­The Panic of 2008: How the financial crisis
will affect governance for corporate legal departments

By Gary Tully and Ajith Samuel

Somewhere in the bustling financial district of New York City in 2006, a man sits alone in his office, staring at his computer screen. He is wearing a rumpled but expensive suit, and looks disheveled, distraught. He has just noticed the first fine cracks in his livelihood: As a securities trader, he has invested heavily in bundles of subprime loans, packaged attractively to look like a solid venture. As defaults and bank foreclosures have skyrocketed, the companies that invested in these loans have begun swimming in red ink, edging ever nearer to bankruptcy.

This hyperbolic vignette serves to illustrate a scene that has been occurring throughout the United States in varying degrees of severity for the past few years. More recently, the problems in the financial and mortgage industries have exploded into the public consciousness, having catastrophic effects on the global economy.

Where did these professionals go wrong? How did the juggernaut U.S. economy fall so far, so quickly, resulting in the most severe credit crisis in two generations? And what will be the ramifications on the world economy, let alone corporate and legal governance?

When French president Nikolas Sarkozy declared that “laissez faire is dead,” and insisted the current system of free market capitalism needed to be reinvented to include a strong regulatory system, it became clear that the very foundations of the U.S. economy are ripe for revolution.

There is argument among experts as to what caused the current economic downturn, with blame shifting among complex financial processes, irresponsible homeowners and careless or predatory lending practices. Greed, politics, lack of oversight and deregulation have each shouldered their fair share of blame. What we can be absolutely sure of, however, is that the consequences will reach far and wide, in the form of a fresh round of regulation and oversight that is likely to spill over into many jurisdictions, with important implications for governance and corporate legal departments.<!--[if !supportFootnotes]-->[2]<!--[endif]--> 

According to Eric Hilt, assistant professor of economics at Wellesley College, current events are now forcing policymakers to begin to reconfigure the United States’ systems for regulating institutions.

“Although recent innovations in financial markets have made the current crisis more complex than its predecessors, the underlying dynamic is fundamentally the same,” Hilt said. “And like those earlier crises, the ‘panic of 2008’ will likely result in dramatic regulatory changes.”<!--[if !supportFootnotes]-->[3]

SEC Chairman Christopher Cox said that a serious lack of oversight is partially responsible for the financial collapse, and began a major overhaul of the structure of the country’s financial regulatory bodies in September.<!--[if !supportFootnotes]-->[4]<!--[endif]--> This is just a small taste of the kind of changes that can be expected in the coming months and years. Every financial crisis of the past century has led to some regulatory or business practice changes, some so systemic that their effects are still felt today. While there are considerable differences between the past crises and today’s situation, there are also significant parallels.

The Great Depression, for example, was a watershed era in terms of legislation and regulation, with its effects shaping the fabric of the nation’s financial, business, agricultural, regulatory and oversight bodies for decades to come. The International Monetary Fund, for example, was created in 1944 to stabilize exchange rates and supervise the reconstruction of the world’s international payment systems.<!--[if !supportFootnotes]-->[5]

More recently, in the 1990s, the Internet bubble and excesses in the latter half of the last decade wiped out Enron and gave rise to the Sarbanes-Oxley Act, with repercussions throughout the world of corporate law and beyond.

“The shadow of [the Wall Street meltdown] will be longer than Enron, Sarbanes-Oxley, HIPAA, or any other regulation of modern times,” said John Bace, research vice president of Gartner IT Management Group, in a keynote address at the Midsize Enterprise Summit in Grapevine. “…Most new rules are coming around governance and transparency.”<!--[if !supportFootnotes]-->[6]

LEGAL’S ROLE

As companies struggle to anticipate the coming reach of new initiatives, progressive general counsels and audit committees are taking no chances: where potential improvements in corporate governance or operations are spotted, they are immediately pursued.<!--[if !supportFootnotes]-->[7]

According to a study by The Economist Intelligence Unit, “Companies are beginning to realize that the full value of (governance) depends in large part on the policies and procedures that govern and control its use, access, analysis, retention and protection.” In a poll conducted by the EIU:

“… 77% of respondents expect … governance to be … very important to their company’s success over the next three years. As a result, many firms have begun building the foundation for … governance policies. A majority (65%) have defined policies around how information is to be stored and shared among employees and stakeholders. Furthermore, some organizations are forming formal governance bodies to create strategies, policies and procedures surrounding the distribution of information inside and outside the firm. This is a good start, but considering that 68% of respondents also expect that the complexity of their company’s information governance issues will grow over the next three years, there is little time to waste.”

Mitigating risks and preventing future compliance issues are both dependent on setting up defensible governance policies now, before regulations force the issue. As internal general counsel, you are responsible for determining and setting the internal controls essential to good governance.

Legal departments’ involvement in crafting, implementing and monitoring policies, processes and rules is essential to ensure the success of any defensible governance plan. Each new initiative places greater demands on the general counsel and elevates the department’s profile and voice in the board room and executive suite.<!--[if !supportFootnotes]-->[8]<!--[endif]-->  The role of general counsel is likely to expand even further into departments outside the executive suite, as aspects of the daily operations of many corporations are re-routed through or reviewed by legal departments.

