5. Coercive Reform Strategies

5.1    Director and Officer Disqualification

A bar by the court or a national securities regulator to future service of directors is a strong deterrent for directors’ misconduct. In the US, Section 305 of the Sarbanes-Oxley Act (SOX) provides the Securities and Exchange Commission greater powers to bar directors and officers. Pursuant to this section, if any person’s conduct “demonstrates unfitness” to serve as an officer or director, the SEC may bar that person from acting as such for a public company. Although figures on bars are not systematically collected, the SEC released a report in 2003 as a requirement of SOX-Section 704 that gave some insight in officer and director bars (Securities and Exchange Commission, 2003a). See also Table 1.

Table 1: Director Disqualification in the US

Fiscal Year

Number of Officer and Director Bars Sought













Source: Securities and Exchange Commission (2003a).

In the UK, directors can be barred for a maximum of 15 years under the 1986 Company Directors Disqualification Act. Under three categories of conduct, the court can disqualify directors and managers from being involved in the management of companies: 1) general misconduct in connection with companies, 2) disqualification for unfitness and 3) other cases for disqualification. According to a study by Wright (2005), the number of directors disqualified by UK courts rose from 399 in 1993-1994 to 1,267 in 1997-1998. Between 2003 and 2004, over 1,500 directors were disqualified from management for between two and fifteen years (the minimum and maximum terms under the law).

5.1.1    Empower Securities and Exchange Commissions

As in developed markets, director and officer disqualification only works when effective enforcement mechanisms are available. For director disqualification to be an effective deterrent, fast resolution of disputes is important. Since courts are notoriously slow in emerging markets, regulators should be empowered to investigate market manipulation and enforce regulations and legislation with adequate resources and expertise (IOSCO, 2000).

SECs are not always respected in emerging markets and should be empowered to suspend directors as part of a well defined disciplinary process with set time lines, clear cut rules and appeal procedures. Especially when court proceedings can take several years even to commence, independent administrative law judges in administrative courts within securities and exchange regulators may provide greater efficiency in disciplining directors.


Case 1: The Passage of a New Company Law in Macedonia and the Involvement of the Private Sector

The USAID Corporate Governance and Company Law, implemented by EMG, provided intensive technical assistance in the drafting of a new company law in Macedonia over a period of eighteen months. The law passed Parliament in April 2004 and incorporates OECD corporate governance best practices and is compliant with EU Directives. The law can be seen as Macedonia’s “private sector constitution” since it regulates all types of commercial legal entities in the country (from economic interest groups and joint stock companies to sole proprietors and small scale traders). According to the World Bank (2005a): “The process used to prepare the 2004 Company Law can be a model for going forward, in that it engaged the private sector and allowed sufficient time for review and revision of the draft.”

Promoting Public Dialogue on New Company Law: Over the course of the drafting of the company law, 27 public hearings with more than 2,000 participants were held (20 hearings after the First Reading, 7 hearings after the Second Reading of Parliament). The hearings served both to educate and solicit feedback on drafts of the laws. Government and project websites provided the legislation and bases to send written submission. Suggested amendments were reviewed by the drafting committee resulting in numerous changes in the draft laws. Following the enactment of the law, an intensive two year nation wide educational program was implemented for lawyers, judges, journalists, accountants and directors and managers of 416 active joint stock companies.

Cooperation with the OECD: With the introduction of the OECD White Paper on Corporate Governance for South Eastern Europe in Skopje in June 2003, the participation in the High Level Working Group in Paris in November 2003, and the organization of the international OECD corporate governance conference in Ohrid, Macedonia in June 2004, Macedonian delegations had an excellent opportunity to discuss and present corporate governance developments to an international audience.

Source: www.emergingmarketsgroup.com


In order to empower regulators, clear cut rules and definitions of “unfitness” are essential to provide guidance to directors, officers and regulators on what is acceptable behavior and what is not. These guidelines and their interpretation should be made available on the regulator’s website. Transparent appeal procedures within a SEC’s administrative court and appellate courts are required to guarantee the integrity of the process.


5.2    Liabilities of Directors

Directors’ liabilities, both criminal and civil, also are effective deterrents for misconduct. As with director disqualification, legislation introducing director liabilities can only be effective when circumstances in which liabilities may arise are well defined and when standards are being enforced. For financial markets to be able to attract the best directors, standards need to be predictable and easy to understand. Directors must be able to assess the risks associated with serving on a board of directors and D&O insurance should be available to protect directors from malicious lawsuits.

5.3    The Business Judgment Rule

While a business judgment rule may shield directors from liabilities in emerging markets, the courts in emerging markets may not be able to understand such a complex concept. The rule provides that courts will not second guess the decisions of a director, even if they turn out to be mistakes in judgment when: 1) they have been made within his authority, 2 when they have been on a rational basis, 3) and when they are made in good faith. This requires a judge’s understanding of “rational behavior” and “good faith.” It also requires a judge’s understanding of a director’s vision, the company’s long term strategic plans, common business practices and industry standards.

As noted by the Michigan Supreme Court in 1919 in a case between the Dodge Brothers and Ford Motor Co., “judges are not business experts.”[12] This certainly may be true for judges in developing countries who often lack the educational background and necessary commercial law experience to interpret business decisions. Judges in less developed markets should therefore abstain from reviewing the substantive merits of business decisions. As stated by Paredes (2005), developing countries need clear cut rules that are easy to understand and to interpret by regulators and the private sector. This also applies to rules and standards that may impose liabilities on officers and directors.


[12] See Dodge v. Ford Motor Co. Mich. 170 N.W. 668 (1919).

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Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.