SECURITIES ANDEXCHANGE COMMISSION

Washington, D. C. 20549(202) 755-4846

TURNING THE TIDE

Address by

John R. EvansCommissioner

Securities and Exchange Commission

Northwest State-Federa1-Provincial Securities Conference

Ramada InnPortland, OregonMay 13, 1976

During the past two years, disclosures thatcorporations have used their funds for illegal or questionablepurposes have attracted national and international attention,and such terms as bribe, slush fund, kick-back, extortion," dt.t a" d" " h bmor 1 a an grease ave ecome part of everyday conversation.It is well known that in many instances, including twoinjunctive actions filed earlier this week, the Securitiesand Exchange Commission has been instrumental in bringing aboutthe disclosure of such payments.

There seem to be. however, some rather significantmisunderstandings regarding our actions. For example, thereis the belief that our actions are the product of rubber-stamped recommendations made by an over-zealous enforcementstaff and are not careful deliberations by the Commission.There is also an impression that the Commission has been badlysplit in its decisions. More substantively. there are thosewho apparently believe that the Commission has ventured into anarea in which it has no expertise; that our actions have beennaive and have jeopardized the ability of U.S. corporations tocompete in foreign markets; that the Commission has misinterpretedand exceeded its statutory authority; that we are utilizing ourauthority to establish standards of business ethics and morality;

The Securities and Exchange Commission. as a mat~er of policy,disclaims responsibility for speeches by any of 1tS Commissioners.The views expressed herein are those of t~e ~peaker and do notnecessarily reflect the views of the Comm1ss1on.

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and that our actions have compromised the Commission'scredibility and imperiled the unique reputation and highrespect that the SEC has enjoyed over the past 42 years. I hopemy remarks today will help clarify some of these issues.

Our program with respect to disclosure of illegal orquestionable corporate payments began in January 1974 when ourDivision of Corporation Finance recommended that the Commissionpublish a release expressing the staff's views on the disclosureof illegal political campaign contributions by public corporations.While this issue was pending before the Commission, we alsoreceived a recommendation to authorize the filing of a complaintcharging the American S~ip fiuilding Company and its cniefexecutive officer with violating the proxy and periodicreporting requirements of the securities laws by failing todisclose that corporate funds had been used for politicalcontributions and that false and fictitious entries had beenmade in the company's books and records to conceal the purposefor which these funds were used.

These two staff recommendations were consideredtogether and the issues involved were the subject of carefuland deliberate Commission consideration in several meetingsspanniag a period of t~ree mont~s. Anong tne issues discussecwere whether the decision to disclose the fact that corporatefunds had been knowingly used for purposes other than those

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recorded on the company's books should be based on economicmateriality standards or whether the amounts involved wereirrelevant because such activities reflected directly on theintegrity of management. At the same Commission meeting, andwithout a dissenting vote, the Commission approved theissuance of the release and instructed the staff the lines alongwhich to draft a complaint against the American Ship BuildingCompany for our review.

I mention this fact because it has been suggestedthat the complaint which was filed on April 15, 1974, along witha consent settlement, was a clear contradiction with the releaseissued on March 8, 1974, and indicated that during the interimtne Commission must have changed its mind. I do not find sucha contradiction between the two Co~ssion actions. The releasefocused on and required disclosure in all specific situationsin which there was a conviction, guilty plea, or pendingindictment alleging that the federal election laws had beenviolated. It stated further that in other instances managementwas in the best position to judge whether disclosure wasnecessary. The Commission could not then, nor in my opinionshould it now, suggest such an absolute disclosure requirementfor all illegal or questionable payments. We have givenfurther specific disclosure advice to registrants and broughtenforcement actions only after considering the facts in eachcase. Without such a consideration, management is still in thebest position to judge whether disclosure is appropriate as

we stated in the release.

