SECURITIES ANDEXCHANGE COMMISSION

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

FOR RELEASE: 1 P.M., Tuesday, August 8, 1978

CORPORATE ACCOUNTABILITY AND THE LAWYER'S ROLEAn Address by Harold M. Williams, Chairman

Section of CorporationBanking and Business LawAmerican Bar AssociationNew York, New YorkAugust 8, 1978

During my tenure as Chairman of the Securities andExchange Commission, I have used many of the speakingopportunities offered me to discuss various aspects of theissue of corporate accountability and how it can beenhanced. I came to the Commission in large measurebecause of my concern about the continued erosion of theintegrity of the capital formation process and of theprivate enterprise system generally. There are manydimensions to the problem, including tax policy, the impactof inflation, and the trend toward ever-increasing regula-tion. Another dimension is that public confidence in theaccountability of business has been shaken -- confidencewhich must prevail if private capital markets are to surviveand flourish and if the advantages of private enterpriseare to be preserved. Questions have been raised, forexample, about the integrity of corporate earnings, aboutwhether American business is run in the best interests ofits shareholders and the larger society of which it is apart, about whether our equity markets are an attractiveand fair place for the individual investor to place hisafter-tax investment dollars, and about the inability ofsmall businesses to gain vital access to capital markets.The answers to these questions are important, not only to

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our economic future, but also in terms of the respectiveroles which government and the private sector will play inthe future shaping of our economic and social structure.

For that reason, I am particularly pleased to havethe opportunity to address the Section of Corporation, Bank-ing and Business Law this afternoon. The gap which seems tohave opened between pUblic perceptions of business account-ability and business's own conception of its role isimportant to those who practice corporate law for tworeasons. First, lawyers are, in their many diverse roles,architects -- consciously or unconsciously -- of theaccountability mechanisms in our corporate structure.Accordingly, if the private sector tends at times to beexpedient, lacking in vision in assessing the future andwhat it holds, and reactive in attempting to meet thedemands and expectations to which it must respond, itscounsel must share in the responsibility for the consequences.Conversely, the corporate lawyer, in his role as counselorand advisor, can playa significant positive role. Iflawyers choose to bring to bear the broader vision withwhich many are well-equipped, they can help to preservethe flexibility and vigor of the corporate system whichhas served our economy so well.

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A second reason why this issue should be of vitalconcern to lawyers is that, because of their role asarchitects of the corporate structure, the blame forperceived corporate irresponsibility is not likely to bedirected solely at the businessmen who run our largeprivate economic institutions. Lawyers are likely to sharein the spotlight of pUblic scrutiny and -- whether it isfair or not -- to be touched by the legislative constraintswhich are almost certain to emerge if a consensus developsthat business, by itself, will not take the steps necessaryto insure that the power it wields over our national lifeis exercised with due regard for our public and socialaspirations and expectations. Already the legal professionis under attack, and calls -- sometimes justified -- arebeing heard that we must, as a society, ~de-lawyerize" or,at minimum, take some of the control over their profes-sion away from lawyers. The question of who should exerciseresponsibility for the ethics and discipline of lawyers isa broad and complex one, and I will not attempt to deal withit here. I would, however, commend to your careful studythe drama which is continuing to unfold concerning wnetherregulation of the independent accounting profession shouldbe made a sUbject of federal legislation. That issue is one

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which was born in revelations of gertain highly pUblicizedfinancial failures and of concealed political and foreignpayments during the last decade, and it provides a clear andvery relevant illustration of how the public and thelegislative branch may seek to remedy perceived ills inthe corporate sector with nostrums directed to those whorender professional service to the business community. Isuggest that, for these purposes, the similarities betweenthe legal and accounting professions far outweigh thedifferences.

