ment of the company is achieving those goals, and if management fails for reasons that seem to be related to their competence in accomplishing the goals established, then it is incumbent upon the directors to initiate whatever measures are necessary to permit the corporation to accomplish its legitimate objectives. Thus the prime responsibility of directors is to assure, consistently with their position as monitors and not as managers, that the corporation functions in an economically productive and useful fashion.

But that certainly does not exhaust the responsibilities of directors: they also have some 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 with no economic dependence upon the corporation 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 and acting its role of good citizen. Does this mean that only outsiders should be allowed as members of the board of directors? I would suggest that it does not mean that but rather that it does imply that the representation on the board of outsiders be substantial and not token, that it be large enough to constitute a visible and telling presence in the deliberations of the board. In two ways this might be accomplished: one, by a requirement, either enacted by legal authority or by such quasi-legal authority as the stock exchanges, that a majority of the board consist of persons with no economic dependence upon the corporation; a second way would be a requirement that a certain minimum number of the directors have such characteristics—thus, for example, at least four or five of the members of the board would have to be outsiders regardless of the size of the board. The presence of substantial representation by outsiders would make it impossible for management to ignore their presence and the presence of a substantial number, such as four or five, would result in a mutual drawing of strength each from the other. I would strongly urge that the least desirable way to change the constitution of the corporate board would be through federal legislation laid atop state requirements; at the moment, given the widespread responsiveness to proposals for change, I would think the most desirable way would be to urge such a course on the exchanges and upon corporations directly, and then judge the effectiveness of that means before venturing further.

I would reject as ill-founded, especially now, when so much beneficial change is occurring through processes other than governmental mandate, such proposals as that made by the Corporate Accountability Research Group that boards be made up of persons representing various constituencies-labor, environment and so on. Much better in my estimation is a board consisting of directors each of whom is fully responsible with respect to the entire gamut of corporate activity and must be alert to the legitimate claims of employees, of society, of the government, of the environment, as well as investors, in making judgments; such specialization on the board would in my estimation result not in better boards, but in less capable, less effectively functioning boards. Similarly, the appointment by public authority of one or more directors of the corporation would mix the functions of government and the functions of corporations together in a manner which I would regard as most unfortunate. Such would be a step toward a more direct regulation of corporate affairs by government than I think desirable, and a step which it would be easy to follow with other steps that would make corporations in this country into a simple economic arm of a central government. This seems to me to be peculiarly inconsistent with what seem to be the dominant trends of American thinking-limitations upon government and reduction of its role in the economic life of the country. The same might be said with respect to a proposal by Senator Church that there be a specified number of outside directors who would have a responsibility of reporting to the Securities and Exchange Commission. This proposal would even more forcibly intrude government into the affairs of corporations; beyond that, it suffers from a more basic fault, namely, it exalts the function of directors as monitors of legality of conduct to a preeminent position, ignoring the responsibility of directors with regard to the economic functioning of the corporation.

Proposals have been made, notably by Justice Arthur Goldberg, when he was a member of the board of TWA, that outside directors should have a staff separate and apart from the corporation and totally committed to the outside direc

tors. While I think it is important that outside directors have the right to call upon and use the services of corporate staff members-and there may be merit in, for instance, giving an assistant general counsel a special responsibility of assisting the board-nonetheless I think a separate staff would be unduly divisive and would create antagonism, tensions and stresses which would not be consistent with the most effective functioning of the corporation. A separate staff beholden only to the outside directors could easily become a quasi-inspector general, regarded with hostility by regular staff people and dedicated to fault-finding the activities of the regular management. Bearing in mind again the primary function of the corporation it seems to me that the establishment of a separate staff answerable only to the outside directors would elevate to inappropriate importance the subsidiary function of directors as monitors of the propriety of the conduct of management.