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The American Ship Building complaint was based onallegations that the company had filed reports which werefalse and misleading with the SEC and that false and fictitiousentries were made on the books of the company to conceal thepurposes for which corporate funds had been used. The factthat the amount of corporate funds involved was just over$120,000 during a period beginning in September 1970 untilthe complaint was filed in April 1974, or an average total

annual amount equal to 4/100 of one percent of the company'saverage annual revenues, should have indicated the Commission'sdecision that the standard for disclosure in such a case wasnot traditional economic materiality, but that such paYmentsreflected on the integrity of management.

The relief obtained in the consent decree and court-ordered undertakin~ pronibited the alle~ed violations andestablished a review committee, including a chairman notaffiliated with the company, and at least two independentmembers of the company's board of directors, to examine allbooks and records beginning with September 1970. Theexamination was to focus upon the expenses or paYments enteredon the company's books for purposes other than those indicated.The Committee was also ordered to prepare a report of itsfindings and to submit it to the court, the Commission, andthe company's board of directors which in turn was directedto review it and take whatever action was necessary and proper

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to implement the recommendations of the report. Thissettlement was accepted by the Commission without a dissentingvote.

Before making the decision to file the complaint, andbefore voting to accept the settlement, various members of

-the Commission expressed concern, and there was considerlblediscussion that tnis apolication of the securities laws andenforcement approach would lead to undesirable results.Although there was some speculation at the time, we could nothave known, of course, that our program would result in thedisclosure of illegal or questionable payments by manycorporations to recipients throughout the world. We couldnot have known that investigations by independent companycommittees would bring about the replacement of top managementofficials of some major corporations. We could not have knownthat so~e corporatio~s had made payments which, if disclosed,would result in political crises in foreign countries. Wedid know, however, and discussed the fact that these resultswere possible, and, ~ith that knowledge, authorized thefiling of the injunctive action and agreed to the settlement.

Since those first important decisions in early 1974,the Commission has brought a total of 15 enforcementactions which differ in factual content, but which have thesame basic allegations of false and misleading reports andfalse and ficticious entries on the corporate books and records.

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And we have obtained settlements with court-ordered relief,similar to that obtained in American Ship Building, in all outone case which has not been resolved. To supplement ourenforcement actions, we have also encouraged corporations toexamine voluntarily their operations for such payments, and,if problems are found, to consider whether disclosure isnecessary.

There have been times when we seemed to be waging alonely battle, but I believe that the tide is turning as othergovernment agencies have become involved, as internationalgroups have begun to seek solutions to these problems, and astop business executives have expressed their views in oppositionto illegal and questionable corporate payments. Instead ofjeopardizing respect for the Commission and its outstandingreputation, as has been argued, I believe that this chapterof the Commission's history will be considered as one of itsfinest hours.

Given the fact that by April 21, 1976, 89 companies,55 of which are among the top 500 U. S. industrial corporations,have filed documents with the Commission containing variousdegrees of disclosure with respect to illegal or questionablepayments, and the fact that there are more than 7,500 companiessubject to reporting requirements under the securities laws,it may be somewhat surprising to know the relatively few casesin which the Commission has made either a specific disclosureor enforcement determination.

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In addition to our 15 enforcement actions the,

Commission has considered disclosure questions with respectto illegal and questionable payments for only 25 companies.There have, of course, been additional cases in which the staffand the company agreed on disclosure without Commission consider-ation. In eight of the 25 cases in which companies raiseddisclosure questions, the Commission, after reviewing the factspresented, expressed no view regarding appropriate disclosurebecause either the company had not completed its own investigation,or our staff was already investigating the company, or furtherinvestigation or enforcement action appeared likely. In thesesituations, the Commission generally deems it best not toprovide any comfort until such inquiries have been completed.

Thus, the number of instances in which the Commissionhas expressed its views regarding disclosure, other than in anenforcement context, is reduced to 17. Of these 17 cases,without being too specific, it can be said that the Commissiongenerally agreed with the degree of disclosure proposed by theregistrants in 12 cases and requested additional disclosure infive cases. In three cases, the Commission determined that nodisclosure would be requested, and, in one of these cases, wedirected the staff to indicate that, although we did notbelieve it was necessary, we would encourage disclosure as agood business practice.

