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Washington, D.C.

The subcommittee met at 3 p.m. in room H-236, the Capitol, Hon. Robert N. C. Nix (chairman of the subcommittee) presiding. Mr. NIX. The subcommittee will come to order.

The agencies of the Federal Government have used the United States Code to deal with the problem of corporate payments by American-based companies to foreign officials.

The law as applied by the Securities Exchange Commission compels "disclosure."

The Internal Revenue Service enforces equality under the Tax Code between American businesses active in this country and foreign businesses insofar as tax deductions are denied for the payment of gratuities to officials as a normal business expense.

Permitting such payments abroad by whatever device would penalize domestic businesses which must operate within the law here at home.

The American people have reason to be proud of the Securities and Exchange Commission and reason to expect firm and fair enforcement program from the Internal Revenue Service which is now going into action on this problem.

I congratulate both agencies on their activity. The June 17 Securities and Exchange statement will be entered in the record at this point.

[The statement referred to follows:]


Mr. Chairman, members of the subcommittee, I appreciate the opportunity to testify before this Subcommittee on the subject of contributions to officials of foreign governments by American companies. We also are grateful for the kind words about the work of the Commission in your letter inviting us to appear here.

We understand that the initial concern of this Subcommittee is whether or not legislation may be required to prohibit or regulate these foreign payments. Naturally, that is a legislative judgment only the Congress can make. But, to assist you in your consideration of this important question, I can detail for you the nature of the Commission's activities in this area. With me today, is Wallace L. Timmeny, Associate Director of the Commission's Division of Enforcement, to assist in responding to any questions you may have about our specific enforcement activities.

I thought it would be helpful, at the outset, to indicate, at least generally, how and why it is that we have become involved in these questions.

An important objective of the federal securities laws is to require full and fair disclosure with respect to securities sold to the public or traded in the American securities markets. This goal is not easily attained, particularly in view of the variety and complexity of American business enterprises and their ever changing nature, including their increasingly international character. The process of devising and implementing the comprehensive disclosure scheme Congress mandated, therefore, is a continuing one, requiring a constant re-evaluation of general principles and specific applications, to adapt our rules and requirements to changing circumstances.

The disclosure portions of the statutes we administer, in brief, require that companies register their securities with us prior to distributing them publicly, and this, in turn, requires detailed disclosures about the company, its background, origins, operations and prospects, as well as about the people who are running the operation and making the important business decisions. Once a company's securities are held by a significant number of public investors, the company is required to file reports with the Commission periodically-that is, at least quarterly and sometimes more frequently-discussing the results of the company's operations. At least once a year, the company must furnish detailed information directly to its shareholders in connection with its annual meeting. Several basic principles of this disclosure pattern are relevant to the subject of your inquiry.

A comprehensive disclosure system should, of course, be designed to elicit, promptly and periodically, material information about publicly-held companiesthat is, information which would be considered important by investors in arriving at their investment decisions. Our mandate requires us to seek "fair" as well as "full" disclosure, however, recognizing that it is counterproductive to require public companies to disclose irrelevant details. Central to the effectiveness of the federal disclosure system, in addition to the requirement of detailed textual, or narrative, discussions about the company and its activities and operations, is the requirement that companies periodically present detailed financial statements. These must be prepared in accordance with generally accepted accounting principles, which, in turn, require a fair presentation of the condition of the company and the results of its operations.

The financial statements are designed not only to reveal the financial position of the company, but also to serve as an accounting of its stewardship. It is also clear, I think, that information bearing upon the ability and integrity of management is material, and, therefore, is an appropriate subject for disclosure. The prospects for success of a company are certainly affected by the quality of its management.

Nevertheless, it should be borne in mind that the Commission's function in this regard is to seek disclosure. We have no mandate from the Congress to act, at least directly, as the guardians of corporate morality. This is not to suggest, however, that there is no nexus between full disclosure and corporate morality. To use Mr. Justice Brandeis' often-quoted phrase in support of the philosophy of full disclosure, "Sunlight is said to be the best of disinfectants; electric light the most efficient policeman."

