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who dropped the ball?

An overview of post-Enron reforms proposed by the SEC, Congress, the White House, and Wall Street.

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June 20, 2002

The collapse of Enron -- the largest bankruptcy in United States history -- has led to urgent calls for reform to restore public confidence in the markets and in the financial reporting on which they rest. The Securities and Exchange Commission (SEC), which regulates U.S. capital markets, is pursuing several investigations into issues brought about by Enron's fall. Besides examining the specifics of the company's collapse, it has made proposals to address accounting reform and is continuing to investigate analyst conflicts of interest. Worried about investor confidence and nudged by the threat of litigation, the private sector has also taken steps toward reforming accounting and corporate governance standards.

On Capitol Hill, however, the fate of legislative reform has been far from certain. While 10 congressional committees have held hearings on issues related to Enron's collapse, no bill has made it through both houses of Congress. The accounting lobby has been active, and its allies in both parties have been accused of watering down reform bills. So far in the current election cycle, the accounting industry has contributed more than $3 million to members of Congress, with top recipients including members of the Senate Banking Committee and the House Financial Services Committee. [Read more about Congress and the accounting lobby.]

Here is a look at reforms currently under consideration.

Accounting Reform

Securities and Exchange Commission (SEC)
On June 20, 2002, SEC Chairman Harvey Pitt announced his proposal for a new private-sector regulatory body to oversee the accounting industry. According to Pitt, the new board, called the Public Accountability Board (PAB), would be comprised of a majority of representatives of investors and business, with a minority of members of the accounting industry, and its funding would be independent of the industry. It would have three main areas of oversight: ethics, competence and quality review, and would undertake a yearly review of all firms that audit more than 75 public companies each year. The PAB would have disciplinary power, but not subpoena power. Critics say that without subpoena power, the board will lack teeth and worry that even with a minority membership, the accounting industry will have too much influence over the board's decisions. There are also concerns that while the board's chairman or vice chairman would have a full-time position, the other board members would have part-time positions. SEC defenders have responded that part-time positions would be necessary in order to attract the most qualified candidates.

Read SEC Chairman Harvey Pitt's statement regarding the proposed Public Accountability Board (June 20, 2002).

Read FRONTLINE's interview with SEC Chairman Harvey Pitt.

House of Representatives
In April 2002, the House of Representatives voted 334 to 90 in favor of overhauling the rules governing the accounting industry. Sponsored by House Financial Services Committee Chairman Michael Oxley (R-Ohio), the Corporate and Auditing Accountability, Responsibility and Transparency Act created a new oversight board under the jurisdiction of the SEC to oversee the industry. The board would be comprised of five members: two who are licensed to perform public audits and have performed audits within the last two years; two who may be licensed, but have not performed public audits in the past two years; and one who has never been licensed to perform public audits. The bill also prohibited accounting firms from performing limited consulting functions for their audit clients, including in-house audits. The legislation was supported by the accounting industry, but criticized by labor unions, consumer groups and some Democrats as inadequate. Critics worried that the oversight board would not be independent, particularly under the jurisdiction of SEC Chairman Harvey Pitt because of his previous ties to the industry. They also argue that the bill could have gone much farther in addressing conflicts of interest between auditing and consulting.

Read the full text of the House bill.

On June 18, 2002, the Senate Banking Committee approved a bill sponsored by the Chairman of the Senate Banking Committee, Paul Sarbanes (D-Md.), that went much farther than the House bill, prohibiting accounting firms from selling consulting services to auditing clients and creating its own independent oversight board to regulate the industry. The board proposed by the Senate would have five members, of which a majority would be independent of the accounting industry. It would have the authority to set accounting standards and would be funded with fees paid by corporations. The bill also limits senior audit partners to serving five years on an account and orders a study to determine whether this restriction should apply to entire firms. Ranking minority member Phil Gramm (R-Texas), who is known for his pro-business positions, threatened to block the legislation, arguing that SEC action and private-industry reforms were sufficient. The committee passed the measure by a vote of 17 to 4 -- a move which surprised many observers who expected it to narrowly pass on a party-line vote. Lauded by consumer organizations and some business groups, the bill is criticized by the industry. According to the American Institute of Certified Public Accountants (AICPA), both the Senate bill and the SEC proposal "raise uncertainties about whether auditing professionals will continue to remain actively engaged in setting auditing standards and that auditors will have sufficient latitude to respond to the needs of both investors and public companies." Senate Majority Leader Tom Daschle (D-S.D.) has promised to bring the bill to a floor vote in the Senate before Congress recesses in October. The future of the legislation is far from certain, however. Even if it passes the Senate, it will still need to be reconciled with the weaker House version favored by the accounting lobby.

Read the text of the Senate bill.


White House
Declaring "Reform should begin with accountability and reform should begin at the top," President Bush outlined a ten-point plan to improve corporate accountability in March 2002. His proposal is based upon three core principles: making financial information easier for investors to access; increasing accountability for corporate officers; and strengthening a more independent audit system. Although the president has said he will work with Congress to provide additional legislative authority to the SEC if necessary, the administration's view is that the SEC can accomplish these goals within its existing authority. Critics called the plan "half-hearted" and argued that it stopped short even of Treasury Secretary Paul O'Neill's suggestion to make it easier to punish corporate executives who mislead investors.

