Regulators must not abandon corporate penalties

[FaGal]

Regulators must not abandon corporate penalties
news.ft.com - By Roel Campos - April 13, 2005


It has become fashionable to attack the imposition of corporate monetary penalties by enforcement agencies, such as the Securities and Exchange Commission. Critics argue that the SEC should seek penalties only against individual executives and not against the corporate entity. However, that approach would hamstring the commission, preventing it from obtaining fair results for investors and defendants. The issue is not whether to penalise people or the company, but how to mete out a sanction to each in the right proportion.

If the SEC charged only individuals, causes of fraud would be left unaddressed. For example, a company may have a culture where cheating is tolerated or where internal controls are ineffective. The corporate penalty is in part to punish and shame the company and its officers for those failures and to require remedial action. Corporate penalties also provide deterrence. As a former business executive, I can assure you that no officer or director wants corporate penalties imposed under his or her watch. Penalties against individuals alone produce far smaller recoveries for victims. The sad fact is that individual fraudsters spend the money as fast as they steal it.

Recognising the enormous losses suffered by investors from corporate fraud, Congress in 2002 showed extraordinary wisdom in authorising the SEC to use penalties to help restore investor losses. Corporate penalties now add significantly to overall recoveries (which include private and criminal actions) for defrauded investors, without imposing legal costs. Last year, the SEC recovered more than $3bn (€2.3bn) that will be distributed to investors to offset some of their losses.

Surveys show that investors have not forgotten the devastating losses from Enron and that they strongly support all types of penalties. Agencies worldwide increasingly use corporate penalties. For example, last autumn Callum McCarthy, Britain's chief regulator, announced the largest monetary penalty ever imposed by his agency against Royal Dutch/Shell.

Before imposing penalties the SEC weighs many factors including: harm; presence and duration of fraud; wrongdoer's history; personal enrichment of the wrongdoer; and degree of co-operation. If a corporate penalty would jeopardise a company's financial health, the penalty may be reduced or not imposed. But executives guilty of a fraud can never bargain away charges against themselves in exchange for corporate penalties.

Critics worry that innocent shareholders ultimately bear the cost of corporate penalties, since penalties take cash away from the company. However, consider that almost all corporate penalties amount only to fractions of a cent of company earnings per share. Corporate penalties by themselves are almost never large enough to have a material impact on the share price.

When a fraud is revealed to the public, the share price often goes down, mostly because of investors' worry that company value may be substantially fictitious. However, when a settlement or judgment is announced and corporate penalties are imposed, the share price of the company often goes up. At that point, the market understands that no further fraud or misconduct affecting value has been uncovered.

Even if it is true that corporate penalties at times impose a cost on innocent shareholders, this is a situation that the American judicial system reluctantly accepts. Indeed, when a parent or spouse commits a crime and receives a jail sentence, the innocent family members will surely suffer in not having that person in the household. As a former prosecutor, who argued for prison time for guilty defendants, this fact always weighed heavily on me. I came to realise that I was supporting an accepted system of punishment and deterrence that condones penalties, even if it sometimes causes pain to innocent parties.

When I was a businessman, I did not view government as my enemy. There was more regulation than I liked, but I knew that the US had less regulation than almost any other place on earth. (That is still the case, even after the introduction of the Sarbanes-Oxley corporate reform act.) My real enemy was a competitor who might be cheating and thus obtaining more and cheaper capital to use against my business.

The investing public demands that cheats are punished and that, as far as possible, losses from frauds are restored to victims. Enforcement and sanctions help to maintain the confidence of the investing public in the integrity of the markets and produce the liquidity and low cost of capital that creates America's prosperity.

[FaGal]

Why financial scandals differ in the US and Europe
news.ft.com - By Michael Skapinker - April 13, 2005


"Does Europe hate us?" Thomas Friedman, the New York Times columnist, asked in a documentary on the Discovery Channel last week. The answer, he concluded after pottering around the Continent looking increasingly worried, was "yes".

From the war on terror to attitudes to maternity leave, Mr Friedman's film made it plain that Europeans inhabited a different world from Americans. When it came to business, he portrayed a Europe whose bureaucrats plotted endlessly to make life difficult for US companies. Brussels was banning pharmaceutical ingredients regarded as perfectly safe in the US. European competition authorities had stamped on the ambitions of US companies from Microsoft to Coca-Cola.