Before I turn to the lawyer's role in fosteringaccountability, I want to touch on a still broader pointconcerning the role of the lawyer and the law in oursociety. In my view, one measure of the health andstrength of a society might be read from a graph whichdepicts two variables. One line on the graph would reflectthe level of ethical behavior. The second line wouldreflect the conduct to which the law compels adherence.When the ethics line is significantly higher than thelaw line -- that is, when concepts of ethically acceptablebehavior are significantly higher than the standardswhich the law imposes -- the society enjoys good moralhealth. If, however, the gap between the two lines

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narrows, it may well reflect a greater dependency on thelaw and a decline in moral vigor. And, in the United Statestoday, I believe that these two lines are coming muchcloser together. Increasingly, we as a society lookto the law to define right and wrong, moral and immoral;the notion that the law sets the floor rather thanthe ceiling receives little currency. By the sametoken, the tendency to focus on the law leads to awithering of interest and concern for the ethical.The implicit assumption increasingly becomes that, ifgovernment has not forbidden it, it must be acceptable.This results in increased dependence on the legal processto define the limits, and the game becomes one -- as ithas in tax law -- of avoidance and loophole-closing.The result is a fundamental change in the mores of thesociety.

Norman Redlich expressed a piece of this idea in thesewords:

"It is our burden and our glory that we areexpected to live by a nigh professionalstandard and earn a living at the same time.We do not have the luxury of the clergy whocan live in the temple and condemn the marketplace. We have to carry the standards of thetemple into the market place and practice our

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trade there. That is why a country whichquestions its moral behavior inevitablyquestions its lawyers." V

My concern is that, as we become increasingly obsessed withthe law as a solution to social problems and as a guide toconduct, we leave less and less room for any conception ofmorality. And that is a trend which is unhealthy for thelaw, for lawyers, and for society.

The debate concerning what is often called "corporateaccountability" or "corporate governance" is a goodexample of this tendency to look for legal solutions to whathave traditionally been perceived as ethical questions. Forexample, demands are being heard, with increasing frequency,that Congress enact legislation to control the exercise ofcorporate power. As I have suggested in the past, in my view,the best antidote for such legislation is for corporationsto take steps to assure the public that they are capable ofself-discipline which is consistent with both the realitiesof the market-place and the noneconomic aspects of the publicinterest. Mechanisms which reinforce that assurance must becomeeffective structural components of the process of governance

~/ Redlich, "Lawyers, the Temple, and the Market Place,"in !~~~~~££9'p. 200.

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and accountability in the American corporation. In order toimplement this concept, I have recommended that corporationsconstitute their boards exclusively of independent, outsidedirectors with the exception of the chief executive officer;that the CEO not serve as chairman of the board; andthat individuals with substantial professional or businessrelationships with the company, such as suppliers or outsidecounsel, not serve as directors.

I do not mean that all corporate boards, constituteddifferently than I propose, are necessarily ineffective.But I do believe that boards can be more effective andthat, in many situations, they do not discharge theirresponsibilities to oversee the management of the affairsof the corporation.

Nor am I expressing a distrust of American business.To the contrary, I have enormous regard for Americanbusiness leadership. And those who rely on notions likethe ~three martini lunch" and the misimpression thatcorporations typically maintain yachts and hunting lodgesfor the personal use of their executives deal in pejorativeswhich cloud the intelligent discussion of vital substantiveissues. Yet it would be unrealistic and foolhardy to ignorethe fact that corporate accountability can be improved, that

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that not all boards are discharging their oversight respon-sibilities, and that the system should be strengthened. Ifbusiness, and the corporate bar which serves it, fail torespond to the challenges which have been laid before them,we run the risk of further government involvement and therestructuring of our corporate system in ways which mayultimately create an economy inadequate to fund our future.

with those thoughts in mind, I want to discuss thelawyer's role in promoting corporate accountability -- thatis, in widening the gap between the dictates of corporateethics and the demands of corporate law. That role can,I think, be divided into several components -- the lawyer ascorporate director, as counsel -- outside and inside --and as a member of the organized corporate bar. I will turnfirst to the lawyer as director.

I believe that lawyers who serve as corporate directorshave an opportunity to make valuable contributions to boththe success of the enterprise and to the evolution andstrengthening of the accountability mechanisms. BeforeI touch on that positive role, however, I want first

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to discuss a negative. In my view, the lawyer who isalso outside counsel to a corporation, along withinvestment bankers, commercial bankers, and others whomight be characterized as "suppliers" to the corporation,should be excluded from board membership.