As has been repeatedly pointed out, the idea of federal incorporation is not a new one; its origins go back to the earliest days of our nation. Perhaps this is not as surprising as the fact that during all these years when strong forces were welding the nation into a powerful economic unity, a federal incorporation law has never been adopted. One would have thought that as we broke the economic barriers down between the states and made them into a genuinely single economic unit the forces tending towards a federal incorporation law, at least one applicable to the larger nationwide companies, would have become irresistible. Why that has not happened is difficult to say. In more recent times, it seems to me that the realization of such a statute has been thwarted by the insistence of those who advocate that it take on a strong regulatory bias-that is, that it not be simply an "enabling" statute, one that delineates the allocation of powers between shareholders, directors and management, establishes procedures for the holding of shareholders' and directors' meetings, and so on, but that it also be the main instrumentality for protecting consumers, breaking up large industrial concentrations, protecting the environment, and implementing antitrust concepts. The proposal made by Mr. Nader and his group, like many proposals before, is designed to do many things; it is rather like the nostrums that were touted in earlier days in our country as the cures for everything from gout to

cancer.

I am deeply troubled by this approach. For one thing, since this proposed statute would be applicable only to companies with certain characteristics and size, it would introduce into many areas where now the law is universally applicable a distinction: some companies-the larger ones-would have special responsibilities with regard to environment, consumers, compliance with antitrust regulations and so on. This would tend to blur the fact that all of us, and all businesses, have responsibilities in those areas and that the public can be harmed significantly by companies that would be subject to lesser regulation than the large companies.

Beyond that, it seems to me the manner in which these problems have been dealt in our country until now is an appropriate one and that tangling all of these public policy considerations into the structure of a federal incorporation law is not a good approach.

However, I do feel that a federal incorporation law which would incorporate the best current characteristics of state corporation laws and which would include perhaps the sort of fiduciary responsibility provisions advocated by Professor William L. Cary would be a desirable advance. The deficiencies of state law, the "race for the bottom", the apparent unwillingness of many state legislatures to impose strict enough standards upon fiduciaries within the corporate system have all been catalogued and detailed and I am sure that other testimony before this Committee will discuss, has discussed, these matters explicitly. These in my estimation are real problems, although I believe there are some evidences that states, through both their legislatures and their courts, are becoming more cognizant of the need for higher corporate standards of conduct. As an example, the recently enacted California corporation law contains a number of innovations which are intended to protect investors to a greater extent than they have been protected before under California law. Furthermore. such decisions as that of Diamond v. Oreamuno by the New York Court of Appeals tells a willingness to impose upon corporate officers significant responsibilities. Likewise a number of state courts, long before the United States Court of Appeals for the Second Circuit rendered its decisions in Green v. Santa Fe Industries and Marshel v. AFW Fabric Corp., found in their statutes the bases

for condemning some of the nefarious practices that arose in connection with the "going private" phenomenon. It may well be that, notwithstanding these tender blossoms, there is no assurance that adequate reform will be forthcoming through state mechanisms.

Regardless of that consideration, however, it seems to me indeed anomalous that corporations whose operations, employees, facilities, shareholders are nationwide and indeed, increasingly worldwide should have the internal relationships between shareholders, directors and management, their modes of procedure, their capacity to pay dividends, and a number of other details, determined by the laws of a state chosen for reasons totally unrelated to the location of the principal office or the principal activities of the corporation. Mandatory federal incorporation, at least by corporations of a specified size, would be consistent with the manner in which our economic life has generally developed. We have eliminated through the years virtually all the barriers to the movement of commerce back and forth across our nation and we have jealously fought in the courts and in the Congress efforts by states to balkanize in any measure the unified economic activity which has been the strength of our nation. It strikes me as totally inconsistent with this economic development in our country to permit large corporations to continue to have their official domicile in states like Delaware while their activities are directed from say, New York, and reach to the farthest regions of the earth. This consideration is totally apart from the question of whether Delaware law is adequate or provides sufficient safeguards for shareholders.

It has been suggested that once Congress had enacted a federal corporation law of the enabling sort it would be too easy to change that into a regulatory statute of the sort that has been persistently sought, such as that proposed by Mr. Nader and his associates. I have serious doubts about the validity of this argument. If Congress wishes to regulate corporations in any manner, it will do so if the appropriate majorities can be secured. If Congress wishes to strengthen the regulation of corporations with regard to consumer matters or in any other way, I would suggest that they do not need the crutch of a federal incorporation law.

