Legal challenges: Which set of company rules are OK? US-style or UK?

Financial Times
By Tony Chapelle
Published: June 17 2009 16:15 Last updated: June 17 2009 16:15
While the debate rages as to whether the worst of the global recession is over, lawmakers in the US and regulators in Britain are engaged in another debate: over the rules that govern public companies.
Most experts say – when comparing their effectiveness – that the Combined Code in the UK fares better than the Sarbanes-Oxley Act of the US.
Indeed, many observers would like to see the US move to a model similar to Britain’s.
“I think that the Combined Code is the preferred way to proceed, because it depends on voluntary action by the private sector,” says Ira Millstein, who is a renowned corporate board adviser and a partner at Weil, Gotschal & Manges, a law firm in New York.
Mr Millstein thinks that the requirement for UK companies either to comply with the Combined Code or explain why they have a good reason not to is “more genteel – which is sort of the British way”.
The Combined Code, written to codify board director conduct, executive compensation and auditing issues, dates back to the 1990s and was most recently revised in 2006. It is currently under review.
The Financial Reporting Council (FRC), the UK’s corporate governance regulator, asked British stakeholders for consultation on how well the Code is working. Those findings are expected to be published some time this year. Changes to the Code could follow.
The principle of comply or explain only works in countries where share¬holders have meaningful rights in law, such as being able to vote individual directors on or off the board, says Chris Hodge, the head of the corporate governance unit at the FRC.
Without those rights, Mr Hodge explains, regulators have to play a more active role to protect investors.
Conversely, shareholders feel that a principles-based approach such as that of the Combined Code produces fewer obstacles to running businesses, says Leo Martin, a corporate ethics consultant at GoodCorporation.
He cites as evidence the drop in corporate listings on US exchanges since the passage of the Sarbanes-Oxley Act.
“Companies have voted with their feet. UK businesses are less encumbered,” Mr Martin comments.
In both countries, a host of financial institutions, including Lehman Brothers and Northern Rock, failed badly at overseeing systemic risk.
Yet that was not the problem the governance laws in either country was constructed to manage.
The Sarbanes-Oxley Act, for instance, was created to assure accuracy in financial reporting.
“We don’t know how much fraud did not occur because of Sarbanes-Oxley, but by and large, it’s been beneficial,” says Eliot Spitzer, who prosecuted some of his country’s largest securities fraud cases when he was attorney general of New York State.
So Sox, as it is called, is likely to stay intact.
Yet it almost certainly will be superseded by new corporate governance provisions such as a shareholders’ bill of rights that was introduced in Congress last month. For one thing, Sox clearly did not solve the underlying problem of excessive financial leverage that later sank many banks.
“More cynical voices would say that Sarbanes-Oxley was akin to building the Maginot Line,” Mr Spitzer quips.
Americans claim that creating norms of corporate behavior is easier in Britain because of the smaller community of regulators, stock exchanges, and investors such as shareholder insurance companies.
“You can call a meeting of most of the institutional owners of a big FTSE company within the City of London with, perhaps, a conference link to Edinburgh,” says Jon Lukomnik, a founding member of the International Corporate Governance Network.
That familiarity encourages what Mr Lukomnik calls “quiet, constructive engagement”.
Thus, UK stakeholders have agreed on governance topics such as shareholders’ right to vote on executive remuneration, required separation of the role of chief executive and chairman, and the point at which directors are “overboarded” or sit on too many boards to be effective.
Some US companies voluntarily govern themselves by these practices but they remain the minority. That is likely to change, however, under the shareholder-friendly Obama administration.
Most observers agree on Sox’s benefits, yet point to its imposing drawbacks.
Erroll Davis says that when he was chief executive of Alliant Energy, a $3bn public utility in the Midwest, he was put off by the “prescriptiveness of Sox”.
He later came to appreciate it, because it forced his corporate managers to gain a deeper understanding of company internal controls and financials.
Today, says Mr Davis, who is an audit committee board member on both sides of the Atlantic, at General Motors and at BP, US regulators and accounting firms are more receptive to using materiality and common sense in assessing companies’ compliance with Sox.
One of the harshest critics of Sox is Harvey Pitt, a former chairman of the SEC. He calls Sarbanes-Oxley “relatively ineffective” and “hastily and badly drafted.” Mr Pitt says that Sox has fostered a tick-the-box mentality in corporate managers rather than an understanding of why risks exist.
“The approach of the Combined Code is superior. The most significant thing is to get businesses to be an active participant in the regulation of their own conduct,” Mr Pitt says.