The suggestion that lawyers and others who supplyservices to corporations should not serve as directors hasreceived both endorsement and criticism. Opponents ofthis suggestion have emphasized -- correctly -- that thesecategories include individuals who are among the mostintellectually-qualified directors and often are thosemost willing and able to probe and criticize management.Some law firms and investment and commercial bankershave begun to decline to have their members serve asclient's directors: others see no objection. The f~£e2!~!~Q!I~!2!'~_~~!9~~~2~which this Section recently pUblished,although indicating some possible problems, takes noposition with respect to the lawyer IS role as a director.A recent Lou Harris survey of outside directors (includingsome who would not qualify as independent) reported that,when asked whether legal counsel should serve on the boardsof their clients, the response from 36 percent was that

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they should, while 56 percent said that they should not.Of the companies on whose boards those surveyed sat,30 percent actually had outside counsel directors.

Those favoring the proposition that counsel shouldserve on the boards of their clients have suggested thatlegal counsel frequently has special knowledge of litiga-tion and other matters of vital significance to directors;that counsel has a special perspective on the day-to-daymanagement; that board membership is necessary to placelegal counsel in a position to deal as an equal with seniormanagement; and that board membership makes the outsideattorney more accessible to other members of the board. Ido not disagree with these contentions, but I do believe thatthere are competing factors.

It is important that we come to grips with the conflictof interest problem created by the board membership of thosewhose income, in some significant measure, depends upontheir business dealings with the management; with theobvious inhibitions on the other members of the boardin terminating or criticizing the service renderedthe corporation as a result of another director's businessrelationship; and with the pUblic perception problem created

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by that conflict. The subtle, and occasionally not sosubtle, pressures imposed as a result of an em~loymentrelationship between a corporation and an individuallawyer or law firm suggest that the legal counsel actingas a director may have a pre-conditioned management view.

An additional problem arises, for example, if the boardis considering a course of action fashioned with the involve-ment of the attorney-director's own law firm -- or indeedby the attorney-director himself. Is it realistic to expectthat he will sUbject the proposal to a dispassionate andunbiased review? Is it realistic to expect that he will evervote, as a director, against what he, as an attorney, has beeninvolved in creating? These questions illustrate why theactual lack of independence and the appearance of the lack ofindependence -- which is inherent in an attempt to wear boththe director and the lawyer hats simultaneously are bothinconsistent with the ability of the board to discharge itsoversight responsibilities and with the concerns which callfor an independent board of directors.

Obviously, in many cases the corporation does benefitfrom having its outside counsel as a board member. Counselcan, however, always be invited to attend -- and they probably

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should attend regularly -- but without actually serving asdirectors. Further, if lawyers make v~luable directors

.and obviously many do -- then corporations could ask membersof the profession other than those engaged in businessrelations with the corporation to serve on the board. Thelawyer traditionally in our society has been independentand the advocate of unpopular as well as popular causes.To exclude the lawyer IS qualities from the board room wouldbe inconsistent with the diversity of viewpoint andindependence of thought which are essential to the properfunctioning of a truly independent board of directors.Why should a lawyer serve in this capacity if he is notcounsel to the company? I think that accepting a positionas an independent director should be viewed as part of thelawyer IS pUblic service obligation. And, if attorneys whoare not also retained by the corporation decline to servein place of those who do business with the company, perhapswe should ask ourselves what this tells us about theindependence of retained attorneys as directors.

I want to emphasize that, in working to improveaccountability, the point is not to devise a set of inflexiblerules -- with respect to director independence or any otheraspect of board membership -- which should be imposed on

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every corporation. Rather, we should explore the principleswhich maximize accountability and the conditions which impedeit, and the existing board structure in each particularcorporation should bear the burden of justifying itselfagainst these. There is an impediment to accountabilityto the detriment of the corporation -- when directors serveconflicting roles and interests. And there is a cost interms of erosion in confidence in the accountability processas a result of the appearance of a conflict of interest.The crux of the problem is to assure that decisions con-cerning board composition can withstand a reasoned andthoughtful balancing of these costs against the benefitsexpected from a given director's board service. Thisdetermination itself should be made by the independentmembers of the board.

