As the stock markets lurch toward the New Year, investors should offer a wistful holiday toast to Arthur Levitt of the Securities and Exchange Commission. For the past two years, SEC chairman Levitt has crusaded against eroding accounting standards at publicly traded US companies, assailing a corporate culture too often willing to blur ethical lines to boost the bottom line.
But the presidential election of George W. Bush means Levitt’s tenure is most likely nearing an end and with it, the SEC’s vigorous campaign against fraud. The thought of a Bush appointee in Levitt’s seat is troubling to anyone who believes that the US financial markets are the world’s most successful because of their unrivaled reputation for fairness, liquidity, and transparency.
Over the years, Bush and other prominent Republicans have done everything within their power to curtail the rights of investors and other consumers hurt by corporate misdeeds.
As governor of Texas, for example, President-elect Bush led the fight to limit the amount of punitive damages juries there can award in civil cases. His stated purpose: to protect companies against greedy lawyers. The result: to make fraud more attractive by removing the threat of financial consequences. The effects of Bush’s tort reform can already be felt. The Wall Street Journal recently wrote that while Texas has one of the largest shares of deaths and injuries related to Firestone tires, the state’s laws restrict victims’ ability to get compensation.
Republican lawmakers and the Washington business lobby have pledged to step up attacks on class actions, lawsuits that allow fraud victims to band together to seek damages against corporations. The same Republicans who discourage consumers from bringing civil suits against corporate wrongdoers also have worked hard to hamstring regulatory agencies like the SEC by slashing their budgets.
Whether dealing with fallout from faulty tires or inflated stocks, federal regulators cannot do the job alone. Private litigation has become an important adjunct for chronically overworked and understaffed agencies.
The SEC must carefully pick and choose its battles, deploying its limited resources on a small number of high-profile cases designed to send a message to would-be corporate wrongdoers. The government simply cannot afford to prosecute most suspected stock fraud.
And make no mistake: Stock fraud is a booming business in America. Soaring share prices, demanding investors, and a generation of corporate leaders whose fortunes are tied to stock options have led to a dramatic increase in accounting gimmickry at publicly traded companies.
Since 1997, the SEC says nearly 400 companies have restated financial results, approximately 1 percent of those making public filings. Accounting and financial fraud cases made up one-fifth of the agency’s caseload in fiscal 2000.
That number is rising in part because the penalties for falling short of Wall Streets expectations can seem worse to company management than the potential threat of a fraud prosecution. If a company misses analyst projections, even by a few pennies, its stock price takes a beating.
Faced with a quarterly shortfall, some corporate managers choose to manipulate the numbers.
In addition to being wrong, succumbing to such temptations can backfire if the maneuver is discovered down the road. But even if the fraud goes undetected, each cooked book burns the credibility of the entire stock market.
Today, American markets enjoy the confidence of the world, Levitt said in 1998.
Since then, Levitt has done much to restore a shining faith in US markets. He beefed up the SEC’s enforcement division. He enacted regulations ending selective disclosure of information that can move stock prices. He established rules to reduce conflicts of interest for the auditors charged with examining a company’s books.
Perhaps most importantly, his staff issued guidelines that make it tougher to use what Bush might call fuzzy accounting to pad revenues.
With Republicans knocking on the White House door and the stock markets continuing their wild ride, Levitt’s legacy should not be squandered.
Corporate America needs to step back from the quarterly numbers game and support stricter accounting standards and greater accountability for fraud, especially those related to revenue recognition. The public, meanwhile, must resist efforts to pass ill- conceived laws that discourage citizens from using private litigation to recover damages caused by fraud.
Glen DeValerio, SEC’s Fight Against Fraud at Risk, The Boston Globe, Dec. 19, 2000, at C4
*In August 2017, our firm name changed to Berman Tabacco. Case references and content published before that date may refer to the firm under our prior name, Berman DeValerio.