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Published online by Cambridge University Press: 06 March 2019
Rational investment decisions require accurate information regarding the operations and performance of issuers. As the U.S. Securities and Exchange Commission (“SEC”) has recently noted: “Accurate and reliable financial reporting lies at the heart of our disclosure-based system for securities regulation, and is critical to the integrity of the U.S. securities markets. Investors need accurate and reliable financial information to make informed investment decisions. Investor confidence in the reliability of corporate financial information is fundamental to the liquidity and vibrancy of our markets.” Issuers have strong motives to signal to investors that the business information they disclose is correct and complete – so as to build solid reputations and avoid discounts that investors might apply to their stock prices as compensation for undisclosed risk or misrepresented results. A similar argument applies to “gatekeeping” reputational intermediaries, such as auditing firms and investment banks that lend their reputations to their clients in various ways. However, dishonest issuers and gatekeepers can take advantage of a generally honest market (that does not contain a substantial fraud risk discount), and the return on fraud for a given member of a firm might exceed such individual's pro rata share of the firm's overall reputational capital, making crime literally pay; therefore, regulation must be introduced to supplement market controls and mandate full and accurate disclosure.
1 Proposed Rule: Standards Relating to Listed Company Audit Committees, SEC Release Nos. 33–8173; 34–47137, 68 Federal Register 2638 (January 17, 2003) (to be codified in 17 CFR Parts 228, 229, 240, 249 and 274) (hereinafter “Release No. 34-47137”).Google Scholar
2 See Ribstein, Larry E., “Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002“, Illinois Law and Economics Working Paper Series, Working Paper No. LE02-008, p. 59 (Sept. 2002), available at http://ssrn.com/abstract_id=33268.Google Scholar
3 See Coffee, John C., Understanding Enron: “It's About the Gatekeepers, Stupid”, 57 Bus. Law. 1403, at 1405 (2002).Google Scholar
4 See Black, Bernard, The Core Institutions that Support Strong Securities Markets, 55 Bus. Law. 1565, at 1567 et seq. (2000) and Theodor Baums, “Changing Patterns of Corporate Disclosure in Continental Europe: the Example of Germany”, Frankfurt University, Institut fuer Bankrecht Working Paper no. 102, p. 5 (2002), available at: http://www.uni-frankfurt.de/fb01/baums/. Coffee supra note 3, at 1406 et seq. explains the particular developments of the 1990s that led U.S. gatekeepers to risk their reputational capital in exchange for the rewards of pleasing their clients.Google Scholar
5 For a nicely framed debate of the issues in the context of takeover regulation, see Johnathan R. Macey, Displacing Delaware: Can the Feds Do a Better Job Than the States in Regulating Takeovers? and Lucian Arye Bebchuck & Allen Ferrell, On Takeover Law and Regulatory Competition, both in 57 Bus. Law. at 1025 and 1047, respectively (2002).Google Scholar
6 For a thorough, yet brief discussion of the “battle of the philosophies” surrounding the adoption of the Securities Act of 1933, see Louis Loss & Joel Seligman, Fundamentals of Securities Regulation 25 et seq. (4th ed., 2001).Google Scholar
7 See Hazen, Thomas L., Treatise on the Law of Securities Regulation §§ 1.1 – 1.3 (3rd ed. 1995) and Siegfried Kümpel, Bank- und Kapitalmarktrecht 1190 (2nd ed., 2000).Google Scholar
8 See Hazen, , Id. at § 1.2 and Kümpel, Id. at 1192 et seq.Google Scholar
9 Eisenberg, Melvin A., The Structure of the Corporation: A Legal Analysis 1 (1976).Google Scholar
10 The Aktiengesetz is a detailed law of more than 400 provisions that not only governs the establishment and governance of a stock corporation, but also provides a detailed regulatory framework for the relationship between a corporation and its auditors and the operation of corporate groups. For a highly informed discussion of current developments affecting German corporation law, see Theodor Baums, “Company Law Reform in Germany”, Frankfurt University, Institut fuer Bankrecht Working Paper no. 100 (2002), available at: http://www.uni-frankfurt.de/fb01/baums/. An excellent translation of the Stock Corporation Act is by Hannes Schneider & Martin Heidenhan, The German Stock Corporation Act (Beck/Kluwer, 2001).Google Scholar
