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lieve that this premise is widely accepted. I have then tried to demonstrate that neither state law nor existing federal law furnish that adequate protection, nor is it possible for state law ever to do so. That leads to the inevitable conclusion that only new federal legislation is capable of achieving the goal of protection. The individual pieces of this logical transition are also widely shared, I believe, although the conclusion is disputed. However, I think the case for change is persuasive and the natural resistance to change should be overcome.

The issue then becomes what kind of change. Professor Cary's thoughtful proposal, I believe, would prove insufficient. The more difficult task of federal chartering, of creating a single federal law applicable to large corporations, is needed. I have tried to furnish some specifics, and to indicate some of my agree ments and disagreements with the ambitious Nader proposal.

In whatever exact form it takes, I suggest several themes should pervade new Federal legislation.

First, new law should develop a corporate organic structure that spells out the standards of rights and obligations more clearly than present law, thereby enabling stockholders to secure greater self protection.

Second, a new law should help create a more effective corporate governance system.

Third, the law should recognize the value of the market for corporate control.

Fourth, the law should express the goals of sound corporation law so as to guide the courts into new attitudes.

At present corporation law has been deserted as an instrument of public policy. It has been replaced by a policy that gives to managers unaccountable power to deploy corporate resources as they see fit. While sometimes this serves the common weal, often it does not. No other instrumentality of the law except the Congress can remedy this situation. It is a difficult job, but it should begin.

Senator HARTKE. Prof. David L. Ratner, Cornell Law School.

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STATEMENT OF PROF. DAVID L. RATNER, CORNELL LAW SCHOOL,

ITHACA, N.Y.
Mr. RATNER. Good morning, sir.
Senator HARTKE. Good morning.

Mr. Ratner. Mr. Chairman, I appreciate the invitation to appear before your committee. I'd like to offer some thoughts as to the reasons, for the present suggestions for a Federal corporation law and some thoughts as to the areas where a Federal corporation law can be most effective.

I think it's important to distinguish the idea of corporation law from other types of controls on corporations, such as the antitrust law, regulatory agencies, and other techniques. I would like to address myself to the areas where I think a corporation law could be useful.

The elements of dissatisfaction with the performance of large corporations at the present time seem to me to fall into three categories, and proponents of a Federal corporation law have addressed themselves to all three.

One complaint is that the largest corporations are too large and powerful. A second complaint is that they are unresponsive to current needs of the society. A third complaint is that they are corrupt, or at least that some people in some corporations are corrupt.

Let me look at each of those in turn and try to see whether a Federal corporation law could be useful in dealing with them.

First, on the question of size and power, how would a corporation law be used to limit it? Suggestions I have seen, in the Nader report and elsewhere, include the idea that a corporation would have a limited life instead of a perpetual life; that its powers and the types of business which it could conduct would be limited in its charter; and that it would have to go before a Federal agency and perhaps have a full hearing before it was permitted to expand into any significant new business or acquire any other companies.

I must confess I'm rather dubious as to whether that is really an effective means of controlling corporate size and power. The idea of a governmental regulatory agency conducting a hearing, trying to guess which expansions of business in the future will be good or bad, I think is likely to re-create in all of our industries some of the problems that we face in regulated industries such as transportation and communications. There, in many cases, the governmental decisionmaking process has been a means of entrenching established monopolies or oligopolies and has stifled creative new developments.

There is a legitimate concern here. I think many corporations, particularly the conglomerates, have grown in size and scope far beyond the point at which they serve any useful purpose by continued growth, but I think it will be far more effective to deal with that phenomenon through better antitrust enforcement by the established agencies, the Antitrust Division, and the FTC.

A corporation law could be useful in helping those agencies by a notice provision requiring a corporation to make some sort of filing whenever it went into one of these new activities so that other agencies could learn about it. But I do not suggest it as a direct control on expansion because the cure may be worse than the problem.

The second area of concern is the lack of social responsibility of corporations. The argument is that corporations pollute the atmosphere, that they perpetuate discriminatory practices and engage in other practices which are socially undesirable.

