Private Rule-Making and Codes of Conduct

From Max-EuP 2012

by Klaus J Hopt

1. Concept and examples of private rule‑making

Private law-making (more exactly: rule-making, also called privatization of law or private governance) is a wide field with no firmly established conceptual basis. Very different phenomena belong to it or are purported to belong to it, stemming from very different fields and including the law of standardization, accounting law, commercial law, banking law, stock corporation law, corporate governance, stock exchange law (exchanges), law of the professionals, environmental law (environmental liability), anticorruption law and many others. Examples include (i) technical standardization norms (DIN norms of the German Institute for Standardization of 1917, norms of the International Organization of Standardization ISO in Geneva, the VDI guidelines of the Association of German Engineers (VDI) and others); (ii) accounting rules (eg the general principles on orderly accounting (GoB)), the standards of the German Accounting Standard Committee (DRSC), the International Accounting Standards (IAS) of the International Accounting Standards Board (IASB), the International Financial Reporting Standards (IFRS) of the International Accounting Standards Committee (IASC) and the US Generally Accepted Accounting Standards (US GAAP) (the last two are engaged in international competition with each other and difficult coordination negotiations are underway); (iii) rules for national and international commerce, such as the Incoterms or the Uniform Customs and Practice for Documentary Credit and the Uniform Rules for Collection set up by the International Chamber of Commerce in Paris; (iv) the principles of the Basel Committee for Banking Regulation at the Bank for International Settlement (BIS) in Basel and other international banking and bank supervisory committees, European codes such as in the banking and consumer finance sectors, and rules for the Ombudsman (ombudsman); (v) the national and international corporate governance codes in many countries, such as the German Corporate Governance Code (corporate governance) and the public corporate governance code of the German federal government and some states; (vi) the stock exchange rules, the conditions for admission to trading at the stock exchange and the rules governing the stock exchanges themselves under their self-regulation in the various countries (exchanges); and (vii) the self-regulation of the various free professions.

But one should also mention here the self-made law of industry and commerce (standard contract terms); the by-laws of capital corporations, which are given considerable leeway in most countries, though Germany is very restrictive in this respect (there is a dispute in Germany over whether to liberalize this as in other countries); the modern transaction law of mergers and acquisitions that has developed under Anglo-American influence and is converging internationally (eg due diligence, information memoranda, letters of intent, punctuation etc); cartels; model contracts and contract forms; international comitology; the Lamfalussy process; ‘co-regulation’; lex mercatoria; and many institutional and other arbitration rules (arbitration (international)).

All of this cannot be brought here to a common denominator. Instead, the advantages and disadvantages of private rule-making and the various degrees of binding force, including the possibilities of enforcement, shall be addressed. Afterwards, two selected areas, international accounting and corporate governance, shall be briefly described as an example for many others.

2. Advantages and disadvantages of private rule-making

Despite some recent contributions, there is not yet an established theory of private rule-making, apart from general sociological theories on social norms (as early as Max Weber) such as system theory (Niklas Luhmann), social self-regulation (Renate Mayntz, Fritz W Scharpf) or autopoiesis (Gunther Teubner). This deficiency is even more apparent in the absence of legal principles for or even a real doctrine of private rule-making similar to the recently developed doctrine of legislative law-making and the long-established rules for the interpretation of laws and contracts. Private rule-making does not fit into the traditional doctrine of the sources of the law. But at least the advantages and disadvantages of private rule-making can be discerned.

Obvious advantages of private rule-making are the higher flexibility and the greater proximity to the market and the needs and behaviour of the market participants. Speaking in terms of economics, this means the reduction of transaction costs for the enterprises as well as for the state and its agents in making and administering the law. Furthermore, there appears to be an interesting possibility of experimenting first with private, non-binding rules when dealing with new developments and challenges. Private rule-making, therefore, frequently occurs when a sector or a profession which previously was not regulated by the state is confronted with the need for regulation, as is happening more and more often. Furthermore, the possibility of private rule-making may lead to greater involvement and commitment of the profession in areas such as fair dealing with clients, fair competition and clean market practices.

