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In fact, the chief executive was removed. That didn't happen in most of the companies where the board of directors represents threehundredths of 1 percent or five-hundredths of 1 percent of the voting stock.
Like Mr. Peterson, I hope that you will look carefully. I think this is a fertile field, including the suggestions he mentioned at the end of his testimony concerning the independent director.
I think that is the best way. The independent director can be enormously useful if he is properly equipped, and if he is really independent.
He is not independent if he is the company's lawyer. He is not independent if he is the company's investment banker.
One of Mr. Peterson's partners and I spent a few years as investment bankers on the same board. I used to joke with the president that we were both suppliers—“I'm willing to get off the board but I want to take that Lehman partner with me.” An investment banker is a supplier. He is not an independent.
A commercial banker, a general counsel—if he is from the outside law firm-those are not independents.
I think you have much fruitful work to do and some which I think will get a broad appeal and support in the country, focusing on the things Mr. Peterson mentioned at the end of his testimony.
If we can indeed establish corporate control by independents, then the election process can be made meaningful.
Senator HARTKE. Thank you, Mr. Petrie.
LEGAL MEMORANDUM ON FINANCING CORPORATE ELECTIONS I. Ancient Rule: Incumbents may spend corporate funds for campaign expenses
when the issue is one of "policy" rather than "personality" In 1886, the English Chancery Court in Studdert v. Grosvenor (1886) 33 Ch Div 528 ruled that the directors of a corporation could not use corporate funds to print and send proxies which were imprinted with the names of management candidates for the board. The court per Kay, J. stated at 539 :
"The directors have no right to employ the funds of the company to get into their own hands the majority of the voting power."
In 1907, the English court overruled Studdert in Peel v. London & North Western R CO (1907) LR 33 Ch Div 528. This case upheld the expenditure by a board of directors of corporate funds for the sending out of stamped proxies desig. nating certain of the directors as proxies, and the sending of circulars soliciting such proxies, for the purpose of effecting at a stockholders' meeting a policy favored by the management but opposed by another stockholders' group. The court proclaimed the rule: That such corporate expenditures are proper where they are used by the directors to inform stockholders of corporate policies that should be followed, but such corporate expenditures are unlawful if they are used by the directors for their own personal interests. 1 Ch at 18. This rule was subsequently adopted by American courts. See Lawyers Advertising Co v. Concolidated R Lighting and Refrigerating Co, 187 NY 395, 80 N.E. 199 (1907); Hall v. Trans-Lux Daylight Picture Screen Corp., 171 A 26 (Ch Ct Del 1934); opinion of Froessel, J. in Rosenfeld v. Fairchild Engine and Airplane Corp., 309 N.Y., 168 128 N.E. 2d 291 (Ct. App. 1955) ; Locke Manufacturing Co. v. U.S., 237 F. Supp, SO (D Conn. 1964); Cullom v. Simmonds, 139 N.Y.S. 2d 401 (1955); Steinberg v. Adams. 90 F. Supp. 604 (S.D.N.Y. 1950): Campbell v. Loews. 134 A 2d 852 (Ch Ct Del. 1957): Cheff v. Mathes, 199 A. 2d 518 (Sup. Ct. Del. 1961); Braude v. Haven. ner, 113 Cal. Rptr. 386 (Ct. App. 1974)
II. The modern rule: It is almost impossible to distinguish “personality" and
"policy". Therefore in modern times, incumbents are not denied the use of
corporate funds for their campaign expenses Modern courts have found it almost impossible to distin zuish “personality" and "policy". In Steinberg v. Adams, 90 F. Supp. 604 (S.D.N.Y. 1950) plaintiff share. holders argued that management and successful insurgents should not be reimbursed because they were engaged in a personal struggle for control of the corporation. The court allowed reimbursement and stated, per Rifkind, J. at 608 :
“The simple fact, of course, is that generally policy and personnel do not exist in separate compartments. À change in personnel is sometimes indispensable to a change in policy. A new board may be tbe symbol of the shift in policy as well as the means of obtaining it." See Hall v. Trans-Lux Daylight Picture Screen Corp., supra, at 228. Dissenting Justice Van Voorhis in Rosenfeld v. Fairohild Engine & Airplane Corp., supra, 128 NE. 2d at 299 wrote: “As in political contests, aspirations for control are invariably presented under the guise of policy or principle." In Braude v. Havenner, supra, at 389 the court stated: “This rule is uncertain in application because every contest involves or can be made to involve issues of policy." Eisenberg, M., in “Access to the Corporate Proxy Machinery,” 83 Harvard L. Rev. 1489 (1970) concludes that the ancient rule has proven to be incapable of meaningful application.
