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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 unger 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 preservation 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 inust 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 corpo. rate 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, 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 10b-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 more 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

as

that corporations have been regulated in relation to other social goals, it has been through special legislation that at least nominally is unconcerned with whether the prohibited conduct is through the medium of the corporations : antitrust laws; pollution and environment laws; legislation protective of employees.

It was thought by some that increased shareholder participation through the proxy machinery would be a means of controlling the corporation's relationships with the external world as well. These thought that the social sensibilities of shareholders might rise higher than those of management and thus through the exercise of their right to elect directors, and thus influence the selection of the managers, those sensibilities might impact the corporation's conduct.

It is at best doubtful whether events have justified these expectations. While there has developed the notion of the “ethical investor” whose universe of interests ranges more broadly than the narrow economic welfare of the corporation, still there is ample evidence that shareholders are animated for the most part by the desire for the economic profitability of the enterprise in the most conventional sense, although certainly many shareholders would probably rebel strongly if their management flaunted grossly developing social concerns. In general it is doubtful if more effective participation of shareholders in the control of corporations' affairs will significantly better their performance or conduct in terms of meeting social requirements and responsibilities, although certainly strong vocal demands by segments of the shareholder population have influenced at least marginally the course which many managements have taken.

The first issue we should confront, then, is whether indeed there is a need for strengthening the restraints on the prerogatives, the control, of management vis-a-vis the shareholders of the corporation. If, as Professor Hurst explains, the once expected restraint that shareholders might, because of their economic interests, place upon management, are not effective, and if "shareholder democracy" has not afforded an answer, and if the restraints of the market are not sufficient, then should the policy implicit in state corporation laws favoring largely unfettered management control be modified? Remember that the pattern existing in state laws derived from notions which related the legitimacy of the corporation to its utility. Have events ordained that the principle of utility be subordinated to other considerations of fairness, equity, economics, social concern? And if that is desirable, what is the most efficient, effective way of doing that? Should we simply look to the courts to continue the task they have undertaken, not only under the securities laws, but through the application of general fiduciary principles and common law development? Or should we look to a federal enactment for relief, either a federal corporation law or the federal adoption of standards which would be minimums which would be effective if state law failed to reach them?

The second major question we must confront is how the affairs of corporations, these aggregations of economic power, should be related to the total social fabric, to what extent should the economic interests of management and shareholders alike be subordinated to larger considerations? These questions revive the classic Berle-Dodds debate about whom the corporation must answer to, a debate Professor Berle conceded Professor Dodd, who said it must be responsible to interests beyond those of the shareholders, had won, if judged by events: **Transition of the large corporation from a private enterprise to a social insti. tution has now been accomplished and is generally recognized."

Professor Hurst has suggested there is a need to further legitimize corporate power otherwise than through the utility of the corporate structure:

“For all the brave talk of a new stockholder democracy and a new corporate statesmanship, it is unlikely that we would find satisfactory adjustment of the large corporation to the social context through new controls built into the corporation's own constitution; this aspect of legal development since 1890 would likely endure. But there would be insistent continuing demand to legitimize corporate power by its responsibility as well as its utility. To this end we would ultimately require a more comprehensive legislative response than any we had achieved by 1970."

The prime method proposed by those who seek to carry out Professor Hurst's suggestions for a “more comprehensive legislative response" is federal incorporation. The response they urge is not simply the substitution of a federal enable ing statute, similar in many respects to those of the states, but with more stringent demands upon management in its allocation of the fruits of the enterprise between themselves and the shareholders, but rather a regulatory statute that might, as Professor Schwartz suggests, deal with the problem of “bigness", the participation in the governance of the corporation by constituencies beyond that of shareholders, the creation of a new regulatory function that would enforce the various mandates of the statute.

Almost universally hopes for reform of corporate control, whether those expressed by Professor Cary or the wider ranging ones entertained by Professor Schwartz and Ralph Nader, look to the federal government for realization. This, of course, reflects a broad strain in American thought. As Professor Hurst has said, “The more important any legal theme is in United States history, the more likely it is that it has been significantly affected by the coexistence and interplay of the national and state governments." Any answers we derive must inevitably include recognition of this American phenomenon. In some measure this turning toward Washington reflects a philosophical conviction that these matters, being of national concern, should be dealt with through national means. And then there is the despair that state law can be molded to the pattern needed. It is not expectable that states will, confronted with the possibility that one state will not conform and thus become the favored haven of corporations, significantly harden their demands upon those controlling corporate enterprise, either in their relations with shareholders or with the social totality of the nation. This is recognized by many, perhaps most notably by Professor Folk who had the unique opportunity of observing the dynamics of state corporation law-making as Reporter for the amendments to the Delaware Corporation Law in the sixties.

The issues we confront at this conference are not newly identified or newly arrived in the American consciousness. Concern with corporate power and corporate control has a long history. As the corporate mode of enterprise has become commonplace, as the size of corporations has expanded, as scholars reexamine the history of corporations and their theoretical foundations in our own and other societies, solutions satisfactory to other generations are called into question. Any conclusions of our time which may be expressed in statutes and court decisions will be questioned by the next generation, and theirs by the one after that. This is the stuff of which life is made.

