Speech by SEC Chairman:
Remarks to the National Press Club
Chairman William H. Donaldson
U.S. Securities and Exchange Commission
July 30, 2003
I want to begin by thanking the members of the National Press Club for inviting me to speak. It is a great privilege to represent the Securities and Exchange Commission at a club that for 95 years has been fostering discussion between those who gather the news and those in the public eye. I am committed to working with journalists to help them present an accurate picture of America's financial markets and the activities of the Commission. Before going any further, I should mention the standard disclaimer that the views I express today are my own and do not necessarily reflect those of the SEC or its staff.
One year ago today President Bush signed the Sarbanes-Oxley Act, the most important securities legislation since the original federal securities laws of the 1930's. Sarbanes-Oxley marked the climax of an era that began in exhilaration and ended in disillusionment or worse. Today I want to talk about how Sarbanes-Oxley is helping to restore investor confidence and improve the integrity of corporate America. I also want to briefly detail both the SEC's achievements since I took office nearly six months ago, as well as a few of the principal areas we intend to address in the coming months to help ensure the integrity of America's public companies and financial markets. Finally, I'd like to talk briefly about the need for America's corporate leaders to internalize the message and lessons of Sarbanes-Oxley and at the same time get on with their important business.
Let me try to put Sarbanes-Oxley in perspective. I have been in the business and financial world for more than 40 years, and I don't recall any other period like the one we've lived through for the past eight years or so. The mid-1990s saw the beginning of the full flourish of the so-called "new economy" in America. Not only had the economy changed, but so had living in America. The personal computer became nearly omnipresent in businesses and in many homes. There were revolutions in information technology and communications. The Internet changed the way people did business, and the way they lived their lives.
The stock market reflected the enormity of the changes taking place in the economy and society. Stock averages soared at increasing rates from the mid-1990s through early 2000. New entrants to the market were among the biggest gainers, especially those that symbolized the "dot.com" sector of the economy. The IPO of then fifteen-month old Netscape in August 1995 was a harbinger for market watchers - the price of Netscape went up 150% on the first day of trading. During the market boom there were IPOs where the first-day price increase left Netscape in the dust. Communications, the explosion of information technology and changes in the culture of equity investing brought millions of individuals with their savings into our stock markets for the first time.
Starting in the second quarter of 2000, the bubble burst. Stock prices plummeted. Investors fled the markets. And the IPO market disappeared.
As happened after the crash of 1929, the falling market that began in 2000 led to other revelations. Starting with the unfolding of the Enron story in October 2001, it became apparent that the boom years had been accompanied by a serious erosion in business principles. The low points in this story are now household names - not just Enron, but also WorldCom, Tyco, Adelphia and others. There was other serious misconduct as well, including in the once-celebrated IPO market, which in too many cases lacked both fairness and integrity. The cost of this corner-cutting reached into the tens of billions of dollars for America's investors. While thankfully we have not witnessed the same intensity of human suffering that came with the depression of the 1930s, the most recent downturn in the market directly affected many more people than the 1929 market crash, because many more individuals had much more of their savings invested in the stock market.
In addition to the grossest displays of greed and malfeasance, there were other more subtle but still pernicious developments. During the boom years, corporate America increasingly emphasized a short-term focus, fueled by an obsession with quarter-to-quarter earnings. In some cases this focus was sharpened by the temptation that inherently resulted from massive amounts of stock options granted to corporate insiders. Analysts, some tainted by conflicts of interest, became cheerleaders for the game of "hitting the numbers". And winning that game, rather than creating the conditions for sound, long-term strength and performance, became the primary goal. Finally, the perception that uninterrupted earnings growth was the hallmark of sound corporate progress caused too many managers to adjust financial results - in ways that were sometimes large and sometimes small, but in all cases unacceptable - to meet projected results.
The widespread collapse of investor confidence and the recognition that something had gone seriously awry in segments of corporate America spurred the Congress to approve Sarbanes-Oxley, and spurred President Bush to sign it. At the East Room ceremony where he signed the bill, the President promised, "to use the full authority of the Government to expose corruption, punish wrongdoers, and defend the rights and interests of American workers and investors."