11 Schmidt, Karsten, Gesellschaftsrecht 771 (4th ed. 2002) (italics in original) (Author's translation. Please note that I have translated Gesellschaft mit beschränkter Haftung (GmbH) as “closely held corporation”, which is inexact because the German form is governed by a separate law rather than taking on its character because of the nature of a less dispersed shareholding structure.)Google Scholar
12 Code, Delaware, Title 8, available on the Internet at http://www.state.de.us/corp/DE-law.htm.Google Scholar
13 Committee on Corporate Laws of the Section of Business Law of the American Bar Association, Model Business Corporation Act (1984).Google Scholar
14 See Wiedemann, Herbert, Erfahrung mit der Gestaltungsfreiheit im Gesellschaftsrecht, in Gestaltungsfreiheit im Gesellschaftsrecht, Deutschland, Europa und USA, 11TH ZGR Symposium 6 (Lutter & Wiedemann eds., 1998).Google Scholar
15 Mertens, Hans-Joachim, Satzungs- und Organisationsautonomie im Aktien- und Konzernrecht, 3 ZGR 426 (1994).Google Scholar
16 See Hirte, Heribert, Die aktienrechtliche Satzungsstrenge: Kapitalmarkt und sonstige Legitimationen versus Gestalungsfreiheit, in Lutter & Wiedemann supra note 14, at 81 et seq.Google Scholar
17 The securities laws consist of seven statutes, of which the most important for this essay are the Securities Act of 1933; 15 U.S.C. §§ 77a et seq., hereinafter “Securities Act”, and the Securities Exchange Act of 1934; 15 U.S.C. §§ 78a et seq., hereinafter “Exchange Act”. For a good, brief discussion of the securities laws, see Loss & Seligman, supra note 6, at 37 et seq.Google Scholar
18 See Coffee, John C., The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control“, 111 Yale L. J. 1, at 26 et seq. (2001).Google Scholar
19 For example, the Listed Company Manual (“LCM”) of the NYSE, at § 303, requires that listed companies adopt certain corporate governance structures and practices. The standard Listing Agreement of the NYSE, at II.7, requires the listed company to maintain an audit committee at all times.Google Scholar
20 The German Exchange Act (Börsengesetz) was originally adopted in 1896, and has been significantly amended over the years, most recently in 2002. The Börsengesetz is available in English translation with other German securities laws in Hartmut Krause, German Securities Regulation (Beck/Butterworths: 2001), although it should be noted that this edition does not include the substantial amendments that were introduced in 2002. For a relatively brief and thorough commentary on the Börsengesetz see Wolfgang Groß, Kapitalmarktrecht (2000).Google Scholar
21 Beyond the Börsengesetz, the two principle laws in this field are the Securities Trading Act (Wertpapierhandelsgesetz), which was first adopted in 1994, and the Securities Sales Prospectus Act (Verkaufsprospektgesetz), which was first adopted in 1990. These laws are also available in translation; see Krause, supra note 20. A leading commentary on the German securities laws is Siegfried Kümpel et al., Kapitalmarktrecht: Handbuch für die Praxis (1971, updated to 2002).Google Scholar
22 Many of the earlier Directives on listing and continuing disclosure requirements have been consolidated in the Directive of the European Parliament and of the Council of 28 May 2001 on the admission of securities to official stock exchange listing and on information to be published on those securities (2001/34/EC) p. 1 O.J. July 6, 2001 (L 184).Google Scholar
23 In her extensive study of European securities regulation, Niamh Moloney notes that while exhibiting extensive differences in regulatory structure (i.e., European laws are focused on market integration and do not (yet) have an overseer equivalent to the powerful SEC), the European securities regime imposes “mandatory disclosure requirements on issuers.” Niamh Moloney, EC Securities Regulation 53 (2002).Google Scholar
24 Initial disclosure requirements and corresponding liability provisions are found in the Verkaufsprospektgesetz and the Börsengesetz and a number of ongoing disclosure requirements are found in the Wertpapierhandelsgesetz. Significant disclosure requirements in the takeover context are found in the German Securities Acquisitions and Takeovers Act (Wertpapiererwerbs- und Übernahmegesetz).Google Scholar
