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CORPORATE RIGHTS AND RESPONSIBILITIES

MONDAY, JUNE 21, 1976

U.S. SENATE,

COMMITTEE ON COMMERCE,

Washington, D.C.

The committee met at 10:30 a.m., pursuant to recess, in room 6202, Dirksen Senate Office Building, Hon. Vance Hartke presiding.

OPENING STATEMENT BY SENATOR HARTKE

Senator HARTKE. The committee will come to order.

Good morning. This is the fourth day in a series of hearings to explore the proper relationship between the Government and the corporation. These hearings are, in part, the result of recent revelations of improper corporate activities, including the well-publicized disclosures of questionable and illegal payments at home and abroad by U.S. corporations.

Thus, it is appropriate that we have three witnesses with us today who are very familiar with the control mechanisms available for preventing illegal or antisocial behavior by the major corporations. These witnesses will be addressing the primary question before the committee: What is the proper relationship between the Government and the corporation and how do we promote efficient economic production while curtailing illegal and antisocial activities?

Our second witness this morning, the Chairman of the SEC, is especially qualified to address this issue. The SEC has been instrumental in disclosing many of the questionable and illegal corporate practices that have focused so much attention upon the issues before us today, and Chairman Hills has not hesitated to pursue these inquiries or to seek additional remedies where existing laws are inadequate. Our first witness this morning will be Prof. Christopher D. Stone, of the University of Southern California School of Law.

STATEMENT OF CHRISTOPHER D. STONE, UNIVERSITY OF SOUTHERN CALIFORNIA SCHOOL OF LAW

Mr. STONE. I have already provided the staff with a copy of my prepared statement and I would just as soon hand those in.

Senator HARTKE. Your entire statement will appear in the record, sir.

Mr. STONE. I would like to make a few general statements and then make myself available for questioning.

First, I would like to make a few remarks placing these hearings in a very broad social and historical perspective. I am aware, from what

I have seen in the press, that most of the emphasis of these hearings on corporations has been addressed to the business corporation, the problems that business corporations pose. My remarks, too, focus primarily on the business corporation.

But I think I would be remiss not to point out that "corporations" has a broader sense that is important to keep in mind. Indeed, the problems that are posed for our society today stem from corporations of all sorts, from institutions of all sorts; not merely the business corporation, but the union, the pension fund, the university. I stress this because, as my statement

Senator HARTKE. Would you include in that foundations?

Mr. STONE. Indeed, sir.

Senator HARTKE. I was going to say, if you don't include foundations, you omit one fundamental. As you know, I happen to be the chairman of the Foundations Subcommittee of the Finance Committee. Mr. STONE. My next point would underscore that. I think people tend to consider the business corporation apart from the other corporations by emphasizing that the business corporation is profit oriented. There is some truth to that, but it is a dangerous oversimplification to suppose that the problems we are having with these organizations spring solely from profit. I know of no corporation that is as insensitive to its staff or to those with whom it comes in contact as the ordinary hospital. We know that the Soviet factories pollute.

I emphasize that for this reason: Those who are too quick to assume with the dreamy theory of economics textbooks that corporations are solely motivated by profit can then suppose, wrongfully in my view, that you can control corporate behavior just by raising fines, or more effectively gathering up damages through civil relief of various sorts, like class actions.

Unfortunately, I do not think we can deal with corporations on the assumption they are purely profit sensitive. Part of our problem stems from the fact that corporations are, in fact, moved, persuaded, motivated by a much subtler and complex array of institutional forces. That is why the drift of by testimony today will be toward meeting head on these institutional forces and demonstrating some of the shortcomings of our present strategies.

Now, the present strategies we use to control corporate behavior are basically twofold: One, we address the corporations' profit centers. We threaten the corporation with a fine. We threaten the corporation with civil damages.

Two, in some cases we threaten key individuals.

Now let me just briefly touch upon the highlights of why reliance on those two strategies is not adequate and, therefore, why I believe this Congress will have to take steps to introduce a slightly different mode of controlling corporate behavior.

First, consider the strategies that are essentially threats to the corporations' profit centers. What threats are these to the chief officers of the corporations? Their salaries, their compensation schemes are largely independent of the ups and downs of the company for whatever causes, and seem to be quite independent of losses the corporation suffers through the largest fines that the law has meted out. After the Ford Motor Co. suffered a $7 million fine for an EPA violation.

a group of law students at U.S.C. doublechecked the salary developments of the top Ford officers.