There have been a variety of suggestions to deal with this problem, to internalize the decisionmaking process on these social issues, to bring the points of view of minority groups, local communities, and other affected people employees, customers and others-into the board of directors so that it would become sort of a legislature in which these various interests would be thrashed out.

I must admit to being rather dubious about those proposals. Each corporation is engaged in a unique type of business or mix of business. I think that any formula that there has to be one environmental director, one minority director, one customer director, is going to be unduly rigid. I think there are serious problems in devising an effective selection process under which these directors would actually feel a responsibility to a particular constituency. I'm afraid that we would wind up by that route re-creating in our large corporations many of the problems that afflict an organization such as the U.S. Postal Service.

While there are similarities between large corporations and other bureaucratic organizations, such as Government agencies or universities, they do have different functions. The function of corporations is to produce goods rather than to regulate areas of the economy or the society, and the type of governmental structure that is appropriate to an overall legislature may not be appropriate to a corporation. So I see only limited usefulness in that area of social responsibility.

In this area again, I think the way to deal with the problem is to be sure that there are effective controls on corporate management through

other types of laws so that they cannot pollute or discriminate or do other undesirable things.

This brings me to the third problem, which is, I suppose, the one that, more than the others, is triggering the current interest in a Federal corporation law--the pervasive corruption which has been found in many large companies.

When we talk about corruption, I think it goes beyond the recent disclosures of political influence, bribery of foreign officials and such things. It's been manifested for many years in departures from fair and decent commercial practices—deceptive advertising, faking of test results where products are supposed to be tested for their safety or performance, manipulation of financial statements, hiding of figures, and various other ways in which corporate managers make it more difficult for consumers, for shareholders, for Government agencies, and others with whom they are bargaining or dealing, to find out what's going on and to deal with them on an equal basis.

Here it might seem that again the answer should be, as I believe the representative of the NAM was suggesting this morning, that if the corporations are breaking the laws, we should enforce the laws. But I think in this area particularly, and to some extent in the other areas, we can make it easier to deal with the large corporations by imposing some internal controls so that they are less likely to do the kinds of things that have been disclosed recently.

How can this be done? I'd like to suggest that there are three major areas in which Federal corporation law could help to produce better, more honest, fairer performance by corporate managers.

First, better access to corporate information. Second, greater shareholder participation in decisionmaking. Third, more effective remedies against management misconduct.

First, on the question of information, the corporations have generally taken the position, I suppose based on the idea of trade secrets and the fourth amendment protection against unreasonable searches and seizures, that nobody is entitled to see the records of the corporation to find out what's going on unless they can demonstrate some right under a specific statute. I think these ideas have been carried way beyond the original intent of that sort of provision.

During yesterday's American Enterprise Institute program on Federal chartering, a representative of a bank was talking about things discussed at board meetings that he thought should never be made public. Two of his three examples were improper payoffs to foreign officials and a pending acquisition of another company. The latter situation has been one of the most fertile sources of insider trading by officers, directors and others who find out about the merger before other people do.

I think there is a need for a new law which provides access to corporate records by shareholders, by customers, by Government agencies, and others, subject only to some obvious exceptions, such as personnel records, and legitimate trade secrets-processes which the company has and which its competitors shouldn't be able to find out about. Improved access to corporate records would greatly help to equalize the presently very unequal bargaining position of Government agencies, consumers, and others that have to deal with the corporate management.

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As a corollary to this proposal, I think it's important to strengthen the power of the independent auditors. At the moment they simply certify that the management's financial statements don't depart from one or another alternative form of presentation that could be considered a "generally accepted accounting principle." I think the independent accountants have to be given a greater independence from management and more responsibility for assuring that all financial information is fully disclosed and disclosed in a fair and comparable

The second suggestion is for increased shareholder participation. There have been many suggestions in recent years that shareholders' democracy is a will-o'-the-wisp, that most shareholders in large corporations have such tiny interests that they have no real concern with what the corporation is doing, and that it makes no sense to require a shareholder vote on charter amendments, new business, issuance of additional securities, mergers, or other changes.