On the other hand, there are considerable disadvantages. The main problem is the fact that private rule-making is voluntary, ie it cannot be enforced against outsiders or ‘black sheep’. This was the main problem for the German Voluntary Insider Guidelines and the German Takeover Code before both areas were regulated by law under the order of the European Union. But also in cases of successful private rule-making like the German Corporate Governance Code, this problem arose with the code’s recommendation to make the individual remuneration of board members transparent without prescription by the law. When this recommendation was not followed by many German companies, the legislature stepped in with a law. The same thing happened later with the more general problem of ‘pay without performance’ (Lucian Bebchuk), when the Code Commission was too slow and too soft in taking up the remuneration issue that had come into the focus of public and political discussion during the financial crisis. The German legislature enacted a far-reaching law in 2009 despite the critique expressed by practice and academia. Another disadvantage of private rule-making is the free rider problem, ie there are always some who will succumb to the temptation to secure economic advantages for themselves by not following the rules while others do. If this is done frequently, it results in considerable distortions of competition and deception of the public.

But there is also the opposite danger that sanctions for not obeying private rules do exist but are used by the self-regulators in an anticompetitive way towards outsiders, eg by setting overly burdensome standards to keep outsiders out or suppressed. An example of this is the former voluntary agreement on curbing banking competition in interest rates and advertisement.

Last but not least, with private rules there is always the danger of going only as far as necessary for keeping the state legislature from stepping in and enacting laws and binding rules that have democratic legitimization and instil a fair balancing of the interests of all concerned. Private rules very often also lack transparency, as in the case of the German Voluntary Insider Trading Guidelines, and are difficult to enforce before the state courts.

3. Degrees of binding force and possibilities of enforcement

Private rule-making can have rather different degrees of binding force and possibilities of enforcement. Much of what has been enumerated above is completely voluntary. It is up to the individual or organization to decide whether they will follow the rule. In many other cases there is at least a certain group or peer pressure to obey. This is particularly true when the group is relatively small and cohesive and its members deal or are constantly professionally involved with each other. For example, this is the case for the City of London and compliance with the Takeover Code.

The British Combined Code, too, with its rules on good corporate governance has a great influence on the companies whose shares are listed on the London Stock Exchange. Yet the enforcement here is not just by peer pressure; the obligation to follow the rules of the Combined Code is expected by the London Stock Exchange. If the admission to trading at the stock exchange depends on the obligation to obey the rules of stock exchange self-regulation, then this in no longer really voluntary. The same is true for the many instances of professional self-regulation.

Another form of enforcement of voluntary corporate governance codes or rules has become rather popular of late. This is the principle of ‘comply or disclose’, or its more severe kin, the principle of ‘comply or explain’. Many modern corporate governance codes oblige those who adopt them to either follow their recommendations and rules or, if they do not, to disclose this publicly. A more demanding form of this kind of enforcement is that mere disclosure is not enough, but that the deviance must be explained in more or less detail. Here, the enforcement effect stems from the expectation that the enterprise must then openly confess that it does not follow good government even if this might concern only a single rule. This may lead to negative reactions by customers, colleagues, competitors, the financial press and the general public. The German legislature has used this means of enforcement for the German Corporate Governance Code. While the code is merely voluntary, the legislature inserted Art 161 into the Stock Corporation Act, which originally followed the ‘comply-or-disclose’ principle, and since 2009 has become more strict by imposing the ‘comply-or-explain’ obligation (see in more detail below).

Finally, an indirect form of enforcement is the threat that a supervisory authority or the legislature will step in. This may be felt as a real threat by the enterprises and certainly by trade associations that issue warnings in this respect, but individual persons and companies may not see a real pressure for themselves. Examples for this are the moral suasion of the central banks—eg the German Federal Bank (Bundesbank)—when legal provisions for the supervision of bank groups did not yet exist. Similar experiences were made with the above-mentioned Voluntary Insider Trading Guidelines and the German Takeover Code, both of which failed in the end.

It is disputed whether, at least in exceptional cases, the violation of private rules may lead to civil liability—eg as so-called protective norms in the sense of Art 823(2) of the German Civil Code (Bürgerliches Gesetzbuch (BGB)), or as professional duties to obey such rules (‘inclusion’ in methodological terms), or because of a deception of the partner of a contract or of other members of an association (cf the German legal concepts of liability for external appearance or for justified confidence). In any case, a resolution of the general meeting to exonerate the members of the (supervisory) board was held to be void by the German Federal Supreme Court (BGH 16 February 2009, (2009) WM 459 (Leo Kirch v Deutsche Bank)) because the board did not disclose a conflict of interest that it should have disclosed under the German Corporate Governance Code, which the bank had adopted.

