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Mr. ALEXANDER. Yes. We will do our best to supply any further details that we can
Mr. WOLFE. This would be true if this were a foreign corporation doing business in the United States or a subsidiary of a foreign corporation. If it were the foreign corporation that made the payment, not through its domestic subsidiary, we would have a very difficult time of ever knowing that, but, if it were operated through a corporation over which we have jurisdiction, our instructions to our examiners are that you look for it.
Mr. BIESTER. Very good. I guess the last question would be: The focus tends to be on transnational corporations, multinational corporations. Certainly the focus of this subcommittee is on that, and we tend to think of those as large corporations.
I trust that the skill of an investigation is such that you would be looking into some more closely held and smaller corporations as well in terms of both domestic abuse as well as foreign abuse?
Mr. ALEXANDER. We certainly are.
Mr. BIESTER. Thank you, Mr. Chairman.
Mr. WHALEN. Mr. Chairman, could I pose one question which occurred to me during Congressman Biester's queries?
You mentioned 111 corportaions. Now, you haven't determined yet whether any or all of them have claimed deductions illegally. Mr. WOLFE. Right.
Mr. WHALEN. How then did you come upon these 111?
Mr. WOLFE. We have this project the Commissioner described in his opening statement of attempting to identify from sources at the various committees. In fact, the Senate Watergate Committee supplied us information in this respect.
We know from the various committees, the two principal committees, the names of their contributors. If they were officers of corporations, we are going to look at the corporations to see whether in fact the corporation paid it rather than the officer.
We have made this public to everyone that we are going to do this. Mr. WHALEN. So it is very probable, then, that these 111 firms did make illegal contributions. What you are now looking at is to determine whether or not these were claimed illegally?
Mr. WOLFE. For tax purposes. That is right.
Mr. Nix. Mr. Solarz.
Mr. BIESTER. If I could, Mr. Chairman, that leaves me a little bit confused. The various mechanisms that you described here for this process all seem to me to be, as I glance through them-seem to be reportable as a business expense, and, therefore, would reduce the tax. Mr. WOLFE. Some of them would not. For example, if it is a capital-for example, you could have a large plant being built somewhere, which is a capital, not an expense, deduction in a given year. It could be spread, of course, through depreciation in later years, but, if you are going to build a plant and, let us say, the contract price would have normally been $50 million, and you agreed to $51 million, with the $1 million coming back into the slush fund or to a political contribution, it does not affect tax liability immediately because that is a capital, rather than an expense, item.
Mr. BIESTER. Surely the auditors, private auditors, would catch that, wouldn't they?
Mr. WOLFE. The private auditors have the same problem we do. If things can be covered up well enough and you run it through enough hands and wash it, it is very difficult to always trace it, when you have got invoices submitted by the builder which appear to be legitimate and the payment equals the amount of the invoice. You have nothing to suspect. As I say, on a $50 million construction, $1 million more would not really raise any concern, so it is not always easy for an auditor to uncover these things.
Mr. Nix. Mr. Solarz.
Mr. SOLARZ. Thank you, Mr. Chairman. I hope you will excuse me if I cover some ground that has already been plowed by the other members of the committee, but I was at another hearing and I didn't have the benefit of your earlier testimony.
As I understand it, tax laws require someone, if they intend to take as a business deduction, payment to some foreign official or what-haveyou, to disclose it on their tax returns, and, if it turns out that that payment is a payment which would have been in violation of American law or American law applicable to that country in those circumstances, then he is not eligible for the deduction for the purpose.
Is that correct?
Mr. ALEXANDER. The tax laws do disallow the deduction under the circumstances you described, and the tax laws, of course, call for the filing of returns which give complete and correct reporting of both income and expenses for U.S. purposes, but there are some gaps, and there are some gaps between the reporting requirements.
Mr. SOLARZ. You had indicated you thought that one of the things we ought to be doing is moving in the direction of full disclosure, that this was a way of dealing with the problem.
Now, of course, if someone makes an illegal payment and chooses not to try, by obscuring the nature of the payment, to benefit, not only of whatever advantages he has accrued from the payment, but an income tax deduction as well, because they think it will be disallowed or will reveal the fact that they have done something that they won't want publicly known, they don't have to ask for a deduction, in which case they don't list it on their tax return, in which case it isn't disclosed. I would like to know what suggestions you might have to offer the committee with respect to what we can do to secure or compel disclosure of such payments in those situations where people, for whatever the reason, don't elect to try to get the benefit of the tax deduction for them.