I think this view is, in many respects, inaccurate and that it's becoming more inaccurate all the time. There is a trend at the moment for increasing concentration of stockholdings in large institutions, particularly pension funds, and managers of those institutions have a responsibility to see that corporate decisions are in the best interest of their beneficiaries. Many of those institutions, particularly the universities and religious groups, also have a concern with social matters, and through their role as stockholders they have in many cases brought significant pressure to bear on corporate management and required them to adopt more socially responsible policies.

I think this idea of giving the shareholders, as shareholders, more decisionmaking power-really not making decisions, but passing on management decisions—is a more flexible way of getting representation of other interests into corporate decisionmaking than insisting on representation of particular groups on the board of directors.

I think other changes could be made in this area as well. For example, mandatory cumulative voting, which would make it easier for a minority group of shareholders to place a representative on the corporate board. The tendency in recent years has been for States which had mandatory cumulative voting provisions to eliminate them, but Federal law could make it mandatory for all large corporations and offer a much more effective control on corporate management. If their actions became too outrageous to any significant group of shareholders, those shareholders would have a chance to elect representatives to the board.

I think it would also be desirable to expand the opportunities for shareholders to nominate candidates for directors and have those nominees appear on the proxy soliciting material that the management sends out. This is something that the SEC probably could do under its present authority, but has never seen fit to do. The SEC could also give shareholders the right, within limits, to have statements of opposition to management proposals included in the proxy material where there are legitimate issues of policy that ought to be exposed.

The proxy solicitation process, under SEC rules, has become the principal forum for discussion of corporate policies. I think that under a Federal corporation law it could be made considerably more effective.

Third, remedies for management misconduct. As the NAM representative pointed out, there are criminal penalties for corporations

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which violate the law, but corporations can't be sent to jail. They can be fined, but in many cases the fines are insignificant given the size of the corporation. The managers, or the people who make the illegal decisions, in some cases could be sent to jail, but courts are reluctant to do it because our criminal sanctions and procedures were originally thought of as punishment for murderers and robbers; people don't feel comfortable applying them to corporate executives. Whether that's right or wrong, they don't.

I think what we need is a provision for more limited sanctions against corporate officers, such as barring them from association with any corporation for a period of time if they engage in certain types of illegal conduct. This is similar to provisions under the Federal securities laws relating to broker-dealers, investment advisers, investment companies, and others, and is a type of remedy the SEC has used effectively in many cases. It really is more appropriately tailored to the types of offenses that are involved.

There could also be provision, such as the SEC has designed on some occasions, for a Government agency or a court to intervene and to require the appointment of new and independent directors where there's been a pervasive pattern of wrongdoing over a long period of time; in other words, when it's quite clear that the existing management does not have the capacity or the will to change the practices. That would be a flexible approach to dealing with the kind of pervasive thing, Mr. Chairman, that you were describing earlier, where a company goes on for years violating the law over and over again.

I think that the provisions for shareholder suits in the courts against management should also be expanded. The trend under State law has been to limit shareholders' suits in various ways. The State legislatures have been responsive to the complaints of corporate management that their time is being wasted by illegitimate suits, but in many cases these suits have been successful and they have been important in imposing liabilities on the individual directors who engage in the improper activities.

These various changes that I have suggested are more limited than some of the proposals you have before you, such as the Nader proposals. Indeed, they are all matters which have traditionally been considered the province of State corporation law. What, then, is the reason for in effect superseding State corporation law with Federal law at this time? Why can't the States make the changes? As Professor Schwartz said, the States could make the changes but they haven't and they won't, because in the case of the large corporations no individual State has the power to enforce the standards. The corporation can simply pick up and reincorporate in another State.

Senator HARTKE. Let me ask you a question. Is there any room for an approach in which you have Federal standards which regulate the entire operation--but if there's a subsidiary of that operation or a plant in the State, for example, you could have that combined jurisdictional concept in which those standards would still apply in addition to the State standards? In other words, could you have a Federal charter and still have the State charter, and if you wanted to do business in another State you'd have to go to that State and get a charter, too?

Mr. RATNER. I think you could certainly do that, Mr. Chairman. What I would envision, as you say, would be a Federal statute applying

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