holders, creditors, employees, or customers of the corporation. Moreover, the package has been designed by the shoppers to suit their particular needs.

Taking account of these phenomena, Pro. Ernest Folk, who served as the reporter for the Delaware and South Carolina statutory revisions, has described State statutes not as enabling laws, a neutral term, but as promanagement and antishareholder. This is manifested in numerous provisions affecting stockholder rights: reduced voting rights; partial elimination of appraisal rights; exalting form over substance in dealing with acquisitions and self-dealing transactions; and generous indemnification allowance.

But, accepting the fact that corporations are managed by persons who are not accountable to serious legal restraints, does that prove that we should now try to assert them? If so, how? Are there dangers?

I would ask first, what are the goals of corporation law and whether State chartering as we now know it, together with the existing Federal statutes, some of which Dr. Smith referred to, can meet those goals.

First. The internal governance arrangements should be oriented toward achievement of the long-term economic goals of the corporation. This embraces a respect for the corporations' social obligations. Business people should make business decisions which, by and large, should be evaluated in a business context, not a legal one. But merely because one claims a business judgment has been exercised does not prove it. Second. The law should seek to create a climate of confidence among investors so they will continue to furnish the capital necessary.

Third. Conflicts of interest between managers and the corporation or with stockholders should be minimized. The goal here is fairness to investors who must necessarily rely on the efforts, honesty, and good faith of others for the attainment of their own economic goals.

Fourth. The law should provide an effective means of enforcement of stockholders' rights, and a means whereby the other interests affected by the corporation may also obtain redress for wrongs that injure them.

Fifth. A political process to achieve accountability of managers is one of the main structural goals. This may mean that we have to provide an effective board of directors which may not be a reality today.

Sixth. The law should preserve what Prof. Henry G. Manne has called "the market for control." The ability to change management is critically important if a system of accountability is to function. This means that transactions that have the effect of hardening management's grip on control, or structural arrangements that impede an outsider's chance to succeed in the market for control, should be viewed suspiciously.

Seventh. The law should provide wide access to information. Disclosure is one of the most effective means of controlling the whole wide range of those with interests in the corporation.

Finally, the law should operate to prevent impediments to the functioning of an efficient marketplace.

State corporation statutes do not strive for the attainment of these goals. In one notable respect, State legislatures have taken a decidedly regressive step away from the goals. A growing number of States have adopted tender offer legislation that discourages the making of tender

offers hostile to management. This is clearly the intent of these laws, and it is probably their effect. These statutes all require an offer to be filed in advance of its being made, an approach specifically rejected by Congress when it adopted the Williams Act as too favorable to management.

I realize I may be treading on some toes, Senator Hartke, since Indiana has adopted one of the laws which I think most easily fits into this description. I think that what the thrust of these laws has been is to discourage the making of tender offers; that is, an outside attempt to take over control of the corporation. Indiana, I might add, didn't start this trend. Ohio did, and it may well be that when one State adopts a law that works in the interest of management other States really have little choice but to follow that lead or else they will see corporations abandon their existing home and run for cover of another jurisdiction.

So what started as a modest development has now grown to 15 States that have adopted this kind of legislation and it's pending in several others, including some of the largest. I think no legislation more clearly reveals a continuing promanagement bias by the State legislatures. The reforms Dr. Smith referred to opening up the boards in terms of more outside directors, more audit committeesis a goal that I think is simply unattainable under State laws. Corporate managements are not flocking to adopt many of these changes and the State legislatures won't do it. The only possibility of achieving any kind of legislative change, I submit, is through the Congress.

The judge-made law of corporations is perhaps more important than State statutes. Professor Cary has proved, I believe, that State courts, exemplified by Delaware, have faithfully administered the State legislature policy.

The issue, of course, is not Delaware, but State law. Defenses of Delaware that its courts are more protective of stockholders, or at least no worse, prove very little about State law in general. Professor Cary has been faulted for not having paid enough attention to important Delaware decisions that imposed high fiduciary standards on management, which in part is true. The main issue is whether Professor Cary misrepresented the state of State law in general. That, I think, he did not do. My own paper develops this a bit more fully in dealing with some of these cases.

Despite some progress, and some occasional good language in the cases. State courts do not seem capable of achieving a balanced corporation law. Affirmative obligations to be fair are rare; diligence is permitted to be minimal; control may still be protected. Only grossness will be condemned, and this is not good enough.

