Markets are rapacious creditors. In the information economy, they are the most powerful regulators of financial and corporate behavior. When they see a company or a country misbehaving and turning sour, markets mercilessly apply the whip-hand and pull their investments. It’s as true for Argentina as it is for Enron.
This year, as the Enron scandal moved front and center, the markets have been on the warpath even while the economic outlook has been improving. They’ve pounded Tyco, PNC, JP Morgan, Global Crossing, IBM, GE, and many others in search of more honest accounting, a higher degree of corporate disclosure and governance, elevated standards for executives, and more ethical corporate-board governance.
This is the tough message of the markets that is now having a major impact on Washington policymakers. It’s the good news that will ultimately transform the Enron problem into a stock-market and economic solution.
Treasury Secretary Paul O’Neill, a former CEO himself, is seeking to raise the standard for CEOs “from recklessness to negligence” in order to increase the likelihood that executives face tough punishment for problems they should have known about — even if they didn’t have the information. And while he hasn’t proposed it, O’Neill has even floated the idea of removing liability insurance from corporate directors and officers.
Labor Secretary Elaine Chao, who has already recommended a deregulation of 401(k) accounts to permit earlier selling of investments, is also pursuing a plan to recover Enron employee retirement losses through the department’s ERISA — or Employee Retirement Income Security Act — mandate. In a recent interview with the Washington Times’ Donald Lambro, she revealed that in the past year her agency has recovered nearly $700 million that was returned to workers, while obtaining 76 indictments and 49 convictions against guilty parties.
SEC chair Harvey Pitt, who started off as a defender of the accounting profession, is now aggressively pushing FASB (the Financial Accounting Standards Board) to force consolidated balance sheets on firms with numerous off-balance-sheet partnerships and subsidiaries. Pitt is also moving to force executives to give up cash gains made by selling their stock or options before a company collapse. “It’s a simple notion of taking money that you haven’t earned, and that’s not the American way,” he told the press.
In Congress, former SEC chair Arthur Levitt’s proposal to prevent a conflict of interest by banning accountants from auditing and consulting with the same company is now headed for passage. Meanwhile, a House bill would require corporate officers to report company stock transactions to the SEC within 24 hours. And Rep. Mike Oxley (R, Ohio) wants to raise the SEC budget by nearly 50% next year to provide for stepped-up enforcement ability and the resources it needs for additional random spot-auditing of firms.
Former presidential candidate and publishing executive Steve Forbes wants a company’s accountants to be hired and fired by its board of directors’ audit committee. He also believes that the audit committee, not inside management, should set accountants’ fees. Mr. Forbes stresses that accountants should work for the shareholders and the public.
All these reform proposals have considerable merit. But nothing will force the executive mind more toward truth and transparency than a tough white-collar criminal and civil prosecution — including jail time — by the Justice Department and the SEC. This will create the ultimate incentive for executives, accountants, lawyers, and bankers to clearly distinguish between right and wrong in their business dealings.
Right now many investors, entrepreneurs, and small-business owners fear that the system has been rigged against them by big business, big accountants, big lawfirms, and big banks. If the U.S. stock market and economy are to function prosperously in the years ahead, a strong reform plan for honest accounting, ethical governance and transparent disclosure must be quickly put into place in order to restore confidence in the system.
Just as with any national scandal, the potential for over-regulation and over-legislation remains a risk. That is why government policymakers should listen carefully to the reform message coming from the markets, and then help the markets weed out the bad apples who are not playing by the rules.
Above all, Washington must take great care not to throw out the economic-recovery baby with the dirty-accounting bathwater.