Corporate Reform’s Baby Steps

llene Graney thought she saw a golden opportunity in last year’s wave of corporate scandals.

The Dana Point management consultant launched a Web site called “Tell the Board” -- a discreet way for employees to report suspected accounting misconduct to company directors.

But Graney still is waiting for her idea to pay off -- just as many people eager for corporate reform are waiting to see if American companies take seriously the remedies that Congress ordered in the aftermath of Enron Corp., WorldCom Inc. and other spectacular failures.

This week marks the one-year anniversary of President Bush’s signing of the Sarbanes-Oxley Act, a sweeping federal law borne out of the public’s outrage over cooked books, self-dealing executives, lying Wall Street analysts and trillions of dollars in lost stock wealth.

The act sought to bolster corporate and regulatory defenses against the financial fraud and abuse that became all too common during the late-1990s boom.

Among dozens of provisions in the law was one specifically requiring companies to find a way for employees to confidentially inform directors of bogus accounting.

That’s where Graney zeroed in, even buying the rights to the name sarbanesoxley.com as a link to her Web site.

But like some other key elements of the legislation, the whistle-blower provision remains a work in progress -- because the rules give some firms until 2005 to comply.

“I’m a little disillusioned with the lack of seriousness by companies,” Graney said. Many, she said, seem to be looking for the cheapest solutions they can find to satisfy the letter of the law, “just to say, ‘Yes, we have this.’ ”

The sheer scope of the law assured that its impact would be immediate in some respects, while in other ways the effects will take years to sort out.

“It’s rare that I go someplace where somebody doesn’t say, ‘Your act has changed the way we do business,’ ” said Rep. Michael G. Oxley (R-Ohio), the main co-author of the law with Sen. Paul S. Sarbanes (D-Md.).

Still, “It’s important that a certain amount of time be allowed” for the bill to work, Oxley said, “and we’re not there yet.”

There is widespread agreement that some of the major issues addressed in Sarbanes-Oxley -- extensive new oversight of the auditing industry, demands for greater accountability by corporate directors who had become virtual rubber stamps for chief executives, and a big budget boost for the Securities and Exchange Commission -- were important in the battle to restore investors’ confidence after the scandals that helped drive the stock market to five-year lows last October.

Much of the law centered on restoring investors’ faith in the financial information companies report. That faith had been eroded by revelations that Enron, WorldCom and other firms had manipulated their results to inflate earnings and boost their share prices, allowing executives to reap big profits on stock options.

If the market’s performance is any indication, Congress might be able declare at least a partial victory: The Dow Jones industrial average is up more than 13% since July 25, 2002, the day the act passed both houses of Congress.

But some corporate-governance experts echoed Graney’s concern that many companies are simply going through the motions -- say, filling out forms, ordering studies of disclosure policies and giving directors reams of new data -- without focusing on the moral imperative behind the changes.

“You’re trying to change an embedded culture that took the better part of the ‘90s to be created,” said Lynn E. Turner, a former SEC chief accountant. “It’s going to take more than a year and some legislation to change that.”

Added Charles Elson, a lawyer and director of the University of Delaware’s corporate governance center: “I worry that there’s more form than substance here. It’s not the recitation, but the spirit behind the recitation that matters.”

Though executives may feel unfairly tarred by a criminal minority, critics have argued that corporate conduct was in dire need of new checks and balances after the go-go 1990s.

Sarbanes-Oxley began the process, but many experts say the law may be more important for the momentum it has given other entities -- the New York Stock Exchange, for example, and large institutional investors such as banks and pension funds -- that ultimately may prove more effective in changing corporate behavior.

Within Sarbanes-Oxley, the most significant sections deal with four principal players: the accounting profession; corporate boards of directors; chief executives and chief financial officers; and regulators. Here is a look at what the law has changed, or is expected to change, for each of them:

Accounting Firms

Enron, WorldCom and other corporate collapses were widely seen as a failure of the accounting industry, which is supposed to certify the honesty of companies’ financial results.

The industry’s image was further tarnished in June 2002 when Enron’s accounting firm, Arthur Andersen, was convicted of obstructing a federal probe of the energy giant’s finances. That led to Andersen’s demise.

Congress used Sarbanes-Oxley to put a watchdog over the watchdog. The law created the Public Company Accounting Oversight Board and banned the firms from selling what had become lucrative non-auditing services (such as human-relations consulting) to their corporate accounting clients. Critics said the industry’s expansion into myriad new services had compromised the auditors’ objectivity.

