IR Resource Center

Corporate Governance in the United States

Each of the 50 states of the Unites States has its own state corporation law, comprised of both statutory and case law. Delaware is the most common state of incorporation.

Delaware's corporation law is considered to strike the best balance between management and shareholders among the corporation laws of the various states. The advantages of Delaware corporation law include: (1) allowing stockholders to take action without a meeting by written consent; (2) a more favorable tax structure than most other states; (3) its judiciary is very experienced in corporate law and has a highly developed body of case law, which adds more legal certainty to Delaware than other states can offer; and (4) Delaware's Secretary of State's office is well regarded as fast and efficient.

The United States Securities Act of 1933, as amended, regulates the offerings and sales of securities by both public and private companies. The United States Securities Exchange Act of 1934, as amended, regulates the public disclosure of information by reporting companies. These are both federal statutes. Reporting companies are companies that are listed on a national securities exchange, or companies that have more than US$10 million in assets whose securities are held by more than 500 owners.

Listing rules of the national securities exchanges, comprised of the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) and the National Association of Securities Dealers Automated Quotation (NASDAQ), are contractual conditions which also regulate corporate governance. In order to list and maintain the securities of its company on a national securities exchange, the company must follow the conditions set forth by that exchange.

The United States Securities and Exchange Commission (SEC), a federal agency, oversees the listing rules and exchanges themselves.

In addition to federal and state laws and regulations, there are voluntary codes of corporate governance that are well-regarded in the legal community, including:

• American Law Institute (ALI), Principles of Corporate Governance: Analysis and Recommendations;
• National Association of Corporate Directors (NACD), Report of the NACD Blue Ribbon Commission on Director Professionalism; and
• Business Round Table, Statement on Corporate Governance.

Board of Directors

The board of directors is generally elected by the stockholders at their annual general meeting. Under state corporation law, the requirements for board meetings are set by the corporation's by-laws or articles of incorporation. No set number of meetings is required. It is recommended that boards meet at least once per financial reporting quarter, however most listed corporations meet more often.

SEC regulations require corporations to disclose the names and ages of members of the board of directors. Listed companies typically disclose compensation of board committees and the number of board and committee meetings. Many companies also disclose their governance standards.

Board Responsibilities

Under Delaware law, the primary responsibility of the board of directors is to manage the business and affairs of the corporation. This responsibility typically encompasses the following activities:

• reviewing and approving the corporation's financial objectives and major plans;
• supervising management and providing advice and counsel to senior management;
• hiring, evaluating and setting the CEO's and other senior management's compensation; and
• replacing the CEO and other senior managers when necessary.

The board has the authority to delegate responsibility to both non-board members and to board committees. The board of directors typically delegates the day-to-day managerial responsibility of the corporation to the CEO and other senior executives. However, there are some matters the board may not delegate. For example, under Delaware law, no committee may have the power to:

• adopt, amend or repeal any by-law of the corporation, unless the resolutions, by-laws or certificate of incorporation expressly provides this power;
• declare a dividend or authorize the issuance of stock, unless the resolutions, by-laws or certificate of incorporation expressly provides this power;
• amend the corporation's certificate of incorporation;
• adopt an agreement of merger or consolidation; or
• recommend to stockholders either the dissolution or the revocation of a dissolution of the corporation.

Delaware law states that the board is fully protected in relying in good faith upon the information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, on matters delegated to them. The board still has the obligation to supervise said officers, employees or committees, to become reasonably familiar with their services, and to act in good faith before relying on such advice.

Board Committees

As a result of the SEC rules implementing the Sarbanes-Oxley Act of 2002, both the NYSE and the NASDAQ have adopted new rules regarding board committees. The AMEX has promulgated new rules regarding board committees, but those rules have yet to be adopted.

The NYSE now requires that all listed companies have a nominating/corporate governance committee composed entirely of independent directors. The NYSE also requires that all listed companies have a compensation committee composed entirely of independent directors. In addition, the NYSE mandates that all listed companies have an audit committee that is composed entirely of independent directors and has at least three members. Among other requirements, each member of the audit committee must be financially literate, or must become financially literate within a reasonable time after his or her appointment to the audit committee. In addition, at least one member of the audit committee must have accounting or related financial management expertise.

