Spotlight: March 25, 2002
The Pitt Bull With No Bite
Or why Harvey Pitt is unable to prevent the next Enron
By Brady Willett

More than seven years ago a vicious battle between the SEC and corporate America ensued after the SEC said they wanted companies to begin expensing stock options.  However, under severe pressure from Congressmen, lobby groups and related interests the SEC eventually surrendered their position.  Years later former SEC Chairman Arthur Levitt said that one of his biggest regrets was failing to get stock options 'expensed'.

The elimination of non-expensed stock option issuance is no longer a top priority for the SEC   In fact, current SEC Chairman Harvey Pitt is against current legislation that would see corporate America expense what is clearly, but perhaps not quantifiably, an expense (stock options). Pitt says, "I would be exceedingly reluctant to reopen this issue.  We have so many other things to do. I don't think the non-expensing of options caused what happened with Enron."  When considering that Enron wrongfully manipulated its financial numbers and that stock options are indeed an expense that is not recorded within the income statement, it would seem that non-expensing options is exactly the type of thing that caused Enron.  

Regardless, the similarities between Levitt, Pitt, and every SEC Chairman before them are apparent: when they leave the SEC they are sure to have many regrets. 

Regrets, I've had a few
Mr. Pitt has been Chairman for less than one year and already he has played a role in the blow-up of the Public Oversight Board (POB).  The head of the POB, Charles Bowsher, offers three reasons why the POB decided to "terminate its existence" after having watched over the accounting industry for more than 25 years:

1) As early as May 2000, "at the direction of then chief accountant of the SEC Lynn Turner", the POB announced that they would start reviewing whether or not the Big 5 (top 5 audit firms) should be allowed to provide consulting services to clients.  Following this announcement the Big 5 said that they would not pay for reviews on auditor independence and that they would no longer meet with the POB until the auditor independence dispute was settled.

2) "Pitt's SEC predecessor, Arthur Levitt, supported Bowsher's (POB's) attempts to monitor internal controls. But after Pitt replaced Levitt and Herdman replaced Turner, the Big Five stopped cooperating with the POB."  Reuters, March 20.

3) Following the Enron debacle Pitt announced plans for a new oversight group. He "consulted frequently with members of the big accounting firms and their industry trade group" , but never bothered to talk with the POB.* 

Three days after Pitt announced his new plans on Jan 17 the POB voted to end its existence.

Regrets: Too many to mention
That Mr. Pitt has snuggled up to the Big 5 appears to be obvious: before becoming Chairman Pitt (then a lawyer) represented many accounting firms that were in the process of attacking Levitt's proposals.  Furthermore, when Pitt took over as SEC boss his first order of business was to replace a POB backer (Turner) with a Big 5 representative (Herdman), and more recently he has said that banning firms from doing audit and non-audit work would  "result in worse audits".

Pretell, how could audits
conceivable get any 'worse'?

Pitt explains himself by saying that banning audit firms from extra curricular activities would be "a simplistic solution to a complicated problem and would produce worse audits than we already have."   However, in forming his opinion remember that Pitt did not speak at any length with the number one audit watchdog (the POB), he has ignored Paul Volcker who says Arthur Andersen should immediately 'separate its audit and consulting businesses', and he has gone against "several bills under consideration in Congress" that intend to "prohibit audit firms from providing nearly all consulting services". Thus, the logical question is where did the Pitt get his ideas? 

The simple answer is that Pitt has given into to pressure from the Big 5 and American Institute of Certified Public Accountants (or the enemy).  To be sure, the new reform package Pitt announced last week still permits non-audit and audit work to mix together so long as certain routes of compensation for new consultant work are scrapped (exactly what the Big 5 and AICPA wanted).  Moreover, Pitt's new oversight group (the PAB) came at the expense of another group the Big 5 openly despised (the POB), and the new group will be SEC appointed with a minority collection of Big 5 representatives (exactly what the Big 5 wanted).

Strangely enough, while Levitt fought against corporate America, accounting firms, and special interest groups, Pitt is fighting with them. 
Undoubtedly, this is something he could regret later.

