Sarbanes' Banking Reform Bill Doesn't Go Far Enough
Sarbanes' Banking Reform Bill Doesn't Go Far Enough
by J. Russell Tyldesley
Monetary penalties are not enough for grossly overpaid executives. The threat that they would lose their "bonuses and profits" (as the S.E.C. proposes) if they made false statements is a joke.
I'm afraid I'll have to take issue with your editorial [Summer print/June Web Chronicle] lauding Senator Sarbanes for his shepherding of a reform bill through the banking committee. Although I have only read reports on the content of the bill, and not the bill itself, it appears to be a very tepid, tentative approach to getting some public control over our fabulously rigged system we call "free enterprise." The champions of free competition would be aghast if the system actually was free and competitive at the S.E.C. regulated level, as advertised.
Anyway, the bill was voted out favorably on 6/18, and now will have to survive conference committee to be reconciled with an even weaker House bill, with many conservatives wanting neither bill to survive. Senator Daschle is not optimistic that anything will become law this year, in any case, as the public's attention span is losing focus, and there are many other apparently more urgent diversions to think about.
I E-mailed Senator Sarbanes on 6/17, asking him to slow down the process, and to not, in haste, produce a bill that has no teeth and no chance at forcing fundamental reform. Alas, I was too late, even if my message was read. The Sun in its report mentioned that there had been 10 public hearings on this bill. Maybe I just wasn't paying enough attention, but if there were all these public hearings, they were not well advertised, and I wonder who the "publics" were who attended the hearings. My guess would be they were mostly comprised of industry practitioners, public officials and lobbyists, not Mr. & Mrs. average citizen.
The Sun also editorialized in favor of Sen. Sarbanes' bill. They called him the " stealth" senator--they meant it as a compliment.
I believe that ordinary citizens need to get fully involved in the reform process. Look, we haven't even been fully informed yet about what went wrong with the checks and balances in the Enron case. Sure, we know about the shredding, and the insider trading and the 900 or so phony off-shore laundering partnerships. More recently, we have learned how California was victimized by the trading companies, which created artificial shortages so they could price-gouge. But even after all this there is yet to be a full investigation of Enron's practices and how Arthur Andersen was complicit in constructing the house of cards. We well may have to await the outcome of civil suits and class actions such as the relentless case being brought by The California and Florida State pension funds which, combined, lost over $500 million in Enron stock.
To rush legislation before we have a clue as to the scope of the problem strikes me as disingenuous--yet another attempt to put lipstick on a pig and hope it doesn't smell as bad. Even Phil Gramm objected to voting out a bad bill (albeit from a different perspective ). Mr. Gramm's opinions should, however, be taken in context, given that his wife was on the Enron board and was head of the board's audit committee, no less. His hands have also been heavily greased by Enron donations over the years. He should have recused himself like John Ashcroft--but then, two thirds of Congress may have had to recuse themselves, depending on where you draw the line. At least Sen. Barbara Mikulski was the recipient of so little Enron largess that she was able to give it all back. I don't think many others in congress did.
It is this lack of comprehensive information that is why this bill by Sen .Sarbanes--or any bill at this point--is not a good idea.
Here is how I see some of the elements of the so-called reform bill by Sarbanes:
The separation of consulting from auditing.
This was already required under existing S.E.C. regulations, to the extent that, as of October of this year, consulting could not be more than 50% of revenues earned from an audit client. Corporations had already "gamed" that one by misallocating costs between auditing and consulting. The S.E.C. was actually on to this ruse, and they ruled that the allocations of these costs would be subject to S.E.C. measurements. That recent decision may have had a lot to do with the timing of the crisis at Enron
they knew the jig was up
better get your money out while you can. One neat self-serving practice that I have not seen reported on yet is that S.E.C.-regulated corporations often "outsource" their internal audit, and they almost always contract with their independent auditors to perform this work. Inasmuch as a main focus of an independent audit is on the integrity of the internal audit, to be on both sides is a blatant conflict.
The S.E.C. will require some disclosures by regulated corporations to be made within two days, rather than five days under current regulations. Wow!
The S.E.C. will require that the corporate CEO make a statement (presumably in writing) that the corporate financial statements are accurate.
Aside from the fact that a CEO would not know this (he might know they were not accurate, of course, if he was involved in the fraud ), accuracy is not the standard in the accounting profession. It is materiality and fairness. However, the word "accuracy" was in a news report, so I'm not sure how the regulation will read.
A CEO already makes such a statement, which is typically required by his CPAs in a management letter. If they have elevated the penalty for a knowing misrepresentation to a criminal felony, then we may have something like teeth. The civil penalties as of now are a joke. CEOs will easily gamble on not being caught when the penalty is a tiny fraction of what they ripped off in the scam.
On June 20 the PBS show "Nightline" had an excellent investigative report on the greater implications of Enron, and they made this point about penalties. (They are open for online debate on http://PBS.org.) Monetary penalties are not enough for these grossly overpaid executives. They are already multi-millionaires and have their money sheltered in trusts and properties insulated against creditors. The threat that they would lose their "bonuses and profits" ( as the S.E.C. proposes ) if they made false statements is a joke. They have plenty of money, but they are after more: fame, celebrity, power, influence, early golden retirement, and a best-selling memoir.
I think school is still out on whether the head of the S.E.C. will have the spine to go up against Congress and the powerful lobbying coming from the accounting and brokerage and banking interests to push for real reform.