The NASDAQ does not require listed companies to have an independent nominating committee. However, the NASDAQ does require independent director approval of director nominations, either by an independent nominating committee or by a majority of independent directors. Although listed companies are not required to have a compensation committee under the NASDAQ rules, independent director approval of CEO compensation, either by an independent compensation committee or by a majority of the independent directors, is required. The NASDAQ mandates that listed companies have an audit committee, and that all audit committee members be independent. Additionally, the NASDAQ rules require that all audit committee members be able to read and understand financial statements at the time of their appointment. Under the NASDAQ rules, issuers must have at least one member on the audit committee that has past employment experience in finance or accounting, requisite professional certification in accounting or any other comparable experience or background which results in the individuals financial sophistication.

Independent-Director Requirement

Pursuant to of the Sarbanes-Oxley Act, the SEC has directed the NYSE and the NASDAQ to prohibit the listing of any company whose audit committee is not composed solely of independent directors.

Under the NYSE listing requirements, for audit committee purposes a director will be considered per se disqualified with respect to director independence if:

• he or she or an immediate family member has been affiliated with or employed by a present or former internal or external auditor of the company, until three years after the end of the affiliation or the employment or the auditing relationship;
• he or she or an immediate family member has been employed as an executive officer at another company where any of the listed company's present executives serve on that company's compensation committee, until three years after the end of such service or the employment relationship;
• he or she has been an executive officer or employee, or an immediate family member has been an executive officer of a company that makes payments to, or receives payments from, the listed company for property or services in an amount which, in any single fiscal year, exceeds the greater of US$1 million or 2% of such other company's consolidated gross revenues, until three years after falling below such threshold; or
• he or she is an employee or an immediate family member is an executive officer of the listed company, until three years after the end of such employment relationship.

In addition, the NYSE rules presume that a director is not independent if he or she or an immediate family member receives more than US$100,000 per year in direct compensation from the listed company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service) until three years after he or she ceases to receive more than US$100,000 per year in such compensation.

The NYSE rules also mandate that no director qualifies as independent unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or indirectly as "a partner, shareholder or officer" of an organization that has a relationship with the company). Disqualifying relationships can include "commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships."

Under NASDAQ audit committee requirements, a director would not be deemed independent if:

• he or she is, or at any time during the past three years was, employed by the company or by any parent or subsidiary of the company or if any family member of the director has been employed as an executive officer of the company or by any parent or subsidiary of the company;
• he or she, or a family member of the director, has accepted any payments from the company or any parent or subsidiary of the company in excess of US$60,000 during the current or any of the past three fiscal years, other than as compensation for board or board committee service, payments arising solely from investments in the company's securities, benefits under a tax-qualified retirement plan, non-discretionary compensation, compensation paid to a family member who is an employee of the company or a parent or subsidiary of the company (but not if such person is an executive officer of the company or any parent or subsidiary of the company), or loans permitted under Section 13(k) of the Exchange Act;
• he or she or a family member of the director has been an executive officer, controlling shareholder or partner in an entity to which the company made payments to or received payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient's consolidated gross revenues for that year, or US$200,000, whichever is more, other than (1) payments arising solely from investments in the company's securities, or (2) payments under non-discretionary charitable contribution matching programs;
• he or she or a family member of the director is a current partner of the company's outside auditor, or was a partner or employee of the company's outside auditor, who worked on the company's audit at any time during any of the past three years; or
• he or she or a family member of the director has been employed as an executive officer of another entity where at any time during the past three years any of the executive officers of the listed company served at the same time on the compensation committee of such other entity.

Similar to the NYSE rules, even if a director is not per se disqualified from being independent, the board of directors will have to affirmatively determine that no relationship between the director and the listed company interferes with the director's exercise of independent judgment.

Fiduciary Duties of Directors

Directors are fiduciaries of the corporation and its stockholders. Directors are elected by the stockholders, and represent the stockholders as a whole, rather than any individual stockholder or group of stockholders. A director's fiduciary duty may expand to its creditors, but only if and when a corporation approaches the "zone of insolvency."

Case law dictates that directors' fiduciary duty includes both a duty of care and a duty of loyalty. The duty of care is codified in the vast majority of states. It requires a director to perform his duties in good faith, in a manner he reasonably believes to be in the best interests of the corporation, and with the care an ordinarily prudent person would use under similar circumstances. The duty of loyalty prohibits self-dealing and misappropriation of assets or opportunities by directors, and requires a director to inform the corporation of any conflicts of interest.

Enforcement Action Against Directors

Depending on the circumstances, stockholders can bring suit against the directors either on their own or in the form of a derivative suit, on behalf of the corporation. Under Delaware law, before bringing a derivative suit the stockholder must demand that the corporation bring the suit.

