It is not possible, I think, to consider amending the Securities laws to require this additional disclosure without looking at what you are trying to do with disclosure, and to do that it is necessary to look at the corporation as a social, economic, and political institution.

The same is true of the fiduciary obligations of corporate managers, as now regulated almost exclusively by State corporation law.

As you are aware, the expansion of the Federal securities laws into the area of the regulation of management fiduciary duties has been rapid and continues to grow-although recent cases decided by the Supreme Court shed some doubt on whether that expansion will continue-but again, you have a tension between a defective system of State regulation and a system of Federal regulation which was designed to protect only one segment of the public, the investor community, and which was simply not designed to handle problems of fiduciary duty.

Again, I think it is necessary, in taking a wholistic view, to attempt to integrate disclosure; for example, with a statute designed to deal with management fiduciary obligations in the the same approach to statutory drafting. It is difficult to deal with fiduciary obligations if you don't consider what kinds of disclosure are available. And the reverse is true.

An intelligent approach, the only rational approach ultimately, is to look at the institution as a whole.

Mr. CUNNINGHAM. So in effect while not leaving behind the existing law, to integrate that law and to examine its purpose?

Mr. STEVENSON. Exactly, and to look at not just the topics addressed by State corporation law, to the extent that it does address these topics, but to look at the problems of fiduciary obligations, corporate governance, et cetera. I have some resistance to writing antitrust provisions into a chartering statute, but we should certainly look at the topic. And we should look at protection of employees, and the protection of the public generally against corporate misdeeds.

All of those things ought to be looked at together, as separate sections in the same statute, if you will.

Mr. CUNNINGHAM. To turn to your disclosure proposal in your prepared statement, you argue the corporation has no inherent right of privacy.

Why doesn't the corporate right of privacy derive from the individual investor's rights of privacy, whose property is held and used by the corporation?

Mr. STEVENSON. When we are talking about individual privacy, we are talking about a subject and a set of laws, such as they exist, to protect individual privacy which derive from social or psychological needs which we are all familiar with-which exist in every societywhich are very important that we protect.

But it is difficult to see how the personal privacy of an individual shareholder is invaded if his company is required to disclose, for example, the number of dollars it makes each year in the manufacture of widgets, or the amount of assets it has invested in the manufacture of widgets, or the cost of manufacturing the widgets. Those are not personal interests.

Mr. CUNNINGHAM. Pardon me for interrupting you, but an argument can be made that these are the personal interests of managers,

just as they should have a right of privacy in their profession, just as the employee should have a right of privacy as an employee, and he should not be subject to incursions upon that privacy by the corporation.

I don't happen to adopt that view, but I am curious how you would respond to that.

Mr. STEVENSON. Again I don't see how the personal interests of managers, who are fiduciaries with respect to assets they have in their care, are any more involved in disclosure of corporate affairs than would be, for example, the personal interests of a trustee of an estate in disclosure of what he has done with the affairs of the estate.

There is simply no personal interest of the manager or trustee in those matters.

Now I think a case can be made that there are more personal interests involved in a closely held corporation, which is why I think it is important that we distinguish in our discussion, as I tried to do in my statement, between closely held and publicly held corporations.

Mr. CUNNINGHAM. One of the exceptions you make to your proposed general disclosure rule is business conversations between managers. Where does that line breakdown? I think if we are really considering the preparation of a statute in this area, it would be very difficult to differentiate the manager's confidentiality requirements, similar to the company's trade secrets requirements to protect innovation, from merely the desire to keep the competition out of your business, so you can compete on the basis of secrecy? How do you make that sort of distinction in a practical manner?

Mr. STEVENSON. Well, I don't suggest that that is the easiest job in the world. We do have a good analogy in the Freedom of Information Act, which has as one of its exemptions intra- and inter-organizational memorandums, which essentially are communications among Federal

managers.

The courts have admittedly had a little difficulty in interpreting that, but so far the decisions seem to be developing a workable body of law. I don't see why we couldn't do the same thing in a Federal chartering statute.

Mr. CUNNINGHAM. One of the arguments traditionally made for more disclosure is the consumer needs the information in order to make better choices about products.

Yet many economists argue that if they are willing to buy the products now with little information available, that this additional information would be a waste, dedicating resources to provide this information is inefficient economically.

Mr. STEVENSON. Let me cite you one fairly apt example, and that is the case of industries which are essentially oligopoly industries.

There was a classic paper written back in 1950 by an economist named Tibor Scitovsky. He demonstrated in that paper that oligopolists, depending on the structure of the industry and the nature of the product, frequently have an incentive to conceal from consumers the qualities of their products.