It has to be remembered that his agency is also viewed by the conservative faction as "big government," and part of the problem. The "get the regulators off our back" crowd still seems to have some currency in the public mind. All that said, the head of the S.E.C. is a political appointee and an ex-Andersen partner and a shill for the industry as a lobbyist. Can the leopard change his stripes? (Clue: Will a Supreme Court Justice drop his ideological proclivities upon donning the robe?)
A five-member commission will be formed to oversee the integrity of the accounting profession. Two of the members would have accounting backgrounds.
I'm not sure how they will be selected, but in view of the 10,000-or-so public corporations subject to audit and S.E.C. regulation, these people will be very stretched. Of all the "slaps on the wrist," this is likely to be the lightest. A better solution would be to elect public citizens in every state
maybe 10 in each State
that would tackle those corporations domiciled in their State. The State of Incorporation would have to be ignored, because most corporations incorporate in Delaware, which has the weakest controls for corporate governance. But, usually a corporation has a headquarters where the CEO hangs out when he is not away hobnobbing, so the citizens of the state with the headquarters would be in charge of policing the corporation, not only for financial infractions, but on a long list of standards of "good corporate citizenship." Depending on the work load, no doubt there would have to be some budgeting for the costs of experts and consultants.
I realized this would be a drastic change from the current system but it still might not go far enough. The idea is to assert a measure of real public control, not the phony public control exercised by privately-owned CPA firms, privately-owned Wall Street security firms and privately-funded elected representatives at the federal level. (Note that only two states
Maine and Vermont
have " clean election" statutes. Massachusetts and Arizona have made significant steps in that direction, and North Carolina has begun the legislative process toward this goal. Connecticut's legislature passed a "clean election" statute, but their governor vetoed it. (See Clean election laws)
There is a proposal to require a rotation of audit firms every five years.
This makes some sense on the surface, but we only have a "Big 4" now rather than the "Big 8" of international audit firms that existed before the merger mania. There has always been a big gap between these large CPA firms and the next tier of accounting firms. The smaller, regional firms are not that interested in auditing S.E.C.-regulated firms. It creates another level of risk for them ,and they typically don't have the manpower to allocate to it. So, for the most part, this leaves the field to the Big 4. Of this oligopoly of 4, they all have their own troubles fending off shareholder suits, class action suits, and regulators. They may not be too far removed from the kind of meltdown going on at Andersen. I guess the Bush administration's answer would be "tort reform" to protect these privately-owned giants from the worst consequences of their shoddy work. But, given that this is the industry we have, what good will the 5-year rotation do to keep corporations (and audit firms ) honest? Well, it is quite likely--since auditing and consulting will have to be separated--that, at any given time, a corporation will employ one of them as auditor, and one as consultant. This narrows the choice even more. Another strong possibility is that when the five-year deadline approaches, the audit team for audit firm X may decide to jump ship and work for the new audit firm Y. If this happens it would not bring a "new set of eyes " into the mix.
Under proposed new regs, stock options would have to be expensed currently so as to better reflect bona fide corporate earnings. One of the aspects of this that has not been accurately reported is that stock options are esspecially important as a tax shelter to a corporation because they can expense them currently for taxes, but not book them on GAAP financial reports. So, they serve a dual benefit
artificially inflating earnings as they enhance cash flow by lowering tax payments. Of course, this nifty gimmick has been one of the engines that has pumped up stock prices for companies employing this technique, so as to make the stock options a very valuable form of compensation to the key employee or corporate executive.
Of course, if the stock price goes down instead of up, and the employee doesn't exercise the option until it drops below its exercise price, there can be "phantom income," which has actually bankrupted some unsuspecting employees for the dot coms who have tanked, because they suddenly have a big tax to pay, and no funds to pay it, when the stock is sold at prices too low to cover the tax.
Corporations and CPA lobbyists have fought efforts to reform this tax loophole for many years. It is still very doubtful that Congress will allow the S.E.C. to mandate this change. It would have a more devastating effect to corporate earnings than the recent change that requires the write-down of goodwill when it is known that its value has been impaired. This got headlines recently when AOL, another darling of Wall Street, wrote down over $50 billion in a one-time charge, recorded as due to "impairment of intangibles." This was required due to the Financial Accounting Standards Board (FASB)-issued SFAS No. 142, which became effective 12/31/01. This reform was an example of the industry policing itself through its umbrella, AICPA
the American Institute of Certified Public Accountants. If any change takes place with regard to the accounting for stock options, its best chance may be through FASB. (PBS aired an excellent program on "Frontline" called "Bigger than Enron," with substantial context and background for the battle being waged over this issue; join the conversation online at http://PBS.org.)
All of the above is offered humbly, because we need to be dealing with the art of the possible. Economics and politics are inseparable, so the good and bad news is that it is up to us to decide what we want. I think ballgames are much more interesting when they have good refereeing. Since sports are a metaphor for everything these days, it may be the only language people will listen to.
Asking the public to question the fundamental assumptions of capitalism and ownership of private property and the unfettered free flow of capital across borders required of all countries interested in being part of the neo-globalization liberalization movement would require a level of education that is totally unlikely when the multi-national corporations control the media. Communication on a small scale will be the best and only approach for now.
Enron does present an opportunity to elevate the debate, but, unfortunately, I don't see it happening. Ralph Nader has toiled in the wilderness for four decades and, if the people had been listening, we probably would have never seen an Enron. The kind of thing we have witnessed would not have happened with enlightened corporate governance.
Boards of Directors are another area rife with conflicts, but enough for now. The struggle for minds is tough arrayed against the powerful influence of government propaganda and Madison Ave. propaganda. We are now getting a peek behind the curtain, but we may not expose the wizard this time.