Thus, the ancient rule has evolved into a non-rule, the effect of which is that incumbents are not denied the use of corporate funds for their campaign expenses. This was shown in Campbell v. Loews, supra, which allowed corporate reimbursement to a faction which, while not presently in control of a majority of the board, "symbolized existing policy." 134 A, 2d at 864, and in Cheff v. Mathes, supra, it was held that corporate funds were properly used to buy up stock of an opposing faction which was reasonably thought to threaten management and policy changes. I have not uncovered a single case which denied incumbents the use of corporate funds for their campaign expenses on the sole ground that a "personality," rather than a "policy" issue, was at stake, cf. Cullom v. Simmonds, 139 N.Y.S. 2d 401 (1955). III. Modern corollary: Successful challengers may be later reimbursed for their
campaign expenses with shareholder approval Steinberg v. Adams, supra, at 607 held that those insurgents who prevailed in a contest for control of the corporation may be reimbursed by the corporation for their expenditures incurred in the contest, provided there is approval by both the board of directors and a majority of the stockholders. The opinion of three justices of the four man majority in Rosenfeld v. Fairchild Engine & Airplane Corp., supra, 128 N.E. 2d at 293 stated that shareholders have the right to reimburse successful contestants for reasonable and bona fide expense incurred in any policy contest. IV. Modern caveat: Unsuccessful challengers get nothing
Van Voorhis, J. dissenting in Rosenfeld v. Fairchild Engine & Airplane Corp., supra, 128 NE 2d at 300 stated: “... success in a proxy contest is the indispensable condition upon which reimbursement of the insurgents depends." See also Eisenberg, "Access to the Corporate Proxy Machinery,” supra, at 1512–1517.
ROBERT L. BILDNER, Senator HARTKE. Our next witness is Mr. Wallace Olson, president, American Institute of Certified Public Accountants.
STATEMENT OF WALLACE E. OLSON, PRESIDENT, AMERICAN INSTI
TUTE OF CERTIFIED PUBLIC ACCOUNTANTS; ACCOMPANIED BY THEODORE BARVEAUX, VICE PRESIDENT
Mr. Olson. Mr. Chairman, I am Wallace Olson, representing the American Institute of Certified Public Accountants. I have with me this morning Mr. Theodore Barveaux, a vice president of the American Institute.
I would like to read my testimony, but I also would like to enter into the record a full docunent with two attachments.
Mr. BARVEAUX. We will supply those for the record.
Mr. Olson. Mr. Chairman, I am pleased to have the opportunity to appear before your committee today to present certain views of the accounting profession which have a direct bearing on the broad question of corporate chartering which is the subject of these hearings.
I am the president of the American Institute of Certified Public Accountants, which is the sole national organization of certified public accountants with a membership approaching 120,000.
In announcing these hearings on corporate rights and duties, Senator Magnuson stated :
In these hearings we will explore the historical development of the corporation in American society, the present role of the corporation, the degree to which present laws are capable of properly controlling giant national and multinational corporations, and the need, if any, for new laws to govern these corporations.
Although the temptation is great to discuss all of these questions in some detail, I believe the time of the committee might best be utilized during my testimony by allowing me to focus on the single subject of the importance of the role of independent auditors in relation to corporations and the nature of auditors' independence.
The work of the public accounting profession in recent years has attracted a high level of attention within the business community and governmental circles.
This increased interest and visibility has resulted in large part from a growing recognition of the importance of obtaining assurance regarding the reliability of corporate financial statements.
As the Nation's economy has grown in size and complexity the Federal Government has found it increasingly necessary to engage in more extensive planning and control.
At the same time, our system of capital formation and the functioning of our capital markets have become widely recognized as essential to the continuing health of the economy.
The availability of reliable financial data is necessary to the establishment of sound economic policies and the maintenance of capital markets which attract a broad base of investors,
The CPA's role as auditor of corporate financial statements is indispensable to fulfilling this need. Thus, the work of auditors is very relevant to your deliberations about the role of corporations in our society.
The public responsibility of the certified public accountant is clear. His work product must serve the needs of a wide range of users of financial statements which include credit grantors, corporate shareholders, potential investors and the public at large.
To meet these needs he has a duty to advise corporate management and boards of directors with respect to the fairness of their financial statements in accordance with generally accepted accounting principles.
Because of this public responsibility and the fact that independence is the touchstone of the auditing profession, I will devote the rest of my testimony to the relationship between auditors and their corporate clients.