!~e La~l~!~CO~~~~!I want now to turn to the lawyer's role as counsel.

It is in this area that the bar can have its greatestimpact on the fostering of corporate accountability. Inlarge measure, the role may be one which is not strictlyHlegal." I believe that counsel has an important role to

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play in protecting the gap I mentioned earlier betweenethical guidelines and legal requirements.

Unfortunately, however, instances are well-documented~I where counsel have been party to the process wherein

management adopted positions or took actions that might havebeen technically legal but which were highly questionableethically. we can all recite well-publicized businessscandals of recent years where it might not be possibleto prove that management acted illegally but where thepublic had reason to be incensed at the evident disregardof the public interest. Many of the problems and adversepUblicity could have been avoided by strong counselacting professionally and advising management to conduct

government control is brought one step closer.

too narrowly, or does his job too timidly, the chance

corporate affairs in a manner that would bear inspection

company, directors,

in the light of day. When the lawyer defines his role

of trouble increases for everyoneand shareholders, as well as counsel -- and perhapsmost importantly, the free enterprise system furtherloses public esteem and the prospect of increased

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In addition to this need to restore some of the healthytension between the requirements of the law and the stand-ards of ethical behavior, counsel faces a second problem --defining who the client is. Ethical Consideration 5-18 of

the f~~~_~E-f!~E~~~i~~~!_B~~E~~~!bi!!!!es provides that alawyer employed or retained by a corporation owes hisallegiance to the entity and not to a stockholder, director,officer, employee, representative, or other person connectedwith the entity. While the general thrust of this proposi-tion is certainly correct, it is a statement of verylimited utility to the lawyer who, as a practical matter,must deal with the corporation's officers and employees.How is counsel to respond when he believes that managementwishes to run a legal risk which the lawyer thinks islikely, in the long run, to prove injurious to the corpora-tion? Indeed, how can counsel determine what is or is notin the interests of the "entity" of which EC 5-18 speaks,as distinct from the interests of its officers, directors,employees, and shareholders? I have no answers to offer forthese questions. ~he rroblem is, however, one which the barneeds to address.

Another dimension to counsel's responsibility ispresented by the P!!~£to~~~ui~~~~~~ suggestion that

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directors must familiarize themselves not only withcorporate affairs, but also with their legal duties.Lawyers owe an obligation to their clients to insurethat directors are cognizant of the laws with whichthe corporation must comply. It is practically impossiblefor a director to make an informed jUdgment on a mixedeconomic and legal problem without knowledge of thepurposes and spirit, if not the specifics, of the law.

Counsel's educative role has an additional, verypractical, dimension. Recent opinions suggest that theprotection against personal liability and jUdicial second-guessing afforded directors by the business jUdgment ruleattaches only to good faith deliberations, and that aninadequately educated board cannot, therefore, make deter-minations that will carry with them that special legalsignificance. Indeed, where counsel is not properlyeducating the board, both directors and managementshould demand it, in there own and the corporation'sself-interest.

Outside counselTo provide the kind of education and advice needed to

represent a public corporation, to advise its management,

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and to assist its board in effectively performing itsoversight functions, lawyers and law firms must insurethat their advice and counsel are objective. This pointis a complex one for a profession which, in most respects,has not traditionally been expected to be independentof its clients; thus, the corporate lawyer at one momentfinds himself acting as an advocate and at the nextas an adviser. As an advocate -- in the courtroom, forexample -- except in unusual situations, his job isto vindicate the client's position, to justify whatthe client did in the past or wishes to do in thefuture. In the advisor capacity, however, the lawyer'srole is different. It is there that he has the opportunityto bring considerations of both ethics and law to bear onthe corporation's future conduct.