His narrative punctuated by the sort of menacing soundtrack film-makers reserve for those moments before dad opens the door to discover that his family has been murdered by machete-wielding maniacs, Mr Friedman asked: "Is this the end of the west?"

Quite possibly - and it gets worse. According to a recent paper by John Coffee of Columbia law school, the US and Europe are so far apart that they even suffer from fundamentally different corporate scandals.*

Take two emblematic examples: Enron in the US and Parmalat in Europe. The Enron misdeeds were aimed at boosting and maintaining the energy trader's share price. At Parmalat, the diary group, by contrast, money appears to have been siphoned off for the benefit of particular individuals.

The divergence reflects underlying differences in the way US and European companies are organised, Prof Coffee argues. In the US, the typical company's shareholders are a widely dispersed group. Being too fragmented to exercise day-to-day control over executives, they attempted to align top managers' interests with theirs by granting them share options.

In 1990, the average chief executive of an S&P 500 Industrial company earned $1.25m (£660,000), of which 92 per cent was in cash and 8 per cent in equity. By 2001, the average chief executive was earning more than $6m, of which 66 per cent was in equity.

The prevalence of share options substantially changed US chief executives' attitudes to presentation of their companies' earnings. "During early periods, US managements famously employed 'rainy day reserves' to hold back the recognition of income that was in excess of the market's expectation in order to defer it until some later quarter when there had been a shortfall in expected earnings," Prof Coffee writes.

"Managers engaged in income smoothing, rolling the peaks in one period over into the valley of the next period. This traditional form of earnings management was intended to mask the volatility of earnings and reassure investors who might have been alarmed by rapid fluctuations."

By the late 1990s, chief executives, stuffed with share options, were doing something different: "stealing" earnings from future periods to create an "earnings spike" to meet market expectations and prevent the share price from taking a dive.

"Although such spikes may not be sustainable, corporate managers possess asymmetric information and, anticipating their inability to maintain earnings growth, they can exercise their options and bail out," Prof Coffee writes. He cites studies demonstrating a relationship between how extensively companies use options and the likelihood of their falling victim to fraud.

European companies, on the other hand, often have controlling shareholders or groups of shareholders, who do not need indirect mechanisms such as share options to control management. They can simply tell them what to do. European chief executives have less freedom to manipulate their earnings. But they also have less incentive to do so.

Fraud still occurs in Europe, but it is a different sort of fraud and different people perpetrate it. Instead of executives manipulating earnings, dominant shareholders use their control to help themselves to the company's assets.

Because European and US companies are vulnerable to different types of fraud, they should adopt different ways of preventing it. While US corporate governance reforms have concentrated, for example, on ensuring that independent audit committees deal with the auditors, this might be less effective in Europe where the board struggles to escape the controlling shareholder's influence.

"Although diligent auditors could have presumably detected the fraud at Parmalat . . . one suspects that they would have likely been dismissed at the point at which they began to monitor earnestly," Prof Coffee says.

He confesses he does not have a simple suggestion on how to prevent European-style frauds. Regulators could require auditors to report to minority shareholders, he says, but he appears to accept this is unlikely to have many takers.

A second objection to his argument that European fraud is different from the American variety is that there are prominent exceptions. What about Ahold and Vivendi? Were not these European companies whose scandals involved earnings manipulation? They were, Prof Coffee says, but that manipulation either happened in their US subsidiaries or in companies such as Vivendi that turned themselves into US-style conglomerates and therefore took an American form.

What of Tyco, a US company where the top managers allegedly appropriated assets for themselves? Prof Coffee acknowledges that the differences between US and European companies are overall tendencies rather than iron-clad rules.

In the polarised world described by Mr Friedman, I suppose we should take some comfort from the small number of Europeans and Americans imitating one another's misbehaviour.

