Tag Archives: Sarbanes Oxley

Capitalism Won’t Be Saved By Republicans

For the sake of this argument let’s assume that while capitalism may not be the most egalitarian system of resource management and allocation, it’s the best one we have to date.  It’s a bit like the definition of democracy – it isn’t perfect, but no one’s come up with anything better.  So, with this in mind we can propose that capitalism is worth saving.  But, saving from what?  And here I climb back on the hobby horse – we need to save free market capitalism from Financialism.

What is Financialism?  If you’ve just tuned in, I’ve been operating with the Armistead definition:

“Financialism is an economic system where the primary activity consists of creating and manipulating financial instruments.  Financial instruments…are in their original form firmly linked to economic reality.  However, when financialism sets in, financial instruments become progressively further removed from their role in supporting commerce in the real world and develop a life of their own.”  [Armistead]

When this “life of its own” comes in to play there are some serious problems for the underlying economy.  Michael Konczal summarizes the issue as succinctly as anyone:

“If you want to know what happened to economic equality in this country, one word will explain a lot of it: financialization. That term refers to an increase in the size, scope, and power of the financial sector—the people and firms that manage money and underwrite stocks, bonds, derivatives, and other securities—relative to the rest of the economy.

The financialization revolution over the past thirty-five years has moved us toward greater inequality in three distinct ways. The first involves moving a larger share of the total national wealth into the hands of the financial sector. The second involves concentrating on activities that are of questionable value, or even detrimental to the economy as a whole. And finally, finance has increased inequality by convincing corporate executives and asset managers that corporations must be judged not by the quality of their products and workforce but by one thing only: immediate income paid to shareholders.”

That second paragraph is a summation of what we’ve been looking at for the last 20 years.   If we were discussing capitalism we’d be talking about economic growth predicated on development in manufacturing, housing, infrastructure, energy, agriculture, primary industries, transportation, etc.  However, we’ve not been talking about capitalism, especially in the media. We’ve been lathered up and shaved by financialism.

We barely know what capitalism is anymore.  What’s the first thing that comes to mind when someone says, “business news?”  If you said, “stock market report” that would reflect what the evening news gives you. Usually the Dow Jones Industrial Average comes first, and then ‘what drives it’ comes in commentary purporting to be analysis.  Consider the following reaction to inquiries about the strength of the economy in 2012:

“The stock market in the past has been a leading indicator, but that leading quality has weakened in recent years. Stock prices are driven by profits and profit growth. During the Great Recession, corporations have been able to maintain profitability by slashing employment to reduce costs. They have streamlined their operations and have squeezed more productivity out of their remaining workers. Thus, higher stock prices don’t necessarily mean a stronger economy, especially in terms of employment growth. That said, I do think the economy is on an upward path, with job growth of about 2 million expected for the national economy in 2012.” [SDUT]

And here we have an illustration of the third point Konczal was making:  Corporations are judged not by the quality of their products, the character of their work forces, the direction of their research and development – but by the immediate income paid to shareholders.

Couple this with the Shareholder Theory of Value, which Jack Welch once referred to as the “dumbest idea in the world,” and the financialist  incentive is to maximize productivity, prioritize immediate results, and ignore the stakeholders for the benefit of the shareholders.  Now, view the Epi Pen issue from the perspective of the shareholders – the object was to increase immediate shareholder value, but:

“While individual consumers may not have had a voice or recourse, the market did. Mylan may have improved its margins and ultimately driven higher returns and shareholder value, but within a week the price increase cost the company $3 billion in market cap and a stock tank of over 12% in 5 days.” [Fortune]

Ethics do matter, especially to stakeholders.  If there is a silver lining in this cloud it is that the stakeholders (individual consumers, school districts, emergency responders, local fire departments…) can place significant pressure on shareholders.  Breach the bounds of acceptable human behavior and the amorphous market will take a bit out of the corporate hide; illustrating former CEO Welch’s point precisely.

Now, let’s enter the political phase.  Republicans would love to dismantle the financial regulation structure which has curtailed some of the excesses of Financialism which precipitated the last Great Recession.  Out with Sarbanes-Oxley, Out with Dodd Frank, out with “excessive regulation.”   This is a recipe for disaster.  Regulation restrains, and restraint is what is needed to prevent capitalism from degenerating into financialism.

Again, a summation from Konczal:

“…the most important change will be intellectual: we must come to understand our economy not as simply a vehicle for capital owners, but rather as the creation of all of us, a common endeavor that creates space for innovation, risk taking, and a stronger workforce. This change will be difficult, as we will have to alter how we approach the economy as a whole. Our wealth and companies can’t just be strip-mined for a small sliver of capital holders; we’ll need to bring the corporation back to the public realm. But without it, we will remain trapped inside an economy that only works for a select few.”