That paper has been borne out more recently by a study done by Michael Scherer, which I think I cite in my paper, who is now the Director of the Bureau of Economics at the FTC, which demonstrates

that private label products sell at a discount of something like 20 percent on the average over their brand name competitors, even though in most cases the private label products are of identical quality and are often even manufactured in the same factories.

Now what I am suggesting merely is that it would make a good deal of sense to give the consumer sufficient information on product quality that he can make the decision to choose between the brand X bleach, brand X bleach being the well-known brand name, and Safeway bleach or Giant bleach, or one of the private label bleaches, which is chemically identical to brand X, but sells at 20 to 30 percent less. As things stand now, the big manufacturers in the bleach industry have an incentive to conceal from consumers the fact that all liquid household bleaches are essentially chemically identical.

Mr. CUNNINGHAM. But the argument goes that the consumer, if he wanted this information, would demand it, he would not buy the product unless he had this information, and yet presumably he is buying, or enough consumers are buying the off-brand product to keep it on the market.

Mr. STEVENSON. Well, I can say no more than that I see that argument as based on a premise which is simply false.

Mr. CUNNINGHAM. What sort of bureaucracy do you think would be necessary to administer the general disclosure rule that you propose? Mr. STEVENSON. Not a large one. The SEC already administers several disclosure statutes, and requires in many cases, I think, too much information, with a relatively small staff.

I would think that the disclosure statute which I have in mind. could probably be administered by the same staff as the SEC now has, perhaps slightly expanded, if we cut back on some of the kinds of excessive disclosure which we now require.

Mr. CUNNINGHAM. Most of it presumably would be done through the courts, by individuals seeking the information?

Mr. STEVENSON. What I propose is two different parts to a disclosure program.

One is an affirmative reporting requirement, which would require the reporting of certain information that is not now reported.

I would add, for example, to what is now reported to the SEC, in annual reports, 10-k statements, 8-k statements, and the like, product line reporting, the "unconsolidation" or "disconsolidation" of reporting by divisions and subsidiaries, more detailed reporting of the overseas activities of multinational corporations, and a number of others which I have listed in my statement."

But those facts need not occupy a great deal of paper, nor are they complicated or unavailable to management.

I would add also some information in a few areas. I haven't studied all of the potential areas. But, for example, it would be no trick for corporations to provide in public reports copies of their EEO-1 forms, which are provided to the Equal Employment Opportunity Commission now, and which contain information on hiring and promotion policy and statistics with respect to women and minorities.

I see absolutely no reason why that kind of information should not be in the public domain.

It might be possible, although I think difficult, to provide some sort of reporting requirement on the environmental activities.

76-083-7628

The Senate is now considering a bill that would require reporting of illegal contributions made overseas. That sort of thing could be in this statute, and it would make for a more wholistic approach and would get away from what I understand as the tension between those who think the SEC ought to administer this sort of statute, and those who think it ought to be administered somewhere else.

Mr. CUNNINGHAM. Thank you very much, Professor Stevenson. I have no further questions.

[The statement follows:]

STATEMENT OF RUSSELL B. STEVENSON, JR., NATIONAL LAW CENTER,
GEORGE WASHINGTON UNIVERSITY

It is impossible to discuss intelligently the desirability of some form of federal intervention in the law of corporations without eventually considering, at least in broad outline, what form such intervention might take. I understand that other witnesses will address the questions of what functions should ideally be served by corporation law, the defects in the state corporate chartering system as it now stands, and whether federal intervention is an appropriate means of remedying those defects. I would therefore like to direct my own testimony toward the task of giving some content to the general principle of an increased federal role in the chartering of the modern Leviathans that have come to dominate our economic and increasingly, our social and political lives.

Corporation law has as its principal end the establishment of the organic structure for the corporate institution; and this structure plays a large role in determining how corporations behave as members of the society. One of the more important aspects of the organic law of corporations is the rules governing access to information about corporations, their products, and their activities. It is those rules, and what might be done to improve them, that I would like to discuss.

I might take as my text a pair of interesting quotations, by two well-known social critics. The first wrote:

...

"A modern corporation cannot in any proper sense be said to base its rights and powers upon the principles of private property. Its powers are wholly derived from legislation. If possesses them for the convenience of business at the sufferance of the public. . . . It is a segment of the public; bears no analogy to a partnership or to the processes by which private property is safeguarded and managed, and should not be suffered to afford any covert whatever to those who are managing it. Its management is of public and general concern, is in a very proper sense everybody's business." 1

The second quotation is very similar:

"Great corporations exist only because they are created and safeguarded by our institutions; and it is therefore our right and our duty to see that they work in harmony with these institutions. . . . The first requisite is knowledge, full and complete; knowledge which may be made public to the world.” 2

The identity of the authors of these two radical-sounding quotations would probably surprise a good many of those who find themselves quite content with the present state of corporate information rules (or think them already too liberal). Neither is Ralph Nader. Neither is Fred Harris. Neither, for that matter to go back in history a bit-is Lincoln Steffens or Robert La Follette. The sources from which sprang these bits of radicalism are both former presidents of the United States, the first, Woodrow Wilson; and the second, Theodore Roosevelt. I cite them here merely as evidence of the respectable lineage of the ideas I wish to discuss.

