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Senator DURKIN. One of the better kept secrets of State government in New Hampshire was that the insurance commissioner was also securities commissioner. But it seems to me there was a dual regulation in some aspects that didn't benefit anyone.

It became a revenue producer for the State to a certain extent, but I don't think it benefited any investors.

With this, with the two tiers, wouldn't you get into a similar problem?

Mr. SOMMER. The States would continue to have jurisdiction over smaller corporations, which tend to be more concentrated geographically.

As I indicated, what leads me to believe in a Federal corporation law of an enabling sort is not a notion that is the only effective way to deal with the regulation of corporations. Rather, it seems anomalous that in a corporation that has plants, shareholders, employees all over the country, the relationship among the various constituents of that corporation, the basic ones, should be determined by the law of one particular State.

I am perhaps not as aggrieved as some people are with regard to Delaware law. I think the statement was made earlier that in many instances corporations go to Delaware because of the relative certainty of law there. That is probably valid.

I would hope that as Federal judicial law built upon a Federal corporation law, you would have the same sort of activity, only this time on a national basis. You would develop an integrated nationwide series of precedents that would provide much the same sort of certainty afforded by Delaware law at the present time.

Senator DURKIN. You have said some of the States-you have inferred some of the States are relatively lax.

Do you think there is anything specifically Congress could do, should do now by way of legislation other than what we have talked about earlier?

Mr. SOMMER. Prof. Abraham Cary has made proposals with regard to minimum Federal standards of fiduciary responsibility and conflict of interest laws. His notion in recommending that stems from despair over enactment of a Federal corporation law that would incorporate those.

I think the kind of proposal he made ought to be carefully considered along with any sort of proposal for Federal corporation law. I don't think that necessitates any massive change in the relationships that exist among directors, shareholders, and management, but I think that the possibility of strengthening the fiduciary responsibilities of the various parties to the corporate process might well be considered as a part of any proposal for Federal corporation law.

Senator DURKIN. One of the reasons I am here, I think, is the frustration that the people of New Hampshire-and I think it just reflects across the country-with what appears to be big and unresponsive Government, namely, the Federal Government.

There is a tremendous amount of power that exists with the big corporations.

Do you think there is anything we should be doing specifically to harness that rather severe concentration of economic power, or substantial power?

Mr. SOMMER. I recognize the economic power and I think it is there. I think Congress has done a great deal to make that economic power more responsive than it has been in the past, for instance, in the area of consumer safety and equal employment.

I think the SEC has done a great deal through its activities—of course, I am more familiar with that than with other areas to establish through various means standards of conduct and to insist upon a candor, if you will, between management and the shareholders and the investing public that has benefited significantly the investment process in this country.

Obviously, echoing what Professor Winter said, I think rigorous antitrust enforcement with regard to such things as price fixing and restrictive combinations and conspiracies certainly should be rigorously enforced, and if anything, perhaps more so than we have in the past.

As far as utilizing the corporate structure as a means for better policing the activities of these economic concentrations, I am less convinced that is an effective means or would be a desirable means. I think there are other ways such as specific legislation and rigorous enforcement of the law to accomplish the same ends.

Meanwhile, as I say, the prime responsibility of the board-again subject to the law and they should not be unconcerned with the law, by any means should be to monitor the economic functioning of the corporation. That monitoring should obviously try to assure it is consistent with corporate responsibility.

Senator DURKIN. Is it unrealistic to expect that a corporate board will have much time or energy devoted to social responsibility?

Mr. SOMMER. Mr. Chairman, I think the boards are becoming so, more than they were. I think there has been, as I indicated in my prepared remarks, a significant change in the last 5 years.

I base that on what I observed at the Commission and conversations I have had with people involved in the corporate process. A number of studies have been done indicating that larger amounts of time are being given by board members. It is unrealistic, I think, to expect them to be full time, because then they become parts of management, rather than bringing to the board, as many of them do, the experience that they have had in other lines of endeavor, which make them very useful board members.

But I think today people are not undertaking to become board members unless they are willing to spend enough time to familiarize themselves with the corporation's affairs, and they are familiarizing themselves with the affairs of the corporation. They are asking telling questions. More and more corporations are establishing committees from among the outside directors to recommend new board members. Certain patterns with regard to boards are becoming current as a consequence of some of the settlements that the SEC and private litigants have been able to secure in litigation, much of which has arisen out of the election contribution and overseas payment scandals. Senator DURKIN. What about class action?

Mr. SOMMER. I think they have served a good purpose.

