“While attorneys arguably have become too intimately involved in the business decisions of their public company clients, many Boards of Directors have maintained an unhealthy distance from the same. Boards – and particularly outside directors – were conceived of as the shareholders’ representative, yet too often, they are dominated by associates and friends of senior management. Moreover, board membership too frequently has been viewed by outsiders as an honor or a perk instead of a substantive job. Many outside directors have lacked expertise in the relevant industry, and in accounting and financial reporting issues. Thus, Boards were too rarely equipped to uncover and derail the determined efforts of management to cook a company’s books.”
November 1, 2002 Speech by Stephen Cutler, Director, SEC Division of Enforcement at the University of Michigan Law School
The 2001 collapse of Enron and the bankruptcy of WorldCom the next year demonstrated what could happen when management made financial reporting a shell game and directors either overlooked or ignored it. The events gave fresh urgency to earlier initiatives by lawyers, accountants and regulators to better ensure financial statement integrity.42
The result was a groundswell of support for the reform of corporate governance standards and passage of the Sarbanes-Oxley Act in 2002, which imposed federal standards for business conduct, although it left states responsible for direct oversight. Sarbanes-Oxley also sought to improve financial reporting by obliging companies to regularly rotate audit partners and limit the non-audit services that accounting firms could offer. It required that audit committee members be independent directors, with at least one able to interpret financial statements. The audit committee received the power to hire and fire auditors, traditionally a management prerogative. Sarbanes-Oxley finally directed corporate executives to certify their financial reports and required auditors to certify internal controls over financial statement reporting.
As state prerogatives were complemented by federal measures, industry efforts were stepped up. The New York Stock Exchange and NASDAQ revised their listing standards to require boards with a majority of outside directors, and audit, nominating, and compensation committees comprised entirely of independent directors.43
The accounting profession was hardest hit by the scandals. Arthur Andersen, auditor to both Enron and WorldCom, crumbled, turning the “Big Five” accounting firms into the “Big Four.” Sarbanes-Oxley established the Public Company Accounting Oversight Board to more effectively set and enforce standards governing audit firms. The profession itself worked to restore integrity to the audit, launching the non-profit Center for Audit Quality in 2007. With members, including large public company accounting firms, the organization sought to promulgate better practices and inform policy development. With corporate accountability scandals cutting a swath of devastation through the economy of the early 2000s, good corporate governance came in demand, as market participants increasingly integrated it into evaluations of corporate performance.44
(42) June 5, 2014 Corporate Governance in the New Century.
(43) May 31, 2013 Interview with Alan Beller. See, for example, pertinent New York Stock Exchange listing standards.
(44) June 17, 2013 Interview with Harvey Goldschmid; January 31, 2007 Washington Post, “Accounting Firms Form Policy Group.”
Daniel Goelzer served on the staff of the SEC from the mid-70’s through 1990. He began his SEC career in 1974 as a staff attorney in the Office of the General Counsel, and rose through the ranks to become the Commission’s General Counsel from 1983 to 1990. He also worked in the Office of the Chairman and was Executive Assistant to both Chairman Harold Williams and Chairman John Shad. After leaving the SEC, he was partner at the law firm of Baker & McKenzie LLP in Washington, DC until his appointment as a founding Board member of the Public Company Accounting Oversight Board (PCAOB) in 2002. He served as PCAOB’s Acting Chairman from 2009 – 2011 and returned to Baker & McKenzie after his PCAOB term ended in 2012. He was one of the founding Trustees of the SEC Historical Society.
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