The Corporate Reform Weekly 5/5/03

The Corporate Reform Weekly
May 5, 2003

NEWS
The Wall Street Settlement

Last Monday, State and federal regulators announced a $1.4 billion settlement with 10 Wall Street banks. For details see last week's edition: http://www.citizenworks.org/news/index.php?id=77

A number of key developments and worthwhile commentary followed Monday's settlement. The highlights are as follows.

SEC's Donaldson rebukes Morgan Stanley's Purcell for not being properly concerned

In perhaps the most telling development last week, SEC Chairman William Donaldson made a very public rebuke of Morgan Stanley CEO Philip Purcell, who had earlier in the week said that he didn't see "anything in the settlement that will concern the retail investor."

Donaldson responded with an angry letter - "I am deeply troubled that you would suggest that Morgan Stanley's conduct, as described in the Commission's complaint, was not a matter of concern to retail investors." Purcell quickly apologized and expressed "deep regret."

But the episode showed that the slap-on-the-wrist settlement had in fact sent the message that Wall Street shouldn't be concerned. After all, for Morgan Stanley, $50 million in penalties and disgorgement is less than half of what the $32-billion-a-year firm takes in during a single business day.

The charges against Morgan Stanley were indeed serious. Regulators alleged that Morgan Stanley paid $2.7 million to other firms to provide research coverage on companies whose Initial Public Offerings were underwritten by Morgan Stanley and that it also compensated its research analysts based on how much investment banking business they generated. In a separate investigation, Morgan Stanley also paid $1.65 million to settle charges for failing to preserve e-mails.

But given the anemic settlements, perhaps we can understand why Purcell was not particularly concerned.

See "The Reeducation Of Philip J. Purcell" by Dan Ackman of Forbes Magazine: http://www.forbes.com/2003/05/02/cx_da_0502topnews.html

Also see "Critics Want more Corporate Remorse,' by Chris Sanders of Reuters: http://www.reuters.com/financeNewsArticle.jhtml?type=businessNews&storyID=2679307

To read Donaldson's letter, see:
http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1051389676135&p=1012571727088
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Grassley, Baucus introduce legislation to make sure settlements are not tax deductible

Senators Charles Grassley (R-Iowa) and Max Baucus (D-Mont) last week expressed concern about one of the many criticisms levied against the $1.4 billion settlement with the 10 Wall Street banks -- that a sizeable chunk of the settlement might be tax-deductible, essentially pinning the fine on taxpayers.

So Grassley and Baucus introduced the Government Settlement Transparency Act of 2003, which promises to make sure that nothing is tax deductible in any settlement with any level of government that involves payment for potential wrongdoing.

According to Grassley, about two-thirds of the settlement could be tax deductible. But nobody was exactly sure how it would all end up.

"Our responsibility is to end all imprecision," Grassley said. "Otherwise some creative people will try to get out of paying whatever they can, and the rest of the taxpayers will bear the burden."

At last week's press conference announcing the settlement, Spitzer said that it was the lawmakers in Washington who write the tax codes and thus it was up to them to handle the tax-deductibility question.

For more, see http://grassley.senate.gov/releases/2003/p03r04-28.htm
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Did Spitzer prevent SEC from giving more to investors?

A Bloomberg News article by Robert Schmidt suggests that "New York Attorney General Eliot Spitzer and other state regulators rebuffed a Securities and Exchange Commission plan to give twice as much money to investors from the $1.4 billion Wall Street Settlement." (See "Spitzer, States Rebuffed SEC on Giving More Money to Investors": http://quote.bloomberg.com/apps/news?pid=10000103&sid=aSWKVHFQunLU&refer=us )

Less money for restitution, of course, means more money for the states. However, in many states the fines go right into the states' general funds, so only a small percentage would go to fighting corporate crime.