The "business judgment" rule was created by case law and is a safe harbor for director liability. Under the business judgment rule, directors discharge their fiduciary duties when they make an informed decision in good faith. If a board's decision is challenged in court, the plaintiff must present evidence to overcome the presumption that disinterested and independent directors make informed decisions in good faith. If the plaintiff does not do so, the court will not review the merits of the case.

If a director is found liable for breaching the duty of loyalty, the court may remedy the breach by setting aside the transactions which violated the duty. However, if the director discloses his relationship or interest in a transaction to the board prior to a vote on the decisions, and a majority of disinterested directors authorize the transaction, the transaction may stand, and the director will not be found liable for breaching his duty of loyalty. Similarly, if the director discloses his relationship or interest in a transaction to the stockholders prior to a vote on the decisions, and the stockholders vote in good faith and approve the transaction, the transaction may stand, and the director will not be found liable for breaching his duty of loyalty.

The articles of incorporation may limit a director's personal liability for monetary damages for breach of fiduciary duty in certain circumstances. Under Delaware law, such a provision may not limit the liability of a director: (1) for any breach of his duty of loyalty to the corporation or its stockholders; (2) for acts or omissions not in good faith or involving intentional misconduct or knowing violation of the law; or (3) from any transactions from which the director derived an improper personal benefit.

State corporation law gives stockholders certain rights, including the rights to:

• enjoin acts beyond the company's authority;
• inspect corporate books and records for any proper purpose;
• institute a derivative action on behalf of the corporation; and
• vote one vote for each share owned by such stockholder, unless otherwise provided in the certificate of incorporation.

If an annual general stockholders meeting is not held to vote on issues of fundamental importance to the corporation, including the election of directors, the stockholders may bring an action to require that meeting. Stockholders may vote at the annual general meeting in person or by proxy. The certificate of incorporation or by-laws of a corporation typically specify the number of shares which create a quorum of the outstanding shares, the holders of which must be present at the meeting. An affirmative vote of the quorum binds the corporation.

State corporation law gives stockholders the right to participate in the following types of decisions:

• amendments to the corporation's by-laws and articles of incorporation;
• election and removal of directors;
• filling vacancies and newly created directorships;
• fundamental corporate changes, including mergers, dissolution or disposition of all or substantially all of the corporation's assets; and
• authorization of additional shares to be issued.

Stockholders of reporting companies have additional rights granted to them by the national securities exchange on which they are listed.

Voting Rights

Corporations may issue different classes of stock, with or without par value and with or without voting rights. In order to issue non-voting common shares, a corporation must have an outstanding class of common shares with full voting rights. Listing rules prohibit companies from unilaterally reducing or restricting the voting rights of existing stockholders.

Controlling Stockholders' Duties

Controlling stockholders owe a fiduciary duty to non-controlling stockholders and to the corporation. A controlling stockholder who violates a fiduciary duty to a non-controlling stockholder upon the sale of control to a third party may be liable for any damages suffered by the non-controlling stockholder.

Delaware law permits a non-controlling stockholder to bring a derivative action on behalf of the corporation against a controlling stockholder if the non-controlling stockholder did not suffer harm independently from the corporation or other stockholders. If the relief granted is insufficient to cure the harm that the non-controlling stockholder suffered, the non-controlling stockholder may then bring a direct action against the controlling stockholder.

Minority Stockholder Rights in Mergers and Takeovers

In certain instances, stockholders have the right to dissent from a transaction and obtain the appraised value of their share through judicial action.

Delaware law gives stockholders the right to an appraisal by the Delaware Court of Chancery of the fair value of their shares in the event of a merger. Most case law indicates that fair value is actual value. In determining actual value, different factors may be considered, such as earnings, dividends, and market price of the stock.

In the event of a hostile takeover, Delaware law protects the rights of non-controlling stockholders by prohibiting a corporation engaging in a business combination with an interested stockholder for a period for three years from the time such stockholder became an interested stockholder, unless:

• the board approved the business combination which resulted in the stockholder becoming an interested stockholder prior to such time;
• upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding stock held (1) by persons who are directors and also officers, and (2) by employee stock plans in which employee participants do not have the right to determine whether the shares they hold will be tendered in a tender or exchange offer; or
• subsequent to the time the business combination is approved by the board of directors and authorized at an annual general meeting or special meeting of the stockholders, and not by written consent, by the affirmative vote of at least 66-2/3% of the outstanding voting stock not owned by the interested stockholder.