Incidentally, in some of these 17 cases, the Commissiondisagreed with the staff, and, in a few, there was a split in

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the Commission vote as to the degree of disclosure that shouldbe provided. Thus, the Commission realizes from first-handexperience that there are some cases in which improper orillegal payments may present difficult disclosure decisionsfor business firms and for professionals such as accountantsand attorneys who advise companies concerning disclosureresponsibilities and acceptable accounting standards, and wehave seriously considered the possibility and desirability ofproviding additional guidance in this area.

rhere are several ways in which this could be done.Court opinions could be helpful, but in their absence ourconsent decrees may provide some guidance, and, of course, underthe voluntary program, our staff will provide specific assistanceif requested to do so. In addition, we have just completed areport which we submitted to the Senate Committee on Banking,Housing and Urban Affairs jesterday discussing our activities,the nature of the corporate disclosures that have been made,and our recommendations for congressional action.

The report sets forth by company name, in tabularform, various categories of information which companies haveprovided in filed documents with the Commission, includingthe amounts of domestic and foreign political contributions,foreign sales-type commissions, paYments to foreign officials,books and records problems, U.s. tax liability, kno~lledge oftop management, and whether cessation of the paYments hasoccurred. It is important to understand, however, that the

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Commission advised only 14 of the 89 companies that madedisclosures and that many companies disclosed paYments forreasons other than a determination that the paYments werematerial, and thus, the fact that the disclosures are madedoes not necessarily indicate materiality decisions either bythe SEC or the companies. However, some guidance may bederived from the information disclosed by the 14 companiesthat sought and received Commission advice favoring disclosure.

In addition to the disclosure information provided,in an effort to be as helpful as possible, the Commission alsoincluded a discussion of the factors which we have consideredin making our decisions. In many instances, the determinationthat disclosure was necessary depended on a combination ofseveral considerations. Our decisions were strongly influencedby the fact that most of the illegal or questionable paYmentcases involved false and fictitious entries on the corporatebooks and records and the filing of false and misleadingreports with the Commission. These two issues were weighedheavily in our decisions because the disclosure system of thesecurities laws is based largely on the principle that allcorporate funds belong to the shareholders and must beaccurately accounted for by the corporation's system offinancial a~countability. Any diversion of funds outside thecorporate system, or any deception with respect to corporatebooks and records, cannot be permitted without undermining t~epurposes of the securities laws.

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We have also recommended that questionable orillegal payments of a significant size, or related to asignificant amount of business, should be disclosed irrespectiveof whether they are properly recorded on the company's booksand records because of the effect such payments may have onthe economic viability of the company. Moreover, smallerpayments which may not individually require disclosure, butwhich have been part of the company's business pattern for aperiod of time, whereas other competing companies have not madesuch payments, may indicate that the company would not becompetitive in the absence of such payments and thus disclosurewould be appropriate.

The Commission has been inclined to requestdisclosure of illegal or questionable payments in relation tothe degree of management's knowledge or approval of suchpayments. This factor is important because investors have aright to be informed regarding the integrity of management inconnection with the administration of corporate affairs andassets. If management specifically approved payments, or ifthey were aware, or should have been aware, of such payments.through an effective corporate accountability system, thendisclosure is usually necessary.

In some circumstances, the recipient of a paymentmay be important in determining whether disclosure should bemade. However, the identity of recipients has thus far not

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been required under the Commission's voluntary disclosureprogram. A direct payment to a high governmental officialin return for a decision in his governmental capacity bestowingunjustified benefits, such as tax changes or awarding agovernment contract to the corporation most likely should bedisclosed. Political contributions and similar payments thatare designed to assure the performance of services which therecipient is legally obligated to perform may call fordisclosure depending on the applicable laws and the amountsinvolved.

Of course, legitimate payments to consultants andcommission agents usually need not be disclosed, but if suchpayments are abnormal in amount, are made in cash, aredeposited in a foreign bank account, or if the agent has anaffiliation or close relationship with the foreign contractingparty, -disclosure of the payments may be appropriate.

