The 1970s: The Committee on Corporate Laws Joins the Corporate Governance Debate

By Small, Marshall L. | Law and Contemporary Problems, Winter 2011 | Go to article overview

The 1970s: The Committee on Corporate Laws Joins the Corporate Governance Debate


Small, Marshall L., Law and Contemporary Problems


INTRODUCTION

The 1970s decade--like the decade now ending--was marked by a number of corporate scandals. The decade was ushered in by the revelation of the Watergate break-in and its aftermath. Watergate was followed by disclosures of numerous cases of bribery of foreign officials, leading eventually to the enactment of the Foreign Corrupt Practices Act in 1977. (1) The decade was also marked by other types of questionable payments by publicly held corporations, both in the United States and overseas, leading to a series of enforcement actions by the Securities and Exchange Commission (SEC) that resulted in consent decrees. (2) These revelations stimulated a vigorous debate in Congress, the federal regulatory agencies, the academic community, the organized bar, public interest groups, and the business community, as to how publicly owned corporations should be governed to prevent corporate misconduct, and to enhance oversight of the corporation, with some suggesting that corporation law should be federalized. (3)

II

PRE-EXISTING LAW ON DIRECTOR RESPONSIBILITIES

The role of the corporate director--particularly the non-management director--became a focus of attention in this ongoing debate. Although there had been a marked increase in the number of manufacturing corporations whose boards of directors contained a majority of non-management directors--from 63% in 1967 to 83% in 1977 (4)--at the start of the decade, the non-management director was often not regarded as playing an active governance role. A survey of board of directors' practices and procedures of twenty-five large, public corporations, published by the General Counsel of General Electric Company in December 1969, disclosed that only about fifty percent of those corporations ever sent out advance notice to their directors of the agendas for board meetings. (5) This view of the passive nature of non-management directors was also reflected in an influential book published in 1971 by Myles Mace, a well-known professor at the Harvard Business School. (6)

Existing legal standards similarly reflected the view that directors (particularly non-management directors) were not expected to be proactive. In the leading Delaware Supreme Court case of Graham v. Allis-Chalmers Mfg. Co., the court held that directors of a large, public company were not expected to be aware of, or take action to guard against, anti-trust violations by subordinates. (7) It would be another thirty years before the Delaware Chancery Court reexamined the Allis-Chalmers decision in In re Caremark Int'l, Inc. Derivative Litigation and recognized a duty of directors to monitor the affairs of corporations. (8) It would be still another ten years before the Delaware Supreme Court endorsed the Chancery Court's decision in Caremark, holding that the necessary conditions predicate for director oversight liability were either (1) an utter failure to implement any reporting or information system or controls; or (2) having implemented such a system or controls, conscious failure to monitor or oversee its operation, thus disabling themselves from being informed of risks or problems requiring their attention. (9) However, during the 1970s, such a duty of directors to monitor was not generally recognized by courts. (10)

In the face of widespread disclosure of corporate misconduct, the SEC, under the chairmanship of G. Bradford Cook, undertook to prepare a position paper on the responsibility of directors. However, this effort was later abandoned by his successor as chairman, Ray Garrett, Jr., as being unworkable. (11)

III

ACTIVITY OF THE COMMIT-FEE ON CORPORATE LAWS

A. Model Act Revisions

In 1973, the Committee on Corporate Laws (Committee) entered the intense debate about the role of corporate directors by establishing a panel on the functions and responsibilities of directors. (12) The initial task of the panel was to consider sections 35 and 48 of the Model Business Corporation Act (MBCA), dealing with the board of directors and liabilities of directors. …

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