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The insistence of chartering proponents on confusing these issues reflects either a desire to mislead the public or a hope that the existence of federal chartering will facilitate the introduction of even more drastic regulatory measures in the future. Because endless conditions can be attached to a corporate charter, chartering is a device by which government control can be easily widened and without adequate debate. This is another reason for rejecting chartering.

On one issue, however, the proponents of chartering have identified a genuine problem, although the remedy they support is easily worse than the disease. There is a serious lack of adequate remedies against corporations which violate the law, a problem caused generally by the inertia and unwieldiness of large bureaucracies. But this is a problem susceptible to remedies far less drastic than revocation of the corporate charter. Congress might, for example, provide that when a District Court found a pattern of violations of particular federal legislation or a failure or recalcitrance in taking steps to see that further violations will not occur, a monitor or trustee might be appointed to exercise the power of the court within the corporation to end the violation and take precautionary measures against the future. That sort of provision seems to me fully adequate to the purpose and far more preferable than federal chartering. Senator DURKIN. IS Mr. Sommer here?

Your statement will be included in the record in its entirety. Why don't you proceed?

STATEMENT OF A. A. SOMMER, JR., PARTNER, JONES, DAY, REAVIS & POGUE, WASHINGTON, D.C.

Mr. SOMMER. I will summarize and read parts.

I am aware of the time problem you have, Mr. Chairman.

Mr. Chairman, my name is A. A. Sommer, Jr. I am presently a partner of Jones, Day, Reavis & Pogue, Washington, D.C. From August 6, 1973, until this April, I was a member of the Securities and Exchange Commission.

During that time in speeches I made, I commented extensively on the problems of corporate directors and the manner in which they were fulfilling their responsibilities under the law, particularly the Federal securities laws.

I would like to submit those speeches and have them incorporated in the record of these proceedings. The full statement which I have submitted to the committee includes several items, including the role of directors in American corporations; and second, the desirability of Federal incorporation. I would like to focus on the director problem because it includes discussion of several parts of the Nader proposal. Until recent years, it is fair to say that far too little attention was given to the role of directors in publicly held corporations. Before 1933, the only law which governed the relationships between directors and their corporations and the shareholders of the corporations was State corporation law, and in the eyes of many, that law did not impose upon directors heavy burdens.

The first assault upon the primacy of State corporation law was the Securities Act of 1933 which established the then revolutionary principle that those not in privity to purchasers of securities, including directors of an issuer, might be held liable for losses suffered by purchasers who were denied full and fair disclosure.

The legislative history of that act clearly demonstrates the radical nature of this proposal and the efforts made to turn it back.

There has been a critical problem with regard to the performance of directors in this country over the past decade. In many instances, it

can be documented that the directors have been insensitive to their responsibilities.

In many instances they were chosen because they were well known to the chief executive officers, not because they were competent with regard to the affairs of the corporation but because they had the time to serve effectively. It became in many instances simply a badge of honor for a person to be a director of a prestigious corporation.

The SEC staff made an extensive study with regard to the board of directors and other activities of Penn Central, a report which eventuated in the Commission suing to enjoin three directors of the corporation from violations of the Federal securities laws. It was documented in that report many of the directors of Penn Central had been indifferent to their responsibilities.

However, I think it is fair to say that as a consequence of many forces this situation happily is changing.

Among the forces that have resulted in this change have been the litigation brought by the SEC, pronouncements by the Commission, such as in the case of Stirling-Homex, and warnings that have been given by the Chairman and other Commissioners of the SEC.

In addition, directors have been charged in a number of private suits seeking to recover damages allegedly attributable to their misconduct.

In addition, there has been a tremendous outpouring of writing. Writers of books and magazines have chided directors because they have not in many instances performed in accordance with their high responsibilities.

I think all of this has heightened the sense of responsibility that directors are presently feeling.