On June 12, 2002, the SEC adopted several of President Bush's initiatives and voted to require CEOs to vouch personally for their companies' financial reports and to require companies to report to the SEC significant events important to investors within two days. The SEC rule is currently in a 60-day public-comment phase.

Read more about the president's plan to improve corporate responsibility.

Read more about the SEC's proposed rule.

Also in March 2002, Senate Democrats introduced a bill sponsored by Sen. Patrick Leahy (D-Vt.) that would toughen the criminal penalties for corporate fraud. The Corporate and Criminal Fraud Accountability Act would increase the penalty for destruction of corporate audit records less than five years old, or any other records involved in federal investigations or bankruptcy. The bill would also increase the statute of limitations for securities fraud as well as give state attorneys general and the SEC new powers to pursue racketeering charges against companies. Critics pointed out that neither the president's plan nor the Democrats' bill contained provisions that would make it easier to pursue private litigation against corporations.

Read a fact sheet on the Corporate and Criminal Fraud Accountability Act.

New York Stock Exchange (NYSE)
On June 6, 2002, the NYSE issued its recommendations for strengthening corporate governance rules. The proposed reforms are designed to enhance the independence of corporate boards. The NYSE's recommendations include requirements that the boards of NYSE-listed companies have a majority of independent directors within two years, and that the independent directors meet regularly without management. The proposal would also require companies to allow shareholders to vote on all equity-compensation plans, and to publicly disclose their corporate governance policies and codes of conduct and ethics for directors, officers, and employees. The proposal, which was commended by SEC Chairman Harvey Pitt is currently in a two-month public comment period and will be voted on by the NYSE board on August 1, 2002.

Read the NYSE report.


White House
Responding to the public outcry over Enron's collapse, in which many workers lost their retirement savings held in company 401(k) plans, President Bush outlined his agenda for strengthening retirement security in February 2002. The president's plan included giving workers more freedom to choose how to invest their retirement funds and more access to professional investment advice.

Read more about the president's plan to strengthen retirement security.

House of Representatives
A bill modeled on the president's proposals and sponsored by Rep. John Boehner (R-Ohio), chairman of the House Committee on Education and the Workforce, was passed by the House in April 2002. The Pension Security Act makes it easier for workers to diversify their 401(k) plans, and prohibits employers from forcing employees to invest their own savings in company stock. The bill also prohibits executives from selling company stock during "blackout" periods (during which employees are not allowed to change investment plans), and allows companies to offer investment advice to employees. Democrats charged that the reforms did not go far enough and that the bill did not deal with unethical behavior of corporate executives. Senate Majority Leader Tom Daschle (D-S.D.) noted that Congress had years ago enacted a ban on companies providing investment advice to workers in order to protect them from being given advice that promoted the company's interests over employees' interests.

Read more about the Pension Security Act.

In March 2002, the Senate Health, Education, Labor and Pension Committee passed the Protecting America's Pension Act. Sponsored by Sen. Edward Kennedy (D-Mass.), the bill was intended to give workers more diversification options for their retirement plans. It would require employees to use financial advisers not associated with their employer, and would limit how much company stock an employer could use in contributing to employee 401(k) plans. Critics of the bill, including business lobbying groups, argue that the restrictions could hurt workers by forcing companies to drop matching contributions to retirement plans. Senate Majority leader Tom Daschle (D-S.D.) has not yet scheduled a Senate vote on the legislation because of fears that it lacks the votes to pass even a simple majority.


New York State Attorney General's Office
In May 2002, New York State Attorney General Eliot Spitzer announced a settlement in his investigation into Merrill Lynch for conflicts of interest in the firm's investment advice. While the firm did not admit wrongdoing, it agreed to pay a $100 million fine and reform the manner in which analysts are compensated. Under the settlement, Merrill Lynch agreed to sever any compensation links between analyst recommendations and investment banking, and prohibit any input from the investment banking division into analysts' compensation. The firm also agreed to create a new investment review committee to approve all research reports, and to establish a monitor who would ensure compliance with the agreement. At least one other firm, Salomon Smith Barney, has announced that it will follow Merrill Lynch's lead in reforming analyst compensation.

Spitzer has said he is pursuing his investigation into other investment banks. The SEC, NYSE, National Association of Securities Dealers (NASD), and other state attorneys general are all also probing the issue. Both the SEC and Spitzer say they would like to see a formal division between the research and banking parts of the business. However, critics warn that because of the decline in trading commissions over the past 30 years, it will be difficult to support high-quality research without the revenues provided by the investment banking divisions.

Investment Banks
Following its settlement with the state of New York, Merrill Lynch announced it would simplify its stock ratings system for investors by introducing a three-tiered system in which stocks would be rated as "buy," "neutral," or "sell." Other banks have followed Merrill Lynch's lead: Morgan Stanley and Prudential have already changed their ratings systems, with other firms, including Salomon Smith Barney, Goldman Sachs, Lehman Brothers, and UBS PaineWebber promising to follow.

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