview; Definitions…………………………………………………….201 Gatekeepers Identified……………………………………………………203

Instructive Examples………………………………………………………204

1. Ratings Agencies…………………………………………………..204 2. Auditors Again…………………………………………………….207 3. Proxy Advisors…………………………………………………… 207 4. Lawyers……………………………………………………………209

Section 2. Lawyers On The Board………………………………….212 A. The Basics ………………………………………………………………212

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Introductory Note

This course is three courses combined into one. It wasn’t always that way. It started out a few years back as one course, covering corporate and nonprofit governance. During that first year, it became evident that I couldn’t teach governance without relying heavily on current events to illustrate and bring home key points. Not only are some of the best governance discussion topics right under our noses in the news every day, but it is also impossible to put governance, business ethics and corporate social responsibility/sustainability in separate silos to be discussed monolithically. How could we cover corporate responsibilities for compliance and ethics and corporate codes of conduct without talking about the almost daily reports of ethical and cultural failures in the news? How could we discuss the board’s risk oversight obligations and need to consider compensation incentives without delving into the financial crisis? How could we talk about the board’s role in strategy development without considering the need to factor in the megatrend of corporate social responsibility? etc., etc., etc.

I am a strong believer in the truth and power behind looking at the connections between things and thus, for that abstract reason alone, these three connected areas of governance, ethics and CSR need to be taught together. Everything is connected. Doing so also avoids the need to spend much time on where each fits in the scheme of things. We can’t even say for sure whether governance is a subset of ethics or vice versa, or whether they are both little pieces of the greater social responsibility of organizations. ..or whether CSR is really all about ethics, or part of governance. etc., etc., etc. Or whether stakeholder discussions belong with basic governance or CSR? Incidentally, it is just an urban legend that Chief Seattle sadly noted in a letter to President Pierce that “All things are connected. Whatever befalls the earth befalls the sons of the earth. Man does not weave the web of life; he is merely a strand of it. Whatever he does to the web, he does to himself”. The best evidence is that someone named Ted Perry wrote the words for a fictional Chief Seattle in a 1972 movie.

Next to last point. This course was designed to introduce upper class law students to key governance, business ethics and CSR concepts and issues in a way that could be of immediate benefit when they entered the real world. The materials and class discussion, including the presence of a dozen or so guests from the business

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and nonprofit worlds, are heavy on practical considerations and information. This was my goal based on my own background as a law firm partner, Fortune 1000 General Counsel, advisor to public and private businesses as well as nonprofits and startup entrepreneur. Thus, as only one among many examples, little (but some) time is spent looking at directors’ duties and responsibilities as determined by courts and Delaware law. The Caremark case is barely mentioned. Instead, the materials tend to discuss key best practices as determined by leading organizations like the Conference Board, NACD and others, as well as leading law and consulting firms. There is as much material from business school publications as from law reviews.

Last point. These course materials are neither a textbook nor a learned treatise. Had there been one available that covered the material I thought needed covering and updated itself weekly based on current events, I might have assigned it. There wasn’t so I set about putting together a compendium of material from a variety of sources, including my views and practical guidance documents prepared by me and others, quotes and ideas referenced in texts, law review articles, SSRN articles, academic blogs, cases, law firm public memos, federal documents, consultant and trade association publication, think tank analyses, popular and business press, and many thoughtful, although nonacademic, blogs. The class was not charged for the materials. Virtually everything but my prior work came from the internet. In every instance where I have referenced the work or words of others, I have sought to either quote directly or give credit and proper attribution. I also have enclosed direct internet links to virtually all of this material so the reader can go deeper if desired as well as see how much I took in, or out of, context. Giving the link also allowed me to avoid having to name every author as the names are in the linked material. Complete attribution, however, does not mean complete or proper citation form or format. Especially when a lot of cutting and pasting and referencing to unique forms of information were involved. No uniform citation manuals or formats were followed or even attempted to be followed. In fact, there is very little uniformity in citations, use of italics, quotes, underlining, etc.

