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TERENCE SMITH: The votes in the House and Senate today were no surprise… overwhelming passage of the toughest new restrictions on business accounting practices since the Great Depression . The lopsided and quick votes followed a succession of corporate accounting scandals and days of plunging stock prices. Final passage came hours after House and Senate negotiators struck a deal yesterday reconciling their competing bills.
REP. MICHAEL OXLEY (R-Ohio), Chairman, House Financial Services Committee: We now have a bill that is superior to legislation passed by either body. The language we consider today will make the capital markets more accountable to investors, increase the transparency that serves as a foundation of our markets, and make corporate executives who break the law and abuse the public trust pay severely.
SEN. PAUL SARBANES (D-Md.), Chairman, Senate Banking, Housing and Urban Affairs Committee: It’s obviously time to act decisively, and I’m pleased that we will shortly send to the president a strong bill and that we now can look forward to this legislation becoming law. I have said repeatedly that unless we can bring this situation under control, I’m concerned that the economy, in the end, will suffer in a major way, with all of the implications of such a development.
TERENCE SMITH: Last night, Republican Senator Phil Gramm of Texas was a lone dissenting voice. He said the legislation opens the door to more lawsuits against U.S. companies.
SEN. PHIL GRAMM: (R-Texas): I believe that you have put together a bill that will do more good than harm, but I do not believe that the bill does as much good as it could do. I think it does more harm than it should do because it doesn’t address the practical problems of making this new law work, not just for the Dow Jones Industrial Average companies, not just for the S&P 500, but for the 16,254 companies that will be governed by this law. I am afraid that we have written a one-size-fits-all prescription when that one size clearly does not fit all.
TERENCE SMITH: The corporate responsibility bill creates: tougher fraud penalties for corporate officers; prison terms of up to 20 years for fraud and document shredding; an independent, five-member board with subpoena power to oversee the accounting industry. The legislation also bans personal loans from companies to corporate officers and restricts the services accounting firms may provide to audit clients. On the House floor today, no member spoke out against the bill..
REP. DAVID BONIOR (D-Mich.): We are here today to send a message loud and clear that if you break the security laws, if you rob hard-working people of their pensions, you will go to jail just like you would if you would rob a bank. We are standing here today, and we’re standing for the rights of working people to know that their wages and their pensions and their benefits are secure.
TERENCE SMITH: But some, like Financial Services Committee Chairman Oxley, did express caution.
REP. MICHAEL OXLEY: We act with the assurance that Congress must do something yet remain acutely aware of the dangers of overreacting to a genuine problem and making matters worse.
TERENCE SMITH: The bill now goes to the White House for the president’s signature.
TERENCE SMITH: For more on the corporate reform legislation, we’re joined by: Jim Cox, professor of securities law at the Duke University Law School; by Nell Minow, editor of The Corporate Library, a Web site that serves as a watchdog on corporate governance; and by Robert Litan, director of economic studies at the Brookings Institution, a Washington research organization. Welcome to all three of you.
Bob Litan, before we get into the specifics of this bill, what impact do you think it will have on the situation as we know it now?
ROBERT LITAN: Well, I think in the short run t clearly is a confidence booster. But I think investors are going to take a “wait-and-see” attitude to see whether or not the SEC in particular takes the money, the initial money that it’s been given, or going to be given, and really finds out how much more corporate wrongdoing there is. I think after the bloodbath in the markets that we’ve seen in the last couple of weeks, investors justifiably want to wait and see if all this is going to work.
TERENCE SMITH: Jim Cox, do you think it’ll be, in Bob Litan’s words, a confidence booster for the investor?
JAMES COX: Yeah, I think if does. I think people are reassured to see that there’s some action here, some response by the Congress. But most importantly is that the public becomes more aware of its terms. It is important that we understand they’re adding up to 200 new people to the staff of the SEC; it’s terribly understaffed. There were 1,700 people working at the SEC in 1941. There are 3,200 now.
That’s a modest growth over– what — five decades. So we find the number of reporting companies and the complexity of their operations has grown exponentially. And so it’s important to find that there’s been a serious augmentation of the SEC’s budget. And many of the provisions in the act are going a good distance to protect investors and laying a nice structure for actions by both the SEC and the new oversight board to strengthen investor confidence in the market.
TERENCE SMITH: Nell Minow, when you look at this overall, good bill, bad bill? What is it?
NELL MINOW: It’s a nice bill. That’s the best I can say about it. I’m going to damn it with faint praise. I think the confidence booster effect of this bill is mostly going to be on those people going out and stumping for votes this fall…
TERENCE SMITH: The politicians, not the investors.
NELL MINOW: That’s right. The politicians will be able to say they did something. But what this shows is just how small a role the federal government has in oversight of large corporations. Yeah, it’s nice that there will be an oversight body set up over the accountants, but how long is it going to take them to set it up? And who’s going to be on it, and how effective is it going to be? We’ve seen watchdogs turn into lap dogs before so I don’t think it’s going to really create a lot of enthusiasm in the market.
