SECURITIES AND ~t:;~EXCHANGE COMMISSION ~ ,~

Washington, D. C. 20549 ~ ~1iJ

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SEC--CATALYST FOR COMPETITIVE FREE ENTERPRISE

- Address by

John R. EvansCommissioner

Securities and Exchange Commission

Brookings InstitutionSeminar on International

Trade and FinanceWashington, D.C.March 25, 1976

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I have been asked to give you a view from theSecurities and Exchange Commission on disclosure requirementsfor multinational corporations, a topic which is presently~emanding the attention not only of the SEC and the corporatecommunity but of our State and Justice Departments, foreigngovernments, and the citizens of many nations throughout theworld. Because the subject is fraught with controversy andsince it is publicly known that there are differences ofopinion among members of the Commdssion with respect to thetype and degree of disclosure the SEC should require of publiccompanies, I want it to be very clear that my remarks do notnecessarily reflect the views of my colleagues at theCommission.

I am firmly convinced that the most effective methodto maximize economic production is for government to providean environment in which there are opportunities for individualsto obtain benefits according to their efforts and sacrifices.Moreover, experience has shown that a system encouraging thedevelopment and management of private capital and competitionamong business enterprises for that capital and other productiveresources and also for sales on the basis of product, price,and service results in the most efficient use of resources.

The Securities and Exchange ComDdssion, as a mat~er of policy,disclaims responsibility for speeches by any of ~ts Commissioners.The views expressed herein are those of t~e ~peaker and do notnecessarily reflect the views of the Comm~ss~on.

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However, the incentives to maximize profits or personalbenefits can be so powerful that unles~ they are balancedeither by high ethical personal and corporate principlesconsistent with the public interest or by external requirementsto assure that certain standards are maintained, abuses willoccur.

One of the elements of a free system is that by itsvery nature individuals are able to make choices and engagein activities which may be detrimental to their own interests,the public interest, and may even be destructive to the verysystem providing such opportunities. It appears from some ofthe newspaper reports that the scandals which have resultedfrom illegal and improper payments by internationalcorporations have provided support for those in this countryand abroad who oppose our free enterprise economic system.Commenting on the situation in Italy, one news article stated,'~ost diplomats and other political analysts agree that thescandal has served to strengthen the Communists." Anotherarticle indicated that, "French Socialists found the corruptionrevelations a further reason for promoting their program ofnationalization of multinational companies in France." Allegedpayments in Japan have resulted in a political crisis andPrime Minister Takeo Miki in a letter to President Ford statedthat if the payments issue is "kept unsolved with the names

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of the officials involved remaining in doubt. democracy inJapan may suffer a fatal blow."

The situation is aggrevated by those who try todefend their improper practices by saying that, "Everybody'sdoing it," or "Any big company has to give bribes to stay inbusiness today." One French official, who sees bribery as a normalpart of commerce, is quoted as saying, '~y did the Americanshave to publish this?" "They are really crazy." Others havestated that "the fuss about bribery is naive."

The suggestion that corruption is a normal part ofcommerce, and that it must remain covered up in order toprotect democratic systems is ironic. Perhaps those whofavor totalitarian and planned economic systems have beenpleased with the disclosure of the indiscretions of some oftheir opponents, but it should be clear that it is the freeAmerican democratic system that has required the disclosure,that we cannot tolerate such corruption, and that our opensociety is strengthened by constructive self-criticism. Thatthese facts have not gone completely unnoticed is evident frcm astatement in an Italian newspaper that, "If there are abscessesin their society, the Americans are not afraid to puncturethem .. "

Indeed, the strength of a political democracy anda free private' enterprise system are both dependent on an

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informed constituency and, in the long run, both are e~odedif information with respect to improper payments made toinfluence government decisions are not disclosed.

In short, I hope that I have conveyed my convictionthat our free economic and political systems are supportedonly by faith and confidence that corporate and politicalleaders are acting with honesty and integrity in accordancewith acceptable moral and ethical standards and that decisionswith respect to whether such standards are being met canbe made only to the extent activities are fully and fairlydisclosed.

One of the major objectives of our securities lawsis to protect investors and the public interest by requiringdisclosure of all material facts concerning the operations ofpublic corporations. Disclosfire is a very effective regulatorytool. In addition to its major purpose of providing materialinformation to investors which enables them to make informedinvestment decisions, disclosure also provides a mechanismwhereby the activities of business institutions, whether large,small, local, national or international in scope, can be maderesponsive to the legal and ethical standards of the localitiesin which they do business. Another beneficial aspect ofdisclosure is that, to a significant degree, it providesregulation through economic forces such as the decisions ofinvestors and consumers rather than through government edictsor direct intervention.