If a federal incorporation law of the sort I envisage were adopted, very quickly the federal courts would begin to interpret the provisions of the statute and we would have the beginnings of a nationwide, coordinated, integrated body of corporation law. One of the advantages asserted for incorporation in Delaware is that, because so many large corporations are incorporated there, it has had the opportunity to develop a sophisticated body of justical precedents which make it easier for attorneys to reach reliable judgments with regard to the impact of the law. I would not discount the importance of that, and I would not dispute that in many respects other states have taken the lead in interpreting their own laws from the judicial decisions in Delaware, thus providing in some measure a nationwide approach to corporation law. However, I would suggest that there is a good deal more logic in the basic body of corporate judgemade law having its origins in the federal court system and that these precedents be the guiding lights for state courts in interpreting their own corporation laws insofar as they may be applicable to smaller corporations.

Such a federal corporation law would have one extremely beneficial effect: it would remove the pressure on the federal courts to seek in the federal securities laws, and particularly in Rule 10b-5, the means of rectifying wrongful conduct of management for which relief in state courts is frequently difficult to secure. The federal courts in my estimation have, by their imaginative interpretation of the federal securities laws, provided a safety valve for frustrations which, if they had been allowed to mount without relief, might very well have seriously damaged the ability of corporations in this country to develop capital resources and perform their essential economic function. Because of the availability of the federal courts, the relatively favorable rules of procedure, and other characteristics of litigation in federal courts, shareholders have been able to pursue much more rigorously their rights and the federal courts have provided them with a friendly forum in which to do this. As Professor William Cary has well pointed out, there is an anomaly when it is suggested that the wrong remedial through federal courts consists in failing to disclose another wrong rather than the commission of the substantive wrong itself. It would be far better if the federal courts could deal directly with the ills and evils that are brought to them rather than being asked to press out the frontiers of the federal securities laws.

This approach would be more direct, more honest, more consistent and more effective.

I think there is, and there has been for some time, a serious temptation to transform corporations, particularly large ones, into quasi-public institutions. Given the network of restraints on their conduct that now exists, perhaps they are that already. However, I find it difficult to conclude that the overall interests of our society and our economy are going to be better served by inserting additional federal presence into the governance of corporations. I think directors should be held to high standards of responsibility. I think every publicly-held corporation should have a significant number of outside directors on its board. I think the board of directors should be organized through committees and otherwise to maximize the ability of the board to participate effectively in the achievement of the corporation's economic goals and in the monitoring of the conduct of management from a legal and moral standpoint. I think that the outside directors of corporations should have access to the services of staff people employed by the corporation on a virtually unlimited basis and I believe those staff people should understand that when called upon by directors they are to serve disinterestedly and objectively. I think that corporations should be encouraged to experiment, as Texas Instruments has done, with new configurations and new approaches to the problems of corporate governance. I would be loathe to see the iniatives and the imagination which are presently being lavished upon this problem undermined and destroyed because of governmental action.

During the time that I was a Commissioner of the Securities and Exchange Commission I repeatedly urged-long before the overseas bribery scandal brought this problem to the level of concern that it has-that directors must attend their duties more diligently, that they must raise their sights and conform to higher standards of conduct. I am not so naive as to think that the oratorical efforts of SEC Commissioners have accomplished very much in this area. However, I am encouraged that a number of events has resulted in considerably deeper insights, and action upon those insights, by corporations and their directors. I would urge that all of us restrain our impulse to seek perfect solutions and instead let what appears to be a healthy evolutionary development unfold. If it appears that this movement is being thwarted or stunted or losing its momentum, then I think we must all seriously consider alternative measures to assure that American corporations are managed efficiently, competently, in accordance with the law and with integrity.

ADDRESS BY A. A. SOMMER, JR., COMMISSIONER, SECURITIES AND EXCHANGE

COMMISSION

(American Bar Association Federal Regulation of Securities Committee Symposium, Warrenton, Va., June 13, 1975)

A KEYNOTE ADDRESS-OF SORTS

(By A. A. Sommer, Jr.*)

In preparing these remarks I re-read that masterful little book by James Willard Hurst, one of our speakers at this meeting, entitled, "The Legitimacy of the Business Corporation." Having done that it was tempting to simply summarize the superb insights of Professor Hurst, or better yet, it would have been well to have dispensed with a keynote address and simply have urged everyone to read or re-read this little masterpiece before coming here. Despite my desire to avoid parroting the thoughts of Professor Hurst, I am sure that the origins of much of what I express will be easily identified as originating in his work.