Professor Winter is correct when he says that the definition of fiduciary duties by courts is difficult. It is precisely for that reason that I do not want that task to be performed under the aegis of a statute whose bias is clear and by judges who seek to fulfill that lopsided policy.

If State law is mired in a promanagement position, can Federal law fulfill the goals of corporation law? Federal law mainly refers to Federal securities law and the judicial interpretations that have done much to expand the Federal presence.

Courts have found varied uses for the SEC's rules. In 1961, the Third Circuit Court of Appeals observed that section 10(b) and rule 10b-5 constitutes "far reaching substantive Federal corporation law." But a change has resulted from recent actions by the Supreme Court. First, the Court has stopped relying on the judgments of the SEC as to the meaning of the outer reaches of the securities laws. The SEC was once virtually invincible in the Court. Between 1936 and 1971, I don't remember the SEC losing a case in which they were involved or in which they were appearing as amicus curiae for somebody else. In the last two terms, the SEC has been involved in seven cases either as a party or amicus curiae. They won two of those cases, two cases involving interpretations of the antitrust laws. Curiously enough, the Justice Department was on the other side of those cases. The SEC argued for a narrow interpretation of the antitrust laws. They won. But in five other cases the SEC came in and argued on behalf of the plaintiffs for an expanded reading of the Federal securities laws and they lost all of those, every one. In one case, the SEC didn't appear and the Court rather gratuitously said, "Well, if they did appear, we wouldn't have paid any attention to their views anyway."

Second, the Court has ruled very narrowly in two important cases under rule 10b-5. Of equal significance, the opinions in those cases appear calculated to retrench the scope of the rule and to halt the growth of Federal corporation law.

So I think those who are pinning their hopes on Federal securities laws to fill the gaps that are left by State law are taking a position that is really no longer tenable.

Federal legislation alone is capable of achieving the goals for corporation law. The only alternative is to select different goals. At present, corporation law is pursuing a different goal-to advance the interests favored by corporate management. Existing Federal legislation ameliorates that condition, but it is only partially successful. The question remains: What should new Federal laws provide?

I am not too interested in labels. Professor Cary opposes Federal chartering, but he offers a sound program for the start of a Federal statute. Professor Stone, from southern California who appeared before you, also opposes Federal chartering, but he too proposes significant changes in corporate structure that, be assured, will not be adopted by State legislatures. Combining the two approximates my own suggestions for Federal chartering. I believe an effective law must be comprehensive and must to some extent oust some State jurisdiction, which marks my point of departure from my distinguished brethren, which are again set forth in much more detail in the fuller paper, so Í won't take the time to go through them now.

I might say that I agree with some of the things Ralph Nader proposes in his impressive work and I disagree with some others. I think that my own assessment would be that Ralph Nader is perhaps a better diagnostician than surgeon, but I think many of his proposals for change are extremely worthy of serious consideration by the Senate.

I do think and I guess this is where I depart from my distinguished brethren Cary and Stone, I think Federal legislation should be reasonably comprehensive and I think that necessitates ousting some, but of course not all, State jurisdiction over corporations.

Finally, how do we calculate the costs of Federal chartering and are they worth paying?

This is not an issue of States rights because the States have very little power to surrender. They have abandoned their control over the internal operations of corporations. The loss would be felt by the management of major corporations. To those who have been concerned about Washington's growing power-and you have been on the campaign hustings this spring, Senator Hartke, and you're fully aware of the sentiment that people express against Washington-I must acknowledge that there would be, to some extent, a growing power on the part of the Federal Government. What it amounts to, though, is some power would be shifted from private to public hands, and that means from persons who are relatively free from accountability to those who are highly accountable to others who are affected by their actions. But power perhaps is not the real question. It is the policy exercised by power holders that is at issue and it must be acknowledged that there is a danger here. A great deal of economic and social progress has been achieved by the efforts of individuals free from what is often bureaucratic stultification as well as from effective accountability. A certain degree of creative style could be lost by reducing management's power and giving it to a powerul government. However, the notion of the swashbuckling pioneering entrepreneur may be largely romantic. Business organization charts resemble the Pentagon's. The relocation of power may be nothing more than replacing Detroit's bureaucracy with Washington's. Moreover, the gain to be won, is to create a corporate system that responds more effectively to the needs of investors, that more readily allows replacement of inefficient management with better people and that wastes less of its resources on conflicts of interest. While there is no assurance of success, at least the game is worth the candle.

