Bush's new Confidence Man

In the grand scheme of things, "shareholder democracy" is an oxymoron.

Nevertheless, Bush's appointment of Chris Cox as chair of the SEC is clearly another disturbing attack on corporate accountability and investor rights, a sop to the Imperial CEOs who continue whining about Sarbanes-Oxley and other tepid reforms like the proposal to open up the corporate governance process so that shareholders can nominate their own corporate board candidates.

Cox's record in fact suggests that Bush and company have learned absolutely nothing from Enron, particularly when it comes to the immediate causes of Enron and the other cases of fraud. Let's review a few of those causes and Cox's position on them:

A) First, there's the incentive to cook the books created by the expanded use of stock options as a form of executive compensation.

Cox opposes a new FASB rule that requires companies to stop using accounting gimmickry to hide the cost of options on the books (i.e. expense them).

Unfortunately, in April William Donaldson postponed the implementation deadline for another six months, which could give Cox and his allies in the high-tech industry enough time to somehow overturn the rule.

It is well recognized that options were a key incentive behind many executives' blind drive to cook the books and meet earnings/share targets so that Wall Street analysts would continue boosting their company's stock, and insiders could exercise those options and cash out before the entire facade crashed.

The expensing rule is a modest reform with broad political support. It doesn't ban the use of options, just requires companies to report their use more honestly. By opposing the rule Cox has sided with a group of extremists rather than the over 800 companies that have chosen to voluntarily expense options already.

B) Blind deregulation. Former Rep. Vin Weber (now a lobbyist) told Bloomberg that he would be "shocked" if Cox turns out to be "anything other than a very strong deregulator."

There are few areas of law and policy that have not been touched by the mindless mantra that assumes that deregulation brings efficiency rather than corporate control and the gradual elimination of smaller competitors.

Proponents of this blind ideological faith have consistently set intellectual honesty aside and steamrolled over mountains of evidence that conflicts with their convictions. Unrestrained market "freedoms" have resulted in monopolization (esp. in recent decades, where there has been an absence of strong antitrust enforcement) which often destroys the very efficiencies that are the avowed goal. Instead, the competitive market system has been replaced by a centralized corporate bureaucracy. (For an extensive discussion I recommend Walter Adams and James Brock's book, The Bigness Complex.)

The scions of Ayn Rand such as Cox also seem incapable of acknowleging that when it comes to ensuring the safety of food and medicine, clean air and water, etc. -- economic Darwinism doesn't translate into the public good, and often leads to serious instances of corporate crime.

An examination of the companies that cooked their books in recent years will reveal that most came out certain industrial sectors where promises were made that deregulation would benefit investors, consumers and the market itself. This was particularly true of telecommunications, energy, and banking sectors.

In the banking sector, for example, it's now clear that the gutting of Glass-Stegall by Enron's friends including Senator Phil Gramm (whose wife Wendy, it should be recalled, helped deregulate Enron's derivatives at the Commodities Futures Exchange Commission just weeks before joining the company's board) created inherent conflicts of interest at big banks like Citigroup, where commercial lending interfered with objective stock brokerage research.

C) Tort Reform. As has been widely reported, Cox was a primary author of the 1995 Private Securities Litigation Reform Act (PSLRA) the securities tort "reform" law that many argue was a key contributing factor to Enron and the other frauds, because it let the accountants, lawyers and "banksters" off the hook for their role in corporate fraud.

In 1998 Cox said: "My 1995 reform law [Private Securities Litigation Reform Act] prevents a handful of unscrupulous lawyers from cheating their clients and investors in public companies through abusive litigation." But what about the unscrupulous lawyers who helped Enron and other companies defraud investors?

In his testimony to Congress in late 2001, shortly after Enron collapsed into bankruptcy, Prof. John Coffee of Columbia University explained that the PSLRA and related laws and court decisions created an incentive for the market system's professional gatekeepers to not only fail to perform their professional duties without worrying about the consequences, but, in some cases, even aid and abet the fraud.

This was all predicted when the law was passed -- over President Clinton's veto. (BTW, although then-SEC chair Arthur Levitt was a vigorous defendant of investor rights when it cames to accounting rules, he did not oppose the PSLRA. In one hearing, he lent tepid support to private lawsuits while giving his imprimatur to a process that led to the PSLRA's passage because "private litigation can impose substantial unnecessary costs if it is abused by private plaintiffs or their attorneys.")