Income inequality on steroids? More Bubbles? More volatility? And, more economic problems associated with those issues.  It will be up to Democrats to resist the financialization of the American system of capitalism because the Republicans are either trapped in its web or ignorant of its consequences.

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Filed under Economy, financial regulation

Nevada Congressional Delegation Votes For Enron Redux?

Enron LogoIt’s not just the Dodd-Frank Act to reform our financial sector regulatory structure that is the target of Wall Street lackeys in the Congress of the United States — Remember Enron?  Rep. Robert Hurt (VA-5) has his sights set on the Sarbanes-Oxley Act in his ironically labeled  “Audit Integrity and Job Protection Act.”  (H.R. 1564)

The CRS summary reads as follows:

“Audit Integrity and Job Protection Act – Amends the Sarbanes-Oxley Act of 2002 (SOX) to deny the Public Company Accounting Oversight Board any authority to require that audits conducted for a particular issuer of securities in accordance with SOX standards be conducted by specific auditors, or that such audits be conducted for an issuer by different auditors on a rotating basis.”

Sounds simple doesn’t it?   First, let’s get rid of the superfluous appendage “job protection act” portion of the title — the only jobs protected by the act are those of corporate executives, managers, and supervisors who are involved in the auditing process of corporations.

Secondly, the bill all but wipes out the independent auditing required of U.S. or international companies which have registered equity or debt securities with the Security and Exchange Commission, AND the accounting firms which do business with those corporations.

The current statute requires that all financial reports coming from a registered corporation include an internal control report.  According to the SEC an internal control report must contain the following:

 “…  (1) a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting for the company; (2) management’s assessment of the effectiveness of the company’s internal control over financial reporting as of the end of the company’s most recent fiscal year; (3) a statement identifying the framework used by management to evaluate the effectiveness of the company’s internal control over financial reporting; (4) and a statement that the registered public accounting firm that audited the company’s financial statements included in the annual report has issued an attestation report on management’s assessment of the company’s internal control over financial reporting.” [SEC] (numbering added)

Note that the last (4th) item in the list requires the independent auditor selected by the corporation to review its books to attest to the adequacy of the internal controls.   Thus, the auditors are supposed to let the public (and the investors who read such things) know that the corporation has been avoiding those questionable practices which brought us the great Enron Debacle.

Now, how do we insure that there’s  no replication of the Enron/Arthur Andersen crash and burn?  We’ve had a tragic object lesson in what happens when the corporation and the auditing firm get too snugly:

“…a firm (Arthur Andersen) that once stood for trust and accountability ended 90 years as an auditor of publicly traded companies under a cloud of scandal and shame. Its felony conviction for obstructing a federal investigation into Enron Corp., its now-notorious client, cost Andersen the heart of its practice. It will continue with a tiny fraction of the 85,000 employees it spread across the globe just months ago.” [ChiTrib 9/01/2002]

The Securities and Exchange Commission adopted rules to preclude these long term love-matches which resulted in the auditing firm being far more concerned with the “health” of its well paying client than with the “wealth” of the investors, shareholders, and the public.  It sought to establish a sturdy curtain, if not exactly a wall, between the auditors and the corporations.

In setting the rules the SEC was to — and did — “establish rules that an accountant would not be independent from an audit client if any “audit partner” received compensation based on the partner procuring engagements with that client for services other than audit, review and attest services.” [SEC]  The SEC went one more logical step and defined the role of the “audit partner.”

“Section 203 of the Sarbanes-Oxley Act specifies that the lead and concurring partner must be subject to rotation requirements after five years. The rules will specify that the lead and concurring partner must rotate after five years and be subject to a five-year “time out” period after rotation. Additionally, certain other significant audit partners will be subject to a seven-year rotation requirement with a two-year time out period.” [SEC]

The reforms were plugging along as of September 19, 2006 when SEC Commissioner Christopher Cox reported to Congress:

“Beyond the independence of audit committees, Sarbanes-Oxley has strengthened auditor independence. The entirety of Title II of the Act is devoted to the topic of auditor independence. The intense focus on this topic reflects Congress’s appreciation that the audit process is most effective when investors are assured that audits are performed by objective and unbiased professionals. The Act bans auditors from providing the kinds of non-audit services to audit clients that could give rise to financial conflicts of interest. It emphasizes the role of audit committees in approving other services provided by auditors. And it requires audit partner rotation. All of this is more protection for investors, and less incentive for the auditors to do anything that detracts from their core mission.” (emphasis added)

The rotation of the audit partners, the selection of a new auditing firm periodically, combined with the prohibition of tacking on more, and often more remunerative, services was specifically intended to prescribe that “intent focus” on the actual financial situation of the corporation, and to proscribe the cozy long term love affairs between corporations and auditing firms that resulted in the collapse of Enron and the demise of Arthur Andersen.