[FaGal]

Financial transparency is good; performance transparency is better
wistechnology.com - Tony DiRomualdo - April 13, 2005


It's barely spring but the temperature is already getting hot in CEO suites throughout the corporate world. Thanks to the creative accounting shenanigans cooked up by the End Runs and World Cons (a.k.a. Enron and Worldcom) of the world, companies are now required to be far more transparent in their financial reporting and operating processes than ever before. Sarbanes-Oxley (in the U.S.) and Basel II (in Europe) are at the head of a cavalcade of legal and regulatory requirements enacted to protect shareholders, employees and customers from financial fraud and accounting sleight of hand.

Some executives, academics and consultants feel these measures are too draconian, particularly those that they believe place top executives and board members in jeopardy of going to jail if the financial statements on which they sign off are the slightest bit inaccurate, let alone intentionally fraudulent.

While the typical CEO is only too happy to pocket the lucrative financial rewards that come with the mantle of leadership, some seem reluctant to accept this degree of accountability - especially if it means personally taking the rap for non-compliance with the law. I guess not many corporate heads are convinced that a minimum-security sabbatical in an orange jumpsuit will be as good for their careers as it seems to have been for Martha Stewart's.

While many might argue that passing laws like Sarbox is overkill, few would disagree that the principle of financial transparency is a good thing for all corporate stakeholders.

But there is another kind of transparency that is also enormously important for organizations. I call it 'performance transparency'. Companies with performance transparency know explicitly what they must do to excel with customers and to outperform their competitors. Most importantly, everyone in the organization knows this as well. Indeed, individual employees can connect what they do in their jobs to the bigger picture of how the organization performs overall and how their customers are affected.

Want to know how performance transparent your organization is? Below are some questions to help you make this determination. Be forewarned – these questions are devilishly difficult to answer precisely. They are also likely to generate heated debate if addressed in a group context. So much the better in my view – stimulating a passionate debate about what drives your organization's performance should be the first order of business in the quest to discover what really matters.

1. How do we make money? This may sound like a dumb question to be asking but I'll bet in the majority of organizations surprisingly few people can answer it accurately. In the performance transparent organization no one has to guess how the company makes money or how what they individually do in their jobs affects bottom line performance.

2. Why do our customers do business with us? What are the reasons customers buy from your company and not your competitors? Price? Convenience? Quality? Fit to need? Aesthetics? Habit? Lack of choice? In the performance transparent company customer traits and behaviors are deeply understood and the value proposition to them is continuously assessed and improved, not merely to keep pace with customer expectations but to stay ahead of them.

3. What determines the best performance of our employees? What factors inside your organization have the greatest impact on the individual performance of workers? In the performance transparent corporation the specific skills, attitudes and behaviors needed to produce excellence are visible and well understood and the organization and people management practices of the company are explicitly designed to create, nurture and sustain these drivers of performance.

4. What characteristics and experiences make the best leaders of our organization? Do we know who the best leaders are and why they are best? Performance transparent companies do and they go out of their way to encourage, develop, assess and reward leaders at all levels of the organization based on the qualities of their most successful leaders.

5. What are the keys to getting promoted? What factors drive promotions within your company? Is the process fair, objective and merit-based? Does everyone understand how it works? Do the most qualified and deserving people advance? In the performance-transparent organization, no one is left wondering how or why people are promoted or terminated. These decisions are based on well known and well understood performance parameters and metrics.

6. What makes our organization truly different from others? What's in your organizational DNA that makes your company unique? Is it a source of pride and advantage? If it isn't, why not? These differences should matter positively and if they do, they should be the focal point of resource investment and management attention.

7. What is the one thing about our organization that we must protect at all costs? This may be the hardest question of all to answer. Is it something your organization possesses? Something it knows? The way in which people think and act? A combination of all three? Indeed if it's more than one thing – so much the better. It will be that much more difficult to copy.

One possible downside of the increasing trend toward regulatory-driven financial transparency is that CEO's may be even less inclined to share important information about financial and operating performance with employees. That would be a shame. Organizations that are intent on achieving marketplace excellence are far more likely to succeed if they practice performance transparency.

[FaGal]

April 17, 2005
Here It Comes: The Sarbanes-Oxley Backlash
By JONATHAN D. GLATER

FOR corporate America, it is always a good time to lobby - even when the public image of business is increasingly associated with executive perp walks.