During the debate over the PSLRA, Anthony Lewis accurately predicted that once the deterrent threat of civil lawsuits was taken away, “companies and their agents could make false projections and estimates of future performance, even if they were deliberate lies, without fear of lawsuits by those defrauded.” (“Friends of Fraud?”, NYTimes May 22, 1995)

In fact, a massive upsurge in securities fraud began shortly after these securities law “reforms” were passed. The number of earnings restatements rose steadily and dramatically, from 158 in 1998 to 233 in 2000. In 2001, 270 public companies restated their earnings. In 2002, the number rose even further to 330. Back in 1981, the number was just 3.

The effect of reducing the ability of victims to sue is that corporate executives and their professional watchdogs are emboldened to engage in all kinds of wrongdoing, knowing that the chances that they’ll successfully be sued are slim.

The Supreme Court's reversal in the Anderson case probably further fuels that perception, although there are new document-shredding provisions in Sarbanes-Oxley that suggest otherwise -- another reason to watch for Cox and his allies' attempts to gut Sarbanes-Oxley.

Although the Andersen case has received a lot of attention, investors ought to be more concerned about another Supreme Court case -- Dura Pharmaceuticals Inc. v. Broudo, No. 03-932, in which Justice Breyer noted that the PSLRA requires plaintiffs to show that the defendant's misrepresentation "caused the loss for which the plaintiff seeks to recover" -- a stricter standard of proof that is but one of the many obstacles to justice set up against the victims of fraud by the new SEC commissioner, who co-authored the PSLRA. Meanwhile, the accounting industry is probably more concerned about two
ongoing cases being brought against Deloitte and Touche
for its role in the Parmalat fraud case, since the case could result in the firm being charged as a "integrated firm" (words of one Deloitte partner) rather than a network of legally separate national partnerships.

It might be pointed out that citizens wouldn’t need to sue the fraudsters and banksters and crooked numbers-crunchers if government regulators and law enforcement agencies were doing their job in the first place. But as the Senate Committee on Government Reform concluded in its excellent report on Enron, “[the SEC] does not, and is not set up to, directly perform many of the tasks necessary to root out corporate fraud. We have a system in which the public relies on a partnership of the SEC and private gatekeepers in order to keep tabs on the enormous U.S. markets.” It therefore shouldn’t have been much of a surprise that after taking away the threat of private lawsuits against the market system’s “gatekeepers,” the incidence of fraud began to rise so precipitously.

That brings up the final factor in the Enron scandal that makes Cox's appointment so disturbing:

D) The gutting of the SEC's role as a watchdog.
This was revealed in
that excellent report
by the staff of the Senate's Committee on Governmental Affairs, which reported that the SEC completed a full review of just 16 percent -- or 2,280 of 14,6000 annual financial reports (10-K's) filed in 2001. Less than half of the listed public companies had had their 10-Ks reviewed in the previous 3 years.

In a March 2002 review of SEC Operations, the GAO concluded that "Critical regulatory activities such as reviewing rule filings and exemptive applications and issuing guidance have suffered from delays due to limited staffing. According to industry officials, these delays have resulted in foregone revenue and have hampered market innovation."

Since Harvey Pitt, the SEC has been beefed up to some degree, but the recent AIG case indicates that it's too soon to say the worst is already over.

For example, in its latest strategic plan, the FBI predicts that "major corporate crime will impact the U.S. economy over the next five years." The FBI adds that "aggressive investigation and prosecution of major corporate fraud will be a key factor in restoring long-term confidence in our business leaders."

Conservatives who believe in the competitive market system should be disturbed by the Cox nomination, and the Republic far right's ideological drive to shrink every part of the government (except the police state apparatchiks and praetorian guard) until it is small enough to be "strangled in a bathtub," since that will pose a substantial hindrance to government's ability to ensure that the market system itself functions fairly and efficiently.

In July 2002, before they were able to cook the evidence for the war and the nation was consumed by a tickertape of scandals involving close cronies like Kenny Boy Lay, President Bush went down to Wall Street to announce his silly "Corporate Responsibility" plan.

That day, he used the word "confidence" 13 times that day, we noticed, and the market dropped significantly.

Bush used the "confidence" word twice again the other day, when he nominated Chris Cox to lead the SEC. Anyone who has learned anything from Enron would have laughed.

(FYI: Much of this analysis draws from the book I recently co-authored with Lee Drutman, The People's Business, recently published by Berrett-Koehler.)

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