Tender Offers

In regard to tender offers, the Exchange Act subjects listed companies to the following regulations, under the Williams Act:

• it is unlawful for any person to make a tender offer for any class of any registered equity security if, after consummation thereof, such person would, either directly or indirectly, be the owner of more than 5% of such class, unless that person has met certain filing and disclosure requirements;
• if a person makes a tender offer for less than all the outstanding equity securities of a class, that person must purchase the shares from those tendering on a pro rata basis;
• if the person making the tender offer increases the consideration offered, that person is required to pay the same consideration to those who tendered before the increase, as it does to those who tendered after the increase;
• securities deposited in response to the tender offer may be withdrawn within seven days after the date of the original tender offer, and after 60 days have elapsed following that date; and
• it unlawful to make a tender offer on the basis of materially false or misleading information.

Unlike many other countries, the United States does not require tag-along rights for minority stockholders.

Under the Exchange Act, any person who owns more than 5% of a registered class of equity securities is required to provide specified information (such as their name, the number of shares owned, and whether or not their purpose is to acquire control of the company) to the SEC within 10 days after the acquisition of the shares triggering the reporting requirement.

The Exchange Act gives the SEC the right to regulate share repurchases by the issuing corporation.

Anti-Takeover Devices

Case law specifically indicates that the following anti-takeover devices are permissible:

• amending corporate by-laws to make a takeover more difficult;
• adopting voting procedures (such as a staggered board) that makes it more difficult for the board of directors to be replaced;
• issuing additional shares to those opposed to the takeover (such as a lockup);
• providing golden parachutes for key executives; and
• buying up the corporation's own shares to increase the share price, thereby increasing the takeover price

Another anti-takeover device that is frequently used is a stockholders' rights plan, also known as a "poison pill." An example of a poison pill is when the board of directors adopts a plan granting existing stockholders the right to buy a large number of shares of additional stock at a deep discount upon the acquisition of a certain amount of shares by an outsider. This makes the corporation a less attractive target because the outsider will have greatly diluted holdings. There are different varieties of the poison pill, all of which make the target corporation less attractive to the outsider.

The SEC requires listed companies to disclose provisions in their by-laws and certificates of incorporation that would serve as anti-takeover devices. Listing rules generally prohibit anti-takeover devices that discriminate among stockholders.

Share Transfer Restrictions

All sales and transfers of securities by corporations must be made pursuant to, or subject to an exemption under, the Securities Act.

Under Delaware corporate law, restrictions on transfer and ownership of securities may be imposed by the certificate of incorporation, the by-laws, or by an agreement among any number of stockholders or among such stockholders and the corporation. Any restriction must be visibly noted on the certificate representing the securities or, in the case of uncertificated shares, contained in the notice sent to the registered owner of the shares. If the foregoing is not complied with, the registration will only be effective against a person with actual knowledge of the restriction.

Corporate by-laws and articles of incorporation may be obtained, for a fee, from the office of the secretary of the state in which the corporation is incorporated. If the corporation is listed on a securities exchange, its by-laws and articles of incorporation are filed as exhibits to various SEC filings and are available on-line through EDGAR.

Federal securities laws and SEC rules require that a corporation's annual report and public offering prospectuses include all information which is material to investors, including:

• a business description;
• a description of material legal proceedings;
• detailed disclosure of the risk factors associated with the business;
• disclosure about related-party transactions;
• the number of stockholders of each class of common equity;
• management's discussion and analysis of the company's financial condition and results of operations;
• financial information; and
• a signed opinion of the corporation's auditors with respect to the accuracy of the financial information.

Reporting companies are also required to disclose the compensation received by directors and named executive officers, which includes the CEO, the other four most highly compensated executives, and up to two additional individuals for whom disclosure would be required if they were executives.

SEC regulations also require the disclosure of the name, address, amount of ownership, percentage and title of class of stock owned of any beneficial owner who the company knows posses more than 5% of any class of the corporation's voting securities. Any person who plans on acquiring more than 5% of a listed company must disclose their intention to do so.

Listed companies must include a copy of the audit committee report in their annual proxy statement. This report must make a variety of disclosures relating to the auditor's independence, the review of the financial information, and the quality of the financial reporting. The SEC's new listing requirements, designed to implement the requirements of the Sarbanes-Oxley Act, require companies to disclose whether or not at least one member of their audit committee is a "financial expert." If the company discloses that they do not have at least one "financial expert" on their audit committee, they must explain why they do not have one.

Corporations are responsible for filing periodic and current event reports in an effort to keep public information current.