NAIC Releases Draft White Paper On Corporate Governance; At Odds With Existing Bodies of U.S. Law

by Earl Zimmerman

This Legal Alert addresses the "White Paper on High-Level Corporate Governance Principles for Use in U.S. Insurance Regulation" Click here for White Paper exposed for comment at the Spring NAIC Meeting in Austin, Texas. The White Paper is controversial in several ways as discussed below. We first provide a summary of the White Paper and highlight problematic provisions. Then, we summarize selected Delaware corporate governance case law and analyze how the White Paper appears to conflict with existing law.

The White Paper is the product of the Corporate Governance Working Group (CGWG) of the NAIC's Solvency Modernization Initiative (SMI) Task Force. The NAIC describes the SMI as "a critical self-examination to update the United States' insurance solvency regulation framework..." taking into account international insurance solvency developments. The SMI Roadmap identifies "governance & risk management" as one of its five focus areas and lists as one of the SMI's "deliverables" the study of international corporate governance principles to determine whether to incorporate these principles into an NAIC "model law or other implementation tool."

The White Paper is controversial, perhaps not intentionally, in several ways. For example, it purports to address corporate governance principles for regulated insurance companies, yet implicates corporate governance at the holding company level in significant ways. Unlike the NAIC's Model Audit Rule, which imposes limited corporate governance requirements on statutory insurers but includes special exemptions for insurers in "SOX-compliant" holding companies, the White Paper neither reconciles nor acknowledges the complex governance interrelationships among holding companies and their wholly owned insurance company subsidiaries.

In addition, the White Paper creates new fiduciary duties of directors to "policyholders and beneficiaries" while describing this duty as currently in existence (but providing no citation). The authors of the White Paper do not acknowledge the significant conflicts and other consequences that creating such duties would have for directors of insurers. For example, shareholders are generally the class to whom the Board and management owe fiduciary duties and are the key beneficiaries of corporate governance and value creation. Rather than accepting and acknowledging this fundamental of corporate governance, the White Paper lumps shareholders in with "other stakeholders" and focuses on the newly created fiduciary duties of directors to policyholders and beneficiaries. By turning corporate law on its head, the White Paper puts itself at odds with state corporate statutes, case law and stock exchange requirements, which focus on the duties of directors to shareholders and generally view policyholders and beneficiaries as part of the class of creditors to whom no duty is owed absent certain extreme circumstances involving bankruptcy or near-bankruptcy. A breach of fiduciary duties carries with it the threat of personal liability for directors.

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