A New York Times column by Baruch professor Seth E. Lipner suggests that the $387.5 million restitution fund should instead go for better enforcement in the future, arguing that the problems addressed in the settlement arose in good part from lax enforcement. (see "The Case Against Restitution" http://www.nytimes.com/2003/05/02/opinion/02LIPN.html )


More recommended reading on aftermath of the settlements

"Why Wall Street's settlement is a joke on the trusting rubes", by Jay Hancock, Baltimore Sun

This article explains how despite the settlement nothing has really changed on Wall Street. "The point I'm trying to make is that wise investment advice in 2003 is the same as in 1993 or 1923. Educate yourself. Do your own research. Don't rely on Henry Blodget or Eliot Spitzer. Stocks are risky, and Wall Street cares more about itself than it cares about you. To suggest otherwise would be the biggest fraud of all."

See: http://www.sunspot.net/business/bal-bz.hancock30apr30,0,4868058.column?coll=bal-business-indepth


"For Wall Street, Fines are a Day's Pay," by Dan Ackman, Forbes.com

This article does a nice job putting the settlement into perspective. "There are reasons for skepticism," Ackman writes.

See: http://www.forbes.com/2003/04/29/cx_da_0429topnews.html
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"Brokerage Settlement Leaves Much Unresolved," by Kathleen Day of the Washington Post

This article explores some lingering questions. "Among them are how to parcel out the $1.4 million settlement, how to create uniform rules to govern company research and investment departments, and how to change the regulatory system to prevent widespread abuses from recurring...Agency officials...say the SEC needs specific rules to address conflicts of interest between stock researchers and investment bankers and in how shares of initial public offerings are handed out to clients."

See: http://www.washingtonpost.com/wp-dyn/articles/A57318-2003Apr29.html
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"Broader Conflicts Disclosed" by Walter Hamilton and Josh Friedman, of the Los Angeles Times:

The article looks into the conflicts of interests that existed between banks. "It has become clear in the last year that analysts whose firms do investment-banking business for the companies they cover have a huge incentive to tout the stocks to curry favor with management to win corporate-financing work. But the documents show that even firms with no direct investment banking ties to a company may have hidden conflicts."

See: http://www.latimes.com/business/la-fi-analyst30apr30,1,6585738.story

Also see "Shopping Spree by the Famous 5" By Gretchen Morgenson of the New York Times: http://www.nytimes.com/2003/05/04/business/yourmoney/04WATC.html
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"Wall Street Investor Settlement Plan Could Take Years," by Greg Retsinas of the New York Times

This article looks at how the $387.5 million in restitution may take years to become available.

http://www.nytimes.com/2003/04/30/business/30SETT.html
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Finally, USA Today has a nice Q and A that can help you determine whether you are eligible for restitution under the settlement.

See: "What to do if you can make claim," by John Waggoner http://www.usatoday.com/money/industries/brokerage/2003-04-29-qna_x.htm
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In the States
California

Corporate Three Strikes Law headed for State Senate Vote

The California Senate Judiciary Committee last week approved a Corporate Three Strikes Law by a 5-2 vote, clearing the way for a full Senate vote. The law would apply the same standard that Californians already apply to street criminals: three strikes and you're out. For corporations, that means that convictions for three major felonies in state or federal courts would result in a corporation losing its ability to do business in the state of California, which by itself is the fifth largest economy in the world. The third felony, however, must be in California.

The bill (SB 335) was introduced by State Senator Gloria Romero. "Most people in California understand the phrase ?'three strikes'," Romero told the LA Times. "Why should white-collar crimes be enforced less seriously?"

This bill is truly a landmark effort that, if enacted, would send a strong message to corporations that repeatedly break the law because they see no credible threat of enforcement.

For more, see: Senator Proposes 'Three Strikes and Out of Business' State Law
: A company's third felony conviction would bring a ban on operating in California" by Carl Ingram of the LA TIMES http://www.latimes.com/news/local/la-me-three30apr30,1,3187087.story

Also check out: http://www.corporate3strikes.org

Also see: "What About Three-Strikes-and-You're-Out for Corporate Criminals?" http://www.commondreams.org/views03/0307-02.htm

To see what you can do to help this legislation pass, check out This Week's Action Items
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In Washington
Congress
Stock options debate rages on

Now that the Financial Accounting Standards Board (FASB) has determined that stock options should be counted as an expense, opponents in Congress are doing all they can to thwart this decision.

