Reform Effort at Businesses Feels Pressure

The New York Times
January 14, 2005
Reform Effort at Businesses Feels Pressure
By KURT EICHENWALD

Martha Stewart is in prison. Richard M. Scrushy, former chief executive of HealthSouth, is sitting through jury selection at his fraud trial. Next week, Bernard J. Ebbers, the former head of WorldCom, will do the same in a court in Manhattan, as will L. Dennis Kozlowski, the former Tyco chief being retried on grand larceny charges. And if all goes according to plan, later this year Enron's top managers, including Kenneth L. Lay, its former chairman, will be on trial in Houston, charged with a raft of crimes related to that company's demise.

It must seem, at least to courthouse watchers, that the sweeping effort to clean up corporate America begun over three years ago in the aftermath of the Enron collapse is still going strong, perhaps even picking up steam. But in the boardroom and executive suites, away from the gavels and juries, a different tale has begun to emerge.

The white-hot movement to overhaul corporate governance has cooled in recent months in Washington and beyond, according to lawyers, institutional shareholders, executives, directors and other experts. On that there is much agreement. But the interpretations of this sudden, little-discussed shift vary widely.

Some experts complain that reform is slowing just as it is reaching what they say is a critical stage, while others argue that the change is the natural consequence of an effort that went too far in the first place.

"The pendulum has begun to swing back," said John C. Coffee Jr., a securities law professor at Columbia University Law School. "We are now seeing the counterreaction to the reform movement of the last few years."

What has emerged, experts from many sides of the issue said, is an intensifying battle over future efforts to revamp corporate governance further. It is one that pits influential members of the business community, including giant organizations like the United States Chamber of Commerce and the Business Roundtable, against institutional investors pushing for greater power over the direction of troubled companies. And it is an effort to handcuff regulators who, from the time of Enron until just the last few months, have been able to issue new directives with little fear of confrontation.

The result, these experts said, is that 2005 could prove to be critical in determining which rules truly become embedded as part of the legal framework governing the future of how American business does its job.

"With the level of the pushback and the momentum that the business community has," said Ann Yerger, executive director of the Council of Institutional Investors, "this is a very important year in terms of holding on to what we have and protecting what we have achieved in corporate reforms."

Executives and other representatives of the business world agree that a change of attitude has taken hold, although they say that the shift is merely curbing the excesses of regulation. They bemoan a combination of heightened action by agencies like the Securities and Exchange Commission, aggressive enforcement efforts by state attorneys general like Eliot Spitzer in New York, and intensified litigation by plaintiffs' lawyers, who recently have begun to see new success with settlements that held directors of WorldCom and Enron personally liable.

"The pendulum has gone too far," said David Hirschmann, a senior vice president who serves as point man at the Chamber of Commerce in Washington on the top issues facing American businesses. "There have been some unintended consequences that are having significant negative impacts on our economy, and we need to fix those aspects that weren't done right."

Mr. Hirschmann said that the unintended consequences have included unnecessary expenditures by companies to meet the bureaucratic demands of new rules, decisions by companies to postpone certain technology purchases to avoid running afoul of new compliance requirements, and a decline in the number of foreign companies willing to list on American stock exchanges. Indeed, the New York Stock Exchange has reported a drop-off in new foreign listings in recent years, including the loss of one giant initial public offering for Air China, whose executives were reported to chafe under the rigorous new demands in the American market.

None of this means that corporate America will be returning to the complacency of the pre-Enron days. And indeed, the criminal and civil pursuit of corporate wrongdoers continues at a breakneck pace.

The Justice Department's Corporate Fraud Task Force, formed by executive order of the president in the immediate aftermath of the WorldCom debacle, has racked up an impressive series of victories. By June 2004, the latest period for which full statistics are available, the task force had obtained more than 500 corporate fraud convictions or guilty pleas, and charged more than 900 defendants, including more than 60 top corporate officers, with various types of fraud. During that period, the S.E.C. filed almost 600 separate civil enforcement actions involving financial fraud or reporting.

As the big fraud trials unfold over the coming months, public anger may build as the excesses of the bubble years - some of which have reached almost mythic status - are again trotted out. Juries will hear about the multibillion-dollar accounting scams at WorldCom and HealthSouth, with executives at both companies purportedly scrambling to disguise numbers revealing the failure of their business plans.

In the trial of Mr. Kozlowski, the $6,000 shower curtain will again be raised, along with other indulgences he obtained with money that prosecutors will contend was stolen from Tyco. And the Enron trials will examine that company's byzantine off-books partnerships, which were used to disguise its deteriorating business and enrich some executives.