Last week, business representatives gathered in Washington at an all-day roundtable discussion held by federal regulators and complained about the cost of complying with a provision of the Sarbanes-Oxley corporate reform law. Not one business leader asked to repeal the law, which was passed in 2002 after a wave of financial scandals, or to gut it. Nearly every executive, however, lamented the costs of compliance.

The criticism is striking, given that it comes against a backdrop of continuing revelations of potential fraud, criminal prosecution of fraud and convictions on fraud charges. Bernard J. Ebbers, the former chief executive of WorldCom, is awaiting sentencing after being convicted last month of fraud, conspiracy and filing false reports. Trials of former Enron executives are set to begin this week. Arthur Andersen, audit firm to both WorldCom and Enron, is still fighting to save its reputation and its few remaining assets in a lawsuit brought by WorldCom shareholders.

"There've been so many companies that have gotten in trouble, none of them want to come out now and say we oppose" the law, said Lynn E. Turner, a former chief accountant at the Securities and Exchange Commission who now works at Glass, Lewis & Company, an investment research firm in San Francisco. "It just leaves people with a bad feeling about that company."

He added that the last person whom he had heard was bashing Sarbanes-Oxley was Maurice R. Greenberg of the American International Group, who resigned as chief executive last month amid a review of the company's accounting and who invoked the Fifth Amendment when being interviewed by investigators last week.

"I don't think you're going to see that anymore," Mr. Turner said of executives' campaigning against Sarbanes-Oxley.

Instead, executives are pushing for what they describe as specific changes in the implementation of the law, while singing its praises in general terms.

"There is no question that, broadly speaking, Sarbanes-Oxley was necessary," said John A. Thain, chief executive of the New York Stock Exchange, in remarks echoed by others at the roundtable.

Nick S. Cyprus, controller and chief accounting officer for the Interpublic Group of Companies, was even more specific, praising a provision of the law that has become a particular target for many critics. "I'm a big advocate of 404," he said, referring to Section 404 of the law, "and I would not make any changes at this time."

Section 404 requires companies and their auditors to assess the companies' internal controls, which are the practices or systems for keeping records and preventing abuse or fraud. Something as simple as requiring two people to sign a company check, for example, is one type of internal control.

Of the 2,500 companies that filed internal controls reports with the Securities and Exchange Commission by the end of March, about 8 percent, or 200, found material weaknesses, the agency's chairman, William H. Donaldson, said at the roundtable. That exceeds the 5.6 percent rate that Compliance Week magazine found in a review of the first 1,457 companies to report.

Executives at the roundtable consistently said that complying with Section 404 has been more expensive than they had anticipated, and they questioned whether the benefit - which no one has been able to quantify - is worth the cost.

There are, perhaps unsurprisingly, several studies of the cost of compliance from various business groups. Financial Executives International, a networking and advocacy organization, said last month that a survey of 217 publicly traded companies showed they had spent $4.36 million, on average, to comply with Section 404.

A different survey, of 90 clients of the Big Four accounting firms - Deloitte Touche Tohmatsu, Ernst & Young, KPMG and PricewaterhouseCoopers - found that the companies spent an average of $7.8 million on compliance. That was about 0.10 percent of their revenue, and less than the $9.8 million paid, on average, to C.E.O.'s at 179 companies whose annual filings were surveyed earlier this month in Sunday Business.

The accounting firms noted that as companies become more familiar with Section 404, the amount they spend to comply with it may drop this year, by as much as 46 percent, according to the survey.

Despite forecasts like this, complaints seem to have registered with regulators. William J. McDonough, the chairman of the S.E.C.'s Public Company Accounting Oversight Board, said at Wednesday's event that the agency would consider ways to provide more guidance on 404 requirements in the next few months.

The quiet campaign against provisions of the Sarbanes-Oxley Act may have had something to do with the proposal by Representative Ron Paul, a Republican from Texas, on Thursday to eliminate Section 404 entirely. In a statement, the congressman said the provision "has raised the costs of doing business, thus causing foreign companies to withdraw from American markets and retarding economic growth."

But representatives of institutional investors emphasized that they are the real parties paying the bill for compliance, and that they are happy to do so. Changes to the rules - and certainly to the underlying legislation - are premature, Cynthia L. Richson, corporate governance officer for the Ohio Public Employees Retirement System, said in a telephone interview after the roundtable. "At this point," she said, "the benefits are just starting to be realized and, of course, the first year is going to be somewhat difficult from a cost perspective."