4. International Financial Reporting Standards, European and national accounting

Today, private rule-making particularly occurs in the accounting field, eg by the International Accounting Standards Board (IASB), which succeeded the International Accounting Standards Committee (IASC); the body responsible for it is the IASC Foundation, established in 2001. The IASC and the IASB have set up the International Accounting Standards (IAS; from 1978 until 1988 there were 28 such standards) and the International Financial Reporting Standards (IFRS; already more than a half dozen). The International Financial Reporting Interpretations Committee (IFRIC), which is the successor of the Standing Interpretations Committee (SIC), issues binding IFRIC, namely, SIC interpretations. The content of these many standards cannot be described here. They are not only voluminous but also highly complex as far as their content is concerned.

After a long hesitation, the European Union became amenable to the International Accounting Standards and adopted the ISA Regulation of 19 July 2002 (Reg 1606/2002). According to this Regulation, companies governed by the law of a Member State, whose securities, at the relevant accounting date, are admitted to trading on a regulated market of a Member State, are obliged to present their consolidated accounts according to the International Accounting Standards. For the normal annual accounts, the adoption of these standards is merely voluntary apart from certain exceptions. Yet the adoption of an individual international accounting standard by the European Union is not automatic; instead, it is done according to the so-called endorsement procedure. In this procedure, it may happen that a whole standard or parts of it (a ‘carve-out’) may be rejected. A recent example is ISA 39 concerning the accounting for financial instruments. In the financial crisis, the fair value method for the valuation of securities at market value (market to market, M2M) raised considerable controversy. European countries insisted on changes because in times of crisis, the market price of a security may not correspond to its intrinsic value.

The transformation of the European accounting rules was executed in Germany by the Accounting Law Reform Statute of 2004. Now all enterprises have the right to choose to adopt the International Accounting Standards, which, if endorsed by the European Commission, are binding for their consolidated accounts as well as for their annual accounts. Under certain exceptions, this right becomes a duty. For annual accounts, the International Accounting Standards are admissible only as far as their information function is concerned. Annual accounts may therefore only be established according to International Accounting Standards voluntarily and apart from and besides the principal establishment of the accounts under German commercial law. The far-reaching accounting law reform of 2009 modernized the more restrictive German accounting law, which is part of the Commercial Code in several respects, yet without really giving up the traditional German accounting law.

5. The international corporate governance code movement and the example of the German Corporate Governance Code

The international code of conduct movement in the field of corporate governance and stock corporation law has its origin in the Anglo-Saxon world. At the beginning, there was the Report of the Committee on the Financial Aspects of Corporate Governance (this has taken on the name of its chairman: the Cadbury Report of 1992). This report recommended principles in the form of a Code of Best Practice for board members. Since June of 1998, the Combined Code of the London Stock Exchange has carried the title ‘Principles of Good Governance and Code of Best Practice’. It is an appendix to the Listing Rules but not part of them.

In most European Member States there have been similar code of conduct movements. Internationally, the OECD Principles are part of this movement, though these principles are more relevant for the developing countries in Asia, eastern Europe and Latin America. The development in the Member States of the European Union is documented extensively in a report for the European Commission of January 2002 and cannot be described here in detail. This report found that 13 of the then 15 Member States had a corporate governance code, mostly established since 1997 (since then a corporate governance code was also introduced in Austria). In a significant number of the Member States there were not only one, but several such codes. Altogether the report analysed around 40 codes as to how closely they corresponded to each other or diverged regarding various parameters such as content, reach and effect. Principal issues dealt with included labour co-determination (where the greatest divergences exist), shareholder protection alone or together with creditor protection (social/stakeholder issues), rights of shareholders, the board, independence of directors, control by the board, board committees and disclosure.

In view of the startling number of corporate governance codes, the idea of setting up a uniform European Corporate Governance Code has a certain attraction. Yet the European Commission’s Action Plan followed the recommendation of the High Level Group of Company Law Experts not to do so. There are two reasons for this. First, national codes are nearer to the specific needs in the relevant country and sectors. Secondly, and more importantly, a corporate governance code must be set up in close relationship with the stock corporation law of a given country. The recommendations in the code cannot be more than supplements, paraphrases and sometimes even mere repetitions of the relevant stock corporation law in force. Yet despite a large number of European company law harmonization directives and recommendations (investor protection), stock corporation law has not yet been fully harmonized, even at its core.

Many traditional stock corporation lawyers and academics in the Member States have looked at corporate governance with rather critical eyes. In Germany, for example, even constitutional objections have been raised, and it has been observed that in view of the dense regulation of German stock corporation law there is no need for such a code. Yet a code provides an opportunity to react more flexibly to new problems and to allow experimentation rather than stepping in immediately with state law, which in Germany at least is mostly mandatory and leaves very little room for by-laws of the corporation. And it must not be forgotten that quite apart from the German Corporate Governance Code, the German Stock Corporation Act has been reformed no less than 68 times since 1965.

