FRAUD BILL: DOES IT GO FAR ENOUGH?
by: Cary Christian
By early next week the new
corporate fraud bill that, hopefully, will work to prevent the recurrence of
Enron- and Worldcom-like debacles, should be signed into law. Such a bill is
needed to restore investor confidence and curb the effects of unbridled
greed among the leadership of our largest companies. But does the bill go
far enough to accomplish these goals? Let's look at the effectiveness of
some of the key provisions of the bill.
- The bill creates an independent five-member board to oversee the
accounting industry and grants it substantial power, including subpoena
power. Each year, the board will audit firms that serve 100 or more publicly
traded companies. This provision will put a leash on the largest accounting
firms, namely the remaining Big 4 and some of the larger firms among the
I would personally prefer to see the board audit any firm that audits a
public company with capitalization that exceeds a certain amount. Nothing in
the bill will prevent a Worldcom-sized company from shopping around for an
accounting firm that audits only 98 public companies. By like token,
auditing a firm that audits more than 100 tiny public companies is probably
a waste of time and money.
But even if an auditing firm is not subject to audit, it is still subject to
the rules and regulations promulgated by the board and fully subject to the
bill's requirements and penalty provisions.
- In an effort to curb conflicts of interest, the bill bans accountants from
doing most types of consulting work for companies they audit. This is an
outstanding provision that the accounting profession has been fighting for
years. In almost all cases, large accounting firms receive far more
non-audit revenues from audit clients than audit revenues. This creates a
major conflict of interest even though accounting firms will tell you they
still maintain their independence. Yeah, right! Money talks.
- The bill prohibits an accounting firm from auditing a company if any of
the company's top executives worked for the accountants in the previous
year. This provision is a good one as well. Accounting firms look to former
employees who move on to positions with clients as a source of new business
and as a friend on the inside. The relationship with such former employees
is a conflict of interest.
- The bill adds criminal penalties of up to 10 years in prison for corporate
financial fraud or obstruction of justice, including the shredding of
documents. I really like this one! Corporate executives who stand to gain
millions of dollars in stock options and stock appreciation by looking the
other way when corporate earnings are fraudulently overstated have been
perfectly willing to assume the risk of a slap on the wrist and a fine from
the SEC. It will be a different story when he or she is facing 10 years in
prison for such activities.
- Civil fines, penalties, payments and assets from corporate wrongdoers will
now be placed into a federal account for the benefit of defrauded investors.
This should allow investors to recover some of the value lost due to
corporate fraud should it occur again. Currently fines and penalties
collected goes to the government, not to defrauded investors.
- The bill requires companies to immediately disclose any and all large
off-balance-sheet transactions or other material changes in financial
condition. Another good one! These are the types of transactions that led to
Enron's downfall. Early disclosure of such transactions will allow the
market to react much more quickly and prevent sudden total loss of value to
the stockholders. The disclosure requirement will also work to prevent
corporations from entering into these types of deals unless they truly add
- The bill bars corporate wrongdoers from serving as company officers or
directors for life. Outstanding! Get caught once and you'll never have the
chance to do it again!
- The bill increases the enforcement budget of the Securities and Exchange
Commission. This was necessary. The SEC simply did not have the resources to
properly police our public companies. It earmarks $98 million to add not
less than 200 additional qualified professional personnel, additional
support staff and other resources needed to strengthen SEC enforcement
- The bill bans personal loans by corporations to their executives unless
the corporation is involved in the lending business and extends credit to
executives in the same manner and on the same terms as it extends credit to
the general public. ALL personal loans to executives SHOULD be banned and
the law as written should put an end to such activities.
- The bill requires CEOs and CFOs to give back bonuses awarded on the basis
of misleading financial statements. This is only fair and is an excellent
provision. Executives should not be able to profit from their misdeeds as
they have been able to do in the past.
- The bill requires top company officials to certify the accuracy of their
financial reports to the SEC. This seems to be a fairly innocuous provision
that doesn't add a lot of value. After all, these executives are responsible
for financial reporting anyway. But this certification will make it much
easier to successfully prosecute those executives who step out of line and,
as such, is actually an important provision.
Additionally, fines of $500,000 to $1,000,000 plus a five or ten year prison
sentence accompany improper certifications!
- The bill also contains provisions related to the independence and
objectivity of securities analysts. The provisions provide guidelines and
timelines for the development of rules, so it does not have teeth yet, but
it is a step in the right direction.
- In addition to new provisions, the law significantly strengthens existing
laws and specifically requests the United States Sentencing Commission to
consider whether criminal penalties for "white collar" offenses should be
Overall, I believe this bill is an excellent beginning. It actually goes
further than I thought Congress would go and appears to be a very serious
effort to make much-needed changes. There will no doubt be bumps along the
way and adjustments that have to be made, but we finally have some legal
accountability required of corporate executives and accounting firms.
I want to thank all of you who actually wrote your Congressman on this issue
as I requested. It turns out that the Worldcom debacle probably did more
good to further this legislation than millions of letters could have ever
done, but the effort is appreciated and Congress does listen to you. After
all, in this country YOU are the boss!
Copyright (c) 2002