Scott C. Newquist, chief executive of Board Governance Services, a consulting firm to corporate directors, said he felt little sympathy for executives seeking to lighten the burden of the new reporting requirements. After all, he said, the law was passed in the wake of several big corporate frauds. "It relates back to the argument that there are only a few bad apples and it's not a systemic problem," he said. "I would argue that a lot of these problems are systemic."

BEYOND the costs of assessing their internal controls, executives focused on a few specific concerns. Auditors, they said, were too conservative - requiring disclosure of everything, testing controls that could not have a material effect on financial reports - because they worry about second guessing by regulators and plaintiffs' lawyers.

Meeting the demands of Section 404, they added, also took time away from more productive activities. Executives from smaller public companies said they should not have to meet the same requirements as larger companies, which they said have more resources to handle regulatory compliance. Several executives complained that relations with outside auditors had deteriorated.

Raymond J. Beier, a partner at PricewaterhouseCoopers, said that while some of these concerns had merit, 2004 was the first year that the new rules had been in place. "Refinements in the process will better serve the system," he said in a telephone interview after the roundtable.

Ms. Richson of the Ohio pension fund said the environment might only become more charged, and added that she expected companies to try to weaken Section 404 and other Sarbanes-Oxley provisions once the atmosphere turned more friendly to business.

"If you listened carefully, you can reach the conclusion that there's more to come, if the business interests are successful at trying to erode some of the investor protections that were put in place three years ago," she said. "That would not be a good thing."

http://www.nytimes.com/2005/04/17/bu...rint&position=

[FaGal]

Maggiori poteri alla Consob e sanzioni più severe l’Europa scende in campo a difesa del risparmio


STELLA BIANCHI

Maggiori poteri e una struttura rafforzata per la Consob. Sanzioni più aspre e il rischio di finire dietro le sbarre più a lungo. Sotto controllo in particolare analisti finanziari e società di rating, ma anche i giornalisti. Arrivano le prime norme che impongono una maggiore protezione del mercato e dei risparmiatori dopo i crack finanziari dello scorso anno. Il merito va però alla legge comunitaria, approvata in via definitiva dal Senato la scorsa settimana, che recepisce, tra le altre, anche la direttiva europea contro il market abuse, contro cioè l’abuso di informazioni privilegiate e la manipolazione del mercato.
Dopo un iter abbastanza difficile e la minaccia di circa centosettanta emendamenti, è quindi diventata legge italiana la normativa europea contro gli abusi di mercato, che fissa anche i criteri di trasparenza ai quali dovranno attenersi chi emette titoli e i soggetti che li controllano. Le novità principali, che comportano modifiche al Testo unico della finanza, riguardano la Consob, che ha ora maggiori poteri sia nello svolgimento delle indagini che nell’imporre sanzioni e potrà contare su 150 persone in più rispetto all’organico attuale pari a 450 addetti.
L’autorità di vigilanza sulla Borsa potrà avvalersi della guardia di finanza e di tutte le pubbliche amministrazioni, quella giudiziaria in testa, per svolgere le sue indagini: dalla richiesta di notizie a chiunque sia informato dei fatti, alle registrazioni telefoniche, alle audizioni personali fino al sequestro dei beni prodotto dell’illecito. La Consob potrà anche avere accesso alla Centrale rischi della Banca d’Italia. Un accesso che però, secondo un odg approvato dal Senato che il governo dovrà recepire, dovrà avvenire di volta in volta e con riferimento ad ogni singolo nominativo, dietro richiesta del presidente della Consob al governatore.
La Consob potrà anche imporre sanzioni amministrative motivate. Se invece si prospetta un reato, la Commissione dovrà informare l’autorità giudiziaria competente. A sua volta il pubblico ministero dovrà informarla quando ha notizia di abuso di informazioni privilegiate in quella che, quindi, dovrebbe diventare una collaborazione stretta tra magistratura inquirente e Consob.
Diventano più severe le sanzioni e in più quelle amministrative si affiancano a quelle penali. Per l’abuso di informazioni privilegiate, l’insider trading, si può arrivare fino a 3 milioni di euro di multa e alla reclusione fino a sei anni. Il giudice può aumentare la multa, all’interno di certi parametri, se questa risulta inadeguata al danno prodotto. Alla multa si può aggiungere una sanzione amministrativa fino a un massimo di 3 milioni di euro, aumentabile anch’essa. Allo stesso modo, per il reato di manipolazione del mercato, o aggiotaggio, è prevista una multa fino a 5 milioni di euro e la reclusione fino a sei anni. Anche qui il giudice può aumentare la multa e può esserci in aggiunta una sanzione amministrativa, anch’essa fino a 5 milioni di euro e anch’essa aumentabile. Potrà essere punito anche chi ostacola la Consob nell’esercizio delle sue funzioni di vigilanza con la reclusione fino a due anni e una multa fino a 200 mila euro. http://www.repubblica.it/supplementi...060komico.html