I should like to turn now to the question of how we got into this area. Before I do, however, I do wish to point out that certain Commission enforcement actionsrelevant to your inquiry are still pending in the federal courts. For that reason, my discussion of those cases will be fairly brief, and solely a factual recounting of what we have alleged, but not yet proven.

As a general proposition, our current involvement may be said to have grown out of the investigations made by the Watergate Special Prosecutor's Office of illegal, and therefore undisclosed, corporate campaign contributions in the 1972 elections. Our staff, observing these proceedings, recognized that the activities disclosed for the first time involved questions of possible significance to public investors, and that this might have a bearing upon our reponsibilities. Accordingly, the Special Prosecutor's Office referred to us information obtained in: various of its investigations.

Starting with the leads thus provided, our staff looked into these matters, using a somewhat broader focus. Inquiry into illegal campaign contributions disclosed the falsification of corporate financial statements to disguise or conceal the source and application of corporate funds misused for this purpose. More specifically, they disclosed, in some instances, the existence of secret "slush

funds", derived from the creation of expenses for fictitious purposes and disbursed without accountability by corporate executives. In our view, this type of activity necessarily rendered inaccurate the financial statements filed with the Commission,

Such secret funds might be, and were, used for a number of purposes, including, in certain instances, payments abroad. Thus, although some of the Commission's actions did not involve foreign payments, the Commission, in its injunctive actions against Gulf Oil Corporation, Phillips Petroleum Company, Northrop Corporation and Ashland Oil, Inc., has alleged violations in connection with funds distributed in cash overseas.

These latter four cases have alleged only that undisclosed funds were distributed abroad; no specific allegations were contained in the complaints that the funds in question were paid to foreign government officials. I should note, however, as a result of testimony before the Senate Subcommittee on Multinational Corporations, that it is known that funds went to foreign officials in some of these cases; further details should be forthcoming in reports to the courts and to the Commission as required by the consent decrees and the lawsuits we have brought.

The only case. to date in which we have made a specific allegation of payments to a foreign government official is our lawsuit against United Brands Company, a case which, by the way, did not result from files sent to this Commission by the Special Prosecutor, but rather, resulted from a routine. Commission investigation of the circumstances following the suicide of that company's Chief Executive Officer.

The Commission's complaint in the United Brands case, which is still in litigation, alleges that, in September of 1974, the company deposited $1.25 million in the Swiss bank accounts of high government officials of the Republic of Honduras, in exchange for favorable government action with respect to an export tax problem. United Brands is further alleged to have agreed to pay an additional $1.25 million the following spring.

As I mentioned earlier, in each of these cases, we have proceeded by filing an action in a United States District Court to enjoin violations of the Securities Exchange Act of 1934. In almost all the cases, the defendants have consented to the entry of an injunction, prohibiting future violations of the periodic reporting or other provisions of the Act, and the defendants have also agreed to the entry of what we call "ancillary" relief. Since some questions have been raised as to why we have proceeded in this way, some further discussion of our enforcement alternatives might be in order.

The remedy of an injunction, which is expressly authorized by Section 21(e) of the Securities Exchange Act, is not only our most effective remedy, but is probably the only suitable one in this type of situation. Upon the entry of an injunction, those encompassed within its terms are barred from future violations of the laws they were charged with violating, and a future occurrence of such unlawful conduct is punishable as a criminal contempt.

While it is true that we could, instead, commence administrative proceedings against the same persons we have sued in court, such an approach would not only likely involve delays, it presumably would produce no more than a Commission order directing the companies to comply with the Act. We do have other remedies in administrative proceedings against publicly held companies, largely centering around our ability to terminate their right to issue or trade securities in interstate commerce, but such a remedy is far more damaging to the shareholders of the company who, after all, are innocent victims of the failure to make full disclosure. As a result, any administrative proceeding we might bring would accomplish no more, and probably less, than a court order to the effect that the company comply with the law.

