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Gatekeepers 6

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Published on December 11, 2007

Author: Me_I

Source: authorstream.com

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Reluctant Guardians: The Responsibility of Gatekeepers for Effective Corporate Governance:  Reluctant Guardians: The Responsibility of Gatekeepers for Effective Corporate Governance John R. Boatright Loyola University Chicago Who Are Gatekeepers?:  Who Are Gatekeepers? Third-parties (intermediaries) Whose cooperation is essential Who can prevent misconduct by withholding cooperation Examples Accountants and lawyers Bankers Rating agencies Physicians, ISPs, bartenders, gun dealers Role in Corporate Governance:  Role in Corporate Governance Gatekeepers Provide information and certification for directors and investors Have ability to detect and deter misconduct Are relied on for effective corporate governance Recent corporate scandals (Enron, etc.) due to multiple gatekeeper failure Slide4:  Properly understood, Enron is a demonstration of gatekeeper failure, and the question it most sharply poses is how this failure should be rectified. John C. Coffee, “Understanding Enron: It’s about Gatekeepers, Stupid” The failure of this network of gatekeepers was a recurring theme in the business scandals. In too many instances, the gatekeepers in pursuit of their own financial self-interest compromised the values and standards of their professions. . . . In the recent round of corporate scandals, the first tier—the managers—failed, and then the gatekeepers failed as well. AAA&S, Report of the American Academy’s Corporate Responsibility Steering Committee Responsibility of Gatekeepers:  Responsibility of Gatekeepers Gatekeeper role is largely a by-product of providing for-fee services Imposes a cost on gatekeeper institutions and the economy What responsibility do gatekeeper institutions have beyond providing contracted services competently? Main Conclusions:  Main Conclusions Each intermediary institution is different; no “one-size-fits-all” answer is possible. Moral responsibilities are linked to legal responsibility/liability. What (morally) should the law be? The appropriate moral and legal principle is what investors would choose. Answer: Cost-effective deterrence Legal and Political Background:  Legal and Political Background Gatekeeper role is currently unsettled and highly controversial. Scandals have been blamed on gatekeeper failure. Hence, reforms to make gatekeepers stronger (e.g. Sarbanes-Oxley). But previous actions weakened incentives by reducing legal liability. Weakening of Legal Liability:  Weakening of Legal Liability Private Securities Litigation Reform Act (1995) and Securities Litigation Uniform Standards Act (1998) made investor suits more difficult. Central Bank of Denver v. First Interstate Bank of Denver (1994) virtually eliminated aiding and abetting liability. Motivation was to reduce “litigation tax,” but may have led to scandals. Further (Mixed) Developments:  Further (Mixed) Developments In re Enron: Prosecution of intermediaries as primary violators based on SEC definition of what it means to “make” a false statement Legal doctrine of “deprivation of honest services” at issue in prosecution of Merrill Lynch bankers in Nigerian barge case More (Mixed) Developments:  More (Mixed) Developments Aggressive federal prosecution guidelines Pressure on potential defendants to cooperate and settle Recent revision of prosecution guidelines The backlash against Sarbanes-Oxley “Paulson Commission” recommendations Challenges to the constitutionality of PCAOB 3 Arguments for Responsibility:  3 Arguments for Responsibility Complicity: An obligation not to be knowingly complicit in (aid and abet) wrongdoing of clients Contract: An obligation to fulfill a contract to serve as a gatekeeper Welfare: An obligation to protect others from the harm of client’s misconduct The “good Samaritan” argument 3 Objectives of Responsibility:  3 Objectives of Responsibility Rectification: To ensure that perpetrators of fraud are rightly punished Compensation: to ensure that victims of fraud are fairly compensated Deterrence: To ensure that potential perpetrators are deterred from committing fraud The Complicity Argument:  The Complicity Argument There is a moral (and legal) obligation to avoid knowing substantial participation. How much effort should be made to know: Whether client is engaged in wrongdoing? The extent to which services enable the wrongdoing? Answering each of these questions involve considerable costs Which are paid by investors. Costs of Avoiding Complicity:  Costs of Avoiding Complicity To avoid complicity, intermediaries may Gather considerable amounts of information Remain purposefully ignorant Costs of high standards of liability Litigation and settlement costs “Ripple effects”: avoidance of risky clients, higher costs of capital (“litigation tax”) The Investor’s Bargain:  The Investor’s Bargain If investor’s could write the law, what would it be? Why should investors’ preferences by considered? They bear the costs and accrue the benefits. Principle: There is no justification for more stringent gatekeeper responsibility than investors would choose (and pay for). What Would Investors Choose?:  What Would Investors Choose? To forgo compensation if deterrence is more cost-effective. Cf. no fault automobile insurance To have the most cost-effective system of deterrence. The most cost-effective system involves How much deterrence? What means of deterrence? The Means of Deterrence:  The Means of Deterrence Gatekeepers are only one means Other means include Direct sanctions on primary violators Structural rules, e.g. PCAOB Safeguarding rules, e.g. on conflict of interest Empowerment rules, e.g. independence Market incentives. e.g. reputation Challenge: to find the optimal total system Contractual/Fiduciary Duties:  Contractual/Fiduciary Duties What contractual/fiduciary duties does an intermediary have toward a client? Merrill Lynch case: What is entailed by a duty to provide “honest services”? Principle: What contracts would be written by shareholders/investors? To what extend should intermediaries be able to rely on assurances of top management? Arguments from Welfare:  Arguments from Welfare When may the law justifiably create a duty for intermediaries to act as gatekeepers to protect investors? Kraakman: Ineffectiveness of direct deterrence Inadequate market incentives Gatekeepers who can be induced by legal rules to deter reliably at low cost Implications:  Implications Developing a cost-effective system of deterrence requires information processing that can be done only by government and markets. Intermediaries should not determine their responsibility unilaterally but abide by legal rules and market incentives. The End:  The End

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