The Implementation of Sarbanes-Oxley
The Commission and the select corps of dedicated professionals who work at the SEC have met the mandate and the challenge set out by Congress and the President, and in record time.
A central purpose of the Act was to restore confidence in the accounting profession. I am very pleased that the centerpiece of the necessary reform is now on very sound footing and in the midst of important implementation phases.
I am of course speaking of the Public Company Accounting Oversight Board - which is awkwardly named and has for a year been resistant to efforts by the press and others to capture it with a catchy acronym. The Board is absolutely vital to our markets going forward. I am especially pleased and gratified that the Board's Chairman, Bill McDonough, is on the job and providing crucial leadership with the other fine members of the Board. Sarbanes-Oxley and our rules also brought new tougher independence standards for auditors and provisions that protect those auditors from inappropriate influence.
Another critical purpose of the Act was to improve the "tone at the top". This important theme dates back to President Bush's ten-point plan of March 2002, even before Sarbanes-Oxley. For example, we now require certification of disclosure and financial reporting by CEOs and CFOs--an important recognition of where ultimate responsibility should lie for accurate information for investors. There are also prohibitions on insider loans and provisions regarding codes of ethics.
In addition to addressing accounting, the Act took other important steps intended to improve the quality of financial reporting--to make the numbers accurate. In addition to executive certifications, we have adopted rules requiring management assessment and auditor attestation of internal control over financial reporting. These are landmark rules; they will require hard work and significant expenditures in the short run by corporations, but in the long-term they will result in sounder processes and more reliable financial reporting.
In addition to the accountants, the Act and our new rules require better focus by other gatekeepers on their proper roles. We have adopted rules that will strengthen the independence and the functions of audit committees through more robust listing standards. Attorney conduct rules make it clear for those who had any doubt that when an attorney represents a corporation, his or her client is the corporation and not its management. And in the last step of the massive directed rule-making project under Sarbanes-Oxley, the Commission has just approved yesterday SRO rules that will prevent the conflicts of interest to which too many research analysts succumbed in recent times.
The Agenda Beyond Sarbanes-Oxley
While implementing Sarbanes-Oxley is a tremendous accomplishment in its own right, I want to touch on some of our other areas of progress, as well as our ongoing priorities, which reflect our desire to restore investor confidence while helping America's financial markets to continue allocating capital effectively and sparking job creation.
We have stressed the SEC's strong tradition of cracking down on corporate wrongdoing. During my current tenure as Chairman, the SEC has filed 258 enforcement actions, 72 of which involve financial fraud or reporting. During this period, the commission has sought to bar 95 offending corporate executives and directors from holding such positions with publicly traded companies. And we have increasingly designed strategies that take advantage of the creative provisions of Sarbanes-Oxley to return funds to investors who have suffered losses rather than merely collect those funds for the government.
Under our enforcement regime, we are holding accountable not just companies who engage in fraud, but other participants involved in such impermissible activity. For example, earlier this year Merrill Lynch agreed to pay $80 million in disgorgement, penalties, and interest, for aiding and abetting Enron's earnings manipulations. And on Monday, we announced a similar settlement with JP Morgan Chase for $135 million, and with Citigroup for $120 million.
Internally at the SEC, we have created a new management structure, operating out of the Office of the Chairman, to help manage our expanded agenda and our expanding resources, while promoting cooperation and efficiency among the SEC's divisions and offices. This structure will help the agency anticipate issues, not just react to them.
While I am pleased with what we have accomplished to date, we will continue pressing ahead on multiple fronts in the months ahead. We will be building on the July 15 report of our Division of Corporation Finance, which recommends improved disclosure and greater shareholder access to the director nomination process.
The Commission has asked the Division to move expeditiously to rule-making in this area, and the Commission is scheduled to consider the first set of proposed rules one week from today.