Pitt On The Defensive
Pitt has offered many reasons for his actions.  To begin with, he states that the media is 'deliberately mischaracterizing' his friendly relationship with accounting firms. Moreover, he concludes that by "consulting accounting firms the profession ended up embracing rigorous reform", and that he has "gotten zero credit for achieving that result".   As for watching the POB blow-up, Pitt argues that he did meet with the POB (no date provided) and that "Nobody negotiated, nobody talked about what kind of a deal we could make."  Taking these things into consideration, has Mr. Pitt been wrongfully been accused of being a corporate shill?

Hardly.  Ask yourself one question: how else can the media characterize Pitt's relationship with accounting firms?  Pitt has spent more time, before and after becoming SEC Chairman, fighting to water down rules intended to keep accounting firms under the microscope rather than backing them up.  As for the Big 5 'embracing rigorous reforms' -- this statement alone defies all logic. The only reason why the Big 5 'embraced' Pitt's ideas was because they were terrified of the real reforms that Rep. John J. LaFalce and countless others were fighting for.  Picture a drowning man with the option of being tossed a life jacket (Pitt's pitch) or a 2 tonne anchor (everyone else who wanted to rip audit firms apart).  Which one would you embrace?  Moreover, while Pitt contends that nobody at the POB 'negotiated' or talked about 'deals', this simply does not make sense: the POB has been the one fighting for new accounting controls for over two years, fighting for SEC support since Pitt took over, and fighting for funding that disappeared once the topic of 'audit controls' was first mentioned by them.

Perhaps if Pitt were to do something, anything, that accounting firms didn't like the media would not be so quick to judge him.  Additionally, the truth may be that the POB didn't want to 'negotiate' or make 'deals' with accounting firms they are supposed to be policing, while Pitt on the other hand did.

"Disclosure is critical for the companies"
Harvey Pitt, March 20, 2002, referring to Fannie Mae and Freddie Mac.

As if the untimely demise of the POB was not enough to damage Pitt's reputation he is doing his best to confuse people on the topic of selective disclosure. At The House Financial Services Committee on March 20 Pitt made some remarks that led many people to believe he was preparing to force Fannie Mae and Freddie Mac to report their financial results to the SEC. Although not covered as widely as Bush's 'devaluation' gaffe, his statements had to be reconciled nonetheless.

"…later in the day, an SEC spokesman issued a statement saying that Pitt was not arguing that Fannie and Freddie should be required to file their financial statements with the SEC. The two groups are exempt from rules requiring publicly traded companies to register new securities and to file financial reports with the agency."
Washington Post, March 20, 02.

"I indicated to the committee that any corporation that raises funds from the public must adhere to the highest standards of transparent disclosure. That was as far as I went."
Harvey Pitt, March 20, 02.

The phrase 'highest standards of transparent disclosure' is, in fact, a poke against the SEC.  Think about it, who supposedly enforces the highest accounting standards today? Is it not the SEC?  If so, why does Pitt not make Fannie and Freddie abide by these standards?

Following Pitt's comments a Fannie Mae spokesman may have confirmed investor's worst fears: "We look forward to working with Chairman Pitt and the SEC on disclosure issues".  Am I missing something?  How exactly does Fannie Mae 'work with' the SEC?   Fannie and Freddie have both fought for years not to report to the SEC and now they are going to 'work with' the SEC on this matter???

Sadly, Fannie Mae and Freddie Mac will decide what they will report to the SEC.  Pitt supposedly has "has so many other things to do".

Restoring Investor Confidence?
Three weeks ago on the Nightly Business Report Stephanie Wood's asked Mr. Pitt, 'Are you able to restore investor confidence?'  Pitt quickly answered, 'Just watch me'.  Question is, what does restoring investor confidence have to do with regulating Corporate America?  At first, this may sound like an odd thing to say.  However, consider this: maybe investor's should and would be considerably less confident if they knew the true financial condition of corporate America?  Moreover, perhaps ensuring that investors remain confident following Enron is what undermines the effort to honestly regulate corporate America?  Didn't Enron occur because investors were looking at a manipulated set of financial numbers?

