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SPEECH ON
CORPORATE GOVERNANCE REFORM
National Press Club |
| For Immediate Release |
| Thursday, Jul 11, 2002 |
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Patriotism in this country is not nor should
it ever be merely a sentimental attachment to blood and
soil. Our love of country is a love of ideals. The
values of freedom inspire our patriotism: government
derived from the consent of the governed; an economic
system that is an open market for creativity,
innovation, competition, and self-improvement.
Americans have proved beyond a shadow of a doubt
that a nation conceived in liberty will always be
stronger, wealthier, more just, and happier than any
nation that rations liberty to exalt the few at the
expense of the many. We are the greatest nation in
history because we trust in freedom. We trust that a
people who are free to act in their self-interest will
perceive their interest in an enlightened way, and use
their wealth and power to create a civilization in which
all people can share in the opportunities and
responsibilities of freedom.
Threats to our
greatness come not just from foreign enemies and alien
ideologies that hold our ideals in contempt. They also
come from those few among us who perceive their
self-interest as separate from the interests of our
society, who in their selfish pursuits abjure the values
of honesty, fairness and patriotism, and threaten to
damage the very trust that makes freedom work.
I
am a supporter of the free enterprise system to the
marrow of my bones. I marvel at the American
entrepreneurial genius, and at the innovation of
corporations that effectively harness that genius to
create greater prosperity for more and more people.
Thanks to free enterprise, our society has constantly
evaded the inertia and historical insignificance that
are the inevitable fate of economies that merely
distribute poverty more equally or sustain a rigid class
system. The advent of the information age did not just
create riches for the lucky few in the corner suites of
corporate America, but swelled the tide of economic
opportunity for many people of less influence and more
modest means. These advances are a tribute to the
American worker, and to the corporations that have
invested in, encouraged and directed their productivity.
As Teddy Roosevelt said almost a century ago,
"We draw the line against misconduct, not against
wealth. The capitalist who, alone or in conjunction with
his fellows, performs some great industrial feat by
which he wins money is a well-doer, not a wrong doer,
provided he works in the proper and legitimate lines."
During my years in Congress, I have opposed unnecessary
regulation of business activity, mindful that the heavy
hand of government can discourage innovation and wealth
creation.
But the current threat to our
prosperity comes not from over-regulation. The culprits
are corporate executives who exploited regulatory
loopholes and diffident oversight -- from boards of
directors, analysts, auditors and government -- to
enrich themselves at the expense of their companies'
health, and the millions of investors who entrusted to
these new "malefactors of great wealth" their American
Dream of a college education for their children, secure
employment and a comfortable retirement for themselves.
The corporate scandals that dominate headlines today
have already claimed millions of victims. Investors who
have lost their life savings. Employees who lost their
jobs and their pensions after being pressured by their
employers to invest the bulk of their savings in company
stock.
Over the past ten years, the system of
checks and balances that protects the investor has
seriously deteriorated. It must be restored, if we are
to restore the public's confidence in our financial
markets, and reinvigorate their faith that there is room
in our markets for THEIR dreams as well as the ambitions
of executives who profit so handsomely from them.
I believe – I STILL believe – that the best way
to ensure the solvency of the Social Security system, to
honor the solemn promise that in exchange for the
payroll taxes they have rendered all their working
lives, all Americans will receive a minimally adequate
retirement income, is to allow them to invest a portion
of their payroll taxes in the financial markets. In
fact, I can see no other viable way to ensure that those
entering the workforce today will receive the benefits
promised to them upon their retirement. Markets
fluctuate. We are in a down cycle today. But it won't
last forever. And investments in the stock market have
over time always yielded higher returns than any other
responsible investment. Allowing Americans to invest
responsibly a small part of their payroll taxes will not
only save Social Security, but will provide them with
greater retirement income than those who now or will
soon depend on Social Security checks.
Some of
my Democratic friends have exploited the occasion of
these corporate scandals to ridicule yet again this
necessary reform. But even without their fear-mongering,
how can we expect to convince Americans that the one
pension plan every American is entitled to is safe in
private investments when the stock market and our
economy are daily battered by revelations of corporate
wrongdoing? According to a recent survey, sixty-nine
percent of those polled now "think most companies lie to
or mislead investors." Unless Congress and the President
move rapidly and boldly to reform corporate governance
and government oversight, and repair investor
confidence, the damage done by these scandals will
outlive most of us in this room.
