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Arthur Levitt Jr.
Former Chairman, U.S. Securities and Exchange Commission
Answers to Written Questions from the Floor:
Q: The scandals that happened which have only recently come to light were actually conducted while you were SEC chairman. How could this happen?
A: I'm asked this question more than any other, and I would say if you look at the experience of regulatory agencies and law enforcement groups, we're there not to be passive custodians, we're there to root out crime and wrong-doing, and no regulatory body can assure the public against all fraud and deception. Many of the cases that I dealt with during my eight years at the commission were developed during my predecessor's era, and many of the cases - Waste Management, the Arthur Andersen initial case - were developed during my years at the commission. If I went back would I do things differently? Probably. We operated in an environment where Congress tried to keep a tight reign on what we could do: limited our budget, limited the number of people we had to do our job. Yet we were probably the most activist commission in the history of the country. We raised the issue of accounting fraud. Congress, in threatening our funding, hampered that process. But, nevertheless, we brought more accounting-fraud cases in three years than in the whole history of the commission. Anything that happens during a law enforcement agency's existence will be addressed partially by that agency and partially by the successor who comes in to clean it up.
Q: How severe is the under-funding of the SEC, and what should its budget be?
A: The under-funding of the SEC is best exemplified by what happened when Seven World Trade Center Building fell down. The most important office that they had outside of Washington had all of their records destroyed, none of them replicated. Can you imagine in this era not being able to have the technology to duplicate records? Technology is a critical need. Another is for more trial lawyers to prosecute cases that have developed; and see that commission employees are paid on the same level as other financial regulators. Until recently, commission employees were paid nearly a third less than other financial regulators. Congress voted for the funds, but the funds have been appropriated for only one year.
Q: Can real reform happen without high-profile criminals going to jail? If most merely lose some money and face, will others be deterred?
A: Ee will see many white-collar criminals wearing striped suits within the next several years. Part of this is a function of the public's attitude; the judiciary, the jury system, the prosecutors are all in a mood to put executives who are guilty of fraud behind bars. I'm often asked, Why does it take so long? Where are the indictments? The SEC doesn't have the power to proceed with criminal action and must coordinate with the Justice Department, and that coordination is time-consuming. I wish that the SEC had penalties more severe than at present, and that the law would allow us to do some things it doesn't presently.
Q: Is there a sensible and accurate approach available to expense stock options on the day of grant?
A: In this part of the country this is a very controversial issue, and I greatly regret that I stood in the way of the independent standard-setter in 1995 from mandating this proposal. The measurement of the value of stock-options is imprecise. International standard-setters will move ahead with a proposal to expand stock-options. The Financial Accounting Standards Board, the independent domestic standard-setter, will follow suit, and will endeavor to establish a standard of measurement that is as accurate as possible. Even accepting an imperfect standard, we're better off than having no standard. With the amount of anger directed at corporate America, for a lot of different reasons the expensing of stock-options will be viewed as a litmus test for companies that either stand with investors or don't. More and more companies on their own are going to move in that direction.
Q: How much did the dot-com world influence corporate greed and unethical behavior?
A: I don't believe that the dot-com world in itself had any more to do with misbehavior than any other aspect of the economy. I had lots of arguments with the dot-com world on one issue: They felt that they were different; that they should be measured by different standards, that they were a new paradigm. I never bought into that. I think they were innovative and courageous. They did more for our economy than any sector in the history of American commerce. But I don't believe they should have been measured by any different standards.
In general we've gone through an almost two-decade long erosion of ethical values on the part of corporate America. We are such a competitive society and when companies A and B move close to the line, companies C and D can't be far behind. In the euphoria of a market where investors see every stock they purchase go up, analysts' every recommendation work out, all of us felt it was our innate genius, rather than the sweep of a runaway bull market, that swept the bad along with the good.
Q: How can and investor distinguish between Wall Street analysts that offer good investment advice from those that are mediocre or corrupt?