No matter the public mood, however, certain aspects of the changes adopted in recent years are here to stay, experts said - in particular the themes from the sweeping Sarbanes-Oxley Act, passed in the summer of 2002 in hopes of cleaning up corporate America.

That law rewrote the rules for corporate governance and financial reporting, requiring greater power for independent directors, fewer conflicts for outside auditors and greater transparency in reporting. Those concepts are now so ingrained in the corporate mind-set that they are unlikely to be reversed, and may well already be showing some benefits to the economy, particularly in the return of investor confidence and the recent growth of mergers and acquisitions activity, experts said.

"Part of the resurgence in the mergers and acquisition market is due to greater confidence among buyers that they can now trust public financials more than they were willing to right after the scandals," said R. Franklin Balotti, director in the corporate department at Richards, Layton & Finger, a law firm in Wilmington, Del. "If part of the result of Sarbanes-Oxley and the rest of the rules is to give the market more confidence in the public statements about the value of companies, then perhaps it has all been worthwhile."

Signs of the growing battle over corporate reform and its ultimate politicization are everywhere, although many are hidden from public view. Soon after the presidential election, a group of senior financial executives from an array of firms and companies visited the White House for a private meeting with President Bush. According to people briefed on the meeting, the executives voiced their frustration with the intensity of the regulatory and legal efforts that their companies had faced since the corporate scandals broke three years ago.

The regulatory battle has turned to the courts. The Chamber of Commerce has sued the S.E.C. over rules it adopted related to governance of mutual funds. The group also threatened to sue if the agency approved rules to give corporate shareholders the ability to nominate board members directly; the proposal is now widely viewed as dead.

At the same time, corporate lawyers expressed dismay that the S.E.C. commissioners had recently elected to reject the recommendation of the enforcement staff to levy a fine against Gary Winnick, the founder and former chairman of Global Crossing, the onetime fiber optic giant that collapsed into bankruptcy.

"It was absolutely amazing, because the commission rarely turns away from a staff recommendation like that," said one corporate lawyer involved in the case, who spoke on condition of anonymity.

There is even growing criticism about the costs and demands of Sarbanes-Oxley, particularly in relation to the demands of Section 404 of the act, which imposes numerous requirements and disclosure demands to ensure that internal controls against fraud are effective. Already, while there is widespread support for the principles of Sarbanes-Oxley, corporate directors and other experts said that there was a quiet effort under way to trim back the demands of the law.

"It's clear to me that we are heading into some very uncertain waters, and that the Bush administration is willing to cut big business a lot of slack when it comes to corporate governance, which I think is a big mistake," said James W. Harris, president and chief executive of Seneca Financial, a merchant banking firm. Mr. Harris also serves on two other corporate boards.

In recent months, Mr. Harris said, he has heard numerous directors complaining about the demands they now face for serving on boards, an attitude he says he has little patience with.

"I was at a meeting of a group of directors back in the fall, and there was a lot of grumbling and groaning about all the extra work required now," he said. "My response was, 'Why don't you give back the check and get off the board?' Of course, none of them wanted to do that."

The signs of a changing attitude in Washington and beyond are being read with some level of dismay by experts in corporate governance. They believe that establishing rules for board independence was just an important first step but one that will have little serious impact unless shareholders are given greater power to remove ineffective directors.

"Board independence, while beneficial, is insufficient to provide directors with affirmative incentives to focus on the interest of shareholders," said Lucian Bebchuk, director of the Program on Corporate Governance at Harvard Law School and an author of "Pay Without Performance."

The problem, according to Professor Bebchuk and others, is that shareholders - the true owners of a corporation - are virtually powerless to effect change in a board unless they begin expensive and hard-to-win proxy battles. Shareholders are not given the right to vote for an alternative candidate for director, or to vote against one advanced by the company. They can either vote yes, or not vote at all.

Responding to such concerns, the S.E.C. proposed rules essentially allowing shareholders to propose their own candidates for director in companies with proven weaknesses in their procedures for electing directors. At the time it was introduced, William H. Donaldson, the S.E.C. chairman, heralded the proposal as a "significant step."

Quickly, the proposal brought widespread opposition from the business community, which argued that the effort was intended to allow unions with huge stakes in corporations through their pension funds to force social policy issues to the forefront on corporate boards.

"We think introducing a special-interest agenda into the boardroom isn't good governance or good for shareholders," said Mr. Hirschmann of the Chamber of Commerce.

But some managers of public pension funds say their desire for a greater voice is simply about giving the real owners of a company a say. Now, about the only option available is to sue the company and its directors.

"We should have some alternative to just being forced to sue ourselves," said Gary Findlay, executive director of the Missouri State Employees Retirement System, a pension fund. "If we are simply taking proceeds from the corporation that we already own to pay ourselves, that doesn't effect meaningful change."