Thank you for your attention, Mr. Chairman.

Senator HARTKE. What you're saying is basically you just don't think the States can do it?

Mr. SCHWARTZ. I do not think the States can do it. I think that's right. I think the State pattern that we now see has been described by one observer as a historical inevitability. Under the law, under the structure as we now know it, there is what Brandeis once called a race of laxity or, as Professor Cary more recently described it, a race for the bottom. Every State tries to outdo each other in offering a State law that appeals to the managers. That's not the only segment of concern with the welfare of the corporation or affected by the corporation. I agree the States can't do it.

Senator HARTKE. But that in no way would mean necessarily that there would be a diminution of legitimate profits.

Mr. SCHWARTZ. I would hope not, Senator, and I would think not. Senator HARTKE. Quite the contrary, it could maximize profits. Mr. SCHWARTZ. Indeed. I think the notion that the managers are pursuing a profit maximizing course at all times is largely nonsense and I think there are a number of economists who can show you ample data to establish that. I'm not an economist, but I have read things that economists have written on this. I dare say that there's considerable amount of corporate waste that is related to pleasures and grati

fications, ego and otherwise, of management than not necessarily related to trimming the corporation to its most efficient style.

Senator HARTKE. Very interesting. I hope you will pursue these hearings and keep up with this and maybe you will have some supplementary comments from some other people. Thank you.

Mr. SCHWARTZ. Thank you, sir.

[The statement follows:]

STATEMENT OF PROF. Donald E. SCHWARTZ, GEORGETOWN UNIVERSITY LAW Center, WASHINGTON, D.C.

I. The Issues

Despite the fact that it is utterly without flesh, blood, soul, or personality, the corporation is capable of arousing intense emotions. Its detractors see it, and not just those who make it work (more accurately, those who work for it) as the reason for a number of ills, ranging from economic sluggishness to maldistribution of wealth. Its defenders view the corporation not only as a convenient mechanism for conducting business but also as essential for the maintenance of free society.

I believe there is truth in all of these observations. One further fact is probably true; the corporation is a durable invention and will remain a part of the American economic and social landscape in our third century. And just as the corporation will endure, so will its critics, to urge reform of its structure. Proposals for corporate reform in the United States have a unique character to them because of the singularity of our federal system. What troubles the critics, and what impels reform, is a catalog of serious substantive issues: conflicts of interest that benefit managers at the expense of stockholders; stock market manipulations and unfair securities transactions; corporate improprieties that go unchecked and often undiscerned by an ineffective board of directors and corporate bureaucracy; anti-competitive trade practices; an unhealthy concentration of power; socially irresponsible behavior. Yet we devote considerable energy talking not about those issues but about jurisdictional issues-whether a particular problem is one for the states or for the federal government. The jurisdictional argument is often a euphimism masking the underlying inquiry into the substance of the problem.

Proposals for corporate reform, at least the kind that is accompanied by law, concern the role the federal government should play in corporate law, and more specifically, whether corporations should be chartered by the federal government. What is really at stake is not whether application for a charter should be sent to Washington, D.C. or Dover, Delaware, but what kind of law will govern the creation and continued existence of the corporation. The drive for federal chartering expresses a goal for corporate law reform that its advocates firmly believe cannot be achieved unless there is a break from the existing state jurisdiction over corporation law.

In order to evaluate the proposal for federal chartering several questions must be asked. First, what is the nature of corporation law? Second, what are, or should be, its goals? Third, is existing state law adequate to achieve those goals, or, if not, is it capable of being reformed so that it can do so? Fourth, if state law is inadequate, can the goals for corporation law be achieved through judicial interpretation of existing federal law? Fifth, if neither state law nor existing federal law can accomplish the results desired, what kind of new federal chartering law, or the like, should be adopted? Sixth, does the proposed new law extract too high a price for its accomplishments?

II. Nature of Corporation Law

Berle and Means described corporation law as a form of constitutional law. It is the organic law of the dominant institution in our society. However, it should not be confused with the law of corporations. Corporations are subject not only to their organic law, but to state and federal law governing securities transactions, tax, anti-trust and countless other laws regulating specific conduct and to the regulations of stock exchanges and the practices of accountants.

The main function of corporation law is to define the internal relationship between the corporate entity and its stockholders and the managers. The cor