D.Boxer, Nov. 2011

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Part One: What Governance is All About

Section 1: History and Background A. A Bit of History and Context

We will get to definitions shortly, but it is important to recognize that governance as a concept has been around for as long as people have been involved in collective activity or constituents or stakeholders in a group—like a clan, kingdom or a tribe, or a Dutch tulip bulb trading company. It doesn’t work to have mob rule. It is also not effective to have everyone with an interest jointly and equally participate in the making of all decisions—unless there are just a few people involved. This all means that when an organization needed to be run, there have been issues over how best to run whatever was being run.

In a relatively (a few hundred years back) more modern, business context, governance concepts reared their head in Adam Smith’s “The Wealth of Nations” (1776) when the father of classic market economic thought expressed concern over the loss of shareholder control and the growing power of management. By the1930’s, scholars in the U.S. were beginning to raise serious questions about the issues involved in holding management accountable as agent for absentee, dispersed share owners. The establishment of management and board friendly state corporate law statutes earlier in the century had done little to effectively deal with these issues. On the federal level, the adoption of the Securities Exchange Act of 1934 helped somewhat by dealing with securities regulation from a national perspective , especially in the absence of meaningful state securities disclosure and regulation legislation.

Merger frenzy and some very visible corporate failures and excesses in the 1980’s and 90’s, resulted in serious shareholder activism and governmental scrutiny of how companies are run and their governance practices. Although the heavy focus has been on publicly traded corporations, the 1990’s and 2000’s also saw major nonprofit governance failures and scandals, involving many local and national organizations such as the United Way, National Audubon Society and the Smithsonian, where the two top people were found to have taken massive time off to attend meetings of for profit boards for which they were paid millions while the Smithsonian suffered from serious mismanagement. They were also found to have personally benefited from lavish, unauthorized expenditures. An internal review

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committee also cited the Board for failing to provide “badly needed oversight” and stated that: “The root cause of the Smithsonian’s current problems can be found in the failures of governance and management.”

(Nonprofit misbehavior continues to be a significant problem as we will see later)

In 2001 and 2002, a new wave of corporate scandals, the most famous of which was the Enron mess, led to an even greater outcry for improved governance practices and enhanced regulation. One outcome was the passage by Congress in 2002 of the landmark Sarbanes-Oxley Act (“SOX”) which imposed stringent new financial oversight and disclosure requirements on public companies. SOX breathed fresh life into a previously modest intrusion of governmental oversight and regulation of governance and accelerated the so-called “federalization of governance”, or what one commentator has called “quack governance” (mainly because it is political, reactive and usurps state law). Board and management- friendly state corporate/judicial law (especially Delaware) was beginning to get some serious competition. In addition, the post-Enron times also resulted in an enhanced focus on the “softer”, but just as important side of good governance— ethics, social responsibility, socially responsible investing, sustainability and stakeholder involvement.

{Important Note: as will be emphasized throughout the course, although the initial thrust of enhanced governance scrutiny and initiatives tends to be directed at publicly traded and regulated for-profit entities, much of the learning and emphasis has been adopted by, or adapted to, smaller, private businesses as well as nonprofits. As we will see, in most cases, “Governance is governance” and expectations of what constitutes good and best practices have trickled down to the most local of organizations. Ironically, best governance practices don’t seem to have been of much concern to the activities of the state and federal government.}

The post-SOX years saw growing shareholder, especially institutional shareholder, activism, greatly enhanced SEC governance related rulemaking, stock exchange governance oversight and listing requirements and greater awareness by business and nonprofit groups, as well as individual boards, of the need for governance improvement, ethical behavior and social responsibility. Similarly, this period saw a much more intense effort by director groups and the legal, accounting, shareholder advisory and consulting sectors to raise the bar (and earn some fees in the process) on best governance practices and corporate accountability. It was finally starting to look, for a while, like much of the regulatory, shareholder and other stakeholder pressure, as well as industry and nonprofit self-policing, were yielding positive results across the whole spectrum of what constitutes

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“governance”. Then the financial crisis of 2008 came along, accompanied by the bursting of the housing bubble, a severe credit crunch and significant unemployment and economic dislocation—all of which shattered the faith of many in the efficacy of existing governance, ethical behavior and organizational self policing, as well as governmental oversight mechanisms—especially with respect to financial institutions through the world. The debate and attention to governance on worldwide and national levels is now stronger than ever and is providing significant and valuable new learning and lessons for large and small, and public and private organizations, even those of a very local nature.