[FaGal]

Risparmiatori in mezzo al guado

Una buona e una cattiva notizia. Sono queste le novità che il buon e attento risparmiatore dovrebbe annotare nella sua agenda. Gioire da una parte. Dopo un lungo e tortuoso iter parlamentare, infatti, la legge comunitaria è stata approvata.

Dietro a questa definizione generica c’è infatti il recepimento di alcune direttive della Comunità europea e soprattutto del rafforzamento della Consob. La commissione di vigilanza per le società e la Borsa. Un rafforzamento sia quantitativo che qualitativo.

L’organico, infatti, viene arricchito di 150 nuovi dipendenti. Peccato che da mesi si sia in attesa della nomina del 5° commissario. Ma per adesso va bene così.

E soprattutto più poteri ispettivi e sanzionatori. La possibilità di procedere a perquisizioni attraverso Guardia di finanza. Ma anche l’inasprimento delle sanzioni amministrative e penali per i casi di insider trading e di aggiotaggio.

Insomma un buon passo in avanti nella direzione delle difesa del mercato e soprattutto dei piccoli investitori. Di solito i meno tutelati.

Resta adesso forte l’attesa per l’altro provvedimento che dovrebbe continuare in questa direzione. Il disegno di legge sul risparmio. E si tratterebbe non di un passo ma di un vero e proprio balzo nella strada auspicata.

Nonostante le critiche piovute addosso a questo provvedimento, infatti, alcuni articoli del Ddl toccano lo zoccolo duro degli scandali Cirio e Parmalat. Il conflitto di interessi tra banche e imprese, ma anche tra le stesse imprese e le società che hanno il compito di controllare i loro conti.

E qui arriva la brutta notizia. Il Ddl sul risparmio, infatti, dopo un burrascoso iter parlamentare è giunto al Senato. Ma vista la situazione della politica italiana di questi giorni e dopo gli ammonimenti per i conti pubblici che sono arrivati da tutte le istituzioni internazionali, le priorità del Parlamento sembrano ben altre. E così a Palazzo Madama questo provvedimento rischia di restarci per molto, troppo, tempo.

ALAN FRIEDMAN

[FaGal]

US red tape ties up foreigners
business.timesonline.co.uk - By Jon Ashworth - April 18, 2005


Foreign companies operating in America face an uphill struggle to implement internal controls required by the Sarbanes-Oxley legislation, a survey has found.

Some 40 per cent of companies with a US-listing expected being compliant with Section 404 of Sarbanes-Oxley with only one or two months to spare, according to analysis by Ernst & Young. Failure to meet deadlines risks leaving them exposed to steep fines.

The US Securities and Exchange Commission has given non-US companies a year’s grace to comply with Section 404, which requires companies to report on the effectiveness of internal financial controls.

Ernst & Young found that many companies were not planning any form of pilot to test their compliance before going live with new systems.

Correcting failings in controls can cost companies up to £1 million each, according to Protiviti, a risk consulting and internal audit service firm. As much as 43 per cent of controls implemented by UK companies seeking to comply with Sarbanes-Oxley are deemed non-compliant on first testing.

Sir Christopher Bland, the chairman of British Telecom, has put the cost of complying with Sarbanes-Oxley at up to £10 million a year for a FTSE 100 company.