Speech by SEC Commissioner:
Remarks at "SEC Speaks"
Comissioner Isaac C. Hunt, Jr.
U.S. Securities & Exchange Commission
February 22, 2002
Good afternoon, as always it is a pleasure and honor to be here today. But before I begin I am obligated to give you the usual disclaimer that you have probably heard more than once today. The views I express here today are my own and do not necessarily reflect those of the Commission, other Commissioners, or the Commission's staff.
It has been quite a year since we last meet. Since last year the Commission has welcomed a new Chairman, responded to the attack of September 11th and its aftermath, and now the Enron fiasco. I cannot remember any other time in the history of the Commission, where the Commission and its business have so dominated the front pages of newspapers across this nation. It is just amazing to me to see complex accounting and disclosure rules discussed in primetime on all the major networks. The Enron fiasco and its tragic effects on investors, employees, and retirees have provided a clear example of the importance of the Commission's prime mission: to protect investors.
Like many others, I too have views on the Enron fiasco and its meaning to our disclosure system. First, let me be clear, I will wait for the results of our Division of Enforcement's investigation before I form any conclusions with regard to who is to blame for Enron. Enron, however, comes on the heels of Cendent, Waste Management, Sunbeam, Micro-strategy and many others. While it may be too early to form any final conclusions with regard to Enron, its tragic predecessors have provided the Commission with plenty of data about the problems that exist with our current disclosure system.
Accordingly, I believe that there are a number of factors that may have contributed to the lower quality of disclosure that we are now seeing. I would like to mention three of them in particular.
- Lack of Commission resources available for review of public filings.
- Inadequate support by our judicial system to combat malfeasance and misfeasance in disclosures, including inadequate penalties enforced against primary actors. An example of my concern is the unwillingness of the courts to order bars against service by wrongdoers as officers and directors of public companies. In addition, I believe that The Supreme Court's decision in Central Bank of Denver to eliminate the private right of action for aiding and abetting a violation of Section 10(b) of the Exchange Act weakened the protection of investors in unfortunate ways.
- Independence issues involving both individual accounting professionals and accounting firms as a whole, including possible inadequate attention to the significant growth of accounting firms' consulting practices.
Before I begin discussing these factors let me make one point absolutely clear. While I believe these factors may have contributed to some of our current difficulties, I do not believe that any of these events or factors, taken either together or separately, caused all of our current troubles. No regulatory system can be a substitute for proper values. We need to think in particular about the value system that permits the deficiencies that we have observed and how our regulatory system can reinforce market and value mechanisms that make proper disclosure a paramount imperative of corporate leadership and all other market participants.
Prior to 1980, the Commission's Division of Corporation Finance reviewed every public company's filings. By 1980, however, the number of public companies and the limited resources available to the Division made it no longer possible for the Division to review every company's filings. Accordingly, the Division of Corporation Finance moved to a selective review process. Over time, with the ever-increasing number of public companies and ever-inadequate resources, this process has become more and more selective. The number of reporting companies currently subject to review each year has become smaller and perhaps so small that review risks no longer being a significant factor in promoting accurate and complete disclosure.
While I don't believe we need to go back to reviewing every public company on annual basis, we must do significantly better. Investors have over $10 trillion dollars invested in S&P 500 companies; they deserve to know that the Commission will review these companies' disclosure to promote full and fair disclosure. "Corporate insiders and others responsible for disclosure must have a greater personal stake in proper disclosure and a closer alignment with the interests of investors. This may require a rethinking of the responsibilities of corporate insiders and market participants. As one example of an issue that I believe should be revisited, in 1994 the Supreme Court, in Central Bank of Denver v. First Interstate Bank, ruled that there was no private right of action for aiding and abetting a violation of Section 10(b) of the Exchange Act. This decision may have dramatically weakened the remedies investors have against professionals, whom they historically have relied upon to provide independent verification of certain material information. Private litigation, historically, has provided significant incentive to professionals to provide high quality services. The decision in Central Bank of Denver may have been a factor in reducing the incentives to professionals.
Finally, the accounting profession's move from being primarily auditors of financial statements to highly compensated consultants, who offer their audit clients a host of other services, also has weakened the quality of disclosure. This move from auditors to consultants did not occur overnight but I believe it has reached critical mass. Accountants' have, historically, been the umpires of our financial system. Companies would run their businesses and it was the accountants that would tally the results. Accountants would call them like they see them. Unfortunately, along the way it became more profitable to be a partner with the company and a player in the game than to be the umpire.
Unlike some, I do not blame the accounting profession. They ran a business and like good businessmen and women they saw a need and opportunity and sought to fill it. Rather, if there is blame to be assigned it must rest with those organizations with some oversight responsibilities over accountants: the Commission, the AICPA, the Public Oversight Board, and the State Boards of Accountancy. Accountants did not overnight become consultants; this problem should have been addressed decades earlier. It is imperative to our financial system, however, that accountants regain their role as umpires.
Well I have outlined some of what I believe to be contributing factors to our current problems. These problems did not happen overnight, and we should be careful not to fool ourselves into thinking they can be solved overnight. Unfortunately, there are no easy solutions. But that does not mean we give up. Rather, I would like to suggest and in some cases endorse certain enhancements to our current system that I believe would enhanced the quality of financial disclosure.