In assessing the extent to which federal and state law should establish standards of conduct for corporate management, we must, of course, have some notion of what the corporation is, what its role has been historically in our society, what society expects-and has expected-of the corporation, the manner in which the corporation as not only an economic entity but a social one

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or speech by any of its members or employees. The views expressed here are my own and do not necessarily reflect the views of the Commission or of my fellow Commissioners.

as well relates to other facets of American life-political, economic, and social. And there must be some consideration of the overall goals that Americans seek, for a structure within which so much of the nation's wealth has developed and been gathered will not long be tolerated unless it has some discernible relationship to those goals. And certainly notice must be taken too of the fears which Americans have often expressed about "corporate power." It is impossible, of course, in this brief paper to elucidate all those considerations; at most I shall only suggest a few thoughts on these broader matters.

The source of the fear of corporations, of course, has not been the corporation as such, an impersonal Goliath bestriding the economy and the nation. As Bayless Manning has pointed out, the real name for what has been feared has been power: the power of certain people to do certain undesirable things to other people. From time immemorial "power" has been rooted in economic power; the ownership of lands once gave power, later the power of industrial ownership was the target of popular concern. Corporations as such have no power; the people who control them-whatever that means-have the power to decide whether a plant will be closed, thus impoverishing a community; to decide to curtail production, thereby adding massively, in some instances, to the rolls of the unemployed, thus creating a problem for the political bodies; to blunder and thereby harm the interests of those depending upon the prosperity of the enterprise for jobs, dividends, security. Running through all this is an abiding misgiving in the American mind about any power, whatever its form or source. We carefully developed a system of political checks and balances to prevent undue accessions of power and, as recent history has shown, we react strongly when that balance is disturbed. This fear is real and hovers over every discussion of American corporations.

We all know the history of corporations, how they emerged initially as special grants from the sovereign, often to undertake a particular socially beneficial chore the development of toll roads, waterways, and other parts of the infrastructure of the economy. Gradually, as men sought to gather capital for purposes of a manufacturing and commercial nature, without any special social purpose as a goal, and as egalitarian notions became more deeply rooted in American life, the general corporation laws emerged. There continued a good deal of confusion in thinking about what the corporation was designed for-was it to effectuate a special purpose or was it simply a useful instrument for the fruitful use of capital?

As Professor Hurst has pointed out, the first legitimacy of the corporation stemmed from its utility. Professor Richard A. Posner has said,

"The corporation is primarily a method of solving problems encountered in raising substantial amounts of capital for a venture."

This utility derived from a number of characteristics. Of outstanding importance, though in the view of some scholars of less importance than usually suggested, was the limitation of liability or commitment of those who invested. Other characteristics were, as Professor Berle has pointed out, the ability of the corporation to accumulate capital for expanding its activities and the increasingly perpetual nature of it. It did not suffer from the iron law of life that proprietorships did or the historic limitations that attended the partnership method of doing business.

Of increasing importance as the 19th century wore on, and as the demands for expansion of the American economy grew, was the ability of the corporate form of organization to centralize control of the corporation. The importance of this factor is repeatedly mentioned by Professor Hurst:

"Corporation law early favored business arrangements which centralized decision making, gave it considerable assurance of tenure, and armed it for vigorous maneuver."

"Law in effect reflected this eclipse as statutes and judge-made doctrine legitimated broad authority in top officers of corporate enterprises and protected this authority with the rule that shareholders might not interfere with regular business decisions of the officers and board of directors or obtain legal redress for alleged mismanagement save upon showing gross negligence or abuse of trust." "For both small and large enterprises the corporation provided a defined, legally protected, and practically firm position of authority for those in central control."

Corporation statutes reflected the utility of such centralized control. While today we blanch at the usual statutory statement that directors shall "manage"