New Efforts to Strengthen Corporate Governance: Why Use SRO Listing Standards?

Wednesday, January 1st, 2003 at 12:00 am by Karessa Cain
Karessa Cain, New Efforts to Strengthen Corporate Governance: Why Use SRO Listing Standards?, 2003 Colum. Bus. L. Rev. 619

In response to recent corporate scandals, regulators have proposed a variety of reforms that emphasize the listing standards of self-regulatory organizations (“SRO”) as a means of strengthening corporate governance. In February of 2002, the Securities and Exchange Commission (“SEC”) Chairman Harvey Pitt urged the New York Stock Exchange (“NYSE”) and the Nasdaq Stock Market, Inc. (“Nasdaq”) to review their listing requirements with the goal of enhancing corporate governance. Accordingly, the following summer the NYSE Board of Directors approved recommendations, which are now pending SEC approval. Likewise, both Nasdaq and the American Stock Exchange (“Amex”) have proposed revisions to their listing rules, which should significantly raise corporate governance baselines.

The accent on listing standards is further evident in the Sarbanes-Oxley Act of 2002 (“Act” or “Sarbanes-Oxley”) , which directs the SEC to establish rules prohibiting the listing of securities of issuers who do not meet specific corporate governance criteria. In addition, private groups such as the American Bar Association Task Force on Corporate Responsibility (“ABA Task Force”) and The Business Roundtable have articulated recommendations that they feel should be considered in conjunction with any listing rule reforms.

However, the spotlight on SROs is not without some shadows. Commentators have varied in the extent to which they have favored SRO standards as a medium of reform, and some have even suggested efforts are better made through other kinds of initiatives. The ABA Task Force has expressed concern that listing standard reforms will lack uniformity, and a recent report by a Special Study Group of the American Bar Association’s Committee on Federal Regulation of Securities (“ABA Special Study Group”) has proposed an alternative “comply or explain” system whereby the NYSE and Nasdaq would jointly develop non-binding best practice guidelines for corporate governance, which the SEC would reinforce with disclosure obligations. Although the authors of the report suggest new listing standards could also be introduced, “best practices . . . should be used for most governance measures.” The Business Roundtable has likewise stressed the importance of voluntary best practice guidelines. Other commentators have pointed out the flaws of SROs as regulators and have advocated alternative rule-making and supervisory regimes.

In light of the current debate, this Note seeks to highlight some of the unique regulatory characteristics of SROs and listing standards in order to frame a reasoned discussion about their use to strengthen corporate governance. Section II begins with a summary and comparison of recent developments in corporate governance listing standards, including the proposals set forth by the NYSE, Nasdaq, and Amex as well as some provisions of the Sarbanes-Oxley Act and related SEC rules. Section III then examines four aspects of SROs and their listing standards, each of which sheds light on ways in which they may be particularly well- or ill-suited as instruments of reform.

First, the reputational branding effect of listing standards makes them an effective tool for companies who wish to signal their commitment to corporate governance in order to reap reputational gains. Furthermore, SRO reputations are oriented toward particular market niches, and SROs are therefore adept at devising standards tailored to the spectrum of companies. However, specialization comes at the expense of uniformity, and it is important to recognize this tradeoff when contemplating an expanded role for listing rules.

Second, the idea of regulatory competition suggests SROs will produce more optimal rules than those enacted by a monopolistic central planner. Their desire to attract both investors and issuers should lead them to choose listing standards which balance these competing interests. However, their market-aligned incentives may also be a source of regulatory weakness, which suggests possible boundaries for the SRO regime.

Third, the ability and incentives of SROs to enforce their rules are limited. There may be a disparity between the standards they promulgate and their actual enforcement of those standards. They also face limitations on the types of sanctions they can impose.

Finally, the implications of listing requirements for private litigation reveal yet another set of pros and cons. Whereas many commentators have worried that the Act paves the way for a surge in class action suits, courts have been reluctant to allow private claims based solely on a violation of listing rules. SROs therefore have the advantage of regulating without the concomitant risk of increased litigation that may be posed by the Act, although this exacerbates the enforcement problems they face.

In sum, this four-pronged analysis will identify some of the key advantages and disadvantages to using SRO listing standards to regulate corporate governance. This assessment may be useful both in evaluating recent proposals and in mapping out further revisions to the regulatory system.

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