It  would be entirely too easy to dismiss Representative Hurt’s bill as a classic example of historical attention deficit disorder, but Wall Street has been paying attention to the Sarbanes-Oxley Act since its passage in 2002 — paying attention as to how it might be able to gut the law.  What easier way than to prohibit the Public Company Accounting Oversight Board from enforcing the sections and rules promoting independent auditors?

Common sense and history notwithstanding, the House of Representative passed Rep. Hurt’s bill on July 8, 2013 by a vote of 321-62. [roll call 306]  Nevada Representatives Amodei (R-NV2), Heck (R-NV3), and Titus (D-NV1) all voting in favor of the measure. Rep. Horsford (D-NV4) is recorded as not voting.

H.R. 1564 deserves to get buried in the Senate, or find itself the victim of the Veto Pen, along with other so-called “job protection” bills like repealing the Affordable Care Act and Patients Bill of Rights for the umpteenth time….

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Filed under Economy, Politics

From Those Wonderful Folks Who Brought Us Enron: H.R. 3606

We have some very loud voices in the political sphere anxiously telling us that Capitalism as we know it is “under attack,” and that those who call for reforming our financial system, or those who call for the implementation of current reforms under the Sarbanes-Oxley and Dodd-Frank Acts, are inserting Big Government into our “free markets.”  The more radical among those voices apply the term “socialism” to the oversight of financial markets, without bothering to explain that a marketplace without oversight is the least likely to be profitable, and the most likely to be the territory of knaves, rogues, and thieves. Knaves, rogues, and thieves are not capitalists — they are knaves, rogues, thieves, and often felons.  We no more want our markets polluted with these types than we want our drinking water polluted by chemical contaminants.

The Pollution

Our capitalist system depends on investors who are willing to purchase shares in publicly traded corporations, individuals and groups who have a variety of interests ranging from short term profits to long range retirement investment accounts.  All investors want the financial waters to be safe.  Our government should be able to help keep our financial waters free of financialist contamination.  What we want and need is a system in which “… the fruits of thrift and industry are accumulated and invested in the creation of additional means of production, thereby generating wealth. Free market capitalism relies on the laws of supply and demand to allocate capital to its most productive uses. ” [SeekAlpha] This system is in peril.

Tom Armistead explained the danger two years ago: “Jungle-ethics or wild-west financialism results in a situation were capital that should be used to create additional means of production is diverted into gaming the system: when it becomes the spoils of a rigged card game played by cheats and scoundrels: when financial instruments become divorced from economic reality; when excessive leverage creates precarious and unstable structures; when financial predators feed off the fruits of thrift and industry, destroying value.”  Cheats, scoundrels or knaves, rogues, and thieves, none have the best interests of our free market capitalist system at heart.

The Early Gamers Gaming The System

There are about 8,ooo listed issues on the New York Stock Exchange, 550 companies are listed on the Amex Exchange, ArcaEdge offers trading in derivatives. [NYSE] The last market day’s listed volume was some 3,145,962,000 shares. [NYSE] There are also bonds for sale, and options and futures on offer.  Potential shareholders and investors have every right to know, and in some cases a duty to discern, which of the transactions are “allocating resources to their most productive uses,” and which might be more closely associated with ethics and policies of Enron, WorldCom, Lehman Brothers, AIG, and Goldman Sachs.  When bad companies go under who gets hurt?

Shareholders lost about $11 billion when Enron crashed in a bankrupt heap in November 2001.  Reckless, unaccountable management combined with auditing rife with major conflicts of interest  (Arthur Andersen, Inc., Enron’s permanent accountant, earned about $25 million in accounting fees and another $27 million in consulting fees from Enron the year before the bankruptcy), and exacerbated by a corporate culture of unrelenting greed,  destroyed the investments made by Enron’s shareholders.