I think now it is fair to say that the people who are asked to join boards of directors only do so after they have carefully considered the responsibilities that they are assuming, and have examined whether they have the time available to adequately perform the functions.

There was a time when investment bankers would brag that they were on 20, 30, and as many of 50 boards of directors. I think that day is gone. I don't think anyone regards that as a badge of honor, now it is regarded more as a sign of insanity.

In addition to that, corporations are aware of the necessity for greater board involvement, because of the factors mentioned, and have developed a number of techniques to provide the opportunity for better board participation by the independent directors.

Audit committees, for instance, are becoming virtually routine. I think both auditors and members of the board can testify to the effect that they have indeed been a very effective means by which the directors have been able to influence and monitor the activities of corporations.

Many corporations have also added to the number of outside directors that are on their boards, so that you have a higher proportion of people who have no significant financial affiliation with the corporation on the boards.

A number of corporations have included on their boards people who have been called "professional directors." These are people who make their living out of being on the boards of major companies, and in

many instances they perform services beyond the customary director. Some corporations such as Texas Instruments have developed some unique techniques for improving director involvement. I don't think many corporations have emulated the details of their program; nevertheless, most corporations are paying heed to these problems.

So I think we approach the problem of how we should deal with directors, whether legislative change is necessary in the pattern that exists with regard to their responsibilities, at a time when I think vast changes are already underway, when old patterns are being broken, when significant experiments are being undertaken, when there is an abundance of concern-much of it stemming from fear-about the proper role of outside directors.

In these circumstances, I think there are two things to avoid. One is percipitate action that would interrupt healthy developments in this area. The second thing is equally dangerous, that is to stand aside and do nothing if these developments slow down or are reversed.

I think we must avoid both of those dangers.

It seems to me that in considering the desirability of governmental action to strengthen the capacity of directors to function effectively, you have to start with a clear understanding of what directors should be expected to do.

That, of course, involves some notion of what corporations are expected to do.

Corporations basically-and this is probably oversimplified-are associations of people and aggregations of capital that are accorded certain advantages by law. They are the principal means by which in our capitalistic society wealth has been garnered from savers and put to productive use.

With all of their faults, they have been successful as producers, albeit at times at social costs which for a long time we did not realize.

While it is important that corporations not be polluters of the environment, not be bribers of public officials, not be violators of the law, not be indifferent to their public responsibilities. I think it is also extremely important that they function in their prime role as the producers of goods and services in our society and as the mechanism through which capital wealth can be used for the benefit of society.

There are those who would conceive of directors as simply policemen on the premises to assure that management doesn't transgress any laws or follow policies socially undesirable. There are some who think that directors should be detectives, constantly investigating management. Another misconception stems from the language of many State corporation laws which speak of the board as "managing" the corporation, when what they really mean, I think, is monitoring the conduct of management.

While no one has said so explicitly, it does appear that many cases brought against directors are premised on the notion that they are the guarantors of the conduct and economic success of the corporation.

I would suggest that the first responsibility of directors, but not by any means to the exclusion of other responsibilities, flows from the nature of the corporation as an economic entity. Preeminently, the directors should be the monitors of the manner in which the corporation is functioning as a corporation in the sense in which we generally regard it.

Thus, I think directors must be concerned with the economic and other goals that management has established-and as a matter of fact, they themselves should be involved in the establishment of those goals. And then the directors should be concerned with the extent to which the management of the company is achieving its goals, and if management is not competent to do that, then they have an obligation to see that other management is brought in.

Thus, their prime responsibility is to assure, consistently with their position as monitors and not managers, that the corporation functions in an economically productive and useful fashion, but that does not exhaust their responsibility.

They also have responsibility to see that the corporation conducts itself as a good citizen, that it does not pursue policies that are at variance with society's objectives and goals, that management uses the shareholders' money in a manner that is consistent with their stewardship and with the laws of the countries in which the corporation conducts business.