We are examining the mutual fund industry, and its impact on investors, looking at everything from how fund companies do business to the fees they charge and the information they disclose to their customers. We are also in the process of reviewing the hedge-fund industry, given its extraordinary recent growth, to ensure that investor protection remains paramount. Recommendations from the SEC staff in this area are likely to be issued in the next month or two.
We also are taking a comprehensive look at the complex issues involving the structure of our markets - including their regulation, the balance between competition and fragmentation, and the use of market data - all in the context of our global marketplace. These market structure issues are among the thorniest the Commission faces, but also the most important. Revolutions in technology and communications and the unrelenting pace of globalization make it imperative that we revisit on a comprehensive basis the framework of our system for regulating markets.
Honest Business in the Current Environment
Just as the SEC is moving forward, so must American businesses. In the nearly six months I have been on the job, I have become aware that some in the business sector feel that they are under siege from new regulations, and the threat of additional litigation. For all the good of Sarbanes-Oxley, it did unleash batteries of lawyers across the country who have created a preoccupation in many offices and boardrooms with the potential dangers of making a mistake while trying to comply with the new laws.
Good, honest companies should fear neither Sarbanes-Oxley nor our enforcement. Rather, they should recognize that the improved standards that Sarbanes-Oxley mandates and smart and fair enforcement of the laws are the right thing to do and help attract capital and investment. As William O. Douglas, then Commission chairman and future Supreme Court justice, pointed out in a 1938 speech, "To satisfy the demands of investors there must be in this great marketplace not only efficient service but also fair play and simple honesty. For none of us can afford to forget that this great market can survive and flourish only by grace of investors."
Successful corporate leaders must therefore strive to do the right thing, in disclosure, in governance and otherwise in their businesses. And they must instill in their corporations this attitude of doing the right thing. Simply complying with the rules is not enough. They should, as I have said before, make this approach part of their companies' DNA. For companies that take this approach, most of the major concerns about compliance disappear. Moreover, if companies view the new laws as opportunities - opportunities to improve internal controls, improve the performance of the board, and improve their public reporting - they will ultimately be better run, more transparent, and therefore more attractive to investors.
I believe that this attitude is beginning to take hold in corporate America. During my travels, and in my discussions with company officials, countless people have told me that America cannot afford a return to the lax standards that preceded Sarbanes-Oxley. Many have added that while they initially questioned the merits of Sarbanes-Oxley, they now see that it can help show the way to a brighter, more competitive era in American business.
Any such era must involve a large measure of the risk-taking and entrepreneurship that are the hallmarks of honest American business. There have been suggestions, including in the press, that the recent crackdowns on corporations and executives by criminal and civil authorities, including the Commission, have discouraged honest risk-taking.
I have a different perspective on recent developments. I believe Sarbanes-Oxley and the other steps that have accompanied it will lead to an environment where honest business and honest risk-taking will be encouraged and rewarded.
What should be discouraged, and what we are committed to stamp out, are the activities that some have sought to disguise as honest business but that, in reality, are no such thing.
Transactions with no substance that are designed solely to assure increased earnings or cash flow in financial reports involve no risk and are not honest business. Neither are transactions that are disguised as rewards for entrepreneurship or superior management but that in fact provide risk-free excessive compensation or facilitate self-dealing for the benefit of insiders.
The SEC will continue to crack down on malfeasance, but our job goes beyond this important responsibility. As part of the bright new era I mentioned a moment ago, we are also committed to working with business to create new expectations among the investing public. By living up to more than just the letter of the securities laws, but also the spirit and underpinnings of these laws, business can help signal to investors that good, honest businesses grow steadily and over time.
I hope we have learned some lessons from the era just passed - and I believe we have. I also hope that America's corporate leaders will not use Sarbanes-Oxley as an excuse for putting off innovation and investment. Looking back one year, and also looking forward, nothing in the law, its implementation, or in the Commission's agenda should make business fearful. Indeed, a new period marked by the responsibility and realism I've just discussed, can provide the foundation for a new era of long-term growth and prosperity.
With that I will conclude. Thank you again for inviting me to be here with you this afternoon. I would be pleased to take questions as time permits.