The first
principles of free markets – transparency and trust –
have been the first victims of crony capitalism,
evidenced most dramatically in the scandals involving
Enron, Arthur Anderson, Global Crossing, WorldCom, Tyco,
and others. Trust was sacrificed in too many corporate
boardrooms on the altar of quick and illusory profits
intended to generate astonishingly inappropriate levels
of executive compensation. Corporations established
off-balance sheet partnerships to mask liabilities and
inflate profits. Executives maximized their compensation
with stock option plans that burdened their companies
with huge hidden costs. Companies gave massive loans as
sweetheart loans to CEOs. Venerable accounting firms,
having looked the other way as companies cooked the
books, shredded documents to hide their misdeeds.
Although American tax policy encouraged them to do so,
corporations that move their legal headquarters
off-shore to avoid taxes give the appearance of
ingratitude to the country whose sons and daughters are
risking their lives today to defend them.
I
agree with the President's observation that those
responsible for these unfolding scandals are relatively
few. Or, at least, the visible abuses are relatively
few, though we have ample evidence that pressures
resulting from avaricious self-interest and weakened
checks and balances are systemic and serious, and may
portend more scandals. Nevertheless, the vast majority
of the 17,000 public corporations in this country are
run honestly, by men and women of sound character, who,
along with their shareholders, have been harmed by the
recent scandals caused by their less scrupulous peers.
But those corporations run by unethical, self-serving
executives that seize our attention today are some of
the largest companies in the land, and their collapse
into scandal has rocked the markets, handicapped our
recovery from recession and scared the hell out of
average investors. A just released study found that nine
out of ten public companies determined "to have
accounting irregularities received a clean bill of
health from auditors." This negligence or worse resulted
in a loss of shareholder value at thirty-three companies
of well over a trillion dollars.
Should these
current scandals pass without another single disclosure
of corruption, who can be certain that in the years
ahead, we won't suffer just as profoundly from similarly
corrupt practices unless corporate leaders find the
regulatory hurdles to misconduct more daunting than they
are today.
In another recent survey, 160 chief
financial officers were queried whether they had ever
been pressured by senior corporate executives to
misrepresent the financial health of their companies.
Fifty-five percent said they had, but refused. Twelve
percent admitted to yielding to those requests. I fear
the problem is not just limited to the relative few
scandals that have claimed space on the front pages of
today's newspapers.
We should make it easier to
prosecute and impose penalties for securities fraud that
will severely afflict the corporate wrongdoer. But
stronger sanctions alone will not be enough to deter new
incidents of corporate misconduct. Neither will pleas
for character building in corporate suites discourage
the reckless greed that threatens our prosperity. Unless
we require responsible management with sensible
regulation, we will suffer future scandals. Freedom
provides opportunities to do good and ill, and we must
restrain the corruption of our cherished values with
more than appeals, however eloquent and appropriate, to
the better angels of our nature.
The circle of
culprits, witting and unwitting, include not only
morally challenged executives, compromised auditors,
negligent institutional investors and securities
analysts, and uninformed or indifferent directors, but
inattentive government leaders, of both parties, and
business journalists that have grown too comfortable on
their beat to look beyond a corporations' annual report
to discern the soundness of management practices. Those
who claim to defend morality in business and politics
must not only condemn the malfeasance that has spooked
investor confidence, but take all necessary steps to
prevent other executives, auditors and boardrooms from
emulating the practices of their selfish peers.
Thanks to the success of our free enterprise
system, the public's stake in America's companies is far
larger and more important to our economy and to the
financial well-being of our citizens than it was in
years past. Almost half of adult Americans own stock
directly or indirectly. Their numbers have increased
sixty percent in the past fifteen years. A growing
portion of the public depends more on private retirement
plans than on Social Security for their retirement
income. And balancing the federal budget also depends
more than before on healthy financial markets, as
demonstrated this year when a shortfall in tax revenues
from gains on securities investments expanded a growing
federal deficit. Over the past year, corporate scandals
have cost the public and the government many billions of
dollars.
Given the damage caused by the ethical
lapses of too many corporate leaders and the breakdown
in checks and balances that were supposed to safeguard
the public against those kinds of abuses, we must make
fundamental changes in corporate oversight that will
securely place the interests of the shareholding public
above the private interests of the few who are entrusted
to manage or advise those companies. To remove the
conflicts and strengthen checks and balances we should
not rely on halfway measures and then resort later to
another set of regulations to prevent the re-emergence
of abuses. Over time, the pressures of remaining
conflicts of interest will erode any initial
effectiveness of incompletely addressing these abuses
now.
