I appreciate the opportunity to appear today to follow up on the testimony and comments submitted by Robert A. G. Monks, the President of Institutional Shareholder Services, Inc. I want to begin by congratulating you on your thoughtful and comprehensive response to the complicated issues presented to you. My comments are limited to the role of corporate governance structures in culpability, damages, and sentencing, which are raised in numbers 10 and 14 of the issues you have identified for today's discussion.

Let me begin by giving you some idea of my perspective and background. At ISS, we provide institutional investors with legal analysis of their obligations as fiduciaries and economic analysis of their options. Our clients are large institutional shareholders who manage over $1 trillion of assets. These clients suffer twice when the companies they invest in violate the law. First, they suffer along with the rest of society the violation itself, and the attendant consequences, like increased health risks or higher prices. Second, they suffer as shareholders, paying the costs of defending the company from criminal and civil suits, paying for any fines or other penalties, and paying other costs that result, like loss of goodwill or market shares.

We hope to see your work here establish a foundation for shareholder participation to remove some of management's incentives to violate the law. Right now, shareholders are not able to hold management accountable for criminal activity. The inadequacy of the traditional mechanisms for sending a message to management--voting proxies, filing a shareholder derivative lawsuit, or selling the shares--have been documented since the days of Berle and Means, more than 50 years ago.

In many respects, institutional investors are the market. The traditional Wall Street Rule--"Vote with management or sell the stock"--does not work for them any more, as they are increasingly investing in index funds, or they are so large and diverse that they might as well be. And the Wall Street rule gives them no help in the case of criminal activity. It does not do much good to sell out of a company after criminal activity has been disclosed. So we and our clients are interested in structures, including sentencing, that deter criminal activity as much as possible. And when criminal activity takes place, we want to remove the people who violate the law from involvement in making or carrying out corporate policies.

Right now, criminal activity is attractive to corporate employees because it is easy to exploit the externalities. The benefits accrue to the corporation, while the costs are borne elsewhere. As Bob Monks noted in his testimony, shareholders in particular bear the costs on both sides. As taxpayers, they pay the costs of the prosecution; as shareholders they pay the costs of the defense.

The risk to corporate employees who decide to violate the law is far less than it IS tO individuals acting on their own. The highest level of corporate managers, for example, pays very little. They almost never go to jail; in fact, they very seldom lose their jobs. The company pays the fines, which are seldom calculated to offset any gains, and the company pays the officer's legal fees. The business judgement rule and limitation on directors' liability restrict shareholders' ability to get the courts to order reimbursement for the payment of these expenses or the loss in share value.

Large institutional investors are too large to sell out of every company that is a possible target of this investigation. It is impossible to maintain a diversified portfolio and sell out of every company that enters into contracts with the government. Even if they would or could, by the time the disclosure is made, the impact on the stock has already occurred. Selling out is only mitigating damages. Litigation is long and expensive, and the shareholders again foot the bill for both sides. The exercise of the other rights of ownership presents a more constructive option.

But corporate managers resist accountability to shareholders, especially since the volatility of the market for corporate control has created additional incentives for entrenchment. This is where it is very important to encourage "effective (corporate) policies and practices reasonably designed to prevent crimes." (DeGenova draft proposal) And one way to do that is with a corporate structure that promotes accountability to shareholders. The reason that corporate executives think they can get away with violations of the law is that there have been too many cases where they have--where there have been no personal penalties of any kind. For example, I can not think of a case where shareholders have voted out the directors of a company that violated the law. Unless someone comes in with a well-financed contest for control, they do not even have a choice.

The frustration with this kind of "teflon executive" has been considerable. When Morton M. Lapides of Alleco was convicted of a price-fixing scheme that resulted in record-breaking fines, the judge found the facts of this case so disturbing that he took the extraordinary and unprecedented step of issuing a prison sentence for the corporation. The judge said, "I cannot imagine any company being more tied up with illegal activity." The sentence was suspended, but he made it clear that, if necessary, he would be willing to "imprison" the company by rurming it himself, along the lines of the bankruptcy model. The terms of the company's "probation" directed four of its top managers to spend up to two years performing community service.

Mr. Lapides' actions are simply and clearly unacceptable in corporate leadership. Anyone who has presided over such wholesale disregard for the law should not be permitted to lead a publicly held company. (His lawyer argued that the company needed him. The man was being investigated by a federal grand jury, the Securities and Exchange Commission and the IRS. Even if he did have the integrity and leadership to manage the company during this critical period, where would he find the time?) Yet he was permitted to stay on (at the successor company), and even permitted to take the company private. His violations of the law were not enough to persuade a court that he was unable to act as a fiduciary for the shareholders in setting a price (to be paid by himself) for their company.

I believe that your guidelines should be more specific in including the existence of some mechanism for accountability to shareholders--established either before or after the criminal activity--as a mitigating factor in sentencing. If it is in place before the activity in question, it goes to the issue of culpability. The activity is less likely to be on behalf of or with the knowledge or consent of the top management, if they have put into place a structure for making themselves accountable for any criminal activity. If it is adopted after the discovery of a violation of the law (whether the discovery has heen internal or not), it goes to the issue of "acceptance of responsibility."

A charter or by-law provision providing, for example, that no director who has served during the commission of certain identified crimes will be eligible for continued service on the board, is a clear example of a corporate governance mechanism designed to decrease the agency costs/conflicts of interest that lead management to commit or permit criminal activity. Another example is a carefully limited provision governing director and officer liability and indemnification. This should be explicitly included as a mitigating factor, possibly within section 3(D), "substantial steps to prevent a recurrence of similar offenses." This will encourage corporations to establish structures that will not only lead to fairer sentencing, but to the prevention of criminal activity, which is one of sentencing's most important goals.

Shareholders have a strong interest in preventing corporate crime, and, in theory, their participation in corporate governance gives them the opportunity to deter it, and to remove directors who permit or participate in it. By making explicit the importance of a structure for shareholder involvement in corporate governance, this Commission can establish an important mechanism for management accountability and remove significant incentives for corporate management to engage in criminal activity.

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