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Cleaning House

The SEC, Congress, industry groups and even companies themselves are suggesting ways to straighten out the regulatory mess and give new gloss to investing.

Will Enron prove to be the last straw?

Investors have been clamoring for Wall Street to clean up its act for decades. And the cataclysmic demise of what was the nation's seventh-largest company (in terms of sales) has many hoping that 2002 will be the year of reform.

Seizing on the current Zeitgeist, various parties are weighing in with ideas on how to straighten out the mess and rebuild investor confidence. Will their concerns lead to genuine reform of the conflict-cursed accounting profession?

In March, SEC Chairman Harvey Pitt kicked off a series of hearings that could eventually lead to a new set of industry regulations. He called for an oversight committee that monitors the accounting profession — a move that überinvestor Warren Buffett applauds. Buffett said auditors are too easily swayed by their clients. “They've got to be more scared of [the shareholder] than the client,” he said.

The SEC would also like to shorten the time a company has to file financial statements. With accounting software now able to compile numbers with lightning speed, critics question why companies spend weeks preparing official results. In addition, the SEC would like to compel companies to publicly disclose “critical accounting policies” that shed light on the judgments made by executives and accountants.

SEC Director of Enforcement Stephen Cutler would also like to find a way to bar unfit executives from holding top jobs in publicly traded companies. And Cutler wants to see federal prosecutors join the SEC in its investigations, which could lead to more execs serving jail time.

How much more the SEC can do remains a question since the General Accounting Office said in March that the agency is already short of resources. To satisfy the voters back home, Congress is also giving Wall Street the once over. Enron-related hearings are looking at how Wall Street analysts rate stocks while their investment banking colleagues are trying to solicit business. (See “Hardball with Sen. Jim Bunning” on page 28.) A few have even suggested that banks be forced to choose whether to analyze or finance a particular company — not do both. “The Chinese Wall hasn't worked,” says Joseph Whall, who heads up The Whall Group, a Michigan-based forensic accounting firm.

Missouri Sen. Jean Carnahan has already introduced a new bill, The Fully Informed Investor Act, which calls for shortening the time in which insiders need to file after buying or selling stock. The legislation would require the company to file the information by the end of the day that the transaction was made, and the SEC would be required to release the information online that same day. Jonathan Moreland, director of research at InsiderInsights.com, notes that the SEC's Pitt has sent Carnahan a letter expressing support for the bill. “Hopefully, his backing will force Congress to adopt the measure,” he says, but adds that Sen. Carnahan needs a co-sponsor to help push the legislation.

Nevertheless, it's an open question whether Congress will enact new legislation. Wall Street lobbyists are a quite powerful force on Capitol Hill and have a history of blocking change. After all, it took 17 years to overcome resistance to a rewrite of securities laws that ended Depression-era Glass-Steagall limits on banks. “It's not clear that everything Congress raises will ever come to pass,” Pitt says.

Whall is a bit more optimistic. “We'll see something everyone can brag about by the end of the year,” he says. But, he says, simply writing new laws isn't enough. “We need congressional mandates that will be enforced.”

Self Regulation

The accountants are also trying to reform themselves in a bid to stave off regulatory action. The Financial Accounting Standards Board (FASB) hopes to have new regs in place by July. One proposal: limit a company's ability to hide debt obligations. Presently, a company needs to find a partner willing to own just 3 percent of a separate entity that will control an asset (or a liability) that can then exist off of the balance sheet. FASB wants to raise that figure to only 10 percent, which would not have a major impact on the “special purpose entity” abuses.

And the Association for Investment Management and Research (AIMR), which certifies CFAs, is calling on analysts to step up the quality of their work. In a full-page Wall Street Journal ad, AIMR implored analysts to “ferret out information contained in the primary financial statements — and adjust valuations accordingly.” Merrill Lynch's research department has already heeded that call. Deepak Raj, director of equity research, issued a memo that called for analysts to dig past company-issued “pro-forma” numbers. Analysts, he said, should look more closely at other measures such as pension plan funding, off-balance sheet entities and asset measures such as inventory turnover.

Companies are also doing their part. General Electric and IBM have already fattened their annual reports with more detail. “The 10-Ks are going to make interesting reading,” says Rick Roberts, a Deutsche Bank institutional broker.

Companies are also looking to improve board-level oversight. Advertising giant Interpublic Group, for example, recently booted four executives off its board and replaced them with outsiders.

In a year, the financial landscape could be radically changed. Or all the current indignation could fail to change the status quo. Finance professionals have a lot riding on the outcome; action or inaction could mean the difference between a stock market that attracts or repels investors.

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