Too often, corporate legal departments have neglected to take an active role in governance decisions and oversight, resulting in avoidable consequences. In the case of Kevin Keithley vs. The Home Store.com, Inc., a poorly governed corporate IT department without sufficient oversight failed to implement proper data preservation measures, resulting in $320,000 in fines and a devastating adverse inference judgment.<!--[if !supportFootnotes]-->[9]<!--[endif]-->

While legal’s role in governance is but one facet in a corporation, it is an essential one. According to Alan D. Jagolinzer and Daniel J. Taylor, Stanford Graduate School of Business, and David F. Larcker, Stanford University, authors of “The Impact of the General Counsel on Corporate Governance,” general counsel’s primary responsibility is to enforce and shape corporate governance inside the firm itself.

Essentially, legal departments must ensure accountability, defensibility and transparency in a company’s processes, systems, protocols, structures, operations and controls. Thought leaders, however, see legal scope growing to fulfill new roles in the realm of corporate governance. General counsel is ideally positioned within corporations to lead important decision-making processes and help companies weather the coming regulatory storm. Working closely with corporate governance ensures that general counsel will be able to lobby effectively for beneficial and fair legislation. General counsel will also be responsible for implementing any pertinent regulations within their industries, leading the way as far as implementing processes and ensuring compliance.

PREPARING FOR AN UNCERTAIN FUTURE

Today, general counsel must ready itself for crunch time. The financial crisis has essentially undone the last eight years of deregulation, and corporate legal teams will shoulder the responsibility of rebuilding whole industries from the ground up.

“When you get to some of these extremely busy times, it is very much a divide-and-conquer strategy,” US Treasury General Counsel Robert Hoyt says. That means, he likes to delegate: for the financial crisis, he is relying on a core senior team that includes deputy general counsel John Knepper, counsellor to the general counsel Stephen Albrecht, and assistant general counsel for banking and finance Laurie Schaffer.<!--[if !supportFootnotes]-->[10]<!--[endif]-->

The financial crisis means that legal teams will have to ask themselves some very tough questions, such as:

·         <!--[endif]-->Before regulations are enacted, how can I influence legislative decision makers to minimize the negative impacts on my company and industry?

·         <!--[endif]-->Where do I get the information I need to interpret and apply the new regulations?

·         <!--[endif]-->Who in each department has the information I need?

·         <!--[endif]-->If a number of regulations are imposed, how do I prioritize the work?

·         <!--[endif]-->Will I have to add staff to handle the increased workload?

·         <!--[endif]-->How do I build support across the organization for an expanded general counsel role?

·         <!--[endif]-->How will legal overlap but not duplicate work being done by records information management (RIM) and information technology (IT) and corporate compliance officers?

·         <!--[endif]-->How can I do this without increasing my budget?

Developing answers to these questions in anticipation of the changed regulatory environment will lead to more effective deployment of legal teams.  In the areas of corporate governance and collaboration, preparation will be critical to successful navigation through and beyond the financial crisis.

CONCLUSION

Presently, the despondent New York man’s career is essentially over. It’s not just his company that’s suffered from systemic governance failures, his entire industry faces extinction. Questions on the minds of people like him and business leaders everywhere are, “What could have been done differently, and what can be done differently in the future to avoid catastrophes of this scale?”

Part of the answer lies in the realm of governance itself. To rebuild the despondent man’s career, businesses will need sound, ethical and well-planned building blocks on which to found their governance principles, regardless of future regulations. Implementing internal controls, breaking down communication barriers between departments and centralizing silos of information are essential to proper corporate governance, as is building a toolset to keep corporate legal departments informed, involved and in touch with the rest of the company.

Within corporations, legal departments are the axis around which all other departments revolve, especially when it comes to regulation. They are key players in corporate governance process origination, and their role has never been as critical as it is today. It is imperative for leaders within corporate legal departments to step up to the plate, and take leadership roles/lead the way/raise the bar and enable businesses to move forward through the financial crisis.

About the Authors:

Gary Tully has more than 15 years of experience in the information technology industry, including more than a decade as a senior IT manager, with extensive experience working in the legal industry. Currently, he is Director of Legal Operations at QUALCOMM INCORPORATED, and sits on the Corporate Law Firm and Advisory Board for a leading legal industry consulting firm, which develops technolgoy standards and creates best practice frameworks for the discovery lifecycle. Tully also takes a leading role in the board for the Legal GRC Center for Innovation, is an active participant in the Corporate E-discovery Forum, and is an active member of the International Legal Technology Association. Tully earned his undergraduate degree in computer science from California State University at San Bernadino, and his Master of Business Administration from Pepperdine University.

Ajith Samuel has 15 years of experience in regulatory compliance and desinging and architecting large-scale information systems for the futures industry. He is the executive vice president of Exterro, Inc.'s process innovation department, and leads the company's trailblazing product strategy team. Samuel also heads the administration and development team of the Legal GRC Center for Innovation. He holds a master's degree in computer applications from St. Joseph's in Tichy, India and works out of <a href="http://www.exterro.com" mce_href="http://www.exterro.com">Exterro, Inc.'s</a>Chicago offices.