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Because of our responsibility to administer thesecurities laws, the Commission has been instrumental inrequiring the disclosures by corporations of the use ofcorporate funds for illegal or improper purposes. Ourapproach has been to utilize our powers of investigation andinjunctive actions as well as offering incentives forcorporations to examine and correct their own problems withminimal government action. We have sought prophylacticreli~f, not punishment, since the sanctions under thesecurities laws are remedial. In the enforcement area, wehave brought 11 civil injunctive actions and have beensuccessful in obtaining what we believe to be satisfactorydisclosure and responsive corporate action. Anotherinjunctive case was approved by the Commission earlier thisweek, and no doubt there will be similar Commission actionsin the future.

In past cases, we have alleged, among other things,that the failure to disclose the establishment of off-the-record funds, the creation of false corporate books andrecords, the use of corporate funds for unlawful purposes,and the use of consultant fees or commissions to bribeforeign government officials has resulted in violations ofour federal securities laws.

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The relief obtained in these cases includes courtorders prohibiting the continuation of such activities andrequiring the companies to appoint a committee of independentdirectors and attorneys to undertake an in-depth inquiry oftheir past and present corporate conduct. The court ordershave also required that the findings of these inquiries bereported to the court, the Commission, and to shareholders.The possible effectiveness of such inquiries was recentlyillustrated when one such report caused a corporation's topmanagement to be replaced.

It is also important to know that in obtaining thistype of self-inquiry the SEC acts as an effective catalystfor corporate reform to a far greater extent than would bepossible utilizing solely its own budgetary and manpowerresources. According to the annual lO-K report filed withthe Commission by one corporation, the investigation by itsappointed committee to ascertain the facts with respect to itsillegal and improper paYments cost the company about $3 million.This was equal to nearly seven percent of the Commission'stotal budget of $44 1/2 million last year, a budget which isalready strained to capacity to bring enforcement actions,to process registration statements, to conduct regulatoryactivities with respect to broker dealers, investmentadvisers, investment companies, utility companies, exchange and

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over-the-counter securities markets, and to process reportsreceived from the 12,000 corporations which are subject toour disclosure requirements.

In addition to our enforcement program, our so-called"voluntary disclosure program" has also been very effective.Although there can be no clear line of demarcation betweenthe enforcement program and the voluntary program, becausethe Commission obviously cannot guarantee that an enforcementaction will not be brought if it is warranted by informationdiscovered through the voluntary program, participation in thevoluntary program may reduce the necessity for an enforcementaction and may also reduce the degree of required disclosure.In instances where the Commission has initiated enforcementaction, we have been satisfied only with a full report ofactivities, including names, places and payments, regardlessof the amounts involved. Under the voluntary program, we havenot always required disclosure of the specific identities ofthe recipients or the names of the countries involved fromparticipants. We have, however, suggested certain "genericdisclosures" and requested that the companies agree to grant ourEnforcement Division access to their investigatory files sothat the information presented to us by the company can beverified.

A company participating in the voluntary disclosureprogram generally undertakes an internal inquiry of its

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conduct over the past five years by a committee of independentdirectors with tae assistance of independent accountants andoutside counsel.

Upon completion of the inquiry, the committee willprepare a report setting forth its findings and submit thereport to the full board of directors. The report should setforth detailed information about each payment; how it wasmade, the country in which it was made, the amount involved,the recipient, and the reason for the payment. Althoughreports of this type have been filed with the Commission aspart-of the settlement of enforcement actions, the Commissionhas not insisted that companies file such a report under thevoluntary program. Nevertheless, a company's board ofdirectors must deal with the information in the report andthe response has generally been to adopt a policy statementregarding such payments or reiterate a previous statement andto consider what public disclosure, if any, should be made.

The policy statement usually indicates the board'sdisapproval of the practice of making illegal or improperpayments, and sets forth a declaration that such payments willnot be made in the future; that false entries will not be madein the company's books and records; that any employee whogains knowledge of any policy violations shall report suchactivity promptly to a designated company official; that

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employees violating the poli.cywill be appropriately disciplined,including possible termination; that the company's independentauditors will be instructed to watch for evidence of suchpayments in their annual audits; and that the policy statementwill be distributed widely to all appropriate supervisoryemployees.

If the company's board of directors decides thatsome disclosure about the payments detailed in the report ofthe independent directors may be appropriate, it will normallyauthorize company officers and counsel to discuss the matterwith the Commission's staff. The disclosures made followingsuch discussions nave included: a statement of tae amount ofpayments made and their purpose or the nature of the corporateactivity to which they relate; a statement of whether anymember of the top management or the board of directorsauthorized or knew of such payments; a statement of whetherthe payments involved the maintenance of false books andrecords or the use of funds outside the corporate accountabilitysystem; a statement of the company's policy with respect tothe making of such payments in the future, the use of fundsoutside the accountability system, and the maintenance ofbooks and records containing false or misleading entries; astatement declaring cessa~ion of all such activities, if onehas been adopted; a statement of whether or not cessation ofsuch payments is expected to have a material effect on the

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company's business, and, if so, a description of that ~ffectincluding the amount of business related to such payments;a statement of whether any tax impact will flow as a resultof the improper deduction of such payments; and some companieshave included a statement that the payments have been voluntarilyreported to the Securities and Exchange Commission pursuantto its voluntary disclosure program.

