To prevent another WorldCom, the US government needs to do something about the practice of keeping one set of accounts for the Revenue and one set for the SEC and investors
Everyone is outraged. President Bush is outraged, Congress is outraged, investors are outraged, the non-investing public is outraged, CEOs are outraged (the ones who aren't the source of everyone else's outrage). Even Jack Grubman, Salomon Smith Barney's star telecom analyst and WorldCom booster until the bitter end, is outraged that the company lied to him.
They all smell blood. Heads will roll. Perhaps a public lynching is in order for all those executives who got rich at the expense of their shareholders and employees.
The rush to judgment is one thing; the rush to over-legislate and over-regulate is another. In this election-year jihad to assign blame and claim the moral high ground, both Democrats and Republicans are eager to take action. 'Do something'' is the mantra when 'do no harm'' should be.
Everyone who's outraged has a proposal on the table. The president put forward a 10-point plan to improve corporate accountability back in March. The public cried out for more, so he tacked on a few points, the creation of a corporate fraud task force and new criminal penalties for corporate fraud, including a doubling of the maximum prison term, in a much-anticipated and long-overdue speech this month.
All of the proposals seek to improve accounting practices by creating independent oversight boards. Audit committees would be independent as well, instead of reporting to management (the current incentives are misplaced). CEOs and CFOs would have to vouch for the companies' financial statements.
The Senate Banking Committee has a tough bill that creates a new quasi-government agency 'with virtually unlimited power to regulate accounting firms,'' says David John, a researcher at the Heritage Foundation. 'Instead of setting standards that a privately established board would have to meet, as the House and SEC propose, it locks into law existing regulations and explicit requirements, which could become outdated rapidly.''
The House of Representatives bill doesn't aim to provide a statutory solution for every problem. Instead, it gives the SEC the authority to prevent further abuses.
The Securities and Exchange Commission has a plan in case Congress doesn't enact legislation, fat chance. So does the New York Stock Exchange. The man on the street has a plan, too, which would probably entail transferring the ill-gotten riches from the ill-getter to the employees who saw their 401(k) accounts implode.
So many plans. What's the matter with enforcing the rules and regulations already in place?
'We probably do need regulation, something in the substantive realm, to restore investor confidence,'' says Bob Willens, a tax and accounting analyst at Lehman Brothers. 'Self- regulation won't do it.''
The public may want more regulation. They also want to see the crooks punished. Investors may feel better about financial statements in the future, but they aren't going to feel like buying stocks until corporations finish restating the 1990s.
It all has a feel of closing the stable door after the horse has bolted. No CEO in his right mind is going to cook the books right now, with financial statements under scrutiny. Stricter penalties for fraud will be a deterrent to future hanky- panky, but the problem seems to be an unwillingness to initiate criminal prosecution under the current legal system.
'The standard of proof in a criminal action is stricter than in a civil action,'' says Charles Elson, director of the corporate Governance Center at the University of Delaware. 'Prosecutors have been unwilling to use the tools. The fear of failure is too great.'
Certain reforms are necessary, and can be implemented within the current legal system, Elson says.
'The needed reforms are threefold,'' he says. 'Corporate boards should be comprised of truly independent directors. The accounting profession needs some reform, but the SEC can do that. And we need stepped-up prosecution for those who violate the law, which is in the purview of the executive branch.''
To do more would be a 'classic case of form over substance,'' Elson says. 'The Senate bill would create a regime where companies would take action to avoid liability rather than getting the right numbers out.''
Enacting new laws now is the opposite of running counter-cyclical monetary policy, according to Chris Low, chief economist at First Tennessee Capital Markets.
'The Fed leans on the market with higher interest rates when things are getting frothy,'' Low says. 'None of the existing laws were enforced during the boom.''
To clampdown now will inhibit risk-taking, the basis of the capitalist system, when it's already been hampered by events themselves, Low says.
The easiest fix for the trend of misstating earnings to keep the stock price up would be for companies to do away with double- booking: maintaining one set of books for the Internal Revenue Service for tax purposes and one set of books for the SEC and investors.
It should come as no surprise that operating profits for the Standard & Poor's 500 companies rose much faster in the late 1990s than corporate profits as reported in the National Income and Product Accounts (derived from IRS data).
'NIPA profits track well with the business cycle,'' Low says. 'S&P profits are practically useless.''
'If companies had to pay taxes on the amount of income they're reporting, there would be no point in overstating earnings,'' Willens says. 'You can throw out all the regulatory proposals. That would be the best regulator of all.''
Bloomberg newsroom, New York