Quite obviously, those without economic dependence upon the corporations are in the best position to engage in an objective, careful, unbiased, analysis of the manner in which the corporation is serving its economic function.

Does this mean that only outsiders should be on the board of directors? I would suggest that is not necessary to achieve the benefits of outside directors.

Chairman Roderick Hills of the SEC has suggested that the stock exchanges should change their listing agreement to require that a majority of the board consist of outside directors.

Än alternative proposal would be to provide that there should be a minimum number of outside directors, say, four, five, or six, regardless of the size of the board. Thus, you would have a sufficient sounding board, a group that could stand with strength, a group large enough to make its presence felt.

Most decisions at the board level are not reached by counting heads, but the influence of four, five, or six outside directors could be significant in determining the course of affairs of the corporation.

I would suggest that this should be done not initially by Federal legislation, but by pressure upon corporations from stock exchanges, selfregulatory agencies, public opinion, all the other forces that are presently afoot, and which are having an impact upon the manner in which corporations structure their affairs.

I think it would be unfortunate to adopt the proposal set forth by the Corporate Accountability Research Group that each director have a special responsibility-consumers, labor, environment, and so on. It seems to me it is much better to place upon the whole board of directors the responsibility for all of those areas, so that none of the directors has an excuse for limiting his activity or his concern or his attention to a narrow corporate constituency or only certain corporate affairs.

Similarly, I think the appointment by public authority of one or more directors would be unwise, because it would mix, I think, government and a free economy to an extent that would be undesirable.

Proposals have been made that there should be outside staff people,

independent of the corporation, to assist the directors. Justice Goldberg suggested that.

It seems to me that suggestion is a problem because then you would have a staff that would be adversary to the staff of the corporation, that would be sort of a quasi-inspector general. I think hostilities would be developed and the staff of the directors would very easily find it more satisfying to fault-find the activities of regular management than to contribute to the goals of the corporation.

Again, bearing in mind that the primary function of the corporation is the production of goods at a profit, consistent with its responsibilities to the community and to the people, it seems to me that the establishment of a separate staff answerable only to the outside directors would elevate the role of directors as monitors of the propriety of the conduct of management to an excessively high level of priority.

Mr. Chairman, that is the end of my prepared statement.
I will be pleased to answer any inquiries.

Senator DURKIN. Thank you, Mr. Sommer.

Senator DURKIN. I gather that you would favor a more restrictive Federal law.

Mr. SOMMER. Yes.

In the remainder of my prepared statement, which I omitted because of time considerations, I state there is a lot to be said for a Federal corporation law that would be of an "enabling" sort, similar to those that exist in States, and I would hope that one of the more enlightened States would be the model for it.

There is a desirability in a uniform set of standards to be developed through statutory law and in cases concerning the relationships between managers, directors, and shareholders. I feel that burdening that sort of statute with a number of regulatory provisions that would apply only to large corporations is not sound policy. I think those regulatory provisions, such as concern for environment, concern for labor, concern for equal employment, should be dealt with across the board and be binding upon all businesses and all corporations. I think they should be dealt with separately from the question of what is the desirable configuration for corporate law.

Senator DURKIN. The corporate law, to allow for pollution, but allow the criminal law dealing with bribery

Mr. SOMMER. Deal with them separately but reasonably, as has been done in most cases.

I think mixing those matters with corporation law which is designed to deal with the relationship between managers, directors, and shareholders and the procedural matters of how to hold meetings and that sort of thing, is undesirable.

Senator DURKIN. Would you recommend preempting State law? Mr. SOMMER. With regard to a corporation that would be subject to Federal corporation law, yes. I think some sort of cut should be made. In other words, corporations of only a certain size would be required to incorporate under Federal law. As you probably know, at the present time, the corporations that have more than 500 shareholders and $1 million of assets are required to file a periodic report with the SEC.

A similar kind of discrimination, I think, would be appropriate with regard to Federal corporation law.

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