Thursday, September 26, 2002, p.
A13
We Need Stronger Financial Regulations
By
Timothy A. Canova
University of New Mexico Law
Professor
When President Bush signed the latest corporate reform into law last month, it
was hoped that investor confidence would be restored to one of the worst stock
markets in decades.
Unfortunately, the Sarbanes-Oxley Act failed to address some crucial issues,
such as stringent standards to ensure that directors of audit committees (and
compensation committees) are truly "independent," and not merely the
hand-picked allies of CEOs. Sarbanes-Oxley also ignored the problem of
undisclosed and enormous stock option compensation packages for top management
of large corporations.
It was
not all that long ago that stock options were being justified as a way of
aligning the interests of management with shareholders by tying executive pay
to the price of the company's shares. But several studies now suggest that
multi-million dollar stock options provided massive and perverse incentives
for top executives to fudge the books and for directors to look the other way - all in an effort to engineer and report higher
quarterly earnings, and to drive up stock prices for short periods of
time.
At
a growing list of companies that includes Enron, Global Crossing, and
WorldCom, top executives were able to exercise their own stock options before
the market was fully informed of the grim realities. Some corporations - such as Coca Cola and General Electric - have taken the lead in announcing that they will
voluntarily disclose their stock options, all in an effort to restore investor
confidence.
Federal
Reserve Chairman Alan Greenspan has endorsed this approach. In addition, the
New York Stock Exchange has proposed requiring its listed companies to allow
shareholders to vote on their stock option plans. And the Conference Board, a
leading business group, has proposed making corporate executives announce in
advance their plans to sell company stock to prevent them from taking
advantage of their inside access to information.
While
all of these efforts are to be commended, a patch-work of voluntary
disclosures is a poor substitute for a uniform standard to mandate greater
financial transparency. In 1994 the Financial Accounting Standards Board
(FASB), an independent body charged with setting uniform accounting standards,
attempted to create such a uniform standard by proposing that companies
disclose and treat their stock options as expenses that reduce earnings and
dilute the value of shares held by the investing public. While the FASB was
designed to be independent from politics, it came under intense political
pressure to back down from its proposal.
The
Business Roundtable, which represents the CEOs of the largest corporations,
engaged in an effective lobbying campaign against the proposal.
On May
3, 1994, the U.S. Senate passed a resolution urging the FASB to withdraw its
proposal. Sen. Pete Domenici, R-N.M., voted in favor of the resolution. The
FASB quickly backed down from its proposal.
The
demise of the FASB proposal was particularly unfortunate because it occurred
at a time when there was still time to correct the defects in the financial
system, to limit the incentives to engineer phony earnings and to prevent the
stock market bubble from getting too large.
When
Sen. John McCain, R-Ariz., recently called for legislation to make the
disclosure of stock options mandatory, he noted their corrupting influence on
campaign finance and the integrity of our political system. Unfortunately,
Domenici has opposed any regulation of stock options, such as requiring
executives to disclose their stock options to the investing public, requiring
shareholders to vote on stock option plans, or limiting when executives can
exercise their stock options or sell their stock.
The
unregulated treatment of stock options was only one factor amongst a range of
deregulation policies that led to the stock market's boom, and then bust. Fed
Chairman Alan Greenspan refused to tighten margin requirements to regulate the
volume of stock being purchased on credit.
In 1995
Congress passed the Private Securities Litigation Act over President Clinton's
veto to make it more difficult for shareholders to sue executives and their
auditors for securities fraud. Congress also passed the Financial
Modernization Act of 1999 to deregulate banking and finance, thereby removing
regulatory restrictions that had been in place since the aftermath of the
great stock market crash of 1929.
Domenici
voted in favor of each of these monumental experiments in deregulation, as
well as the Commodity Futures Modernization Act of 2000 which deregulated
derivatives markets, a development which eventually permitted Enron to evade
the scrutiny of regulators.
But the
deregulation agenda did not stop there. After the 1999 accounting fraud
involving Waste Management, former Securities and Exchange Commission (SEC)
Chairman Arthur Levitt, Jr. tried to restrict the conflicts of interest of
large accounting firms which were earning many millions of dollars in
"consulting fees" from the same corporations they were auditing. Members of
Congress who had raised hundreds of thousands of dollars from the Big Five
accounting firms promptly threatened to cut the SEC's
budget.
Rep.
Heather Wilson, R-N.M., joined 45 other House members in pressuring Levitt to
drop the proposed rules. During that same year, Wilson raised more than
$85,000 in campaign contributions from the Big Five accounting firms and the
accounting industry.
The
deregulation agenda served the interests of many incumbents, such as Domenici
and Wilson, both of whom have raised many hundreds of thousands of dollars
from mostly out-of-state corporate executives (including Enron and WorldCom
executives) and Big Five accounting firms.
But the
deregulation agenda has not served the public interest. Much damage has been
done to market confidence, and the stock market decline has eroded the
retirement savings of millions of Americans. Many workers and even
professional employees face an increasingly bleak job
market.
And New
Mexico's permanent fund and public pension funds have lost a combined $3.3
billion this year alone.
More
than ever, investors know that markets need rules for minimum disclosure and
transparency. Until Congress requires that stock options be disclosed to the
market on a routine basis, investor confidence is likely to remain weak.
There is
too much fear in the markets that many large corporations are still being run
by executives with enormous stock option plans, and therefore with enormous
incentives to hide any bad news from their
shareholders.
Timothy A.
Canova is an Associate Professor of Law at the University of New Mexico School
of Law, where he teaches corporation law.