I believe it is significant that some companies havechosen to make disclosures which were more extensive thanthose suggested by the Commission. Several large corporationshave described with specificity payments which amounted to afew thousand dollars or less, and a number of companies haveindicated that they were motivated to disclose questionablepayments in order to avoid -the embarrassment that could resultfrom disclosing such payments for the first time in responseto a request at a shareholders' meeting.

The most difficult question we face with respect tothe improper use of corporate funds is when must such paymentsbe publicly disclosed? The answer to this question is thatthey must be disclosed when a reasonable investor would belikely to consider such facts important in making an investmentdecision or in making a decision on how to vote in a proxysolicitation.

But that is just the starting point for analysis.Unfortunately, we do not have access to answers from the

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"theoretical reasonable investor" as to what constitutes 'factsimportant in making such decisions. Most, if not all,investors believe themselves to be reasonable and yet considerdifferent facts important in their decisionmaking. Let meshare with you some of the difficult considerations which havebeen discussed at great length by the Commission.

Does it make any difference for purposes of disclosurewho authorized the illegal or improper payment and who acceptedit? Perhaps not from a moral or ethical viewpoint, but itcould,make a difference to investors whether the action wassanctioned by top management or whether such payments weremade by a lesser employee in the company against company policyand without management I s knowledge. Another significant factormight be whether the payment; was made to a high governmentofficial, or with knowledge that it would be passed on to suchan official, to influence the making of a decision other thanon its merits. In my opinion, the greater the position ofpower or responsibility, the more important it is from asocietal viewpoint to act with integrity, and the more importantit is that improper activity be disclosed.

Can the importance of disclosure be determined on thebasis of the size of an improper payment? Size may be animportant factor, but the size of payments may be a very smallpercentage of a transaction and yet an extremely large absolutesum of money for an individual and, thUS, a very strongimproper influence.

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Is the amount of business affected by the paymentor the amount of business done by a company in the country inwhich such a payment is made a determinative factor? Itcould be in some instances, but it cannot be dispositivebecause knowledge of an improper payment in one country canand has resulted also in adverse reactions such as nationalizationof property, nonpayment for previously expropriated property,cancellation of contracts for future purchases, and revocationof operating permits in other countries.

Should the size of a payment as a percentage of foreignsales, profits, or assets or total sales, profits or assetsbe a factor in determining whether to require disclosure? Ifit is, the result could be that a multi-billion dollarcorporation with a small division equal in size to the totaloperations of a small competing company would not be requiredto make disclosures of the same dollar size improper paymentsas would be required of the smaller company. In my opinion,this would be inherently unfair and, thus, an unacceptablegovernment policy.

Does the country in which an improper payment takesplace make a difference in whether it should be disclosed?Although it has been suggested that such payments are a wayof life in some countries, we have seen that they have beenmade in all parts of the world, in developing countries, andin the most highly industrialized countries including our own,and I am not aware of an official statement from any country

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that bribes of their government officials are acceptable.Experience has shown that peoples in all countries areincensed by such payments, and perhaps Prime Minister Mikiof Japan said it best when he stated, "We cannot overcome thepresent difficulties without having the people's trust. Andto obtain this trust we have to reveal the truth."

Do all payments approved or known to managementreflect on its integrity and its stewardship of the companyand thus require disclosure or should small expediting paymentsbe-excluded? If a distinction is made, what is the dividingline between the significant payments and those which are notsignificant?

Should disclosure be required of all paymentsinvolving funds outside the accountability system or involvingfalse books and records? The response to this question wouldseem to be obvious in the affirmative because without suchdisclosure the integrity of the company's accounts would becalled into question and investors could not be assured thatthe financial position of the company is accurately reflected,yet the specificity of terminology that should be used todescribe such payments and the extent to which they shouldbe isolated from other expenditures are subject to disagreement.

Although the Commission has been criticized for notproviding clear guidelines as to what it considers impropercorporate paYments, we have been unable to provide guidelines

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because the facts in each case differ so significantly-thatmeaningful categorization is difficult, if not impossible.In deciding when questionable payments must be publiclydisclosed. the Commission has proceeded on a case-by-casebasis. considering the recommendations of our staff and thewritten submissions of the companies involved. and in my opinion.we should continue to proceed in that manner. As we gainexperience. however, we can expect certain patterns to emerge,and I believe that some patterns are already emerging.