1. Congress should immediately fund pay parity.
Over the recent years the Commission has lost many experienced professionals. The loss of these professionals has not only affected our existing investigations, inspection of our capital markets, and current reviews of companies' filings but more significant it has affected our ability to train new employees. When you lose large numbers of experienced staff in a short period of time it becomes extremely difficult to train new employees. Accordingly, the loss of experienced staff has a lasting affect on this agency. In addition, even for those many dedicated and gifted employees that have remained with the Commission, the failure to provide pay parity and then the cruel paradox of having legislation providing pay parity but then not having the funding to make the promise a reality have dramatically affected morale of the staff on which the Commission, and the markets, critically rely.
2. Congress and the President need to consider significantly increasing the Commission's budget.
I believe the Commission is significantly under funded and this is and will have a critical effect on the Commission's ability to protect investors. As recently discussed by our Director of Enforcement, Stephen Cutler, our Division of Enforcement is receiving an average of 525 email complaints a day compared to 365 a day a year ago. Last year alone the Division of Enforcement received over 100,000 email complaints. These emails are only one way the Division of Enforcement obtains cases to investigate. Referrals and complaints come from many other sources, including other divisions at the Commission, the NASD, NYSE, and the other Exchanges. Now so you get an idea of how understaffed we are, the Division of Enforcement has only 750 attorneys and 75 accountants to investigate all these complaints. You do the math.
As I mentioned earlier the Division of Corporation Finance is another area where we are severely understaffed. Investors have over $10 trillion dollars invested in the S&P 500 yet resources to permit the level of review that I consider adequate are not available-- the Commission should be reviewing a substantial portion of the companies that represent the largest investors' stakes -- our largest companies and those which would otherwise appear to merit review. The current review levels are unacceptable. The Commission should have the resources to conduct a full review of enough companies in the S&P 500 annually to provide meaningful input, and maybe every company in the S&P 500 annually, as well as continue with its current selective review process. While I do not believe that SEC review will detect fraud or other intentional attempts to mislead, I believe that the improvement that review and the increased chance of review could alleviate market concerns.
3. Congress should consider legislation that would provide for the assessment of a penalty up to $1 million against the CEO and CFO of a public company whenever there has been a books and records violation.
CEOs and CFOs are often well compensated. With this compensation should come responsibility and accountability. The financial statements of a company are the responsibility of the CEO and CFO. Ultimately, when these statements are inaccurate, it does not matter whether by fault of negligence or fraud investors will be harmed. Ensuring that CEOs and CFOs feel some of the investors' pain may provide an enhanced incentive for those corporate officers to ensure that the financial numbers that the company reports in its quarterly and annual reports are of the highest quality.
4. I would like to endorse the recent proposal requesting Congress to grant the Commission additional authority to seek Officer and Director bars in administrative proceedings.
Currently the Commission has the ability to suspend or bar broker-dealers in follow-on administrative proceedings; similar authority should be provided to the Commission with regard to corporate officers and directors. There should be no privileged class when it comes to fraud. If officers and directors commit fraud they should be treated and subject to the same penalties as broker-dealers. The Commission should have the ability to administratively suspend or bar these corrupt individuals.
5. Congress should consider legislation providing the Commission with the ability to administratively fine, suspend or bar directors for failing to monitor the corporation where as a result of their failure a financial fraud was perpetrated by the corporation.
Similar to the powers the Commission has in the area of broker-dealer supervision, the Commission should have the authority to administratively bring "failure to monitor" cases against directors of public companies. Currently the Commission may suspend or bar supervisors who fail to supervise a broker and where, as a result of that failure, a fraud was perpetrated on investors. Again, there should be no special privileges for corporate directors who were hired to monitor the corporation but failed in their responsibilities and duties to investors and as result of their failure a significant financial fraud was perpetrated.
6. Congress should seriously consider enacting a ban on accounting firms providing consulting services to their audit clients.
There has been much discussion on this area at the Commission, in Congress, and in the profession for years. There is currently legislation pending proposing such a ban. I fully endorse Congress holding hearings on such legislation. It may be time to return the auditor to the role of an umpire. I would propose that the Commission have the authority to define which services are essentially audit or related services that should be permitted; those that go beyond the category of audit or attestation services should perhaps be banned.
7. Congress should consider legislation that would eliminate state homestead exemptions when a financial fraud has been committed and the courts have ordered disgorgement.
Currently, many defendants who have robbed investors of millions and have been ordered to pay back these defendants continue to reside in mansions, while investors see nothing. Often there are significant consequences to investors that are victims of a financial fraud: retirees may be unable to maintain their homes, children may not be able to go to college, medical procedures may need to be postponed or even abandoned. It is repulsive to see perpetrators of these crimes living in their mansions when their victims continue to suffer long after the fraud. Justice demands that this situation change.
Well these are just a few suggestions that I believe would improve our current system. I can assure you that the Commission and its staff are considering these points and a variety of disclosure and other approaches that will improve our market system and maintain it as the best system in the world. Thank you again for your time and I hope that you all enjoy the conference.