This particular subject is especially important since it has been proposed by the Corporate Accountability Research Group that the existing relationship be altered to provide for the rotation of auditors on a predetermined schedule.
1 The attachments Appendices A-C are in the Committee files.
In considering this proposal it is necessary to discuss the fact that auditors are sufficiently independent without the imposition of a rotation requirement which, on balance, we believe would do more harm than good.
An understanding of the concept of audit independence requires a knowledge of the basic reasons why audits are useful.
Because those who are responsible for the representations in financial statements are employees or principals of the issuers, they cannot be expected to be unfailingly impartial in portraying the financial condition and results of operations of their respective business enterprises.
Thus, the users of financial statements must look to others to gain a greater measure of confidence that statements are fairly presented.
It is this need which is met by the examination conducted by an external auditor and by his professional opinion as to whether the financial statements are presented fairly in conformity with generally accepted accounting principles.
In order to fulfill this role, the auditor must be someone who is not only outside of the business enterprise, but is as free as possible from the influence of it management and owners and from other conflict which might impair his objectivity.
Under these circumstances, the more an auditor is involved in the work which enters into the preparation of financial statements, the greater will be his knowledge of their content and fairness of presentation in conformity with generally accepted accounting principles.
This is an important fact which we should keep in mind when considering how far an auditor ought to go in providing services to an audit client. I will examine that question in more detail in a few moments.
To assure that auditors maintain a satisfactory posture of impartiality, the profession has included a rule in its code of ethics which prohibits two types of relationships with audit clients :
First, financial interests in connection with a business entity which is the subject of an audit.
Second, serving the audited entity in a capacity which would cause the auditor to be in fact or essentially equivalent to being an officer, director, or employee of the entity.
The term "independence” has been traditionally used by the profession to describe the required integrity and objectivity of auditors and it is those qualities which are the essence of professionalism.
However, auditors cannot practice their calling and participate in the world's affairs without being exposed to situations that involve the possibility of pressures on their integrity and objectivity.
To define and proscribe all such situations would be impracticable. To ignore the problem for that reason, however, and to set no limits at all would be irresponsible.
It follows that the concept of independence should not be interpreted so loosely as to permit relationships likely to impair the auditor's integrity or objectivity nor so strictly as to inhibit the rendering of useful services when the likelihood of such impairment is relatively remote.
I would now like to describe more specifically some of the prevalent types of relationships and pressures that have a bearing on where the line should be drawn to maintain an appropriate degree of independence on the part of auditors.
Certain relationships have long been regarded as posing such a serious threat to the independence of auditors that they have been prohibited under rule 101 of the profession's code of professional ethics.
Under this rule auditors are prohibited from expressing opinions on the financial statements of a client if, with certain qualifications, they:
First, have any financial interest in the client.
Second, have a material joint, closely held business investment with the client.
Third, have a loan either to or from the client.
Fourth, are connected with the client as a promoter, underwriter or voting trustee, director, officer, or in a capacity equivalent to a member of management or an employee.
Fifth, are trustees or executors of trusts or estates having any financial interest in the client.
Sixth, are trustees for any pension or profit-sharing trust of the client.
These prohibitions have received a high degree of compliance within the profesison and are being rigidly enforced. Accordingly, the relationships described under the rule need not be examined further except to note that in some respects the proscriptions have been made exceptionally stringent to facilitate their enforcement.
Among the relationships which are not prohibited and which are perhaps most frequently cited by the profession's critics as a basis of concern are the fact that auditors:
First, are appointed and paid by the clients which they audit.
Second, provide a variety of nonaudit services that entail acting in the role of advisor or advocate for their audit clients.
Inherent in the first of these concerns is the suspicion that auditors might unduly favor a client's wishes when making difficult judgments in the course of an audit.
The concern is based on the assumption that the fear of losing a client and the resulting effect on the auditor's income or prestige is sufficient to cause him to be less than objective.
The second concern arises from the belief of some that providing services in the role of advisor or advocate to an audit client will, in some instances, result in an auditor having to pass judgment on the reporting of financial data that is a result of his own advice or actions in behalf of the client.
The type of services most frequently cited as causes for alarm involve acting as an advisor on matters that are furthest removed from the traditional field of accounting.
Consulting on matters that are more directly related to accounting seems to generate less concern. This ambivalent attitude toward consulting appears to indicate that competence rather than independence is what is being questioned.
Other types of relationships with clients which are not prohibited are those which are purely social in nature. While it is recognized that