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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 hecause 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"

the corporation because of a concern that it suggests an unrealistic role for directors, it bears notice that this provision had its origins in a desire to make clear that the shareholders were not to manage the corporation. Accompanying these statutory limitations on the power of shareholders were court developed doctrines, sometimes reflected in statutory provisions, that limited the ability of shareholders to make various sorts of agreements that might impinge upon the centralization of management in the directors and the officers of the corporation.

Virtually contemporaneous with the development of strong tools for centralized control of the corporation was the disappearance in statutory law of virtually every vestige of social control over the conduct of corporations. In some measure this was the result of the disappearance of the special purpose charters which, as indicated, frequently elicited initiative and capital to do quasi-governmental chores and which were the beneficiaries of special economic benefits given by the state, thus justifying the regulation of their activities in order to serve the purpose for which the state granted the franchise. The elimination of a regulatory dimension was a response to the concept of the corporation as primarily defined in terms of its utility. Also during this time there was strong belief in the efficacy of the marketplace as a means of effective control over the conduct of the corporation; if the corporation adhered to its proper function of maximizing profit, then it would be rewarded or punished on the basis of its economic performance, and this would be an effective regulator of its conduct. Bayless Manning summarized the results of this development in this manner: "... corporation law, as a field of intellectual effort, is dead in the United States. When American law ceased to take the 'corporation' seriously, the entire body of law that had been built upon that intellectual construct slowly perforated and rotted away. We have nothing left but our great empty corporation statutestowering skyscrapers of rusted girders, internally welded together and containing nothing but wind."

The concentration of control in management necessarily widened the gap between management and the shareholders, a development noted and deplored by Berle and Means in 1932. The popular theme became "shareholder democracy", a reversal at least in part of the dominant strain in corporate law which had previously enhanced the utility of the corporate form as a means of economic development. Central to the development of federal securities law was the enhancement of the right and power of the shareholders of a corporation to participate in its affairs. In general the Securities and Exchange Commission, exercising its broad power under Section 14(a) of the Securities Exchange Act of 1934, sought to make more effective the rights which shareholders enjoyed under state corporation law, but which were difficult to exercise under that law, since it usually defined no effective procedures for their exercise. These mechanisms for the exercise of shareholder power were accompanied by the requirement that the shareholder have the opportunity to exercise his power knowledgably. The extent to which the hopes underlying these reforms have been realized I will comment upon in a moment.

As Professor Schwartz will point out in the paper he proposes to deliver, “The task of reform may embrace two broad objectives: first, to constrain the power of corporations within the society; second, to contain the power of the corporate manager, or at least to render the exercise of the power more accountable."

Taking the second "task of reform" first, this relates essentially to the relations between the shareholders and the management. Professor Posner states in the chapter on corporations in his book, "Economic Analysis of the Law", that the “main concern of this chapter has been to explore ways in which the individuals who manage corporations are prevented from substituting personal goals for that of maximizing profits.” He sees the problem of "accountability" as one involving essentially defeating the capacity of managers to place their own economic and general welfare ahead of the shareholders. In this endeavor he denigrates the influence of "shareholder democracy” and emphasizes instead mobility of control, the ability of the shareholders to oust management, the préservation of a market for control.

Thus, in his notion, the opportunity for shareholders to oust management by their own efforts and for management to be ousted by someone from outside the corporation should be relatively unimpeded, for only then will the corporation operate most efficiently for the benefit of shareholders. If this is sound economics, it is interesting to reflect on the extent to which mobility of control is realized in practice. Because of the enabling nature of corporate statutes, managements have

been able to place very considerable impediments in the way of a “market" for corporate control. First, of course, there is the difficulty of organizing a sizeable body of shareholders in a proxy contest, one that begins obviously with the odds weighted heavily in favor of management because of their access to corporate funds to fight the contest as contrasted with the contingency of the antimanagement group ever recovering its expenses. As for efforts to secure a shift of control from the outside, witness the proliferation of devices to impede the transfer of control: unusual majorities to effect mergers with holders of stipulated numbers of shares ; staggered boards of directors; and other ingenious devices.

Notwithstanding the limited increase of efforts to preserve mobility of control, the federal securities law has developed fruitfully to govern many aspects of the relationship between corporations and those who purchase their securities. In an effort to maximize the effectiveness of the scheme which has developed under the Securities Act of 1933 and the Securities Exchange Act of 1934, the courts, limited though they have felt themselves to be by the Birnbaum doctrine, now affirmed by the Supreme Court, have nonetheless effected imaginative extensions of the notion of who is a "purchaser" or "seller" of securities.

Of course it must be recognized that in many respects the federal law contains rules governing the relations of shareholders and management regardless of the presence of a purchaser or seller. The proxy rules, with their requirements for disclosure on a regular basis of transactions between the corporation and “insiders”, have become a fairly effective regulator of the conduct of management. Even though rarely do shareholders, without the stimulus of an organized proxy contest for control, override the recommendations of management on proposals submitted for a shareholder vote and perhaps never do they refuse to elect the recommendations of management for directoral office, nonetheless the necessities of disclosure operate as a governor on the conduct of management. Management may not fear rebellion by shareholders, but they do fear the pen of Forbes, The Wall Street Journal, Barrons and other commentators on the corporate scene if they expose to public view the manner in which they have utilized their positions for private gain. Not only may they suffer the opprogrium that follows from such disclosure, they may also become the targets of suits spawned by the disclosure.

As the courts have steadily expanded the situations in which the federal securities law will introduce into corporate relationships, the line between mis management and conduct violative of the federal securities laws has become increasingly blurred, and management is less and less able to rely on the limitations once thought embedded in those laws.

In the eyes of Professor Cary this process is not sufficient to do what must be done. His proposal for a "Federal Corporate Minimum Standards Act", which must be credited with a large measure of responsibility for the theme of this conference, is, as Professor Schwartz suggests, mainly concerned with “Contain[ing] the power of the corporate manager." It appears to stem from several concerns. First, he is obviously disturbed with the strains placed upon a single, simple, limited rule in the development of policy which many consider desirable, and toward which the courts seem congenial. To some extent perhaps this concern is esthetic: law should be cleaner, more defined, more predictable, more candidly stated than the restraints on management are in Rule 105–5. Second, he is disturbed by the inherent conceptual limitations of the present federal basis of jurisdiction. As he states, “... there should be as much federal concern about the management of the public issue company and about its share owners as about the investor engaged in the purchase and sale of its stock.” Third, he obviously despairs of state law forsaking its now firmly established bases, if for no other reason than the built-in competitive drive which stems from the multiplicity of jurisdictions concerned with incorporation and the total absence of any requirement of any economic relationship between the enterprise and the locus of its incorporation. In the face of this concern for the strains of expanding Rule 106-5 and the proxy rules, and this despair of redemption through state law, plus the unlikelihood of any move toward a federal incorporation law, he opts for a cleaner, more explicit response to the deeply felt concern about relations between management and shareholders and seeks through federal standards limits on the conduct of management.

The first task of reform mentioned by Professor Schwartz, to "constrain the power of the corporations within society” reflects the fact that such constraints are no longer part of the basic statutes governing corporations. To the extent

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