Shareholders lost about $26,865,000 when WorldCom admitted to a $3.8 billion accounting fraud, as of September 2, 2002.  [Chesler pdf] See also: CRS – WorldCom, The accounting scandal, August, 2002 pdf]

Adding up such companies as Adelphia, Enron, Global Crossing, Peregrine Systems, Tyco, WorldCom and others under investigation in late 2002 yields a lost to shareholders as of September 2002 of approximately $236.389 billion. [Chesler pdf]

Sarbanes-Oxley Act and the Protection of Shareholders

The major provisions of the Sarbanes-Oxley Act were designed to prevent the kinds of accounting and management activities that caused the shareholder losses in the rash of scandals in the “Enron Era.”   Executives would have to certify their financial reports to shareholders.  The act forbid the policy of retaining a permanent accountant, requiring that corporations rotate accounting partners every five years. A firm cannot audit a publicly traded company whose officers used to work for the audit firm the previous year, and financial analysts cannot be involved in marketing securities.  So, why are we taking this trip down memory lane when the Sarbanes-Oxley Act was supposed to have resolved the issues that cost shareholders $236 billion?  Because the knaves and their acolytes are back.

The Repealers

Republican presidential candidate Newt Gingrich has been on record since 2008 supporting the repeal of the Sarbanes-Oxley Act, arguing that it has caused too many companies to go private (examples not provided), it has made accumulating capital difficult for Tech Companies (examples not provided), and it didn’t prevent the Crash of 2008 (the result of new forms of financial knavery). [SFgate] Gingrich is not alone.  As of March 3, 2012 Republican presidential candidate Mitt Romney declared his support for repealing the Sarbanes-Oxley Act.  [WSJ]  Whether this stance gets shaken in the EtchASketch remains to be seen.   As of last January Mr. Romney merely wanted to revise the law. [DB]

Corporate managers and executives are quick to proclaim that their primary duty is to secure shareholder value.  However, how is shareholder value to be protected if we revert to the accounting rules — or lack thereof — of the Enron Era?  Are shareholders better protected when executives do not have to sign off on financial reports?  Are shareholders better protected when whistleblowers who are aware of corporate mismanagement aren’t protected?  Are shareholders better protected when corporations and auditing firms can return to the days of cozy relationships while ignoring conflicts of interest?

The Nibblers

The 112th Congress has a plethora of bills designed to gut portions of the Sarbanes-Oxley Act.  The recently passed H.R. 3606 contains the following:

“Amends SA to state that an emerging growth company need not present more than two years of audited financial statements in order for its registration statement, with respect to an initial public offering of its common equity securities, to be effective. Amends both SA and SEA to state that, in any other registration statement to be filed with the Securities and Exchange Commission (SEC), an emerging growth company need not present financial data for any period before the earliest audited period presented in connection with its initial public offering.”

Thus, if a company is categorized as “emerging growth,” then it needs no more than 24 months of audited financial statements before launching its IPO — and how is a prospective shareholder supposed to determine if this corporation is a good fit for a portfolio for long term growth with only 2 years of data?  If this smacks of “Dot.Com Bubble Redux” it probably should.  But, there’s more:

“Amends the the Sarbanes-Oxley Act of 2002 to exempt a registered public accounting firm that prepares or issues a report on its audit of an emerging growth company from the requirement that it attest to, and report on, any assessment of internal controls the company’s management has made.”

What? Excuse me, the accounting firm preparing the reports on which prospective shareholders may be basing their decisions doesn’t have to evaluate the company’s internal controls?  Wouldn’t a shareholder like to know if the company has a policy of discussing risks and sharing that information with its board of directors?  Wouldn’t a shareholder need to know that fraudulent accounting will not be tolerated under any circumstances?  Why wouldn’t a shareholder want to know that the auditing functions are carried out separately from management — in a company of any size?  [IC: Journal of Accountancy] [H.R. 3606 pdf]

To make a longer story a bit shorter — H.R. 3606 doesn’t protect shareholders, and if it leaves shareholders open to losses of the Enron Ilk, then why would any investor in his or her right mind put any money into the unregulated “emerging growth company?”  The authors of the bill which is now awaiting action in the House to accept Senate amendments, appear to believe that slapping various warning labels about speculative investments will be sufficient protection.

It’s going to take more than a conference committee report to fix the problems with this Financialist serving bit of legislation.  A law that doesn’t protect shareholders doesn’t protect capitalism.

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Filed under 2012 election, conservatism, Economy, financial regulation, House of Representatives, oversight, Republicans, Romney, Securities Exchange Commission

Wall Street Wins! H.R. 3606 passes Senate

Wall Street won the “gut Sarbanes Oxley & Dodd Frank” oversight provisions as the Senate passed H.R. 3606 today on a 73-26 vote.  Both Nevada Senators, Heller and Reid, voted in favor of passage.

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Filed under financial regulation