I think they have had the effect of making all parties in the corporate process alert to their responsibilities. I think there have been some that have been launched without a sufficient basis, but in general

I think they have served a useful purpose. I wish I knew a way by which the ones that didn't have the earmarks of responsibilities are weeded out, but as we know, the courthouse doors are open to anybody. Senator DURKIN. I sometimes suspect if we could get disclosure, rigorous enforcement of the antitrust laws, the fear of the class action in the board room, no matter who else is there, in the long run we might not have more effective enforcement procedures.

Mr. SOMMER. Well, I would not argue with that. I have been of the belief that the SEC's mandate on disclosure is confined to the investment process-and I have spoken on that. Whether other disclosure outside that context would be desirable is another matter.

I think the requirement of disclosure with respect to social policies is separate from the question of disclosure for investors.

I think too much disclosure can impede public understanding. In many instances disclosure has the effect of concealing rather than putting the spotlight on important matters. However, disclosure can serve a very significant social role. As everyone has heard, almost ad nauseum. Justice Brandeis said the electric light is the best policeman and sunlight the best disinfectant, and I think that is true.

Senator DURKIN. I want to thank you on behalf of the committee for your time.

Mr. SOMMER. Thank you, Mr. Chairman.

[The statements follow:]

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

WASHINGTON, D.C.

Mr. Chairman, committee members, my name is A. A. Sommer, Jr. I am presently a partner of Jones, Day, Reavis & Pogue, Washington, D.C. From August 6, 1973 to April 2, 1976 I was a member of the Securities and Exchange Commission. During that time I had occasion to express myself publicly concerning the responsibilities of directors and management and the role of corporations in American society. With the permission of the Chairman and the Committee, I would like to submit for inclusion in the record of these hearings copies of some of those statements.

I would like to discuss today two problems: first, developments with respect to the role of directors in American corporations; and second, the desirability of federal incorporation.

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.

Since then, and particularly since 1946, when the right of private individuals to maintain actions under Securities and Exchange Commission Rule 10b-5 was established, directors have had increasingly to be alert to the strictures of the federal securities laws. While the number of cases determined adversely to directors under the federal securities laws has been relatively small, nonetheless the impact of those cases, pronouncements of the Securities and Exchange Commission and other developments have heightened the awareness of all involved in the corporate community that indeed severe liabilities might be inflicted under the federal securities laws upon directors who are not attentive to their duties, particularly when their responsibilities touched upon the issuance and sale of securities.

Until fairly recently, certain patterns were clearly discernible in many publicly held corporations: the directors were the personal choices of the chief executive officers; some directors frequently regarded directorships as pelts to be displayed proudly on their belts; directors frequently regarded board memberships as sinecures, honors, pleasant experiences and paid scant heed to the responsibilities that attended such office. The Securities and Exchange Commission's staff study of the Penn Central collapse clearly indicated the routine, ineffectual manner in which some of the directors of that corporation approached their responsibilities; one result was three of the directors were named as defendants in the action brought by the Commission stemming from that debacle.

Happily it is possible to see in the corporate world today strong evidences of dramatic change in the functioning of boards of directors. This has come about as a consequence of many forces. Certainly litigation has been a significant one, both that initiated by the Securities and Exchange Commission and by private litigants. I have mentioned the Penn Central case as a singular instance of the Commission's activities. Another was its release accompanying the filing of an injunctive action in the Stirling-Homer matter wherein the Commission criticized sharply the inattention of the outside directors of that hapless corporation to their responsibilities, their failure to pursue lines of inquiry when a reasonable man would have done so, their near-total reliance upon the representations of management even when warning signals about their credibility confronted them. There has been a vast outpouring of writings, both books and magazine articles, discussing and delineating the responsibilities of directors, and invariably the thrust of these writings has been that there is indeed a heavy burden upon someone who undertakes this responsibility. Heightening both concern about the role of directors and awareness of directors that their duties are indeed substantial, have been the disclosures with respect to illegal political contributions and overseas payments. The evidence at hand would indicate that invariably the outside directors of the corporations had no knowledge that the corporation and its officers were engaging in reprehensible activities. Apparently the directors never made inquiries with regard to these matters and management never volunteered the information. The disclosures that now are occurring have not only raised anew questions about the role of outside directors, but have also been an embarrassment to many who have served on the boards who now find that indeed they were like the proverbial mushroom-kept in the dark. All of these problems are highlighted in the article about the Gulf Oil Corporation appearing in the current issue of Fortune.