TERENCE SMITH: Bob Litan, this new oversight board, what impact do you think that will have? And how will it be different than the way things are done now?
ROBERT LITAN: Well, frankly, in my view, this is something the SEC should have done all along. And if I had my druthers, I would have had the SEC given additional authority to carry out the responsibilities that have now been given to the new PAB, but given that we have a PAB, I think that’s where we’ve got to put our chips.
There’s going to be the harsh glare of public scrutiny on the PAB and I’m a little more optimistic than Nell. I think, given all the attention that’s been given to all the abuses, I think there’s a good chance that whoever’s appointed to it will carry out the responsibilities seriously and if nothing else, the press and Congress will be watching the whole time.
TERENCE SMITH: Jim Cox, what do you think — an effective new instrument or not?
JAMES COX: You know, I think that what is important here is when you read this legislation closely, it’s a reminder all the way the through the important oversight role that the SEC has. Even the instructional relationship of the oversight board to the SEC — the primary responsibility remains in the SEC. And in fact we don’t need… didn’t need this legislation.
The SEC’s always had the historical power over both accounting standards and auditing procedures if it’s cared to exercise it. And I think it’s a very clear message coming from the Congress right now that the SEC has to stop being a lap dog on these points and needs to be getting in the lead on accounting standards, as well as making sure now that the oversight board does its job in assuring independence of accountants, clear and precise auditing standards, and at the same time, the SEC needs to take the lead in getting the Financial Accounting Standards Board, the private sector boards that set forth the metric for measuring revenues, assets, liabilities, et cetera, to get moving, get off the dime and get on with the work.
TERENCE SMITH: What are the chances of that, Nell Minow?
NELL MINOW: Well, I think that will happen. I think the Financial Accounting Standards Board tried to do the right thing on stock options a couple of years ago, and Congress in an unprecedented move stopped them, so it’s nice that Congress is getting out of their way now.
But I think the most meaningful reform that we can expect right now is not going to come from Congress or the SEC; I think it’s going to come from the New York Stock Exchange and the NASDAQ. The NASDAQ announced some very powerful new corporate governance requirements today — the New York Stock Exchange expected to adopt something even stronger next month.
And until we get the boards of directors to do a better job, nothing is going to change. That’s really ground zero in corporate governance.
TERENCE SMITH: Explain, Nell Minow, that they have control over these companies by their very listing on the markets.
NELL MINOW: That’s right. The New York Stock Exchange can’t tell them what to do, but it can tell them that they can’t sell their stock on the New York Stock Exchange unless they comply, so I think this is very important. With regard to the oversight of the auditors, the primary oversight comes from the board’s audit committee, and if they don’t do a good job, there’s nothing that this new SEC or the new PAB is going to be able to do.
TERENCE SMITH: Bob Litan, this bill also of course includes stiffer penalties for fraud and other abuses. How practical is that? How much of a difference will it make?
ROBERT LITAN: Well, I think all these stiffer penalties are more show than substance. They make for great sound bites. Congressmen can now say, “look, we’re going to throw away these executives that are wrong doers and we’re going to lock them up.” It sounds tough.
The reality, though, is that it’s very, very difficult to bring white collar fraud cases. It takes a lot of resource. It’s hard to convince juries that people are guilty, and so I think at the end of the day you’re going to see very few people go to jail.
The one thing I would agree with Nell on, I think one of the more important reforms instead is that the auditors are now going to be hired under both this bill and under the New York Stock Exchange rules, the auditors are going to be hired by the audit committees or boards of directors, no longer by management, so there’ll be much less incentive for auditors to kowtow to the firms that hire them.
TERENCE SMITH: And so that you think will be a significant difference, right, Bob Litan?
ROBERT LITAN: Excuse me. I couldn’t hear.
TERENCE SMITH: I’m sorry. That you think, then, will be a significant difference?
ROBERT LITAN: Well, I think, yes. I think the changing who hires the auditors is one of the more significant things that’s happened. I also think the oversight board is a significant development. And finally, all that more money and more resources that Jim talked about given to the SEC, that’s a big deal. That’s eventually going to make a difference.
TERENCE SMITH: Jim Cox, stiffer penalties, will they make a difference?
JAMES COX: I don’t think it’s going to change the quality of disclosure that’s occurring. I mean whether somebody goes to jail for five years, ten years or twenty years is pretty much at the margins. I think what we see here is really in some parts of the bill a quest for social justice. I mean you know, the public was outraged by the conduct here, couldn’t understand why somebody doing this wouldn’t have a maximum prison sentence of five years, where if you go down and hold up the local 7-11, you may get fifteen or twenty.