What one finds is that their salaries continue to rise, above the President's wage guidelines, I will add, including $600,000 bonuses for each of the two top officers. My point is that the strategies of the law that are addressed to the corporation do not necessarily intimidate the top executives. They are going to get paid whatever they are going to get paid. And threats to the profit centers don't necessarily intimidate the people who are working at the lower levels of the corporation, either. That is, a lot of harms are not arising at the directorship level, but at the lowest levels of corporate operations. I think directors would like brakes bolted more securely down on the cars, but these threats to the company again have a relatively small impact on the workers down below, where a lot of these things are taking place. Their aim is to rise up the corporate ladder through whatever compensation strategies have been developed for them, and these internal strategies are only indirectly affected by the threats to the company. There are other reasons I go into in my book and in my prepared testimony why I doubt that the threats aimed at the profit center are really adequate to induce the company to make the internal changes that are necessary if the company is not going to run afoul of the law. Second, take the threats to the top executives. There is a lot of emphasis that has been placed on that: Raise the fines, put them in prison. I, too, think we should be tougher. But I caution that is a very limited approach.

To begin with, the people at the top of any company are apt not to know what is going on about a lot of things. They are apt not to know because corporations are very, very large. They can't know everything that is happening at the operating levels.

Second, there develops in many institutions a pattern of not reporting to the chief executive problems that are going on. Indeed, I am sorry to say that it may be the job of counsel to intercept such information on the way up so as to screen and protect the top, especially the outside directors, from taint. And even when cases are brought against executives, and they are found liable, the judgment can often be blunted by indemnification or liability insurance. One wants to say, as I said when I was in law school, well then, here is how you have got to handle the corporation problem, you throw these guys in prison. Indeed, we probably should be tougher. But I am much more persuaded today of the difficulties that come with the complexities of life in a large organization. And in fact if you look at these standards that the ABA and the ALI have established for commitment, you see that usually these top executives do not meet the profile, the sentencing profile, which would lead to commitment. They are not likely to have a prior record, for example, or need rehabilitation, which is another reason why I think the tendency of the law will be not to order commitment of executives, except in the most flagrant and clear-cut cases-and most of the problems corporations cause are not so clear-cut.

For these reasons, I don't think the two basic strategies work adequately, either, the strategies aimed at the corporation's profit centers, or the strategies aimed at the key individuals. We can no longer, in

my view, trust to these traditional threats to get the corporations to make changes internally. What then do I think should be done?

We have to start at the beginning, with basic organization and principles. If a corporation is, let's say, producing soup that has botulism, why is it, and how do you stop it? Certainly the problem is not going to go away just because the company writes a check to a widow. The problem is going to go away, it is going to be repaired, only if the company makes certain changes in its internal organization. It has got to improve its purchasing procedures. It has got to improve quality control. It has got to improve its hiring and firing, its supervision. It has got to make these internal changes.

If the present threats of the law are inadequate to induce these changes, then the key is, the law has got to bring them about directly. What do I mean by that?

Take the problem of how roles are defined in the company. We trust almost entirely to companies to establish roles and to define roles within the organization. We let a company that is operating a nuclear facility decide on its own whether it is going to have a vice president in charge of safety.

That is absurd. That is absurd! The law says that a company, to enjoy the corporation privileges, has to have a board of directors, and it stops there. I suggest that the law will increasingly-I am advocating and I am predicting that the law will increasingly-begin to establish roles within companies operating in very critical areas; the law will have to say, Look, if we license you to engage in this highly dangerous and highly critical field, then you have to have a vice president in charge of X-pollution control in highly polluting industries, safety in nuclear or liquid natural gas transport.

Second, it is not enough to have a name on the door and call someone a vice president in charge of safety. They will give him a nice rug and closet away somewhere. The law will have to define the role, its powers and functions. That is not unthinkable.

The new FDA rules on good manufacturing practices have adopted these suggestions; and now will require a company in the pharmaceutical field to have a quality control unit; the regulations say, in effect, it is not up to you to decide whether or not to have a quality control unit if you are producing pharmaceuticals. You have to have a quality control unit. And the regulations go on and establish what the responsibilities of that unit are and what the powers are.

Now if the law will specify the responsibilities within the organization for certain things, then the criminal law can be an effective backup, because by locating and setting resposibility for particular acts within the organization on particular people, the law then has pierced the anonymity that ordinarily obtains in an organization; and if something goes wrong, you, X, under the rules of your company, which were published, are the person who was responsible for monitoring the system; and it puts the heat where the heat belongs, not sort of diffusely on the total organization, not illusory on the people at the top, to be responsible for everything, which they cannot be. It sets responsibility where responsibility can be effective.

My other suggestions go to changes of this sort. There are changes: in role definition within the organization, changes in information pat

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