What Roosevelt and Wilson were saying, and what I hope to establish as my principal point here today, is that there is nothing private about a public corporation. (By "public corporation” I mean—and I would like my remarks to be understood as limited to the country's several hundred largest corporations. A precise definition of the class is not important for our present purposes.)

There is increasing concern, and properly so, about the erosion of individual privacy in our society. But the interests comprehended by our conception of individual privacy are altogether different from the interests that cause corpora

1 Woodrow Wilson, The New Freedom (1913).

2 Theodore Roosevelt, First Annual Message to Congress (December 1901).

tions to claim entitlement to "corporate privacy." To equate, as is so often done, the individual right of privacy with an asserted corporate "right of privacy" is to commit a blatant logical fallacy. There is nothing about a corporation, which Chief Justice Marshall once described as "an artificial being, invisible, intangible, and existing only in contemplation of law," that entitles it to any "right" of privacy. Our concern for the protection of individual privacy grows out of fundamental human values shared by people of every society. That there are legitimate corporate needs for secrecy cannot be doubted. But none of them is absolute. All are derivative of other, more basic social interests. Properly understood, "corporate privacy" is deserving of our concern only where it appears that permitting corporations to keep information secret will serve to protect individual interests or to improve the functioning of the economic system, in which corporations play so important a part.

The odd thing is that largely because of the historical accident that led us for legal convenience to "personify" the corporation, thereby endowing it with most of the legal privileges of tangible, warm-bodied "natural" persons, the presumption in our system of laws is that, with a few limited exceptions, corporations are entitled legally to keep secret any and all information they are able to. The question I would like to explore here today, stated in its simplest form, is what would happen were we to stand this legal premise on its head and require that corporations provide the public access to all information about themselves except when it can be shown that secrecy is justified because it serves a larger social end.

Since, as Sir Francis Bacon taught us nearly four centuries ago, knowledge is power, the mechanisms that define and limit the flow of knowledge are a crucial part of the structure of any institution. If, as social scientists tell us, technological advances in the field of communications are making ours increasingly an information-oriented society, the role played by information rules in guiding the conduct of our major social institutions is bound to take on an evergrowing importance.

Let us consider some of the ways in which we can now get information about corporations. First, corporations volunteer a good deal of information about themselves, largely in the form of advertising. While most advertising serves to convey at least some minimal amount of useful information-if only that "This product exists"-as anyone who watches even as little television as I do can tell you, the quality and utility of that information is severely limited.

Twenty-five years ago an economist named Tibor Scitovsky wrote a now classic article entitled, "Ignorance as a Source of Oligopoly Power," in which he demonstrated that in many industries corporations have strong economic incentives to conceal from their customers most information about product quality. Thus instead of advertising that enables consumers conveniently to compare quality and price without costly trial and error experimentation, we are bombarded with assertions that, "Acme fradastats have sex appeal," or "The Rattlesnake Mark III is the car for those who think young." One result of this information phenomenon is that the retail price of "private-label" merchandise is often substantially lower than that of brand name products that are identical in quality— sometimes even made in the same factories. Michael Scherer, the respected economist who is now the Director of the Bureau of Economics at the Federal Trade Commission, has estimated that the average price differential between "private label" and "name" brands is in the vicinity of 20 percent.*

While this sort of failure to provide consumers with useful information does no positive harm, some corporate information practices are hardly so innocuous. For example testimony given only two weeks ago before another Senate committee indicated that some major American drug manufacturers, who are required to disclose potential adverse side-effects of their products in promotional literature distributed in the United States, leave out such warnings to physicians to whom they sell overseas." That practice, I suggest, is the height of corporate irresponsibility; and it is made possible exclusively because of the nature of this particular set of information rules.

There are a number of ways corporations may be compelled under existing law to provide access to certain kinds of information; but they fall far short of meeting the test of adequacy I have suggested. Shareholders for example are, under the laws of most states, entitled to "inspect the books and records" of

8 40 American Econ. Rev. 49 (1950).

F. M. Scherer, Industrial Market Structure and Economic Performance 331 (1970). 5 State ex rel., Pillsburg v. Honeywell, Inc., 291 Minn. 322, 191 N.W. 2d 406 (1971).