Ed Nussbaum, chief executive of Grant Thornton, the nation’s fifth-largest accounting firm, said the reforms would have “the biggest impact of any financial-services legislation” since the New Deal-era laws that created today’s regulatory system.

By restoring the idea that an accounting firm’s paycheck should come primarily from making sure the client’s books are in order, the new rules supposedly would remove the incentive for auditors to turn a blind eye to financial shenanigans.

“Companies used to ask them to make accounting moves that were maybe a bit gray,” said Charles W. Mulford, director of Georgia Tech’s DuPree Financial Analysis Lab, “but now it’s much easier for the auditor to say, ‘No.’ ”

Turner, the former SEC official, is less upbeat. He believes accounting firms should follow the same advice they’ve been giving clients: Develop independent panels to oversee their own business. But of the Big Four firms -- Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers -- “not a single one has an independent director,” Turner said.

The Big Four, like most accounting firms, are private partnerships rather than public companies. But Turner said there was precedent for creating advisory boards with outsiders to provide a check on management.

Company Directors

In theory, a company’s board of directors represents the interests of shareholders. But the rash of scandals raised the question of whether directors had become lap dogs for the chief executives who tapped them.

Sarbanes-Oxley didn’t attempt to legislate how directors are chosen. Yet some veteran directors said the law sent a clear message that their responsibilities amounted to more than nodding yes at whatever management put in front of them.

“On any board there are some who ask tough questions and some who go with the flow,” said Linda Fayne Levinson, a principal at investment firm GRP Partners in Los Angeles and a director of NCR Corp., Jacobs Engineering Group Inc. and Internet firm Overture Services Inc.

In effect, Sarbanes-Oxley gave some previously passive directors “permission to ask tough questions,” she said.

Retired Adm. Bobby Inman, who once headed the National Security Agency and now is a director of five public companies, said he too has found that some traditionally quiet directors are speaking up more -- but only in executive-session board meetings that exclude management.

In regular meetings with CEOs, he said, “those directors who were quiet before are still quiet.”

Under Sarbanes-Oxley, one group of directors -- those who sit on a board’s audit committee, which oversees a company’s financial reporting -- face a host of new responsibilities.

The law requires audit committees to settle disagreements between a company’s management and its outside accountants. The goal is to have accountants go directly to the audit committee if they believe management is doctoring the books.

The law also requires companies to disclose whether at least one member of the committee is a financial expert -- and reveal if no director qualifies.

Beverly Hills-based City National Corp., parent of City National Bank, responded by naming Michael Meyer, a director since 1999, to the company’s audit committee as the designated financial expert. Meyer spent 30 years as an accountant, and his duties as an audit-committee member now include looking through a financial document “two to three inches thick” that City National sends him each month.

But the SEC, which has been writing voluminous rules implementing many Sarbanes-Oxley provisions, didn’t get as specific as some experts had hoped in defining what constitutes “financial expertise” for an audit-committee member.

Despite the mind-numbing complexity of many companies’ books, most directors are unwilling to admit they can’t sort it out, said Roman L. Weil, an accounting professor at the University of Chicago. “In all my time in boardrooms, I’ve only met one audit committee member who’s ever said, ‘This stuff is over my head,’ ” he said.

The section of Sarbanes-Oxley requiring that audit committees set up procedures for employees to confidentially tip off directors to fraudulent accounting -- the need Graney is trying to meet with her Web site -- also is proving problematic. The SEC gave companies more time to decide how to comply, and most aren’t rushing, Graney said.

Some audit committee directors, according to Graney, have suggested there is a simple solution to satisfying the whistle-blower provision: “Some have said, ‘I’m just going to give employees my phone number. They can call me direct.’ ”

But Levinson, who chairs the audit committee at Overture Services, said she believes most employees would feel far too intimidated to call a director with a tip about potential fraud. It’s important to make the process confidential by using a third party as a go-between, she said.

CEOs and CFOs

One of the first elements of Sarbanes-Oxley to take effect was the requirement that chief executives and chief financial officers certify their companies’ quarterly and annual financial statements.

The executives must attest that they are responsible for “disclosure controls and procedures” and that the financial statements don’t contain “misrepresentations.”

To some executives, the certification requirement initially smacked of overkill.

“If you run a clean shop this is more or less doing what you were doing all along,” said Jim McGinty, chief financial officer at City of Industry-based retailer Hot Topic Inc.

But legal experts said Congress wanted to destroy the “Ken Lay defense,” referring to the former Enron chairman who claimed to know nothing about his company’s accounting irregularities.