While events and activity related to the financial crisis continue to unfold (like the mortgage foreclosure and “robo-signing” mess) and causes and fixes are still being debated, a new round of intense governmental, shareholder and judicial scrutiny of corporate governance failures and remedies is underway. Major governance reforms are contained in the much heralded Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). The SEC and other agencies are in the midst of massive rulemakings dealing with compensation, disclosure and many other governance topics as directed by Dodd-Frank. This new regulatory activity comes on the immediate heels of massive SEC governance rulemaking in 2009. Financial scandals, business and moral failures and political posturing always seem to elicit clamors for better governance and politicians are always looking for new whipping boys.

B. Definitions and General Concepts 1. Many Definitions; Overlapping Concepts

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It is easy to find plenty of definitions of the term “governance” (most of which say pretty much the same thing) but it is important to recognize that the term has no universally recognized, legally applicable definition. The absence of a single definition upon which to focus is not a problem, however, since there is little value in trying to use simplistic formulations to understand what essentially a concept is and the issues and the many causal factors involved in effective or dysfunctional, governance. Governance involves a combination of practices (both longstanding and emerging), legal requirements, personalities and personal interactions, behavioral psychology and group dynamics. Furthermore, governance is a concept which is being continually broadened, refined and expanded. Thus, relying on any definition for guidance will provide no more enlightenment than trying to extract value from the definition of words like “job” or “law”.

Nevertheless, as we seek to learn more about governance, we have to start somewhere, so we will start by looking at a range of definitions, mainly drawn from the business context because that is where most of the learning comes from. {Note: Many of the definitions we will look at below were principally developed in a corporate governance context. This means that they will have a heavy focus on a limited universe of governance—the ordering of relationships between owners (stockholders) and management and protecting shareholders from management while allowing the board and management to do their jobs. As we will see later, virtually all of the principles are applicable to both publicly traded profit and nonprofit organizations. Furthermore, the governance universe is far broader than that of many hardcore corporate, transactional lawyers, as we will see.}

Complicating the definitional search is the reality that as times change, expectations change for what governance of organizations is expected to embrace. Fast moving current events like the Enron scandal of 2002, financial crisis of 2008, the mortgage foreclosure scandal, Rupert Murdoch and News Corp’s hacking scandal, recent NCAA scandals, Bernie Madoff and the BP Gulf oil spill (just to mention a few) as well as global trends and developments such as sustainability, ethics and social media invariably lead to the embrace of new concepts and expectations within the context of what good governance involves. A good example of this would be the recent recognition that board oversight of risk also involves risks posed by compensation programs. Basically, “you get the conduct you incentivize”. Could we have avoided the financial crisis altogether if bond salespeople were not paid a commission to sell subprime mortgage bonds?

If an executive team is rewarded for the outcomes of good investments, but has no downside from the negative consequences of investments a board should be concerned that excessive risk-taking will be encouraged. More on all this when we get to compensation.

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Furthermore, much of the internal mechanics and structural aspects of governance have become institutionalized and well understood. This has paved the way for greater focus on “externalities”, or impacts of corporate behavior, and where they fit into the governance scheme of things. As we will see later, arguments can be made that governance is really a subset of ethical behavior–i.e., an ethical organization will be well governed. Or vice-versa– a well governed organization will be ethical (by definition). Or a socially responsible and sustainable organization will be both well governed and ethical. But, others have said that social responsibility may be an externally driven business imperative and has nothing to do with ethics or governance. More on this to come when we get to ethics and CSR. We don’t however; want to get too hung up on terminology or what belongs in which basket. They are all connected and no one has yet figured out exactly how, or whether, it matters that nothing is clear as long as an organization and its board understands, considers and deals with the relevant risks, opportunities, roles and responsibilities presented by whatever we call this set of overlapping concepts.

Here is my graphic display of this uncertainty. It is simplistic but hopefully of some conceptual help. There is an infinite combination of ways to size the circles, draw the overlaps and determine what they include.

Ethical