S. HRG. 111–315 PROTECTING SHAREHOLDERS AND ENHANCING PUBLIC CONFIDENCE BY IMPROVING COR- PORATE GOVERNANCE HEARING BEFORE THE SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT OF THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION ON EXAMINING THE IMPROVEMENT OF CORPORATE GOVERNANCE FOR THE PROTECTION OF SHAREHOLDERS AND THE ENHANCEMENT OF PUBLIC CONFIDENCE JULY 29, 2009 Printed for the use of the Committee on Banking, Housing, and Urban Affairs ( Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html U.S. GOVERNMENT PRINTING OFFICE 55–479 PDF WASHINGTON : 2010 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS CHRISTOPHER J. DODD, Connecticut, Chairman TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama JACK REED, Rhode Island ROBERT F. BENNETT, Utah CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky EVAN BAYH, Indiana MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee SHERROD BROWN, Ohio JIM DEMINT, South Carolina JON TESTER, Montana DAVID VITTER, Louisiana HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas JEFF MERKLEY, Oregon MICHAEL F. BENNET, Colorado EDWARD SILVERMAN, Staff Director WILLIAM D. DUHNKE, Republican Staff Director DAWN RATLIFF, Chief Clerk DEVIN HARTLEY, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT JACK REED, Rhode Island, Chairman JIM BUNNING, Kentucky, Ranking Republican Member TIM JOHNSON, South Dakota MEL MARTINEZ, Florida CHARLES E. SCHUMER, New York ROBERT F. BENNETT, Utah EVAN BAYH, Indiana MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey DAVID VITTER, Louisiana DANIEL K. AKAKA, Hawaii MIKE JOHANNS, Nebraska SHERROD BROWN, Ohio BOB CORKER, Tennessee MARK R. WARNER, Virginia MICHAEL F. BENNET, Colorado CHRISTOPHER J. DODD, Connecticut KARA M. STEIN, Subcommittee Staff Director WILLIAM H. HENDERSON, Republican Subcommittee Staff Director DEAN V. SHAHINIAN, Senior Counsel BRIAN FILIPOWICH, Legislative Assistant RANDY FASNACHT, GAO Detailee HESTER PEIRCE, Republican Counsel WILLIAM HENDERSON, Republican Legislative Assistant (II) CONTENTS WEDNESDAY, JULY 29, 2009 Page Opening statement of Chairman Reed ................................................................... 1 Prepared statement .......................................................................................... 42 Opening statements, comments, or prepared statements of: Senator Bunning ............................................................................................... 2 Senator Schumer .............................................................................................. 3 WITNESSES Meredith B. Cross, Director, Division of Corporation Finance, Securities and Exchange Commission ......................................................................................... 6 Prepared statement .......................................................................................... 42 Responses to written questions of: Senator Bunning ....................................................................................... 230 John C. Coates IV, John F. Cogan, Jr., Professor of Law and Economics, Harvard Law School ............................................................................................ 8 Prepared statement .......................................................................................... 45 Responses to written questions of: Senator Bunning ....................................................................................... 232 Senator Vitter ............................................................................................ 234 Ann Yerger, Executive Director, Council of Institutional Investors .................... 9 Prepared statement .......................................................................................... 50 Responses to written questions of: Senator Bunning ....................................................................................... 235 Senator Vitter ............................................................................................ 239 John J. Castellani, President, Business Roundtable ............................................ 11 Prepared statement .......................................................................................... 127 Responses to written questions of: Senator Bunning ....................................................................................... 240 J.W. Verret, Assistant Professor of Law, George Mason University School of Law .................................................................................................................... 13 Prepared statement .......................................................................................... 224 Responses to written questions of: Senator Bunning ....................................................................................... 244 Senator Vitter ............................................................................................ 244 Richard C. Ferlauto, Director of Corporate Governance and Pension Invest- ment, American Federation of State, County, and Municipal Employees ...... 15 Prepared statement .......................................................................................... 225 Responses to written questions of: Senator Bunning ....................................................................................... 245 (III) PROTECTING SHAREHOLDERS AND ENHANC- ING PUBLIC CONFIDENCE BY IMPROVING CORPORATE GOVERNANCE WEDNESDAY, JULY 29, 2009 U.S. SENATE, SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The Subcommittee met at 2:35 p.m., in room SD–538, Dirksen Senate Office Building, Senator Jack Reed (Chairman of the Sub- committee) presiding. OPENING STATEMENT OF CHAIRMAN JACK REED Chairman REED. Let me call the hearing to order and welcome our witnesses. Thank you, ladies and gentlemen. We expect mo- mentarily that the Ranking Member will arrive, and I thank Sen- ator Corker and Senator Menendez for joining us. Today’s hearing will focus on corporate boardrooms and try to help us better understand the misaligned incentives that drove Wall Street executives to take harmful risks with the life savings and retirement income of so many people. This Subcommittee has held several hearings in recent months to focus on gaps in our fi- nancial regulatory system, including the largely unregulated mar- kets for over-the-counter derivatives, hedge funds, and other pri- vate investment pools. We have also examined problems that resulted from regulators simply failing to use the authority they had, such as our hearing in March that uncovered defective risk management systems at major financial institutions. But although regulators play a critical role in policing the mar- kets, they will always struggle to keep up with evolving and cut- ting-edge industries. Today’s hearing will examine how we can bet- ter empower shareholders to hold corporate boards accountable for their actions and make sure that executive pay and other incen- tives are used to help companies better focus on long-term perform- ance goals over day-to-day profits. In this latter regard, this is a timely hearing based on the action yesterday of the House Finan- cial Services Committee. Wall Street executives who pursued reckless products and activi- ties they did not understand brought our financial system to this crisis. Many of the boards that were supposed to look out for share- holders’ interests failed at this most basic of jobs. This hearing will (1) 2 help determine where the corporate governance structure is strong, where it needs improvement, and what role the Federal Govern- ment should play in this effort. I will ask our witnesses what the financial crisis has revealed about current laws and regulations surrounding corporate govern- ance, including executive compensation, board composition, election of directors and other proxy rules, and risk management. In par- ticular, we will discuss proposals to improve the quality of boards by increasing shareholder input into board membership and requir- ing annual election of and majority voting for each board member. We will also discuss requiring ‘‘say-on-pay,’’ or shareholder en- dorsements of executive compensation. We need to find ways to help public companies align their compensation practices with long- term shareholder value and for financial institutions overall firm safety and soundness. We also need to ensure that compensation committee members who play key roles in setting executive pay are appropriately independent from the firm managers that they are paying. Other key proposals would require public companies to create risk management activities on their boards and separate the chair and CEO positions to ensure that the CEO is held accountable by the board and an independent chair. I hope today’s hearing will allow us to examine these and other proposals and take needed steps to promote corporate responsive- ness to the interests of shareholders, and I welcome today’s wit- nesses and look forward to the testimony. Now let me recognize Senator