A range of proposals to reform corporate
governance and government oversight are now before
Congress. Others will be considered in the weeks ahead.
Many of their provisions are commendable. Some fall
short of doing all that is necessary.
Senator
Sarbanes' bill, which I support, requires accounting
firms to refrain from providing non-auditing services to
the companies they have been engaged to audit. But the
bill does allow some exemptions to the prohibition,
which I believe should be removed.
Over the last
fifteen years, the leading accounting firms diversified
their services to include lucrative consulting to the
auditing clients on tax management, mergers and
acquisition strategy, systems, cost control and
corporate structure. The reason seemed logical at the
time: to strengthen client relationships, improve
profitability and retain talent that was being lured by
the firm's corporate clients. The result, however, was
to create a fundamental conflict of interest between, on
the one hand, rigorously and objectively scrutinizing
their auditing clients and, on the other hand, currying
favor with those same clients to win their consulting
business.
Investors will no longer trust the
audits of public companies if they perceive an apparent
conflict of interest when accounting firms provide
either simultaneously or at some future date consulting
services to the same client. Only a complete and
permanent separation of auditing and consulting services
will safeguard the integrity of audits. Any firm that
serves as the auditor of a company should be prohibited
from providing any consulting service to that company
ever.
The Sarbanes bill also establishes an
accounting oversight board to establish and enforce the
standards for audits of publicly traded companies. But
this oversight board should be completely independent
from the industry. The bill provides that two of the
five members of the board come from the profession. It's
appropriate to have a minority of board members with
professional expertise in the industry they regulate.
But they should be at least five years removed from the
practice of accounting to completely guard against
conflicts of interest. Also, the board should be
financed as an independent agency or, if as part of the
SEC, it should possess considerable autonomy.
We
should also require that disciplinary hearings before
the auditing oversight board be public. Exposing the
misdeeds of registered public accountants and
corporations is essential to reinvigorating our system
of checks and balances, discouraging misbehavior and
restoring public confidence.
Stock options are a
legitimate and valuable form of employee compensation.
But they must be reported as an operating expense.
Otherwise they obscure the company's real worth,
misinform investors, and encourage continued false
reporting of profitability. Options are no less tangible
a cost than depreciation, another non-cash expense. Like
depreciation, option costs should be run through the
income statement.
Top executives should be
precluded from selling their holdings of company stock
while serving in that company. They can be allowed to
exercise their options, but their net gain after tax
should be held in company stock until ninety days after
they leave the company. In the past, this measure might
be viewed as intruding on the right of executives to
manage their personal finances as they see fit. But it's
time to recognize that with privileges and power come
important obligations to the public. Stock option grants
awarded to top executives by corporate directors who
represent the public are intended to align the interests
of corporate leaders with the interests of public
shareholders. Diversification of investments is a good
idea for the investing public. But it's not a good idea
to allow those responsible for the stock prices of
publicly owned companies to reduce their financial
exposure to the performance of their companies at a time
of their choosing. As long as they retain their great
responsibilities and attendant privileges, they should
retain their full exposure to the consequences of their
management decisions.
With the exception of the
CEO, all members of corporate boards of directors should
have no material stake in the company. The purpose of
the board is to represent the shareholders, not
themselves and not the management. Management needs no
more than one representative on the board to represent
its views. In many cases, the top management owns no
more than a few percent of the company's stock. With
more than one director on board, its interests are
over-represented. In those cases where management owns a
larger percentage they can vote their shares for
director candidates of their choice, as can all other
shareholders, and will have appropriate influence in
determining the makeup of the board.
A large
percentage of public companies is owned by corporate
pension funds. The funds are controlled by the top
management of those companies. These executives have no
incentive to scrutinize the performance of each other's
companies or vote their shares against the
recommendations of other companies' managements. Because
corporate executives control the pension funds of their
companies, unscrupolous executives are in a position to
manipulate the amounts and valuation of those funds,
disguise actual operating earnings and jeopardize the
fund's capacity to meet future obligations to employees.
Corporate pension fund committees, and the funds they
manage, should function independently of management and
be appointed in the same manner as directors of mutual
funds.
