Board Interlocks and Corporate Governance
By: Michal Barzuza & Quinn Curtis
After the 2001 financial collapse of publicly traded Enron Corporation-caused by alleged accounting fraud-the US. Congress included Section 307 in the Sarbanes-Oxley Act of 2002 (“Section 307”). Section 307 requires in-house corporate attorneys to report instances of corporate wrongdoing and fraud at their companies “up the ladder” to senior management and the board of directors (“Board”). In certain circumstances, Section 307 also permits in-house counsel to “report out” wrongdoing to the Securities and Exchange Commission (“SEC”). However, when complying with either the “reporting up” or “reporting out” provisions of Section 307, in-house corporate attorneys face possible pushback and retaliation from their senior executive team (including chief executive officers). This is especially true if senior executives are implicated in the wrongdoing. Additionally, given the influence of managerial power over a corporation’s legal department with respect to hiring, disciplinary action, and firing, in-house corporate attorneys will be hesitant to act as whistle-blowers and report up or report out instances of corporate wrongdoing.
The current debate on Section 307 centers on whether the provision permitting reporting out to the SEC conflicts with an attorney’s duty to keep her corporate employer’s information confidential. However, there is less discussion on Section 307’s reporting up provision, and how existing managerial power and governance structures discourage in-house corporate attorneys from reporting corporate wrongdoing up the ladder. There is also very little guidance on how corporate attorneys may immunize themselves from retaliation when they report wrongdoing to the very same senior managers that may be involved in the wrongdoing. This article’s contribution, therefore, is twofold. First, this article will examine how existing managerial and governance structures contribute to the risks that in-house corporate attorneys face when complying with Section 307’s reporting up provision. Second, this article proposes a normative, modified reporting structure that requires in-house attorneys to bypass the Chief Executive Officer (“CEO”) and report directly to the Board. Our normative model would insulate in-house attorneys from retaliation and pushback from senior management. As such, corporate attorneys should be more willing to report corporate wrongdoing and fraud up the ladder to their company’s Board for corrective remedy. This increased reporting, in turn, should enhance corporate transparency and investor protection against fraud.