In order to alleviate the danger that, in the advisoryrole, the lawyer will shape his judgment to please theclient, lawyers might borrow a leaf from the accountingprofession. Accountants, of course, are expected to beindependent of their clients, and have found such stepsas second partner review and rotation of assignments tobe useful methods of minimizing the natural blurring ofobjectivity which can result from longstanding personal

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and professional relationships between the client'smanagers and the firm's partners. Similarly, lawyers inlarge, business-oriented practices might considerimplementing a system in which partners with less of aneconomic or career stake in telling the client what itwants to hear would review proposed recommendations oropinions which the firm proposes to render to the client-- particularly in areas where there are obvious publicinterest factors and potential liabilities to weigh.Changing the senior lawyers on a corporate accounton a periodic basis just as accountants rotateaudit responsibilities -- may also tend to alleviatethese pressures.

In short, the lawyer has a vital role to play ininsuring that basic principles of corporate accountabilitycontinue to evolve and develop. In the terms I used earlier,the lawyer can help to open the gap between the ethical andlegal lines on our society's graph by raising corporateethical standards without raising the legal constraints.Constructive criticisms from the legal professioncan, in my view, do more toward implementing the goalsof corporate accountability than any form of federallegislation or regulation.

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Inside counselThe kinds of contributions which lawyers who sit as

independent board members can make and the functions ofoutside counsel are relatively clear. But what of theinternal counsel -- the lawyer who is permanently employedby the corporation?

The attributes of the insider lawyer do not lead tothe conclusion that he lacks a role in insuring both thefact and the perception of greater corporate accountability.On the contrary, a lawyer's professional responsioilitiesare not diminished when he becomes an employee. Indeed,inside counsel can be the vehicle through wnich thecorporate conscience can be activated. Inside lawyersplaya daily role in shaping events as they occur, indetermining corporate policies, and in establishing themoral tone and standards for the conduct of corporations.

Internal counsel's responsibility runs far beyondnarrow legal issues. Although not the 2~1Y officer whodeals with corporate problems which are not exclusivelyrelated to the profit and revenue producing activities ofthe corporation, he is one of the few corporate officerswho is likely to hear from all of the corporation'sconstituencies. Thus, inside counsel is uniquely

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involved in an assessment of risks and consequences in thetypes of situations which typically give rise to pUblicconcern and reaction.

Because they are corporate insiders, individual internalattorneys are in a unique position to help the companieswhich they serve, and the corporate community as a whole,to focus attention on the issues of corporate responsibility,to weigh the costs and benefits, and to decide on positivesteps which, in the context of each particular corporation,can help to promote accountability and thus retard thepressure for regulation. As in the case of outside counselthe inside attorney's job extends beyond answering questionswhich focus only on what the law allows -- or what is worththe risk that the law does not forbid it. The inside attorneyshould also help to evaluate the potential impact on thecompany of dropping below the ethics line even if corporateconduct remains above the legality line. The most fundamentaltask is to sensitize and inform management and directorsregarding the implications of the pUblic's expanded percep.tion of corporate responsibilities.

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The inside counsel has dual obligations of loyalty.While he must be loyal to his employer -- as must any employee-- he also must be loyal to his responsibilities as aprofessional -- as must any lawyer. In normal circumstances,these dual loyalties do not conflict. There may, however,be extreme situations in which the requirements of law orthe ethical obligations of the legal profession force eventhe inside lawyer to consider resignation, disclosure ofunlawful conduct, or other measures which sometimes con-front outside counsel and which are likely to mean an endto the inside attorney's employment relationship.

Stated differently, inside counsel, if he is to beeffective, requires a certain measure of independence. Insome companies, of course, inside counsel lacks independenceand his role is more circumscribed. Where that is the case,we must, at minimum, recognize that we are asking theattorney to perform, not as an attorney, but as a legaltechnician -- an expert in the law who is disabled fromexercising the independent judgment which is the hallmarkof a professional. Anyone dealing with him should be awareof that incapacity. Ind~ed, I believe that serious questionsexist as to whether the ethical responsibilities of

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someone holding himself out as internal counsel can beany less than those of outside attorneys.

