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Abstract:
The summer of 2005 saw the third anniversary of the passage of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"). Characterized by some as "the most sweeping federal regulation of public corporations since the federal securities laws were enacted some seventy years ago," Sarbanes-Oxley has both supporters and critics in diverse arenas. Recently, attorneys and executives from the business community have agreed that Sarbanes-Oxley "set the right tone following the scandals at WorldCom Inc. and Enron Corp., both through force of law and the message it sent." Those who have concluded that Sarbanes-Oxley has merit still express the concern that the biggest impact of Sarbanes-Oxley would be an increase in the cost of compliance with federal securities laws and listing standards, and that ten years from now the reality might be that Sarbanes-Oxley actually will have had minimal impact on the type of corporate fraud that was the catalyst for the legislation.

This article discusses the standard of director conduct implied by the legislation, raises questions about the long-term impact of the legislation, and suggests answers as well as the possible implications of both "the force of law" and "the message sent" to corporate directors and officers in the context of attempts to oversee corporate business performance. Prominent scholars and judges have written that in enacting Sarbanes-Oxley, the legislature did not intend to change directors' fiduciary obligations under state law, and that nothing was explicitly written into Sarbanes-Oxley to modify the state court test for liability for wrongful board conduct. That may be factually accurate; nonetheless certain Sarbanes-Oxley provisions appear to set a new standard of board conduct. Further, some speculate that the legislation sends a message to state courts to scrutinize more closely directors' conduct for potential breaches of due care.

This article proposes that Sarbanes-Oxley redefines the concept of due care in a manner which mandates the content of reasonable directors' attention to the operation of the corporation. Further, this article proposes that Sarbanes-Oxley implicitly modifies state court standards of review from a lenient standard that gives great deference to directors' business judgment to a stricter standard that allows courts to more closely scrutinize directors' conduct in overseeing and monitoring the corporation. When courts scrutinize directors' behavior more closely than in the past, issues of whether the directors took reasonable steps to properly inform themselves are given less deference to the judgment of the board. This article does not propose that Sarbanes-Oxley represents a de jure change in the standard of review, but rather that Sarbanes-Oxley represents a de facto shift from a very lenient judicial review of the process the board followed to become properly informed about corporate operations, to more judicial scrutiny into that process.

corporate governance, director, fiduciary duty, Sarbanes-Oxley, Enron

Abstract:
In the United States, federal and state laws envision a variety of roles for management and non-management directors on corporate boards. At bottom, the proper and lawful performance of these roles, and the legitimacy of director decision-making and monitoring turns on the extent to which the directors exercise judgment without being unduly swayed by cognitive bias. A recent empirical study conducted by the Cultural Cognition Project at Yale University suggests that cultural-identity-protective cognition - a type of cognitive bias related to one's cultural worldview - influences risk assessment in the general population. This Article proposes that identity-protective cognition may influence systematically director behavior, including recommendations to dismiss shareholder derivative litigation, decisions regarding executive compensation, and director monitoring of conflict-of-interest transactions.

Generally, courts and regulators assume that directors' risk assessment may be influenced by financial incentives and familial ties. Courts give greater scrutiny to a board's decision-making process if the process may be tainted by financial incentives and familial ties. Alternatively, courts give more deference to a board's decision-making process if the decision was made by directors who are free of financial and familial ties. However, courts and regulators assume that directors' risk assessment would not be influenced (at least not in any way that needs to be addressed by regulation) by other incentives, such as a need to protect one's cultural identity.

While more research is needed to determine the extent of cultural-identity-protective risk assessment on board behavior, and such research should be informed by evidence from directors on their perceptions of their roles and functions, the theory of cultural-identity-protective cognition suggests that changes in corporate governance law and behavior are necessary to promote unbiased decision-making by directors. This Article proposes that such changes should include greater diversity in worldviews on corporate boards. Perhaps this diversity could be accomplished by assuring that directors are educated about different worldviews, and assigning a director (or board committee) the task of "chief naysayer" - someone whose questions would arise from worldviews not represented in the majority of the board. Also, courts may need to account for directors' identity-protective bias when reviewing directors' decisions.

corporate governance, board of directors, cognitive bias

Abstract:
In the United States, federal and state laws envision a variety of roles for management and non-management directors on corporate boards. At bottom, the proper and lawful performance of these roles, and the legitimacy of director decision-making and monitoring turns on the extent to which the directors exercise judgment without being unduly swayed by cognitive bias. A recent empirical study conducted by the Cultural Cognition Project at Yale University suggests that cultural-identity-protective cognition - a type of cognitive bias related to one's cultural worldview - influences risk assessment in the general population. This Article proposes that identity-protective cognition may influence systematically director behavior, including recommendations to dismiss shareholder derivative litigation, decisions regarding executive compensation, and director monitoring of conflict-of-interest transactions.

Generally, courts and regulators assume that directors' risk assessment may be influenced by financial incentives and familial ties. Courts give greater scrutiny to a board's decision-making process if the process may be tainted by financial incentives and familial ties. Alternatively, courts give more deference to a board's decision-making process if the decision was made by directors who are free of financial and familial ties. However, courts and regulators assume that directors' risk assessment would not be influenced (at least not in any way that needs to be addressed by regulation) by other incentives, such as a need to protect one's cultural identity.

While more research is needed to determine the extent of cultural-identity-protective risk assessment on board behavior, and such research should be informed by evidence from directors on their perceptions of their roles and functions, the theory of cultural-identity-protective cognition suggests that changes in corporate governance law and behavior are necessary to promote unbiased decision-making by directors. This Article proposes that such changes should include greater diversity in worldviews on corporate boards. Perhaps this diversity could be accomplished by assuring that directors are educated about different worldviews, and assigning a director (or board committee) the task of "chief naysayer" - someone whose questions would arise from worldviews not represented in the majority of the board. Also, courts may need to account for directors' identity-protective bias when reviewing directors' decisions.

corporate governance, board of directors, cognitive bias

Abstract:
Accounting fraud may be the most pervasive type of fraud infecting modern corporations. As demonstrated by recent cases, such schemes may be facilitated by management directors and senior executives who know how to hide fraud within the camouflage of legitimate transactions, by non-management directors who fail to investigate obvious red flags, by ineffective internal control systems, and by accountants, lawyers, bankers and analysts who are captured by their clients. Executives who know of accounting fraud and take no steps to prevent the fraud may be liable for violating fiduciary duties as set forth in state corporation statutes or for violating disclosure requirements as set forth in federal securities law.

This article proposes that both management and non-management directors who knowingly or recklessly engage in accounting and financial fraud are unfit to serve and should be barred from serving as officers and directors of publicly traded corporations. In particular, it proposes that non-management directors' reckless failure to respond to red flags may amount to an intentional omission of material information, and violate the Securities Exchange Act section 10(b), among other federal laws. Further, non-management directors who fail to take action should be found unfit to serve as company executives. Moreover, directors who knowingly or recklessly fail to halt or to disclose accounting fraud and similar unlawful behavior should be temporarily or permanently barred from serving as officers of directors of public corporations.

securities law, corporate governance