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The debate over the cost of regulatory compliance for corporations is heating up. For example, in a report released in February, the Securities Industry Association reported that compliance costs at U.S. securities firms rose from $13 billion in 2002 to $25 billion in 2005. Similarly, other reports bemoan the disproportionately high compliance costs facing small companies. Predictably, the two sides in the debate have staked their ground: those who argue that increased regulation, such as Sarbanes-Oxley, is necessary to protect the integrity of the capital markets versus those who think that regulation should be scaled back, especially for smaller businesses. Oddly, the debate to date has ignored one basic fact: The federal layers of regulation, which have spawned apparently massive compliance costs, have emerged because the core of state corporate law is frequently empty. Let me offer some specifics. State law-through corporate statutes and judicial decisions-in theory governs the workings of U.S. corporations. Yet, in an attempt to attract incorporations by catering to the needs of managers and their lawyers, state laws offer few protections to shareholders. Corporate statutes are, by and large, “enabling”: For all practical purposes, they do not impose mandatory protections. For their part, judicial decisions articulate seemingly impressive-sounding fiduciary obligations such as the “duty of care” and “duty of loyalty” that managers, as agents, must exhibit toward their shareholders. Yet, in application, these duties become largely empty. How is this possible? In virtually all areas of the law, courts match their “standards of review” to societal “standards of conduct.” That is, courts judge the behavior of individuals according to how the perennial reasonable person should behave in her community. Laws governing the internal affairs of corporations, however, are somehow different. As students of corporate law soon realize, care doesn’t really mean care and loyalty doesn’t really mean loyalty. Provided insiders are smart enough to jump through the proper procedural hoops-hiring advisers, appointing special committees and the like-they are effectively insulated from judicial review through doctrines such as the “business judgment rule,” which suggest that courts should not be second-guessing the decisions of businesspeople. To boot, state corporate law is focused on the behavior of directors. But anyone who has had even a passing encounter with a corporation knows how management-centered they are. The bottom line is simple: Impressive-sounding obligations can be carefully skirted through clever process. Absent in the wake of scandals The traditional justification offered is that business is complicated. Yet the idea that judges somehow are not qualified to judge “care” and “loyalty” is difficult to stomach: State courts delve into the most difficult and delicate areas of our lives-how we reproduce, raise our children and even die-yet somehow, corporations are off limits. The result? State corporate law has been eerily absent in the wake of the most recent corporate scandals. Federal regulations, and their concomitant compliance costs, have emerged as layers, or bandages, to cover up the empty core of state corporate law. Let’s return to first principles. The central problem of the modern public corporation-the separation of ownership and control-has not changed in a century. Managers are agents of their principals and should be governed, first and foremost, by robust fiduciary duties that match “standards of review” to “standards of conduct.” In addition, laws should focus squarely on the behavior of officers, not merely directors. Put simply, even though corporate miscreants have been neither loyal nor careful, basic corporate law has sat idly by. We can continue to do what we have been doing by adding increasingly burdensome and expensive layers of regulation as bandages to recover from recurring crises. Or we could give meaning to the core of corporate law. The choice should be simple. Reza Dibadj is an associate professor of law at the University of San Francisco.

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