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Last week, Liz blogged about the SEC’s recent enforcement action targeting a former CEO & director who did not disclose a close personal friendship with a company executive that the SEC contended resulted in misleading proxy disclosures concerning his independence.  In a recent blog, Gunster’s Bob Lamm raises some concerns about this proceeding:

Why does this case concern me? Of course, once the board learned of the actions taken by the director/former CEO, it had every right to determine that he was not independent. However, it’s not at all clear to me that the actions in question violated the proxy rules. There have been many cases over the years in which directors were alleged – often by investors and/or the media – to have lacked independence because they belonged to the same country club, served on the same boards (including boards of charitable organizations), or generally hung out in the same social circles. Some of these cases generated calls for SEC rulemaking that would require disclosure of these informal relationships and thereby disqualify directors in such cases from being described as independent. However, for whatever reason (and I can think of a few), the SEC never took such action.

Similar situations have also resulted in judicial decisions disqualifying such directors from serving on committees of independent directors. Perhaps the most famous of these cases is a Delaware Chancery Court opinion, written by Leo Strine, in which two directors of Oracle were disqualified from serving on an independent committee due to their ties to Stanford University, which had received substantial donations from Oracle and/or certain of its directors.

However, to my knowledge, none of the cases referred to above resulted in an SEC enforcement action. In fact, the two Oracle directors continued to be listed as “independent” in Oracle’s proxy statements, and, to my knowledge, the SEC never brought a case against them or objected to the characterization in the proxy statements.

In light of this background, Bob goes on to say that this proceeding looks a lot like regulation by enforcement. In the SEC’s defense, in this action it not only alleges a failure to disclose the relationship, but also alleges that the director actively encouraged the executive to conceal its existence. That seems to me to be a meaningful difference between this situation and the ones that Bob references in his blog.

So, I’m not sure I agree with Bob here, but I think he is right to raise this issue. Regulation by enforcement is an increasing concern in an environment where the courts are becoming ever less deferential to SEC rulemaking. If the SEC can’t make new rules to address conduct it concludes is problematic, it will be tempted to push the envelope when it comes to the kind conduct that it contends violates existing rules. At some point, those efforts may call into question whether the due process rights of enforcement targets are being adequately protected.

– John Jenkins