The GM conflict of interest that wasn’t

November 20, 2010, 1:53 AM UTC

A few days before General Motors (GM) went public, an investor called me to say that the company was in violation of Sarbanes-Oxley. Specifically, he said that a member of the automaker’s audit committee was not adequately independent.

Juicy story – a state-owned company violating federal law. But my source was wrong. GM was not violating either Sarbanes-Oxley or NYSE listing requirements. It was just violating their spirit, in a way that has become so common as to be ignored.

The “offending” audit committee member was Erroll Davis, a GM director whose day job is Chancellor of the University System of Georgia. My source argued that because USG receives a large portion of its funding from the federal government (i.e., GM’s controlling shareholder, pre-IPO), Davis could not claim independence.

Now, before continuing, this clearly was an academic exercise. Even if Davis’ arrangement did violate SOX, no one short of Glenn Beck would seriously consider a conspiracy between the Department of Treasury, the Department of Education and bureaucrats responsible for cutting checks to Georgian colleges. And for what? To pressure one audit committee member – yes, the chairman – into fudging some numbers in the most publicly-scrutinized IPO of all time?

But back to why it’s legal for Davis to serve on the audit committee: He does not receive compensation from the issuer (save for director-related fees, which are allowed).

Erroll Davis

It seems to be irrelevant that he receives compensation, director or indirectly, from the company’s controlling shareholder. Under this construct, Tim Geithner or Barrack Obama also could serve on the GM audit committee.

This is bizarre. The reason for independence requirements is to promote… well, independence. Controlling shareholders, by definition, are more powerful than is company management. In fact, controlling shareholders routinely install company management (hello Dan Akerson).

So if a controlling shareholder really runs the show, how come it’s okay for an “independent” audit committee member to be on that controlling shareholder’s payroll? Doesn’t such a juxtaposition encourage the very conflict that SOX was hoping to remove?

Maybe you say: “Well, GM was an unusual case. This doesn’t typically come up.”

To that I respond: “Take a look at the audit committees of IPO issuers controlled by private equity firms. You’ll find the same conflict.”

Seems like someone didn’t think this one through too clearly…