Where public disclosure has already been made in areport filed with the SEC or circulated to shareholders, theCommission has generally not objected to non-disclosure inproxy statements, although there are situations in whichdisclosure is appropriate. When one or more members of topmanagement authorized, or were aware of improper payments, theCommission has required generic disclosure of the payments,and the fact that management knew or authorized them but,generally, disclosure of the name or names of those involved

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nas not been required. Cessation of undisclosed illegal orquestionable payments qas been one of the primary aims of theCommission and in some cases, the fact that the payments haveceased has made the difference between disclosure and non-disclosure.

Guidance of the type I have discussed, and which wehave provided in our report to the Senate Committee, representsthe extent to which the Commission is able to offer generalassistance to the business community and professionals at thistime. Although we may be criticized for not providing morespecific guidance, in my opinion, greater precision cannotbe provided except in a factual context, because many factorsmust be considered and weighed. Moreover, even if it werepossible, it might not be desirable to establish guidelinesas to how far one may go in utilizing corporate funds forillegal or improper purposes without accurately recording suchexpenditures on corporate books or disclosing the existenceand effect of such payments. In a real sense, whether we likeit or not, this type of activity does reflect personal andbusiness standards of ethics and morality, and I do not believethat a public service is performed by the SEC, or anyone else,in condoning any degree of such activity.

I realize that such a statement may fan the flames ofcriticism that the Commission is improperly attempting to setstandards of business ethics and morality. However, in my

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opinion, there is no basis for this criticism. In each casebrought before us , we have considered and weighed the relevantfacts and have made a good faith decision regarding disclosureobligations. If that process has improved ethics and moralityin the business community) it is because businessmen mustdesire to meet the standard they perceive their family, associates,or the public expect of them, or which will be in their owninterest or in the corporation's interest, and I am certainlynot ashamed of that result. It will be a sad day for thiscountry and its people if we reach a situation in which govern-ment officials must .apo10gize for taking action that improvesbusiness practices, or in which public servants must assurethat their actions do not.have a positive effect on ethicsor morality.

Moreover, the basic purpose of the securities lawsis to promote and maintain securities markets that are fairand honest. I do not understand how fair and honest marketscan be promoted and maintained without requiring corporateissuers whose securities are traded in those markets to behonest and fair in describing their activities and accountingfor the use of corporate funds which belong to shareholders.It is also difficult for me to find any basis for suggestingthat fairness and honesty are not related to ethics andmorality.

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On the other hand, I am somewhat concerned that theissue of illegal and questionable corporate payments is beingconsidered by some in a context that is too narrow, legalistic,and short-sighted. In view of the objectives of the securitieslaws, such as investor protection and fair and honest markets,compliance with the ,spirit of the'law may be more meaningfuland prudent than quibbling about meeting the bare minimumlegal requirements. I would suggest that many.companiesand their professional accounting and legal advisers wouldserve their own and the public interest by being less conceznedwith just avoiding possible enforcement action by the SEC orlitigation with pr~vate parties and more concerned with pro-viding disclosure consistent with the present social. climate.Such a course of conduct should promote the company's publicimage, its shareholder. relations, its customer re1at,ions,and its business prospects. If a company has e~gaged inconduct involving substantial improper or illegal payments,then it is not difficult to determine that disclosure isnecessary. If there are no problems or only m~ima~paym~n~s,then it would seem to be a good business practice to in~orminvestors and the public of .those facts a~d ~any responsiblecorporate executives are choosing that course of action.

Furthermore, an effective corporate disclosuresystem is an integral part, if not the cornerstone, of thefoundation underlying our free enterprise capitalistic

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system. Investor trust and confidence are based on the beliefthat corporate books, records, and reports accurately reflectcorporate activities. Without investor trust and confidence,our corporations would be unable to obtain the needed capitalto develop, expand, and innovate. In addition, knowledgeabout the operations of business enterprises is necessaryfor investors to make choices between alternative firms andthe choices made allocate capital among alternatives.

Also, whenever business does not meet responsiblestandards, there is a demand for increased government inter-vention. And with every increase of government involvement,burdens on business are increased and the amount of freedomthat business entities have is reduced. While this may benecessary in order to protect investors and the public, it isnot without costs.