As we witness these sorry events, and we realize that in many particulars the conduct of directors has been deficient, well may we inquire why this has been. Certainly one of the factors has been the relatively lax standards exacted by state corporation law and the dearth of litigation under that law. Had there been greater insistence by shareholders in the courts that directors perform properly, it is not unlikely that the state courts would have responded and imposed upon directors greater fiduciary duties. Another circumstance has been the widespread uncertainty and confusion among many directors concerning their appropriate role were they to manage the business? were they to monitor? were they to be on-board policemen? were they simply to listen to management presentations and critique them? Certainly another element contributing to poor performance has been the circumstance that in many instances the directors were selected by the chief executive officer from among his friends, such people are not likely to be boat rockers. And directors simply have not thought enough about their duties; in this, perhaps, they have been abetted by corporate personnel who should have given them guidance but didn't.

The situation is changing dramatically and drastically. I would suggest that persons asked to join boards of publicly held companies now do so only after reflecting carefully upon the responsibilities they assume and the availability of time to perform adequately; gone are the days when it would be regarded as a badge of merit for an investment banker to be on half a hundred or more boards of directors. Corporations, aware of the necessity of greater board involvement in their affairs, have developed a number of devices to achieve that. Audit committees are becoming routine and numerous conversations with both auditors and members of boards of directors have indicated the utility, nay, the necessity, of this mechanism. Many corporations are strengthening the influence of the outside directors by involving them not only on the audit committee but other committees as well, and by expanding the number of board members without significant financial affiliations with the corporation. Many boards have added so

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called "professional directors" (a term which I regard as a misnomer) who are expected, usually for additional compensation, to spend more time on the affairs of the corporation than the typical director; two significant examples of such people have been Robert Haack, formerly president of the New York Stock Exchange, now head of Lockheed, and Joseph W. Barr, formerly Secretary of the Treasury. I speak of the term "professional director" as a misappelation; rather I think of those men commonly called that as simply directors who expend larger amounts of their time on the affairs of the corporation and thus can constitute a helpful bridge between the other outside directors and management. Some corporations such as Texas Instruments have developed elaborate means of bringing to their boards qualified persons imbued with a sense of responsibility and an abundant opportunity to exercise it. The recent disclosures with respect to overseas payments have thrust boards into new roles: the outside directors have typically been called upon to conduct investigations when improper conduct has been suspected or ascertained and they have in many instances become the mechanisms for monitoring future activities.

We approach this problem of directors in modern American public corporations at a time when vast changes are already underway, when old patterns are being broken, when significant experiments are being undertaken, when there is an abundance of concern in the board room-much of it stemming from fear, no doubt about the proper role of the outside director.

In these circumstances, it seems to me it is imperative that two dangers be avoided the first is the danger that action be taken which might very well stifle initiatives already started, that would change radically the relationship between the Federal Government and corporations as creatures of the individual States and that might be an unnecessary, even harmful, intrusion into affairs that have traditionally been private; the second is the danger that everyone lapses into unconcern about this problem and allows present healthy trends to be reversed or slowed.

In considering the desirability of governmental action to strengthen the capacity of directors to function effectively, it is imperative, I think, to start with a clear understanding of what directors should be expected to do, and that of course requires some notion of what corporations are and how they fit into our total social scene. Corporations are associations of people and aggregations of capital accorded certain advantages by law; they are the principal means by which in this capitalistic society wealth has been gathered voluntarily from the savers in society and put to productive uses. With all of their faults they have been massively successful as producers, albeit at times at social costs unrealized. 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, it is also extremely important that they function effectively in their prime role as the preeminent producers of goods and services in our society and as the mechanisms through which capital wealth can be utilized for the economic benefit of society. This is obviously a very inadequate elaboration of the "concept of the corporation", which has been the subject of innumerable excellent works by scholars such as Peter Drucker, but I think it is sufficient to give us hints about the role of directors in these entities.

There are those who would conceive of directors as simply policemen on the premises, there to assure that management does not transgress any laws or pursue policies that are socially undesirable. There are those who would suggest that the outside directors should conduct a continuing ongoing investigation of management conduct to a similar end. A related, but somewhat different, misconception has its origin in State corporation laws which frequently state that the board shall "manage" the corporation. And while to my knowledge no one has said this explicitly, there does occasionally appear to be underlying litigation directed against directors when a corporation stumbles, the notion that in some fashion the directors are guarantors of the success of the enterprise.

I would suggest that the first responsibility of directors-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 directors must be concerned with the economic and other goals that the management has established-and as a matter of fact, the directors themselves should be involved in the articulation of those goals. And then the directors should be concerned with the extent to which the manage

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