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Independent Directors

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A series of corporate scandals in 2001 and 2002 led to the collapse of some of the largest U.S. corporations, most spectacularly Enron, Tyco, Global Crossing, and WorldCom, and one “Big Five” accounting firm, Arthur Andersen. The legislative and regulatory response to these scandals was wide ranging. After hearings and debate, the Congress passed the Sarbanes-Oxley Act of 2002 (abbreviated here as SOX), the Securities and Exchange Commission (SEC) implemented new rules, and U.S. stock exchanges revised their requirements for listing corporations. Designed primarily to stem abuses in financial reporting, these reforms attempted to codify corporate governance rules to protect the interests of investors and make spectacular failures less likely. The preamble to the new SEC rules summarized the intent of the changes:

The strength of the U.S. financial markets depends on investor confidence. Recent events involving allegations of misdeeds by corporate executives, independent auditors and other market participants have undermined that confidence. In response to this threat to the U.S. financial markets, Congress passed, and the President signed into law, the Sarbanes-Oxley Act of 2002 … which effects sweeping corporate disclosure and financial reporting reform.

Besides setting up a new governance structure for the accounting profession and making senior managers more accountable for financial reports, the new regulations emphasized the important role of boards of directors in management oversight. For boards to be what SEC Commissioner Cynthia Glassman described as “gatekeepers to financial markets and strategic thinking for thecompany,” reformers wanted directors to be actively involved and informed, as well as independent of corporate management. Therefore, the new rules also strengthened the requirements and responsibilities for independent members of boards of directors.

Published Date: 27/03/2007

Suggested Citation: Jean Rosenthal,  Rick Antle, and Jonathan Koppell, "Independent Directors," Yale SOM Case 07-022, March 27, 2007.

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