25 See Theodor Baums & Stefan Hutter, “Die Information des Kapitalmarkts beim Börsengang (IPO)”, Frankfurt University, Institut für Bankrecht Working Paper no. 93 (2002), available at: http://www.uni-frankfurt.de/fb01/baums/. Also see Deutsche Boerse AG, “Going Public-Grundsaetze” as of July 15, 2002; available from the Frankfurt Stock Exchange at http://deutsche-boerse.com/INTERNET/EXCHANGE/index.htm.Google Scholar
26 For recommendations to facilitate actions for liability, see Bericht der Regierungskommission Corporate Governance (Government Report on Corporate Governance) Margin Note 71 et seq. (Baums ed., 2001).Google Scholar
27 For an article by a leading commentator promoting the advantages of the U.S. model, see Marcus Lutter, Vergleichende Corporate Governance – Die deutsche Sicht, ZGR 2001, p. 224. For an article presenting a less favorable, post-Enron view of the U.S. model, see Günter Christian Schwarz & Björn Holland, Enron, WoldCom … und die Corporate Governance-Discussion, ZIP 2002, p. 1661.Google Scholar
28 The discussion led by American scholars such as Michael Porter at the end of the 1980's suggesting that certain advantages found in both Japan and Germany be adapted (see Porter, Capital Disadvantages: America's Failing Capital Investment System, Harv. Bus. Rev. (1992)), have scarcely been raised since the Asian financial crisis and the U.S. bull market of the late 1990's. See Ronald J. Gilson, Globalizing Corporate Governance: Convergence of Form or Function, Am. J. Comp. L., 328, at 331 (2001).Google Scholar
29 Public Law 107-204, July 30, 2002 (H.R. 3763) Sarbanes-Oxley Act of 2002, An Act to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. Available on the Internet at http://frwebgate.access.gpo.gov/cgi-bin/multidb.cgi.Google Scholar
30 See § 301 SOA. This point is discussed at length below. Another such structural measure, the outright ban on most types of loans to executives set forth in § 402 SOA, goes even farther than the equivalent measures found in §§ 89 and 115 Aktiengesetz, which provides a type of disinterested director approval rule approaching a standard used under § 143 Del. Gen. Corp. Law in connection with § 144 Del. Gen. Corp. Law.Google Scholar
31 The SEC proposes to comply with this requirement through proposed Exchange Act Rule 10A-3; 17 CFR 240.10A-3, released on January 8, 2003 in Release No. 34-47137, supra note 1.Google Scholar
32 See proposed Exchange Act Rule 10A-3(b) nos. 4 and 5.Google Scholar
33 See proposed Exchange Act Rule 10A-3(b) no. 2.Google Scholar
34 See proposed Exchange Act Rule 10A-3(b) no. 3.Google Scholar
35 See proposed Exchange Act Rule 10A-3(b) no. 1.Google Scholar
36 See proposed Exchange Act Rule 10A-3(e) no. 1.i).Google Scholar
37 See proposed Exchange Act Rule 10A-3(e) no. 1.i).Google Scholar
38 See proposed Exchange Act Rule 10A-3(e) no. 1.ii).Google Scholar
39 See proposed Exchange Act Rule 10A-3(b) no. 1.iv).Google Scholar
40 See proposed Exchange Act Rule 10A-3(a).Google Scholar
41 Sante Fe Industries v. Green, 430 U.S. 462 (1975).Google Scholar
42 Id., at 479.Google Scholar
43 The Business Roundtable v. SEC, 905 F.2d 406, 413 (1990), citing CTS Corp. V. Dynamics Corp. of America, 481 U.S. 69, 89 (1987).Google Scholar
44 For an excellent discussion or the issues surrounding the separation of corporate and securities law, see Donald C. Langevoort,Seeking Sunlight In Santa Fe's Shadow: The SEC's Pursuit of Managerial Accountability, 79 Wash. U. L.Q. 449 (2001).Google Scholar
45 See Banner, Stuart, What Causes New Securities Regulation: 300 Years of Evidence, 75 Wash. U. L.Q. 849, 850 (1997).Google Scholar
46 See § 7 Gesetz über die Mitbestimmung der Arbeitnehmer of May 4, 1976.Google Scholar
47 For Delaware law, see Aronson v. Lewis, 473 A.2d 805, at 812 (Del. Supr. 1984), and with regard to the Revised Model Business Corporation Act, see § 8.31(a) no. 2.iii).Google Scholar
48 For a balanced evaluation of whether the increased regulation stemming from the SOA can be expected to bring positive results on the capital markets, see Ribstein, supra note 2.Google Scholar
49 Pub. L. No. 104-67, amending the Securities Act and the Exchange Act.Google Scholar
50 On the regretful possibility that the PSLRA helped to create the Enron disaster, see Coffee supra note 3, at 1409 et seq.Google Scholar
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