Module-4: Developments in Corporate Governance in USA

 

The milestones of corporate governance in the United States (U.S.), viz.., the stock market crash of 1929, which resulted in the Securities Act of 1933 and Securities Exchange Act of 1934 , the Foreign Corrupt Practice Act of 1977 and the Sarbanes Oxley Act of 2002 is explained in the foregoing.

1. The Stock Market Crash of 1929 and its Consequences

The stock market crash of 1929 indicated the need for regulations promoting corporate governance practices and a regulatory body for securities markets. 

1.1. The Stock Market Crash of 1929

The stock market crash of 1929, which occurred during the last week in October, was a series of days in which the stock market plummeted in a chain reaction, ruining many companies, banks, and investors. Its consequences affected American consumption, banking, and the economy in general (Erickson, 2007). The stock market crash, which had triggered the Great Depression, was the first event that catapulted a chain of events that influenced corporate governance in the early 1900s. Following the stock market crash of 1929, Congress passed two pieces of legislation that continue to serve as the cornerstone of U.S. securities laws; Securities Act of 1933 and Securities Exchange Act of 1934.

1.2. Securities Act of 1933 

The Securities Act of 1933 had two main goals: (1) to ensure more transparency in financial statements so investors can make informed decisions about investments, and (2) to establish laws against misrepresentation and fraudulent activities in the securities markets. It is largely a disclosure law, requiring issuers of securities to disclose information that purportedly allows investors to make informed investment decisions. In addition to its disclosure provisions, the 1933 Act also prohibits the fraudulent sale of registered securities (www.sec.gov). 

1.3. Securities Exchange Act of 1934 and the Maloney Act of 1938

While the 1933 Securities Act focused on primary markets, ensuring disclosure of pertinent information relating to publicly offered securities,  the 1934 Securities Exchange Act focused on secondary markets, ensuring that parties who trade securities— exchanges, brokers and dealers—act in the best interests of investors. Certain securities—including US Treasury and municipal debt—were largely exempt from either act’s provisions (Holton, 2002). Provisions of the 1934 provide for the creation of

(i)                 the Securities Exchange Commission (SEC);

(ii)               a system for regulating the markets themselves and those who trade in those markets;

(iii)             a continuous disclosure system for issuers; and

(iv)              anti-fraud provisions (www.sia.com). 

The Securities Exchange Act of 1934 was created to provide governance of securities transactions on the secondary market (after issue) and regulate the exchanges and broker-dealers in order to protect the investing public. All companies listed on stock exchanges must follow the requirements set forth in the Securities Exchange Act of 1934. Primary requirements include registration of any securities listed on stock exchanges, disclosure, proxy solicitations and margin and audit requirements. From this act the SEC was created. The SEC's responsibility is to enforce securities laws (www.investopedia.com). SEC, which is an independent federal agency, is granted by the 1934 Act broad authority over all aspects of the securities industry and markets. Congress intended the SEC to be the regulator that establishes national policy over the Nation’s securities markets. The Commission adopts rules implementing the provisions of the federal securities laws.  The SEC also cooperates with the U.S. Department of Justice (DOJ), which has responsibility for criminal enforcement of the federal securities laws, and with state securities officials (www.sia.com).

The 1938 Maloney Act, which extended the SEC's regulatory jurisdiction to the Over-the-Counter (OTC) market, is related to the regulatory authority of SEC over securities firms, which include investment banks as well as non-banks that broker and/or deal nonexempt securities. This act provided for self regulating organizations (SRO’s) to provide direct oversight of securities firms under the supervision of the SEC (Holton, 2002).

The establishment of the Securities Commission through the Securities Act in 1933, the Securities Exchange Act in 1934 and the establishment of the National Association of Securities Dealers by means of the Maloney Bill to the Exchange Act in 1938 created a system of regulation and supervision over brokers, dealers and the OTC markets (www.nbs.sk).

2. Foreign Corrupt Practices Act (FCPA) of 1977

Congress enacted the FCPA in 1977, in response to recently discovered but widespread bribery of foreign officials by U.S. business interests. Congress resolved to interdict such bribery, not just because it is morally and economically suspect, but also because it was causing foreign policy problems for the U.S.. In particular, these concerns arose from revelations that U.S. defense contractors and oil companies had made large payments to high government officials in Japan, the Netherlands, and Italy (Martin, 2004)

3.”Treadway Commission”(1985) :- Due to high profile failures in the US, the Treadway Commission was constituted, they highlighted the need of putting in place a proper control environment, independent boards and its committees and objective internal audit function.

 

The FCPA had provisions on Anti-Bribery, accounting and Record keeping and also Penalties.

4. OECD Anti-Bribery Convention 

Largely owing to consistent complaints by the US, in late 1997 the Organisation for Economic Cooperation and Development (OECD) concluded the thirty four country Convention,  which was immediately joined by all 29 OECD member and 5 non-member States (Gounari, 2001). The OECD Convention entered into force on February 15, 1999. On July 27, 2000, the U.S. Senate gave its advice and consent to ratification of the OECD Convention, clearing the way for the U.S. to join one of its international anticorruption treaty. The OECD Convention entered into force as to the U.S. on October 29, 2000 (Martin, 2004). By 2004, all 35 signatories had ratified the OECD Convention and had approved legislation to implement the Convention. In the U.S., the International Anti-Bribery and Fair Competition Act of 1998 amended the FCPA to implement the OECD Convention. Other countries have similarly adopted legislation, which vary widely on many significant points. As a result, corporations conducting international business must scrutinize carefully the law in each OECD country where they do business (Tarun, 2006).

(Source: Dr. N. Nalân Altınta, “Evolution of corporate governance  in the United States of America”, Sosyal Bilimler Dergisi  2010, (2), 153-161)

The closest equivalent to the Corporate Governance Code is the Annual Corporate Governance Report, which is required by listed companies in the United States.

5. Sarbanes-Oxley Act ,  2002 (SOX Act)

The SOX Act provides sweeping new legal
protection  for employees who report corporate misconduct. It deals with Corporate Responsibility, Conflict of Interest and Corporate accountability. After ENRON debacle of 2001, came other scandals involving large US companies such as WorldCom, Qwest, Global Crossing and the auditing lacunae that eventually led to collapse of Andersen, the Sarbanes Oxley Act popularly called SOX was enacted.

The Act made fundamental changes in virtually every aspect of corporate governance in general and auditor independence, conflict of interest, corporate responsibility, enhanced financial disclosures and severe penalties for wilful default by managers and auditors, in particular

 

—  CEO and CFO must certify every report containing company’s financial statements

—  Restricted corporate control of executives, acting, firms, auditing committees, and attorneys

—  Specifies duties of registered public acting firms that conduct audits

—  Composition of the audit committee and specific responsibilities

—  Rules for attorney conduct

—  Disclosure periods are stipulated

—  Stricter penalties for violations

In the new structure created by Sox Act, the role of internal auditors was elevated and they directly deal with top officials directly. CEO information provided directly by the company’s Chief Compliance Officer and Chief Accounting Officers.

 

 Further down the timeline,  in 2020, the focus on the “E” and the “S” of Environment, Social and Governance (ESG) has emerged as the leading trend globally, including in the United States, where it traditionally has not received as much attention by boards. Indeed, many of the key global trends for 2020, such as board oversight of human capital management (HCM), can be seen as subsets of ESG.

 

 


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