The Feds Move In: Get Ready for the Regulatory Storm
from
July/August 2002
by John R. Engen
Suddenly everybody wants to protect the little guy. And that, big
guy, can spell trouble for you. In the wake of Enron (for how many
decades will sentences begin like that?), “the mood in Washington has
shifted toward tougher regulation,” says William Williams Jr., a
partner in Sullivan & Cromwell’s corporate law practice. You could
practically rope off the city with the fine print from all the
regulatory proposals in the works, ranging from tighter control of
accounting procedures to stricter Securities and Exchange Commission
surveillance of the boardroom. “Everybody’s going to be under a more
powerful microscope,” Williams says. And one result, predicts Richard
Phillips, a partner with Kirkpatrick & Lockhart LLP in San
Francisco, will be “a general hardening of attitudes toward directors.”
Stephen Cutler, the SEC’s enforcement chief, has been talking tough about halting “illegal conduct expeditiously,” in part by cracking down on officers and directors who hold “positions of public trust but place their own interests ahead of those of the company or its shareholders.” He’d like Congress to give the SEC administrative power to bar from officer or director posts people whose conduct “demonstrates substantial unfitness”—an idea that has the support of President Bush. These would include men and women who engage in fraudulent insider trading or stock-price manipulation schemes. Currently, the SEC must convince a court that someone is unfit to serve on a board—and that has typically proved difficult.
In April, the House of Representatives took the first step toward fulfilling Cutler’s dreams when it passed the Corporate and Auditing Accountability, Responsibility, and Transparency Act (CAARTA) by a 334-to-90 margin. The bill, sponsored by House Financial Services Committee chairman Michael Oxley (R-Ohio), gives the SEC just such administrative authority. It also requires disclosure of insider trades “before the next business day,” greater disclosure of off-balance-sheet transactions and business relationships, and plain-English explanations of key accounting policies in a company’s quarterly filings.
Accounting procedures are under scrutiny, too. As its criminal indictment of Arthur Andersen indicated, the government has little patience these days for record-keeping shenanigans or efforts to conceal them. A key CAARTA provision would make it illegal for directors or officers to “influence” or “mislead” accountants. CAARTA also bars accounting firms from providing both auditing and most types of consulting services to the same client, and envisions a new five-member government board charged with overseeing and disciplining the profession.
The big question is, What, if anything, will become law? Many CAARTA provisions have the blessing of President Bush, including one that would force CEOs to forfeit bonuses if accounting-related abuses are uncovered.
Democrats have criticized CAARTA and similar House proposals for being too soft on corporate wrongdoers, which means that the bills may face trouble in the Democrat-controlled Senate. There, Senators Jon Corzine (D-New Jersey) and Chris Dodd (D-Connecticut) are backing the Investor Confidence in Public Accounting Act, which calls for stricter regulations on both corporations and accounting firms. Meanwhile, Senator Edward Kennedy (D-Massachusetts) is supporting a bill that would allow employees to seek financial remedies from executives who harm their retirement plans. As one congressional watcher put it, “Can anything get reconciled in a conference committee during an election year?” The likely answer: yes. It could be political suicide not to back some reform after the Enron debacle.
How should directors weather the regulatory storm? Phillips says that boards should begin by getting attorneys more deeply involved in reviewing notes to the financial statements, to ensure that the disclosure is sufficient and the language understandable. “You’ve got to ask yourself, ‘Do I understand the disclosures?’” he says. “‘Would I expect an average investor to understand them?’”
Some boards are already working to meet the anticipated new standards, often by conducting their own “Enron reviews” of governance, auditing, and transparency issues with attorneys. General Electric CEO Jeffrey Immelt has vowed to disclose more information—even, he told journalists, if it results in quarterly reports “the size of the New York City phone book.”
Others are making such disclosures sooner. In a recent teleconference among board members of Apria Healthcare Group in Costa Mesa, California, the corporate counsel advised the directors that by law, they had five months to disclose an important transaction. That wasn’t good enough for Apria chairman Ralph Whitworth, who is also head of Relational Investors, a group with a significant stake in the company. He said, “No. We’re going to do it now,” according to Richard Koppes, an Apria director and former general counsel for the institutional investor California Public Employees’ Retirement System. As Koppes points out, “Everyone today is on heightened alert.”
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CONGRESSMAN SEES ENRON AS LEAD ROACH
As chairman of the House Committee on Energy and Commerce’s Subcommittee on Oversight and Investigation, Representative James Greenwood (R-Pennsylvania), 51, has emerged as a leader in Washington’s post-Enron reform movement. He talked with Corporate Board Member’s John Engen:
CBM: What’s the mood in Congress toward corporate America?
Greenwood: There’s a sense that the emperor has no clothes when it comes to the credibility of audited financial statements. We have to make some reforms to restore investor confidence.
Is Enron viewed as an aberration, or is there a deeper problem?
Nobody really knows. I don’t think it’s the norm, but I subscribe to the roach theory: If you see one scurrying across the floor, it’s a good bet there are others behind it.
What have you been hearing from constituents?
The average person simply knows that some big guys got very wealthy and a lot of working stiffs got creamed. If I walk into a hardware store, I’m likely to hear “Go get those bastards.“
What are corporate leaders saying?
Most believe that we need to make some changes to restore confidence.
Does that mean new laws or stricter enforcement of existing laws?
Both. The Justice Department and the SEC are charged with punishing violations of law. Congress’s job is to examine how the laws function
and make changes. What we’ve discovered is that Andersen—particularly as applied to special-purpose entities and off-balance-sheet accounting—helped Enron create false impressions in financial statements without necessarily breaking the law.
Is there a danger that Congress might overreact?
It’s important to strike a balance. Congress could do nothing, and then the public would say that we’re beholden to special interests. It could also overreach by creating new bureaucracies to audit every publicly traded firm. Frankly, with a Republican House and president, there’s not much chance that we’ll wind up with a big-government approach.
Your committee is pursuing reforms in the Financial Accounting Standards Board. What do you envision?
We want to reconstitute FASB as an independent entity, not one that’s owned and operated by the Big Five accounting firms. Congress would require that every determination an accountant makes would encourage transparency and prevent management from fooling the investor.
You voted for the Corporate and Auditing Accountability, Responsibility, and Transparency Act, which, among other things, gives the SEC administrative power to bar “unfit persons” from serving as directors. Are you comfortable with that approach?
In very egregious situations, where directors are clearly lawbreakers, there is a role for the SEC. But I think the private sector will take care of this itself. I wouldn’t expect, for instance, to see Enron board members being snatched up by other companies.