Since 2002, corporate governance has been dealt with by Art 161 of the German Stock Corporation Act. This article mandates that the German Corporate Governance Code (DCGK) is to be enforced by the duty of the members of the board to follow the principle of ‘comply or disclose’. Article 161 was reinforced by the accounting law modernization reform of 2009 (BilMoG), which in turn has transformed European law. The reform concerned, inter alia, the conditions for application (inclusion of multilateral trading systems) and also adopted the ‘comply-or-explain’ principle. According to the new version of Art 161, the members of the management board together with the members of the supervisory board are obliged to declare annually that the recommendations of the ‘Governmental Commission German Corporate Governance Code’, which are published in the official part of the electronic Federal Gazette, have been followed in the company and are still being followed or, if not, which recommendations have not been followed or are not being followed and why. This declaration must be made permanently and publicly available on the internet pages of the company. Article 161 of the German Stock Corporation Act has led to a vivid discussion and has given rise to many intricate legal problems. Among these problems are the reach of the declaration of the board, the declaration concerning not only the adoption but also the time afterwards (whether it ‘is’ being followed or ‘is’ not being followed) and the liability for incorrect or incomplete declarations towards the company or possibly even directly towards investors and creditors. In this context, it must be remembered that Art 161 does not itself say what good corporate governance is; this is up to the code.

The German companies have followed the recommendations of the code to an impressively high degree, namely with an overall quota of 83.8 per cent. But the Code Commission was not successful with some of its recommendations, eg the recommendation concerning the disclosure of the individual remuneration of each director, or, in the case of D&O insurance, the deductible, ie the percentage of the damage to be borne by the insured board members themselves. As to the former, the German legislature stepped in immediately and prescribed individual disclosure by law. Similarly, in 2009, when the financial crisis led to a harsh critique of excessive remuneration of directors, the German legislature reacted by considerably strengthening the law concerning the appropriateness of directors’ remuneration. Yet the legislature has been criticized for not leaving the issue to the Corporate Governance Code and the Corporate Governance Commission, who could have reacted more flexibly.

It is clear that, as a consequence of the financial crisis and the widespread failure of self-discipline shown by the banks, the financial institutes, the auditors and the rating agencies, private rule-making—at least in banking, stock corporation law and corporate governance—has lost momentum and state law is on the increase. This is shown by a variety of sometimes quite ambitious law reforms both in the Member States and in the European Union. It remains to be seen whether this is a permanent process. If so, this would be a clear setback from a legal, political and sociological perspective.


Klaus J Hopt, ‘Self-Regulation in Banking and Finance: Practice and Theory in Germany’ in AEDBF/EVBFR (ed), La Déontologie bancaire et financière/The Ethical Standards in Banking and Finance (1998) 53; Weil, Gotshal and Manges, Comparative Study of Corporate Governance Codes Relevant to the European Union and Its Member States, Final Report to the European Commission (2002); Jan Damrau, Selbstregulierung im Kapitalmarktrecht, Eine rechtsökonomische Analyse der Normsetzung der deutschen Börsen und ihrer Träger (2003); Carl-Heinz Witt and others (eds), Die Privatisierung des Privatrechts—rechtliche Gestaltung ohne staatlichen Zwang (2003); Uwe Blaurock, Nils Goldschmidt and Alexander Hollerbach (eds), Das selbstgeschaffene Recht der Wirtschaft (2005); Gregor Bachmann, Private Ordnung—Grundlagen ziviler Regelsetzung (2006); Johannes Köndgen, ‘Privatisierung des Rechts. Private Governance zwischen Deregulierung und Rekonstitutionalisierung’ (2006) 206 AcP 477; Jörn Axel, ‘Kämmerer, Selbstregulierung am Beispiel des Kapitalmarktrechts. Eine normativ-institutionelle Positionsbestimmung’ in Klaus J Hopt, Rüdiger Veil and Jörn Axel (eds), Kapitalmarktgesetzgebung im Europäischen Binnenmarkt (2008) 145; Henrik-Michael Ringleb, Thomas Kremer, Marcus Lutter and Axel von Werder, Deutscher Corporate Governance Kodex (3rd edn, 2008); MT Moore, ‘Whispering Sweet Nothings: The Limitations of Informal Conformance in UK Corporate Governance’ (2009) 9 Journal of Corporate Law Studies 95; Jörg Baetge and others (eds), Rechnungslegung nach IFRS (looseleaf).

Retrieved from Private Rule-Making and Codes of Conduct – Max-EuP 2012 on 28 May 2022.

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