I agree with the President that corporate
executives should be required to return all compensation
directly received from proven misconduct. I agree that
top corporate officers should be required to certify
personally to the SEC that the company's financial
reports are accurate and that all information material
to the health of the company has been disclosed.
Executives who intentionally misstate their companies'
financial reports should go to jail. But to enable the
SEC to determine whether there has been intentional
wrongdoing, executives should be required to provide
with the certification a narrative statement of the
factual basis for the correctness of the statements, and
disclose any "close calls" management made with respect
to accounting treatment.
The responsibility of
investment advisors, including stockbrokers, is to put
their clients' interests first. The responsibility of an
investment banker is to represent the interests of
issuers by selling corporate securities on the terms
expected by their corporate clients. The interests of
investors and issuers are, and should be, in conflict.
It is the function of the market to resolve that
conflict by finding prices and other terms that best
balance the interests of both. The right balance can
best be found by the market, not by "full service"
financial companies that house both investment and
issuing services. Even the best managements of full
service firms face intense pressure from time to time to
take more of the securities offered by their investment
banking clients than the brokers might otherwise place
in their clients' portfolios. Research analysts of full
service firms confront the conflicts most fully. Their
principal role should be advising investors. But the
power of their influence with investors is highly prized
by corporate issuers and can be decisive in the awarding
of underwriting contracts to the investment banking arms
of full service firms.
We've seen ample evidence
that combining issuing, investing and research services
leads to abuse of investors' interests and severely
undermines public confidence in the investment advice of
full service firms. The President made reference to this
when he chastised investment advice that urges investors
to buy when they should sell. The best solution is to
place analysts where they belong – with the investment
groups advising and serving the public – and to house
investment services in companies separate from those
conducting investment banking and securities trading.
The overriding public interest demands that we legislate
that separation so that the most egregious of those
conflicts is eliminated.
It is also fair
criticism to recognize that government does not always
set a sterling example of honesty to corporate
executives. Beyond offering carefully considered
regulation to right the checks and balances governing
our markets, government should also forswear the slight
of hand that we employ in our budgeting and spending
decisions. Too often, we have cooked the books,
exploited off balance sheet accounting, fudged budget
numbers and failed to disclose fully the nation's assets
and liabilities. If we in Washington are to have
credibility in the public eye as we address the
corporate accounting mess, we must reform our own fiscal
practices.
Moreover, strengthening public
confidence in government oversight requires that those
public officials charged with the greatest
responsibility for that oversight will impress the
American people with their unshakeable resolve to
protect the country from corporate abuses and conflicts
of interest. Obviously, that will also require that
those officials not be the object of any reasonable
public doubt that they might be influenced by their own
conflicts of interest. Regrettably, the chairman of the
SEC fails on both counts. I am sure Harvey Pitt is a
fine man, motivated by good intentions. But he began his
tenure with an assurance that under his leadership the
SEC would offer "kinder and gentler" oversight.
Initially, he seemed to prefer industry self-policing to
address corporate misconduct rather than necessary
lawmaking to prevent future abuses. Not exactly what is
called for in this environment. His past association
with leading accounting firms has obliged his recusal
from twenty-nine SEC decision in less than a year.
Moreover, given his past association, it is unlikely
that the public will have confidence in his decisions
when his period of recusal ends next month. Aggravating
public doubts were his decision to meet with former
clients while they were under investigation. Simply put,
fine man though he may be, the circumstances today
require a new leader of the SEC whose background and
record leave no question that he or she will proactively
assert the independence and authority of the SEC to
protect the integrity of our markets. I hope that Mr.
Pitt will continue to serve our country in another
capacity.
Let me emphasize again: the purpose of
these suggestions and others is not to hobble the free
market with excessive regulation, but to restore the
efficacy of the checks and balances on which the market
has always depended, which have been weakened because of
the growing interdependence among the "checkers and the
checkees." Much like the federal government is now the
world's most successful because of a strongly defended
separation of powers, we must have equally strong
independence between each of the market's checks and
balances.
Some will counsel that this crisis in
corporate governance is not so grave that it requires
decisive government intervention. I disagree. What is at
risk in this series of unfolding corporate scandals is
the trust that investors, employees and all Americans
have in our markets, and by extension, in the country's
future. To love the free market is to loathe the
scandalous behavior of those who have betrayed the
values of transparency, trust, contract and faith that
lie at the heart of a healthy and prosperous free
enterprise system, and the patriotism that sustains an
aspiring and confident free society.
Thank you.
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