!~~~2!~~f-!~~2rg~~!~~dB~rAttorneys, perhaps more than any other profession,

have a long tradition of acting to improve the state of theircraft through the efforts of organized professional societies.Similarly, in my view, the organized bar has an importantrole to play in defining how lawyers and the corporatesector should respond to the challenge of corporate account-ability.

The bar's canons of ethics and disciplinary proceduresare, of course, a part of that process. The ~2~~ does not,however, deal comprehensively with the realities of modern lawpractice and should be revisited -- as a disciplinary, not aprotective device. As lawyers, we cannot expect to be ableto cloak self-serving behavior behind a code of ethics assuccessfully as we have in the past. I have mentionedsome of the gaps I see in the present Code -- the definitionof the corporate lawyer's client and the issue of theresponsibilities of inside counsel are two examplesof complex questions which need explicit treatment.Those in this room could, I am confident, significantlyexpand that list. ,

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Many professions are undergoing rapid change andare having difficulty in fulfilling pUblic expectations.This problem confronts the legal profession as well. If itis to continue to enjoy public confidence and to performits functions responsibly, it must meet the legitimateneeds of society. 'I'heprimary test should be, "What is inthe public interest?~ and the legal profession should make

certain that it has a ~2Q~2f P!2!~~~i2~~l-~~~E2~~!~!!!Ei~~which meets that challenge.

r believe, however, that an equally important challengefacing corporate lawyers is to synthesize -- from the day-to-day experience and expertise of individual practitioners-- guidelines for both lawyers and other actors in thecorporate governance drama. The ~2EE2!~!~_Q!!ec!2E~~~~!9~e22~'prepared by this Section's Committee on CorporateLaws and recently published in ~~~~~~!E~~~_~~~l~E'is animportant positive step in that direction. It lays out,intelligently and thoughtfully, some important aspects ofthe rights, duties, obligations, and issues facing corporatedirectors. The ~~iQ!~92~will, I think, prove an importantaddition to the literatll::'eof corporate accountability.

I do not mean to suggest, however, that the bar cansafely view the ~~i9~e22~as completely discharging its

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responsibilities to define new parameters in this area.The ~~id~boo~ is silent on very important issues, includingconflicts of interest questions such as outside counsel'sservice on the board of directors and the obligation, if any,of directors, and indeed of attorneys, to disclose unlawful

or proposed unlawful -- conduct on the part of thebusinesses they serve.

ConclusionIn a real sense, as I mentioned at the outset, the

central problem which lawyers engaged in a corporatepractice face is not one which can be resolved in legalterms. We must decide, consciously and deliberately, whatrole ethical considerations will play in the decision-makingof American business. What is legal and what is ethicalare not synonymous. We tend to resort to legality oftenas a guideline; in that sense, ethics is on the wane andthe age of the legal technician is in full flower.

when we take this route, we must recognize that we aredealing in legal opinions, but not necessarily ethicalor moral ones. The pUblic, the pUblic advocates, andmany of the legislative and administrative authoritiesrecognize the distinction even if we do not. When we

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engage in development of products which create seriousside problems, or in marketing and advertising practicesin which our justification is that they are ~legal,~ we arein a position we can no longer defend. We are avoidinga responsibility we can no longer avoid. Perhaps weare not immoral, but we are amoral -- we lack moralquality.

I have set forth some of the reasons why I believethat attorneys should devote their talents and ingenuity tothe issue of corporate accountability and to closing the gapbetween corporate and public perceptions on that issue.Some of you already are. I have a great deal of faitnin the ability of the private sector -- and specificallyof the private bar -- to be creative and responsivein this area. Each of us who believes in the corporatesystem we enjoy today and the concomitant individualfreedom which it has provided us, must give seriousthought to his or her personal role in preserving it.Lawyers have to recognize that the system places heavyresponsibilities on them. Because of the complexitiesof modern corporate affairs, the private sector lawyerswho make the system work carry an especially substantialburden. If we, as a nation, lose faith in the effectiveness

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and fairness of that system, the consequences will befelt, not simply by business alone, but by the bar andevery other segment of our society.

Thank you and good afternoon.