For example, last week, Senators John Ensign (R-Nev.) and Barbara Boxer (D-Calif) have introduced the Broad-Based Stock Option Plan Transparency Act of 2003, which directs the SEC to spend three years studying the effect expensing options would have on the economy, a delay tactic. It also calls for options to be disclosed more thoroughly.

A similar bill has been introduced in the House by Reps. David Dreier (R-Calif.) and Anna Eshoo (D-Calif.), also called the Broad-Based Stock Option Plan Transparency Act of 2003.

Senator Ron Wyden (D-Ore.), meanwhile, has introduced the Prevention of Stock Option Abuse Act of 2003 (S. 690), which would require disclosure and restrictions on options, but not expensing.

But Senators John McCain (R-Ariz.) and Carl Levin (D-Mich.) remain vociferous supporters of expensing options. They have introduced the Ending the Double Standard for Stock Options Act (S. 182) to end the abuse of stock options.

"Stock options are the 800-pound gorilla that has yet to be caged by corporate reform," said Levin. "Corporate scandals have shown how current U.S. accounting rules are fueling stock option abuses."

Meanwhile, FASB still has to figure out a formula for valuing options before the rule change can be adopted by the SEC.
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Public Company Accounting Oversight Board
PCAOB official lays out plan for inspections of the Big Four

The head of inspections at the Public Company Accounting Oversight Board, George Diacont, said last week that when the PCAOB investigates the Big Four accounting firms, as it has promised to do, it look closely at how the auditors run themselves.

Diacont said PCAOB investigators would look at quality-control measures, the tone of top management, compensations, and promotions.
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In Business
Scandal
Firms that restated earnings try to claim refunds from the IRS

Corporations forced to restate earnings because of accounting fraud are now trying to get the IRS to give them a refund based on their restated earnings , the Wall Street Journal reported Friday.

For example, WorldCom, which restated earnings by more than $9 billion, has already collected refunds of up to $300 million based on its restatements.

Enron, HealthSouth and Qwest, all of which had major restatements due to fraud, were also reportedly seeking refunds.

Upon hearing about this, Senate Finance Chairman Charles Grassley (R-Iowa) said the he will "encourage Justice to take aggressive action against the companies and individuals who were in on the con."

For more see: Firms Want Refunds Of Tax on Fake Profit, by By Anitha Reddy and Christopher Stern of the Washington Post: http://www.washingtonpost.com/wp-dyn/articles/A7656-2003May2.html
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U.S. files new charges against 11 Enron executives

The government case against Enron got some new life last week as prosecutors announced three distinct indictments involving 11 executives

1) Prosecutors charged former CFO Andrew Fastow with 31 new counts on charges ranging from tax and securities fraud to money laundering and insider trading. Fastow, the alleged mastermind behind Enron's complicated off-the-books accounting, was hit with a 78-count indictment back in October.

2) Prosecutors charged Fastow's wife Lea with fraud, money laundering and tax violations for her role in helping her husband profit from shell companies and skirt rules on wind farm ownership

3) Prosecutors charged eight executives in Enron's broadband division with promoting the division as a runaway success even though prosecutors say the division was never operational, pumping up the division with false accounting and phony sales. One phony video-on-demand deal, known as Braveheart, allegedly generated $111 million in false profits.

For more, see "U.S. Indicts 11 Former Enron Executives" by Kurt Eichenwald of the New York Times: http://www.nytimes.com/2003/05/02/business/02ENRO.html
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Tyco announces $1.3 billion in accounting errors

Tyco, the international conglomerate that fell apart last year under the greed and incompetence of former CEO Dennis Kozlowski, last week announced it had discovered $1.3 billion in new accounting problems, which resulted in a quarterly loss of $467.9 million. Tyco has now readjusted earnings by roughly $6 billion since Kozlowksi left last year.

One interesting angle to this story is that in December, lawyer David Boies completed a months-long internal probe of Tyco by saying there was no evidence of "significant or systemic fraud."

In January, Tyco sold some $4.5 billion in convertible bonds.