Faced with possible jail time if they sign off on false data, many CEOs and CFOs now are requiring individual department heads within their company to certify their units’ results before the top executives give their OK. At City National, for example, “we now have signatures that roll up from the reporting units,” CEO Russell Goldsmith said.

Whether such certifications reduce financial fraud will only be evident with time, experts noted.

Sarbanes-Oxley also took aim at executive perks. The law forbids companies from granting or guaranteeing personal loans to executives and directors. A study by the nonprofit Corporate Library research group found that companies lent executives more than $4.5 billion in 2001, often at low or no interest.

The law also would require a CEO and CFO to give back certain bonuses and stock-option profits if their company is forced to restate financial results because of misconduct.

Outsized pay packages and lavish perks were symptomatic of what William Patterson, director of investments at the AFL-CIO in Washington, terms the “entrenched imperial CEO.” Some reformers say Sarbanes-Oxley’s greatest contribution is that it legitimized an assault on the throne.

Regulators

For the SEC, the nation’s primary regulator of public companies and markets, Sarbanes-Oxley provided a huge boost in resources -- and created a hefty new workload.

Like accountants and corporate directors, the SEC has been criticized for being asleep at the switch during the bull-market boom. It was left to a state official, New York Atty. Gen. Eliot Spitzer, to launch the investigation of Wall Street analysts that led to the historic, $1.4-billion settlement with major brokerage firms last spring.

The SEC also struggled through a leadership crisis last year. The agency had barely gotten to work on implementing Sarbanes-Oxley when Harvey L. Pitt resigned as SEC chairman amid criticism that he was too close to the accounting industry and had bungled the process of choosing the head of the new accounting oversight board.

Pitt was replaced in February by William H. Donaldson, who set a goal of transforming the agency’s culture -- to make the SEC less reactive to events and enable it “to look around corners to what’s ahead,” in Donaldson’s words.

Thanks to Sarbanes-Oxley, the SEC’s budget grew 47% to $716.4 million this year and is slated to rise to $841.5 million next year.

Yet last week, the agency said it won’t spend $103 million of this year’s budget because it can’t hire accountants and other new staff fast enough.

Many corporate-governance experts say one lesson of the last few years is that responsibility for corporate and accounting oversight can’t lie solely with federal regulators. State securities officials, led by Spitzer, point to their success in exposing Wall Street wrongdoing as justification for a continuing higher role in regulation, even as some in Congress have argued for them to defer to the SEC.

The nation’s principal stock markets, the New York Stock Exchange and the Nasdaq stock market, must play large roles, experts said. In the last year the markets have issued rules forcing companies to improve the independence of their boards or risk losing their listings.

Enhancing board independence “is very important,” said Elson of the University of Delaware. “It makes it much tougher structurally to have an imperial CEO.”

Some analysts view Sarbanes-Oxley as the opening act to battles on other hot-button issues, including executive pay, stock-option costs and mutual fund fees and sales practices.

At company annual meetings this spring, public pension funds won more proxy votes than ever before on proposals challenging executive pay, severance agreements and other perks.

“We’re trying to bring about a shift in the culture of ownership,” said the AFL-CIO’s Patterson. “Unless you have active, responsible shareholders and receptive boards, we aren’t going to get where we need to be” in terms of better corporate governance.

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The Sarbanes-Oxley Act

Here are some of the provisions of the Sarbanes-Oxley Act, which President Bush signed one year ago this week. Some of the provisions have taken effect, while others will be phased in over time.

* Created the first federal regulatory agency over the accounting industry, the Public Company Accounting Oversight Board, which reports to the Securities and Exchange Commission. The PCAOB began operations in spring.

* Ordered all accounting firms to register with the PCAOB or lose the right to audit public companies.

* Restricted the kinds of non-auditing services that accounting firms can perform for corporate clients whose books they are auditing, to reduce conflicts of interest.

* Required that accounting firms rotate their lead auditor on individual company accounts every five years.

* Required greater oversight of company financial results by the audit committee of the board of directors, and establishment of a system for employees to confidentially report suspected bogus accounting to audit directors.

* Ordered chief executives and chief financial officers to certify their company’s quarterly and annual financial statements, and risk fines and jail time if the results are misrepresented. Also required companies to establish a code of ethics for senior officers, or explain why there is none.

* Restricted companies’ use of “pro forma” financial information in reports and press releases.

* Made it illegal for a company to fire, demote or harass employees who attempt to report suspected financial fraud.

* Banned companies from giving or guaranteeing personal loans to executives.

Tom Petruno

Los Angeles Times

Times staff writers Jonathan Peterson and Walter Hamilton contributed to this report.