Where public disclosure nas already been made, andtop management. including nominess for directorships were notaware of or did not authorize the improper payments, theCommission has generally not objected to non-disclosure inproxy statements. Along with other factors. when one or moremembers of top management authorized or were aware of relativelysmall improper payments, the Commission has required genericdisclosure of the payments and the fact that management knewof or authorized them.but generally the name or names ofthose involved have not been required to be disclosed. In aborderline case. the fact that payments have ceased made thedifference between disclosure and non-disclosure. If acompany which has not yet completed its own investigationrequests an advisory opinion from the Commission as to themateriality of certain information. we have generally felt

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constrained to take no position or to inform the company toproceed on its own. In some instances where information wasnot, strictly speaking, required to be disclosed, we have hadthe staff inform the companies of that fact but have also hadthe staff inform the company that the Commission believedmaking those disclosures would be a good business practice.

Lest you have the impression that the Commission'sconcern for improper paYment activities pertains only to theinternational markets, I should indicate that we are aware ofand have brought enforcement actions against companies whichhave made similar types of payment s in our domestic markets,either to influence government officials on national or locallevels or to obtain benefits other than in the ordinary courseof business. While we do not know how widespread thesepractices are in this country, reported estimates of domesticcommercial bribery activities range from a two year oldChamber of Commerce figure of $3 billion annually to an estimateof as much as $15 billion by a lawyer who has considerableexperience with fraud and other questionable corporate conduct.The corporate community should be aware that the ComGdssionaas a responsibility, which I believe we will fulfill, toinvestigate any such cases brought to our attention and takewhatever enforcement action is appropriate, including therequirement of public disclosure.,

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To date approximately sixty-five companies havemade public disclosure of improper foreign or domesticpayments, either as a re~ult of e~forcement action or throughthe voluntary disclosure program, at least 15 companies arecurrently discussing disclosure problems with the staff, andI expect that the number will continue to grow in the nextmonth or two as many companies submit their lO-K reports andpreliminary proxy materials. Moreover, our program hasprompted many companies to look more closely at theiroperations, and a growing number have simply filed disclosureinformation with us concerning improper payments without priorconsultation with our staff.

~le there are still many who suggest that bribes,kickbacks and other illegal or improper payments are normaland necessary in commercial transactions and that Americancompanies will not be able to compete in internationalmarkets unless they are allowed to make such payments, thetide is turning and many b~siness executives who disagreewith such claims on the basis of their own experience havespoken out on the issue. Mr. David S. Lewis, chairman of theboard of General Dynamics, which was successful in ob~ainingwhat has been called the "deal of the century" to sell F-16aircraft to several countries in Europe and in the UnitedStates, is quoted in the New York Times as saying that:

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Th~re were zero payoffs, there were'zerobr~bes, there were zero offers. There's~othing in the future and there'e nothing~n the past, and there'e no one in anyof these governments that has to be awakenights wondering when the whistle is goingto blow on him because it isn't going tohappen.

Mr. A. W. Clausen, president of the Bank of Americahas stated:

Integrity is not some impractical notiondreamed up by naive do-gooders. Ourintegrity is the foundation for, the verybasis of our ability to do business. Ifthe market economy ever goes under, ourfavorite villains--sQcialist economiesand government regulators--won't be toblame. \.Jewill.

Mr. Frank T. Cary, chairman of IBM has said:When some businesses turn out shoddyproducts. or engage in misleadingadvertising or ignore customercomplaints, the public gets sour onbusiness as a whole. When someexecutives have to admit that theybribed foreign officials or illegallychanneled corporate funds into politicalcampaigns, the public believes this isstandard busines s conduct. And whenwe read in the papers about corporatekickbacks and secret Swiss bank accounts,all business suffers. Some businessmenhave tried to excuse themselves bysaying that everybody does it. Well,everybody doesn't do it ... The timehas come for those of us in business toput our house in order . . . to restorethe faith of Americans in the basiccompetence and purpose of business. Andthis requires a lot more than public-relations efforts.

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These statements are representative of many whichare being made by businessmen who do not like to be improperlycategorized with firms in the business community whichapparently are. through their shortsighted, impropercorporate activities, jeopardizing the private enterprisesystem that makes it possible for their businesses to exist.I am pleased to see businessmen who are not afraid to supportand speak out in favor of moral and ethical conduct in thebusiness community, and I would like to conclude bysuggesting that the only way for the business community toavoid additional burdensome regulation and legislation is toaccept the responsibility to establish and maintain highethical and moral standards and to disclose fully and fairlytheir operations so that shareholders and the public willknow that everybody isn't doing it.