For more, see "Tyco Finds $1.3 billion in Accounting Errors" by Brooke A. Masters of the Washington Post: http://www.washingtonpost.com/wp-dyn/articles/A62679-2003Apr30.html
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ACTION
Fighting Back

Shareholders continue to battle executive pay with a boost from Buffett

Shareholders continue to remain active in battling the excesses of executive pay. Of more than 1,000 shareholder resolutions at large corporations, roughly 30 percent are related to executive pay.

At Apple, for example, shareholders approved a proposal to treat stock options as expenses. A similar proposal at IBM fell just short of a majority. Meanwhile, a proposal at Hewlett Packard that would require shareholder approval of generous "golden parachute" severance deals narrowly passed.

On Sunday, investing guru Warren Buffett, speaking at the annual meeting of Berkshire Hathaway, told investors that shareholders need to become more active in combating excessive pay. Buffett said that there was "probably more misdirected compensation throughout corporate America in the last five years than in the 100 years before that."

For more, see "Demands from shareholders for greater transparency," by Andrew Hill and Caroline Daniel of the Financial Times: http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1051389737039

Also see "Buffett Urges Corporate Reform," by Bill Rigby of Reuters: http://www.reuters.com/newsArticle.jhtml?type=topNews&storyID=2680432
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Public Citizen releases new documents detailing Enron's Washington influence

In many ways, it's an old and familiar story: Enron officials lobbied heavily in Washington for a broad deregulatory agenda, using their money and connections to get what they wanted with great ease.

But new documents obtained by Public Citizen show just how entrenched Enron was in Washington, particularly at the Clinton Treasury Department. The documents feature such gems as personal letters between former Treasury Secretary Larry Summers and former Enron CEO Kenneth Lay, as well as numerous e-mails and meetings between Treasury and Enron officials.

Enron also lobbied for the deregulation of derivatives markets, which ultimately became law thanks to former Senator Phil Gramm.

"These documents help explain how Enron used its money and connections to distort government policies in a way that give it a free rein to cheat consumers," said Tyson Slocum, research director with Public Citizen's Critical Mass Energy and Environment Program.

For more on Public Citizen's Enron documentation, see:
http://www.citizen.org/pressroom/release.cfm?ID=1408
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This Week's Action Item

Don't let Wall Street get away with shifting the cost of the settlement onto taxpayers

Regulators handling the $1.4 billion settlement with 10 Wall Street banks did not structure the deal to ensure that the banks could not write off the cost of their settlements. What this means is that taxpayers will wind up paying for the settlement, further weakening an already anemic settlement.

To attempt to prevent this, Sens. Charles Grassley (R-Iowa) and Max Baucus (D-Mont.) have introduced the Government Settlement Transparency Act of 2003, which promises to make sure that nothing is tax deductible in any settlement with any level of government that involves payment over potential wrongdoing.

As This Week's Action Item, please ask your senators to support the Government Settlement Transparency Act of 2003. Tell them that Wall Street banks shouldn't foist their costs onto the little guy anymore.

For details on the legislation, see: http://grassley.senate.gov/releases/2003/p03r04-28.htm

To contact your senators - http://www.senate.gov/contacting/index.cfm
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Californians: Support the corporate three strikes law

Now that the California Senate Judiciary Committee has approved the Corporate Three Strikes law, the entire Senate will have a chance to vote on this important and historic piece of legislation.

The law would apply the same standard that Californians already apply to street criminals: three strikes and you're out. For corporations, that means that convictions for three major felonies in state of federal courts would result in a corporation losing its ability to do business in the state of California, which by itself is the fifth largest economy in the world. The third felony, however, must be in California.

If you live in California, please call up your State Senator and express your support for this landmark bill. For information on contacting your State Senator from California, see: http://www.sen.ca.gov/ftp/SEN/senplan/Zip.htp

To help out with local press conferences and other work relating this bill, contact Margaret Strubel at the Foundation for Taxpayer and Consumer Rights: 310-392-0522 or [email protected] .

For arguments on supporting the Corporate Three Strikes Law see: "What About Three-Strikes-and-You're-Out for Corporate Criminals?" http://www.commondreams.org/views03/0307-02.htm
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News summaries based on original reports in other publications are prepared by Citizen Works staff and are not created, sponsored, approved or endorsed by the publications to which the original reports are attributed.