It is important to realize that the general SECregulatory approach is probably the most effective, the leastdisruptive, and the most supportive of private decision-makingthat can be taken by government. In the securities industry,where we exercise direct regulatory jurisdiction, there is aunique regulatory structure in which the industry regulatesitself subject to Commission oversight. Our jurisdiction overindustrial corporate issuers is generally limited to requiringdisclosure of the material financial and business operationsof such firms. Although we have had authority to establish

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accounting procedures and practices for the purposes ofdisclosure documents, we have relied almost entirely on theprivate accounting profession to set acceptable accountingprinciples and standards. We have also relied heavily on thelegal profession to assure that registrants are complyingwith the securities laws.

I believe that the principles and approach that havebeen so effective in maintaining maximum freedom for privatebusiness corporations and professionals should be retained andused as we seek to remedy the illegal, questio~able, andcorrupting business pra~tices which have been engaged in bysome business firms.

Of course, other alternatives have been suggested.One of these is for the Commission or some other governmentalbody to set substantive standards in this area and to performroutine audits or examinations of companies~ This course ofaction would require a substantial increase "in governmentactivities and government intervention in private businessoperations, and would seem to have little support.

Another alternative, which has been proposed inlegislative form is 8.3133, a bill requiring registra~ts tofile with the Commission public periodic re?orts describillgany payments of money or value in excess of $1,000 to anyperson employed by, representing, or affiliated with a foreigngovernment, any political party or candidate, or to any person

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rendering advice in connection with obtaining or maintainingforeign business. The proposed legislation would also makeunlawful certain foreign payments for the purpose of influencingforeign governmental decisions or which violate the laws ofthe foreign jurisdiction. In addition, the legislation wouldauthorize the Commission to initiate criminal actions arisingunder the Securities Act of 1933 and the Securities ExchangeAct of 1934.

Specific statutory reporting levels may providecertainty, but such a mandate by law would reduce the Commission'sflexibility and effectiveness to tailor its requirements toparticular problems. There is also some question whether thedisclosure of $1,000 payments, as well as the recipients, isnecessary in every instance in order to protect investors.

The Commission is also concerned whether the outrightprohibition of certain foreign payments should be consideredin conjunction with matters arising under the federalsecurities laws. There has never been a serious question thatthe Commission has adequate authority to deal with this problemin connection with our administration of the securities laws,and, since foreign payments affect issues and problemsseparate and apart from the federal securities laws, perhapsoutright prohibition of such payments should be consideredindependent of the statutes we administer.

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The alternative which I believe to be appropriate,and which has been recommended by the Commission, is toretain and strengthen the professional community's responsibilityfor assuring that proper standards of corporate conduct arefollowed. Otherwise, professional expertise and serviceswill be overlooked, and the private sector will have missedan excellent bpportunity to demonstrate its good judgment andsensitivity to investor and public interests.

Our legislative proposal is based primarily uponthe Commission's confidence and trust in the professionalcommunity. Among other things, our draft proposes a require-ment that issuers must maintain accurate books supported byan adequate system of internal controls, as called for inthe authoratitive accounting literative. These internalcontrols would assure the accurate preparation of financialstatements consistent with generally accepted accountingprinciples. This requirement would be supplemented by pro-visions making it unlawful for any person to-falsify, directlyor indirectly, books and records for an accounting purpose,or for any person to make a false or misleading statement toan accountant in connection with any audit. These provisionsshould enable the private sector to ensure accurate andmeaningful corporate accountability to investors, and webelieve strongly that the professional community is equippedand qualified to perform this function.

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I hope that this discussion has been helpful indispelling misunderstandings regarding the Commission'sactions. I believe that the Commission's approach is soundand consistent with the securities laws, promotes investorprotections and the public interest, and supports the role ofprivate sector participants. The reactions of both thecorporate and professional communities have been encouraging,but there is still much to be done, and I hope that theprivate sector will support our legislative proposal and willaccept the challenge and utilize this opportunity to resolvethe problems of illegal and questionable corporate paymentswithout further government intervention.