secUrities eXCHaNGes The Sarbanes-Oxley Act extends Washingtons oversight of corporate governance practices but offers questionable benefits to investors The le creeping Federalization of Corporate Law BY STEPHEN M. BAINBRIDGE UCLA School of law HE NEW MILLENNIUM HAS NOT BEEN For over 200 years, corporate governance has been a mat kind to Wall Street. In 2000-01, the stock ter for state law. Even the vast expansion of the federal role market recorded back-to-back years ofloss- begun by the New Deal securities regulation laws left the inter- es for the first time since 1973-74. With a nal affairs and governance of corporations to the states. To be furtherloss in 2002, the market fell for three sure, over the years, there have been countless proposals to fed- consecutive years for the first time since the eralize corporate law.To date, however, none have succeeded Great Depression The collapse of Enron and World Com, along with the varying On top of the continuing retrenchment of the economy fol- degrees of fraud uncovered at too many other companies, rein- lowing thelate'90s bubble, concerns over terrorismand the Mid- vigorated the debate over state regulation of corporate gover- dle East, and uncertainty over oil, investor confidence remains nance. Many politicians and pundits called for federal regulation shaky in the wake of last year's corporate governance revelations. not just of securities but also of internal corporate governance, We all know the litany: repeated accounting scandals, of which claiming it would restore investor confidence in the securities Enron and World Com are merely the most notorious; a high pro- markets. As Congress and market regulators began implement file investigationby New Yorks attorney general calling into ques- ing some of those ideas, there has been a creeping-but steady tion the integrity of stock market analysts; and so or federalization of corporate governance law. The NYSE's new In such an environment, it was inevitable that Congress and listing standards regulating directorindependence are oneexam- the Securities and Exchange Commission would step in toease ple of that phenomenon. Otherexamples appeared to little pub- investors'fears. But how quickly we forget Ronald Reagan's licdebatein thesweeping Sarbanes-Oxley legislation. Takenindi adage: "The nine most terrifying words in the English language vidually, each of Sarbanes-Oxley's provisions constitutes a are:'T'm from the government and Im here to help significant preemption of state corporate law. Taken together, they In responding to the Enron and World Com scandals, Con- constitute the most dramatic expansion of federal regulatory gress and the regulators have implemented a set of reforms that power over corporate governance since the New Deal are deeply flawed. They have adopted policies that have no empirical support or economic justification. Worse yet, in WHO REGULATES CORPORATIONS? doing so, they have eviscerated basic federalism rules that have No one seriously doubts that Congress has the power under the long served us well Commerce Clause, especially as it is interpreted these days create a federal law of corporations if it chooses. The question stephen M,Bainbridge is a professor at the ucLA School of Law where he specializes in of who gets to regulate public corporations thus is not oneof aw and Economics(Foundation Press, 2002). He can be contacted by e-mail at constitutional law but rather of prudence and federalism Until the New Deal, corporate law was exclusively a matter 26 REGULATION SPRING 200326 REGULATION SPRING 2003 For over 200 years, corporate governance has been a mat￾ter for state law. Even the vast expansion of the federal role begun by the New Deal securities regulation laws left the inter￾nal affairs and governance of corporations to the states. To be sure, over the years, there have been countless proposals to fed￾eralize corporate law. To date, however, none have succeeded. The collapse of Enron and WorldCom, along with the varying degrees of fraud uncovered at too many other companies, rein￾vigorated the debate over state regulation of corporate gover￾nance.Many politicians and pundits called for federal regulation not just of securities but also of internal corporate governance, claiming it would restore investor confidence in the securities markets. As Congress and market regulators began implement￾ing some of those ideas, there has been a creeping — but steady — federalization of corporate governance law. The nyse’s new listing standards regulating director independence are one exam￾ple of that phenomenon. Other examples appeared to little pub￾lic debate in the sweeping Sarbanes-Oxley legislation. Taken indi￾vidually, each of Sarbanes-Oxley’s provisions constitutes a significant preemption of state corporate law. Taken together, they constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal. WHO REGULATES CORPORATIONS? No one seriously doubts that Congress has the power under the Commerce Clause, especially as it is interpreted these days, to create a federal law of corporations if it chooses. The question of who gets to regulate public corporations thus is not one of constitutional law but rather of prudence and federalism. Until the New Deal, corporate law was exclusively a matter SECURITIES & EXCHANGE he new millennium has not been kind to Wall Street. In 2000-’01, the stock market recorded back-to-back years of loss￾es for the first time since 1973-’74. With a further loss in 2002, the market fell for three consecutive years for the first time since the Great Depression. On top of the continuing retrenchment of the economy fol￾lowing the late ’90s bubble, concerns over terrorism and the Mid￾dle East, and uncertainty over oil, investor confidence remains shaky in the wake of last year’s corporate governance revelations. We all know the litany: repeated accounting scandals, of which Enron and WorldCom are merely the most notorious; a high pro￾file investigation by New York’s attorney general calling into ques￾tion the integrity of stock market analysts; and so on. In such an environment, it was inevitable that Congress and the Securities and Exchange Commission would step in to ease investors’ fears. But how quickly we forget Ronald Reagan’s adage: “The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’” In responding to the Enron and WorldCom scandals, Con￾gress and the regulators have implemented a set of reforms that are deeply flawed. They have adopted policies that have no empirical support or economic justification. Worse yet, in doing so, they have eviscerated basic federalism rules that have long served us well. T Stephen M. Bainbridge is a professor at the UCLA School of Law where he specializes in business and corporate law. A prolific writer, Bainbridge recently released Corporation Law and Economics (Foundation Press, 2002). He can be contacted by e-mail at bainbridge@law.ucla.edu. The Sarbanes-Oxley Act extends Washington’s oversight of corporate governance practices but offers questionable benefits to investors. The Creeping Federalization of Corporate Law BY STEPHEN M. BAINBRIDGE UCLA School of Law Bainbridge.Final 3/13/03 2:34 PM Page 26