Hillary A. Sale

Observations on the Role of Commodification, Independence and Governance in the Accounting Industry

In this Article, we argue the internal corporate governance structure of the big accounting firm is fundamentally flawed, and that this flaw contributed to the current crisis of confidence in the integrity of public reporting. The incentive structure within accounting firms makes it virtually impossible for auditors to be independent of significant clients like Enron. The result has been a change in the balance of economic power between accounting firms and their clients - individual audit partners suffer from client capture. In addition, to their lack of independence, accounting firms and partners lack accountability in part due to the advent of the limited liability partnership structure. Despite these problems, federal securities laws and regulations require auditors to provide independent audits to companies. The result has been the commodification of audits and a market in which audits are bought and sold. As a consequence, audits no longer serve the economic purpose for which they were required - providing information that protects investors and leads to the efficient pricing of securities. Although the provisions of the Sarbanes-Oxley Act offer some help in resolving the capture, governance, and commodification concerns we raise, we conclude that more is needed. Sarbanes-Oxley established the Public Company Accounting Oversight Board. This Board is to register the public accounting firms, set standards for their reports, inspect and investigate the firms, and, when appropriate, sanction firms and individuals. To be successful, the Board will have to replace the incentive system eliminated with the creation of LLPs with its own set of rules and standards, which it will have to enforce vigorously. In addition, Sarbanes-Oxley provides new standards for auditor independence, establishing a requirement that audit firms rotate the partners assigned to clients in order to prevent capture. We conclude that this provision is less likely to achieve its goal, as long as client satisfaction remains the dominant measure of partner performance. Instead, we argue that until lead audit partners are confident that they can fire dishonest clients without fear that doing so will result in the destruction of their own careers, the problems that contributed to the Enron and other significant corporate failures will continue to exist.

Delaware's Good Faith

In the post-Enron era, there has been considerable discussion about what went wrong at Enron and elsewhere and how to fix it. Congress passed the Sarbanes-Oxley Act, the New York Stock Exchange adopted new corporate governance regulations designed to create better checks and balances, and other self-regulatory organizations followed suit. In addition, the Securities and Exchange Commission, both before and after the Sarbanes-Oxley Act, promulgated many new regulations. One voice, however, has been fairly quiet. The State of Delaware, the mother of all corporate law, has been largely absent from the debate. The Delaware judiciary, however, has issued several opinions that indicate movement may be afoot. In this Article, I raise some questions about Delawares (declining) role in corporate law, and discuss the emerging duty of good faith and its potential for curbing abuses like those seen in the past few years. To do so, I examine several key cases from Smith v. Van Gorkom, to Caremark, to the Disney cases. In these, and other cases, I argue, the judiciary has put forth a set of guiding principles for fiduciary good faith. I argue that this duty is appropriately a separate duty, not an obligation on the other two key fiduciary duties of due care and loyalty. I compare the Delaware cases and the standards within them to the standard for pleading and proving scienter under the federal securities laws. Using the federal standard as a jumping off point, I argue that the duty of good faith can be analogized to the types of situations involving scienter and, thereby, limited in a meaningful manner. As a result, good faith can help to fill the gap in fiduciary duties without becoming excessively capacious.