Congress passed the Sarbanes-Oxley Accounting Reform Act in 2002 after the cascade of scandals at Enron, WorldCom, Tyco et al. contributed to a market decline that cost investors, employees and trillions of dollars and shattered public faith in corporate executives, deregulated markets and the integrity of the system's gatekeepers - corporate lawyers and accountants. Following the requirements set out in Sarbanes-Oxley, the SEC is completing a series of regulations required by the law. Almost all of those rules have been completed. And most have been winnowed down from their original form, as the interests of small investors and the public have been drowned out by the din of comments coming from corporate lawyers and accountants.

Auditor Conflicts

The conflicts that arose from auditors performing non-audit services were most obvious at Enron, where executives concealed billions of dollars in debt in offshore partnerships and WorldCom, where Andersen accountants somehow missed the fact that the company had inflated its earnings by $9 billion. These scandals ultimately led to Andersen's own demise. And as the other scandals have shown, Andersen is not the only accounting firm whose green eye shades were turned into rose-colored glasses by its conflicts of interest.

The Sarbanes-Oxley Act failed to establish the complete independence of financial audits. The Act did address many areas where accounting firms have traditionally consulted to the same clients for whom they perform audits, but even after the Big Four accounting firms sold off their consulting arms, they continue to receive more than 50% of their revenue from non-auditing sources. This situation is not likely to change significantly as the SEC failed to use its rule-setting discretion to set tough new auditor independence standards. For instance, the SEC has decided to allow auditors to continue performing tax planning services. Now the same accountants who help companies figure out how to use tax shelters to dodge their taxes will be providing supposedly independent audits of their own work. As the Washington Post editorialized, "This puts accounting firms in the conflicted position of first recommending tax shelters to their clients and then having their own auditors review the permissibility of such schemes."

The rule means that auditors will be tempted to go easy on a company's books in order to win lucrative tax planning contracts. As the New York Times editorialized, "It is widely recognized that the eagerness of accounting firms to sell lucrative consulting services to the companies they audit creates powerful conflicts of interest that are harmful to investors."

Even worse, under the new rules, accountants will be able to classify more work previously considered "non-audit" as "audit" or "audit-related" work, allowing more conflicts of interest to go undetected. As the New York Times editorialized, "The S.E.C. compounded its error by revising fee reporting requirements for auditors in a manner that will enable them to minimize the extent of their conflicts."

Until the accountants who perform audits are completely free of such conflicts of interest investors cannot be assured of the objectivity and independence of financial audits.

(For more about the auditor independence rules see the attached statement by Barbara Roper of the Consumer Federation of America, also available on CFA's web site at http://www.consumerfed.org/auditreformeval.pdf)

Professional Standards for Attorneys

Lawyers played a key role in the scandals at Enron and other companies, where to notify shareholders and/or boards of directors when they witnessed ongoing fraud.

Instead of requiring corporate lawyers who observe possible fraud to alert the public via the SEC, the Commission voted to allow lawyers to keep such observations internal, even in cases where internal officers do nothing to correct the fraud. Given the absence of strong state-level professional standards for attorneys, the SEC should not drop its "noisy withdrawal" requirement in the rules, as it originally proposed. It's not clear that in cases where top executives are complicit or a company has an endemically corrupt culture as seemed to be the case at Enron that simply reporting the fraud to the company's lead lawyer or to a director would have been enough to prevent fraud.

Worse, the SEC softened the language of what counts as "evidence of material violation" worthy of reporting even internally. Instead of sticking to its original definition of a material breach as "information that would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur," the SEC defined it as "credible evidence, based upon which it would be unreasonable, under the circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing, or is about to occur," a more difficult standard to prove.

(For more information about the SEC's proposed rules regarding professional standards for attorneys see the comments submitted by Susan P. Koniak, Professor of Law, Boston University School of Law, and others, available on the SEC's web site. Note that the SEC has postponed part of this rule for another 60 days. We encourage interested investors and other members of the public to comment on the remaining rules before the comment period expires. See www.sec.gov/rules/proposed.shtml)

Disclosure

The SEC should be applauded for requiring that mutual funds disclose their proxy votes for which they received thousands of comments from concerned citizens and investors.

We believe the Commission should continue to advocate for the further expansion of disclosure standards. As chairman Pitt himself wrote in a 1971 law review article, SEC disclosure laws could be used to advance corporate social responsibility. Pitt wrote long before the Socially Responsible Investment movement emerged as a significant market force, and three decades before Sarbanes-Oxley, that "[t]he Commission has within its power the wherewithal to make corporations socially responsible and afford a substantially higher degree of investor and public protection."

It's time for the SEC to stand up to big corporations and force them to further disclose their social and environmental track records. Putting this information into the balance sheet will enhance transparency, improve the efficiency of markets, and empower the growing number of investors concerned about social and environmental accountability.

Other Challenges for the New SEC

No matter how strong they are, by themselves rules won't be enough. Even the best regulations require strong enforcement to be effective.

The Senate Committee on Governmental Affairs pointed out in October that the SEC did not review any of Enron's financial statements after 1997 and did not monitor Enron's compliance with special accounting treatment it permitted the company to use. Although the SEC said the company should use objective standards when using the mark-to-market accounting method, it never followed up to see that the company complied. "The SEC missed potential opportunities to identify serious problems before the house of cards fell," the investigators found.

The SEC's ability to protect investors and the public from corporate fraud and crime would be improved with increased resources. Although the Sarbanes-Oxley bill increased the SEC's budget for 2003 by 66 percent, and the Bush Administration has announced its support for this increase, it still won't be enough. The increase is vastly outmatched by the numerous responsibilities the SEC has been saddled with in recent years. The size of market activity has skyrocketed, while new regulations and laws have increased the SEC's responsibilities in other ways. Meanwhile, the scale of corporate crime in recent years is practically unmatched in history (e.g. U.S. earnings restatements leaped to a record level in 2002, with public companies making 330 accounting restatements, up 22 percent from 2001), and the SEC's overworked staff, doing its best, is finding it hard to keep up.

A March, 2002 Government Accounting Office (GAO) report to Congress on SEC operations reported that critical SEC regulatory and enforcement activities have suffered from limited resources and staff turnover in the face of vastly increased responsibilities. (One indication of the SEC's inability to keep up with its workload is the fact that it reviewed only 16% of the 12,000 annual reports submitted in 2001.) The result is a lack of aggressive oversight, which not only means corporate criminals get away undetected, but the economy itself can suffer. "[T]hese delays have resulted in foregone revenue and have hampered market innovation," the GAO concluded.

The SEC and the Department of Justice are the two agencies charged with tracking and cracking down on corporate crime. Although the Bush Administration established a new Corporate Crime Task Force last July, it has no staff and no budget. Congress should increase the resources the Department of Justice devotes to tracking and cracking down on corporate crime. DoJ should produce an annual corporate crime report as an analogue to its Crime in America report, which is solely focused on street crime. The Department of Justice should also establish a permanent corporate crime enforcement division.

Although there is much room for improvement, the SEC cannot realistically be expected to do everything. Investors need to be empowered to act on their own. Congress must restore the ability of defrauded investors to seek restitution through civil lawsuits against the aiders and abettors of fraud. In the wake of Enron, the Private Securities Litigation Reform Act was identified by securities experts such as Columbia University's John Coffee as a significant contribution to the failure of gatekeepers such as lawyers and accountants to serve shareholders and stop the fraud at Enron and other companies. This law should be repealed, and the rights of defrauded investors restored to pursue civil lawsuits that obtain from the aiders and abetters of fraud and other forms of corporate crime what the SEC's disgorgement process can't.