Enough of the questions. Let us now seek answers.

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

EXHANGE COMMISSION

(American Bar Association 97th Annual Meeting, Honolulu, Hawaii,

August 14, 1974)

THOUGHTS FOR THE INSURANCE COMPANY DIRECTOR

(By A. A. Sommer, Jr.*) Discussing the impact of federal securities laws on the responsibilities and the duties of insurance company directors is in a sense something of a melding of uncertainties.

Because of the McCarran-Ferguson Insurance Regulation Act which was intended to preserve the regulation of insurance to the states the general feeling has existed that the federal securities laws have minimal importance to insurance companies. Surely it has always been clear that insurance companies were subject to the registration provisions of the Securities Act of 1933. However, the amendments to the Securities Exchange Act in 1964 reinforced in the minds of many the minimal relevance of the federal securities law scheme to insurance companies when insurance companies were exempted from the proxy, insider trading and reporting provisions of the 1934 Act provided they satisfied comparable provisions in the laws of their state of incorporation.

I would suggest that the true scope of applicability of the federal securities laws to the insurance industry began to appear in the case of SEC v. National

• 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.

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Securities, Inc. in 1969 when the Supreme Court gave a fairly narrow reading to the McCarran-Ferguson Act and determined that indeed Rule 10b-5 did have applicability to the conduct of insurance companies and those who managed and controlled them. The conclusion was rather decisively reinforced in the case of Superintendent of Insurance v. Bankers Life & Casualty Co., decided by the Supreme Court in 1971, in which, while the Court made law of significance to many more than those involved in insurance companies, it made clear that the requirement of Rule 106–5 that prohibited conduct be “in connection with the purchase and sale of securities” was satisfied by dealings of an insurance company in its portfolio securities and not only by dealings in securities issued by itself. This, of course, meant that even mutual insurance companies which have technically no shareholders nonetheless might, along with their officers, directors and controlling persons, find themselves in violation of Rule 10b-5 if in some fashion they committed fraudulent, manipulative, deceptive or other kinds of improper conduct which resulted in harm to their corporations in connection with their dealings in portfolio securities.

I mentioned at the beginning that the relationship of Rule 105–5 and the insurance industry involved a melding of uncertainties. The second uncertainty melded together is, of course, Rule 10b-5 itself. Despite extended litigation over a period exceeding three decades, despite case books bulging with procedural and substantive decisions involving Rule 105–5, despite the abmirable effort of Professor Alan R. Bromberg in his three volume work on Rule 10b-5 to bring together and rationalize all of the disparate elements, vast areas of uncertainty exist. These uncertainties are, to use the phraso increasingly found in decisions involving Rule 105–5, “aided and abetted” by the peculiar structure of American jurisprudence which devides up appellate jurisdiction not only into a Supreme Court but among 11 circuits, each of which, in keeping with traditional common law theory, by its decisions binds only the district courts within its circuit. Rule 10b-5 is undoubtedly one of the most prolific sources of litigation presently found in the United States Code or the Code of Federal Regulations. It is not suprising then that it has fomented innumerable conflicts among the circuits. While I do feel that many of the conflicts have gradually been reduced in significance, nonetheless many remain.

It is both fortunate and unfortunate that Rule 100–5 has grown in significance to the extent that it has. It is fortunate because it filled a raher gaping void or more accurately a number of gaping voids which if some means had not been found to fill them might have had extremely adverse social consequences. Any of us who have read Professor William Cary's recent masterful article entitled, Federalism and Corporate Law: Reflections Upon Delaware, knows the sad deficiencies in our state corporation laws. We also know how ineffective have been proposals for a federal corporation law. We all know the manner in which involvement of the public in securities matters has grown over the last 30 years. We all know of the increasing public demand for higher standards of performance on the part of corporate executives, directors, accountants, lawyers. And we all know the profound distaste which has grown among the members of the public for overreaching and inside dealing among corporate officials, ethical reactions which have now spread to other countries, notably the United Kingdom. I would suggest that in many respects Rule 100–5 has been the safety valve which has prevented the buildup of these pressures to intolerable proportions and which has permitted the Securities and Exchange Commission in a remarkable fulfillment of its role as an administrative agency, and the courts in fulfillment of their common law tradition, to relieve these pressure by constructive and imaginative lawmaking. Without Rule 105-5 and its flexible ability to respond to the ethical conceptions which the public demanded be translated into legal mandates, and given the counter pressures which in my estimation would have prevented sufficiently timely and effective state action to deal with these demands, I think we would have had an even greater erosion of confidence in corporate responsibility and corporate decency than we have had with many misfortunes following from that.

I spoke of Rule 105-5 being both fortunate and unfortunate. I think it is unfortuate that we have, because of the circumstances that I mentioned, been impelled to load so much on this Rule, which after all was admittedly adopted in haste, erpressed with bewildering and sometimes even angering breadth and generality, and which is only 115 words long. Responsible commentators have suggested that it is wholly inappropriate for the Commission and the courts to try to draw through some alchemy out of those few words a whole code of conduct for the legal profession, the accounting profession, directors, corporate officers, insiders

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