A: We ought to become skeptical investors. The two words most important to investors: Ask questions. Take nothing for granted. There is no industry in America that has greater conflicts than the investment banking and brokerage industry. A public willing to accept the words of advisers as some Olympian quality which they can't question, a public that believes that they are asking dumb questions if they question what they are being told, is going to get hurt. I shan't forget the case that we had four years ago involving Internet fraud where a purveyor of electric eels raised $12 million from a gullible public that deserved to lose their money. Nobody should buy anything from someone over the telephone. Small investors should not use stock pickers. I have spent 40 years in our markets and have yet to meet a consistently good stock picker. As for fraudulent analysts, if the analyst works for a company that is the investment baker for the company that is being researched, stay away from it.
Q: How do you solve the conflict of interest between auditors and management when management pays for the audit?
A: While the implicit compromise of the audit being paid for by the company is there, there are many standards that can be applied in terms of how that audit is conducted. Auditors are a pretty prideful and independent group. Even though they are being paid by the company, the value of their reputation is far greater than the immediate compensation they may get from an individual client. Auditors out there today, and audit committees in particular, have a different attitude and a different culture. And that hasn't come about as a result of regulation, it's come about as a result of exposure and humiliation.
Q: You say what happens when major accounting firms go under. If the remaining four major public accounting firms follow Arthur Andersen into the tank, what will replace them?
A: I don't know. I think Arthur Andersen's failure was as close to an economic tragedy as you can get. It wasn't necessary. It reduced competition. The industry has to rebuild itself. It's got to change the management and direction of its trade group, the American Institute of Certified Public Accountants. I remember walking through the airport here in San Francisco and at JFK and other airports and looking at signs that advertise what accountants did. They weren't talking about audits, they weren't talking about integrity, they weren't talking about helping investors. They're not there any more; there's no advertising now. But I hope in the future the new leadership of the firms, and there is new leadership, will be smart enough to understand that their franchise is a fragile one, and that they better pay attention to the public interest.
Every chairman of the SEC has about 25 political appointees that historically must be approved by the White House. Of those 25 I had, 15 were made to Republicans or Independents. Not once on my eight years did the White House talk to me about personnel or any issue. Nor did I meet the president alone until the day before he left office. He invited me to come and meet him and talk to him. After the usual niceties I said, "Why is it in all these years that I've been here doing this job that I never heard from you?" He said, "In your case and with Bob Rubin and Joe Stiglitz and Jim Wolfensohn, I knew that you were experienced at what you did and I trusted you and I let you do your thing." Whatever you may think about Bill Clinton, that resonated with me, because that stood for standing behind the integrity and the independence of an agency that this country can be well proud of.
Q: Shouldn't we go further with regulation? Maybe a website to report cases and prosecute more?
A: Yes. I think that Regulation Fair Disclosure was a major boon to investors. When I went around the country to town meetings, the comment I heard over and over from investors was, "This isn't a level playing field. The institutions and others get information before we do." I'm disappointed the commission hasn't brought but one FD case, and that was settled with a fairly mild settlement. The use of the Internet would be constructive. Corporate Communications Broadcast Network, which I have some exposure to, does business with nearly 4,000 public companies in providing websites and webcasting conferences and analyst meetings. More will be done.
Q: What can we in the United States learn from the systems in other countries?
A: We can't afford to be smug and accept the primacy of U.S. capital markets as an enduring fact. Markets that are becoming electronic, markets which developed recent equity cultures, such as Germany and the U.K., are beginning to do some exciting things. America has got to be part of the system. Our accounting standards have been shown to be not quite as good as we thought they were, and we've got to balance formulaic standards we have with some principle base standards being embraced by other countries and other markets.
Q: What would you have liked to put into your book that is not in it?
A: Not much. My wife told me that I would lose every friend I ever had. My son urged me not to mention the name of his boss unkindly. My colleagues in the securities industry said that I dealt with them unfairly. Others said that I was a product of the system that I'd been critical of. I have in the back of the book something I'm just delighted that I did put in. During the height of this fight with the accountants, one of the many letters I received from a corporate executive said, "Arthur, Arthur Andersen is critically important to our company and your efforts to divide consulting from auditing will just hurt their ability to help us to do the job to protect the public. Signed, Kenneth Lay."
Tom Campbell
Dee Dee Myers