We can also recommend the institution of criminal prosecutions against such companies, but that can only be undertaken by the Department of Justice. Certainly, criminal prosecutions could only be viewed as a supplement to, and not as an alternative for, our own civil injunctive actions, since criminal proceedings do not always provide an effective remedy against the corporations involved and might appear to some merely to duplicate the prior work of the Special Prosecutor.

Once we institute a civil enforcement proceeding in a federal district court, if the defendant is willing to consent to the entry of an injunction, and, if appropriate, to additional, or ancillary, relief, there would be no point in trying to insist on litigating the case to a conclusion, nor would the courts view favorably

any effort on our part to waste their time in that way. A defendant is entitled to consent to the entry of appropriate relief which satisfies our complaint, without admitting or denying guilt.

More significantly, as I have already indicated, in an injunctive action we can also seek broad ancillary relief.

In the Phillips, Northrop, Ashland and Gulf Oil cases, the Commission sought the appointment of a special master to: Inquire into and examine the books and records of the subject corporation; render a proper accounting; and submit a report to the court and the shareholders concerning the matters included in the complaint, including the expenditure of corporate funds for unlawful political contributions or other unlawful purposes.

An order was also sought in those cases, as part of the ancillary relief requested, requiring individual defendants to reimburse the corporate defendants for unlawful political contributions and other unlawful purposes. In accepting consent decrees in these actions, which include injunctions against future violations, the Commission has settled for undertakings by the defendants, punishable by contempt, which require corporate actions beyond what the Commission is explicitly authorized, by statute, to seek. The corporate defendants in our lawsuits have, generally, undertaken to establish Special Committees of their Boards of Directors to conduct investigations into the matters alleged in the Commission's complaint and to have these Committees submit a written report of their investigative findings and recommendations to the company's Board of Directors, which must review and implement the report.

It should be noted that the Commission retains the right to seek further relief in these cases if the terms of the injunction or the undertaking have not been fully complied with or implemented. To date, none of the reports have been submitted by the corporations alleged to have made undisclosed foreign payments. Therefore, the extent of payments to foreign government officials, if any, in these cases, has not yet been definitely established.

These questionable payments by American corporations in foreign countries present a number of difficult problems for us, and for you in your deliberations. For one thing, the exact purpose of such payments is often difficult to determine. It is normal and understandable that American corporations seeking to do business abroad will employ or retain sales agents, business consultants and others who are on the scene and familiar with local ways of doing business, Payments made to such intermediaries are often entirely proper, but may not always be so. Once the money is in the hands of a foreign agent, it may be difficult to determine exactly what he does with it. Of course, suspicions are always raised where large sums are paid for unexplained services and it is hard to determine exactly what the company is receiving for its money.

We are told that in many foreign countries it is almost customary to distribute various gratuities to persons in strategic positions in order to obtain favorable treatment. Indeed, such practices are not wholly unknown in the United States. These payments may or may not violate the laws of the country involved, and in countries having entirely different legal systems from the United States, local law on the subject may be quite obscure.

But, even where a payment does not violate the laws of the country involved, it is to be expected that foreign officials and governments would be sensitive to publicity about such payments and, therefore, such publicity may jeopardize the position of a company in foreign countries. Thus, while I am sure we can all agree that American companies should not, as a matter of principle, make payments to officials of foreign governments in return for favored treatment, it is often difficult to determine whether or not this has occurred.

Moreover, we are not insensitive either to the difficulties American companies experience in doing business abroad, or to the fact that our lawsuits might create an impression in some minds of United States interference in the affairs of foreign countries.

Most of the cases that we have brought involving foreign payments are so recent, that all the facts are not yet available. We have preferred, at the outset, to approach these matters on a case-by-case basis, to permit us to deal with the more egregious situations first, and to place the business community on notice of our concern. Whether or not general guidelines should be articulated to govern cases which have not yet arisen and which may involve less egregious fact patterns, is something we at the Commission have not resolved.

For the present, we have not pursued a dragnet approach in this area; rather, as in other areas, the Commission will act when specific information is brought

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