Mr. ALEXANDER. At this point I am not wearing my tax administrator's hat because the tax administration problem is excluded in your example, there being no claim of the improper deduction.
In my statement, I did support Commissioner Loomis' position last month, and presumably his present position, that disclosure is a good disinfectant and perhaps the only effective disinfectant here.
Where changes might be required in the laws, of course, is for the Securities and Exchange Commission and this committee to consider. The tax laws are not the appropriate instrument for the resolution of this problem of basic morality. The tax laws surely should be strictly, firmly, but fairly, enforced to make sure that those whose greed is double edged find that at least one edge is removed.
Mr. SOLARZ. So you don't think it would be appropriate through the mechanism of the tax law to compel disclosure of the payment which the individual or the corporation didn't elect to claim as a deduction?
Mr. ALEXANDER. No; I don't, for this reason: I am quite concerned about the present complexity of tax returns that we require, the number of returns that we require, and the number of items that we require and must require on these returns.
I would hope that the problem could be solved, but solved outsidethe framework of the tax system.
Mr. SOLARZ. Supposing someone decides to try to get a double benefit from an immoral, if not an illegal, payment, the benefit of whatever advantages the payment is intended to secure as well as the advantage of the tax deduction.
The auditors, sharp eyed as they are, spot this pernicious effort to defraud the American taxpayers out of the revenues that are their due. What happens at that point? Do you simply disallow the item or is there any kind of a stiffer penalty involved?
Mr. ALEXANDER. First, we disallow the deduction and, because the taxpayer has withheld money that should have been paid at an earlier time, we charge the taxpayer interest, and the interest rate is now 9 percent.
There are also a series of penalties. It is possible that the item might be of such size as to bring into effect one of these penalties. More likely, however, it wouldn't. There is a penalty of 5 percent for negligence in fulfilling one's tax responsibilities and a penalty of 50 percent for fraud.
There are criminal penalties for fraud.
Mr. SOLARZ. Is it considered fraud if an individual claims a deduction as a deduction something which is clearly not deductible?
Mr. ALEXANDER. Not necessarily. Fraud means a willful evasion of one's tax responsibilities, and an item may be so small in comparison with the whole or may be a doubtful shade as opposed to one that permits no reasonable interpretation, or may be simply a mistake. That would not be fraud.
Establishing fraud requires us to prove the fraudulent act and intent by clear and convincing evidence, by the way.
Mr. SOLARZ. You have made the point that someone cannot deduct the expenses associated with a payment which would be illegal under American law, if American law were applicable.
Would it make sense perhaps to add another provision to the law providing that in the event someone attempts to deduct a payment which was illegal under American law or would be illegal under American law, if American law were applicable-that in such circumstances, such a person would be susceptible to criminal as well as civil penalties?
Mr. ALEXANDER. I am not sure whether we might be engaged in overkill there if we did that. Since we are those having responsibility of enforcing the tax laws, such thought should be music to our ears, but we might be going too far. Suppose the item involved $5,000 and the income correctly and completely reported was $2 billion. It would be difficult, I think, to convict the offender of the type of crime or subject the offender to the type of penalty that you describe, under those circumstances.
Mr. SOLARZ. One final question. Do you have any sense of the extent to which those who are engaged in making illegal payments—I don't want to say "illegal payments"—those who are engaged in bribes and gratuities and other means for securing commercial advantages abroad, which would be illegal in our own country, but which possibly may not be illegal in the countries in which they take place, are in point of fact trying to also claim these payments as legitimate deductions, or do you think that on grounds of prudence and privacy they do what they do and then try to sort of cover it up, as it were, by asking for deductions as well?
Mr. ALEXANDER. I would be leaping in the dark if I gave you a percentage answer. I am skeptical enough to be surprised if a majority of those making the illegal payments were so mindful of their tax obligations as to refrain from deducting them.