So there’s some sense of social justice here. Related to this also is expanding the statute of limitations so that injured investors no longer lose their claims after three years, but now can present those claims even though the injury occurred five years earlier. That’s an important factor.
And you know, another matter that’s… of social justice is also placing the insiders; that is, the officers and directors, trading behavior in the company stock within the same blackout period that applies to the foreman or anybody else working in the corporation.
So there’s a lot of parts of this act, which maybe don’t go to deterrence function, maybe don’t go so much to protecting investors as such, but nevertheless, are trying to sort of equal the scales of justice between the blue collar worker and the white collar executive.
TERENCE SMITH: Nell Minow, any serious deterrent factors here?
NELL MINOW: I don’t think that any executive weighs the prospect of prison when they think about defrauding their financial disclosures. I’d kind of like to see them bring back the stock. I think that that would be an appropriate punishment for these guys. But, given the fact that that’s unlikely to happen, I agree that it’s more for show than anything else.
TERENCE SMITH: Bob Litan, the new rules restricting the auditing companies from consulting, that sort of separation participation, is that useful and significant?
ROBERT LITAN: I’m actually a contrarian on this. I know the conventional wisdom is, that, especially in the case of Enron, that Arthur Anderson supposedly bent over backwards, favored Enron because they had all that non-audit business. But the reality is in my view, that if you restrict audit firms only to doing audit business, if they want to kowtow to management in order to keep their auditing fees, they’ll still do it.
So keeping them out of the non-audit business, in my view, doesn’t change matters. The really important reform is to change who hires the auditors, and that at least the legislation does. It’s what the New York Stock Exchange does, and it says no longer shall management choose the auditors. But I think this supposed separation, I think there’s, again, here, more show than substance.
TERENCE SMITH: Jim Cox?
JAMES COX: I guess I couldn’t disagree with Bob more on that point. First of all, I think what happens with the rendition of non-audit services is that you make that fee, that total income that the auditors get even larger, and since you don’t change auditors very often, when you capitalize that by any sort of investment magnitude, it becomes a very large number and you do compromise the independence.
And I think we made too much of the fact that this bill requires “the audit committee” to hire the outside auditors. I think the proof of the pudding is going to be in the testing of it. It remains to be seen just how independent this relationship is by the audit committee members from senior management, and really it’s going to take a very long time, I think, for any corporation, audit committee to establish the kind of rapport with the outside auditors.
So the auditors really do see the audit committee as being the person of their engagement. So there’s a lot of things on paper here that suggests there’s going to be new independence for the auditors. A lot of that depends on just how savvy and successful the audit committee members are, and this comes down to basic personalities.
And my final remark on this is the fact that I’m afraid that there really are too few good people around to serve on audit committees to make that function really work, so what’s on paper may not turn out to be in reality.
TERENCE SMITH: All right. Two different views. Nell Minow, where do you come down?
NELL MINOW: Well, Jim is right it that it all boils down to the audit committee. And they actually do have the right to hire and fire the auditors right now even without this legislation, I would like to see more of them exercise that. I would also like to see regular rotation of auditors. I think that’s the best solution. But Bob is right that whether you’re paying the audit firm in one pocket or two, they’re still beholden to you, and that’s why I like rotation of the auditors every five years. That makes sure that you’ve a fresh look.
TERENCE SMITH: In other words, it’s still big money, and they’re still going to be very interested in pursuing it.
NELL MINOW: They’re still service providers; they still want to make the client happy.
TERENCE SMITH: Yes, Jim Cox, go ahead.
JAMES COX: I was just going to add two minor points there. One is that the legislation indicates some hand-wringing. They’re calling for a study I believe by the SEC or the GAO, I can’t remember which one it is, to investigate rotating audit firms.
The other thing I wanted to point out here is Europe is getting away ahead of us in their capital market. They’re looking at what Nell is suggesting in mandatory requirement of changing auditors every seven to ten years and it’s going to be very interesting to sort of see how faith and confidence in the European markets gets restored by that.
TERENCE SMITH: Bob Litan, when the investor reads that the president has put his signature on this, from all of this that we’ve discussed, what should he or she take most confidence from?
ROBERT LITAN: Well, I think the big picture here is that something has happened. I think the average investor is not going to pay a lot of attention to the details that we’ve been discussing. There will be a general impression that Congress has done something; the president has signed it. They may be dimly aware the New York Stock Exchange has done something.
They may be dimly aware that now institutional investors are putting a lot more pressure on companies to behave and so forth. But the I think the average investor’s going to sit back and wait and watch, and frankly, in the short run with all that extra money and all those extra people, the SEC’s likely to find more wrongdoing, it’s more likely to see more stories of earnings restatements and in the short run, investors could still stay nervous.
In fact, they may get even more nervous. Over the long run, hopefully they’ll have more confidence, but I don’t think we’re out of the woods.
TERENCE SMITH: All right, Bob Litan, Jim Cox, Nell Minow, thank you all three very much.