Director Oversight and Monitoring: The Standard of Care and the Standard of Liability Post-Enron

52 Pages Posted: 23 Aug 2007

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.

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

JEL Classification: K22

Suggested Citation

Burch, Regina Frances, Director Oversight and Monitoring: The Standard of Care and the Standard of Liability Post-Enron. Wyoming Law Review, Vol. 6, No. 2, 2006, Available at SSRN: https://ssrn.com/abstract=1009003

Regina Frances Burch (Contact Author)

Touro Law Center ( email )

225 Eastview Drive
Central Islip, NY 11722
United States
6317617142 (Phone)
11722-4539 (Fax)

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