Mr. SOLARZ. So I think in fact what we may have here is a situation not only where American corporations are engaged in what we might consider improper activities abroad, but where the American taxpayer is conceivably subsidizing, as it were, their improprieties by virtue of the reduced tax revenues available to us as a consequence of that asking for deductions for the improper activities in which they have engaged.
Mr. ALEXANDER. And it is our responsibility to see to it that this particular subsidy is not granted.
Mr. SOLARZ. Thank you, Mr. Chairman.
Mr. Nix. Thank you, Commissioner Alexander. Commissioner Loomis, you may proceed.
STATEMENT OF HON. PHILIP A. LOOMIS, JR., COMMISSIONER, SECURITIES AND EXCHANGE COMMISSION
Mr. LOOMIS. Mr. Chairman, I am Commissioner Loomis. It is a pleasure to be here today before the subcommittee. As you know, I had planned to be here exactly a month ago, but it was necessary for the subcommittee to cancel the hearings at that time.
I have prepared testimony for delivery then, which you introduced into the record at the outset, and that testimony has been made public, and I will not repeat it here.
I am accompanied on my left by Mr. Wallace L. Timmeny, Associate Director of our Division of Enforcement, who has had particular responsibility for this phase of our enforcement;
And on my right by Mr. Theodore Barreaux, our Legislative Liaison Officer.
I, in preparing my testimony for today-I had in mind the suggestion that I attempt to bring up to date my prior testimony, and that is essentially what I will attempt to do.
In the prior testimony, I attempted to indicate how and why we became involved with this question of payments-illegal payments abroad, outlining the principal cases we have brought and the reasons why we have brought them, and I pointed out some of the difficulties which we have encountered in connection with foreign payments, and I will come to that later.
I closed on a fairly optimistic note in the hope that we had, on balance, done more good than harm.
In bringing up to date my testimony, my prior testimony, I have the following to report. While our staff has continued its inquiries in this area, no additional cases have been brought.
As I indicated in my prior testimony, one of the remedies which we commonly sought was to require the corporation to make a thorough investigation of the situation and to file with us a report disclosing what was uncovered in that investigation, and I would add that that seemed a particularly appropriate way to go about it, not only because of our limited personnel, but because of the fact that the companies could collect information in foreign countries more readily than we could, particularly as we have no people abroad.
The report of the special committee of the board of directors of Ashland Oil Co. was filed with the Commission on July 8. I read that report, which is a very interesting document and which reflects a quite thorough investigation.
However, that report was directed primarily to the question of illegal political contributions in this country and money expended for unreported or questionable purposes or improperly accounted for. They did turn up some payments to foreign officials in the course of their inquiry as to diversion of corporate funds. They did not disclose in their public report the recipients of these payments.
I might add that we have just received-I believe it was filed about noon today-a comparable report from Northrop Corp. We have not as yet had a chance to look at it, but it is there.
We have also been devoting a good deal of thought to this question. of foreign payments. It presents some very difficult questions for us, and I would associate myself with Commissioner Alexander's remark that our purpose and mission is not to eliminate sin, but to enforce the statutes entrusted to us, which, in general, require disclosure of facts material to investors. Companies with foreign payments present some questions in turn in that connection.
Chairman Garrett discussed this subject together with other matters in a speech on June 27, before the American Society of Corporate Secretaries, and I would like to submit for the record the relevant. portion of that speech, which does discuss the problems which we have in this area.
Mr. Nix. Without objection, it may be inserted into the record at this point.
[Supplementary information follows:]
OF SECURITIES AND EXCHANGE COMMISSION CHAIRMAN RAYMOND GARRETT'S SPEECH BEFORE THE AMERICAN SOCIETY OF CORPORATE SECRE-TARIES ON JUNE 27, 1975.
One of the frustrations in this development has been our inability to retain sufficient control over the swift pace of events to enable us to make reasoned. judgments regarding precisely what should be disclosed and why. Through consent decrees in several cases we had worked out careful programs for the assembly of data by examining committees to be followed by review and deliberation on the disclosure policies to be applied. Other persons have not been interested in waiting, however, and much detail has been spread on the public record whether or not mandated by the disclosure requirements of the federal securities laws. This makes it somewhat difficult for us to foresee where it will all end in terms of our laws. It may very well end in legislation expressly directed at improper expenditures abroad-whether in terms of disclosure requirements or flat prohibitions, I cannot say.