Point being, no one seemed overly concerned about restoring investor confidence before Enron went bankrupt.  Now, apparently, if the SEC purges all the accounting tricks (fraud) out of financial statements this is supposed to restore investor confidence?  I'm sorry – it doesn't work this way.  To be sure, Enron exploded six months ago and still not one blockbuster accounting reform has come to pass (seemingly confidence has been somewhat restored has it not?).  As such, Pitt has not helped in restoring investor confidence (the influence of his stern rhetoric aside).  Rather, investors have simply forgotten what happened to Enron and Pitt is praying that another blow-up doesn't materialize (God forbid he finds the next Enron himself).

Keeping The Land Mines Underground
Few people specifically blame the SEC or any other regulatory body for what happened to Enron. However, look at it this way: did the SEC know that offshore accounts, the multi-trillion dollar unregulated OTC derivatives market, and off balance debts existed before Enron?  Yes they did.  Furthermore, did the SEC know that these instruments could enable investors to remain 'confident' without knowledge of the true financial condition of many U.S. companies?  Again, yes they did.  Keeping this in mind, here is the kicker – exposing corporate America's hidden secrets would undoubtedly crush investor confidence in the markets (Corporate America).  As well, exposing such secrets would hurt confidence in the SEC (near term).  Investors would query 'why did the SEC allow these problems to flourish?' That said, longer term the SEC would be patted on the back for a job well done.

The fascinating contradiction: If the SEC is worried about the shockwaves regulatory efforts will have on near term investor confidence they cannot possibly do their job properly.

Th
ere is no excuse for Pitt to be confusing the phrase 'restoring investor confidence' with doing his job.  Rather, in today's pro forma, offshore, tax benefits through options issuance world, in order to restore investor confidence he must first smash it: something Pitt has not yet recognized and probably never will.  As a man with few regrets once said:

I did what I had to do
And saw it through without exemption.    ~    F. Sinatra.

Harvey Pitt is exempt from exposing the true financial condition of corporate America because in doing so he would smash investor confidence in both the markets and the SEC.

Pitt is the Wrong Man
Things will not change until the SEC understands that corporate America and the Big 5 are the enemy.  Failing to realize this simple fact of life in the early stages of setting new policies is exactly why new rules that should take one month to finalize take years.  For instance, back in the early 1990s the SEC only needed to fashion one statement -- "companies must use the purchase method of accounting rather than the pooling method" - instead, it took nearly a decade to stop companies from 'pooling' and along the way confidence in stocks such as Cisco remained extremely high because Cisco's 'pooling' practices artificially inflated its bottom line (actual SEC approved numbers mind you – not fraud).   Why did this happen?  Because the SEC had no backbone, and corporate America had to be consulted.

While Pitt should be attacking non-expensed stock options and immediately forcing Fannie and Freddie to abide by SEC's standards rather then their own, instead, as expressed in his 41-page report last week, he is planning many toothless initiatives.  Perhaps realizing that he has done absolutely nothing thus far, Pitt's most recent mantra has been that audit problems 'cannot be resolved by simplistic solutions'.  Hogwash.  If Mr. Pitt really believes this then he is most certainly the wrong man for the job.

The Need for A Real Pit bull
Investors do not need to watch regulators form opinions, consult with corporate backed groups and convince us that widespread accounting problems are really not that severe.  Rather, investors need action!  They need to see the Big 5 broken up into little pieces and every accountant in America terrified that they are going to go to jail if $1 in debt is not disclosed.  They need the SEC (FASB) to change so many accounting rules that, if anything, companies will begin to understate financial results rather than overstate them.  They need to see Pitt on his knees pleading for public support because every U.S. Corporation and accounting firm hates his guts, and every politician thinks he is a crackpot trying to bankrupt companies with too many tough regulations.  Lastly, investors need new oversight groups to become so violent when attacking corporate America that Fox creates a new television program called 'The Accountant Killers' - and millions of investors begin watching this program rather than CNBC.

In sum, investors need a war hero.  Instead they have Pitt…

The Next Enron
Enron didn't collapse because Arthur Andersen reported a clear and honest set of financial documents each quarter.  Rather, the demise of what was once the seventh biggest company in America occurred because Enron management and Arthur Andersen lied to investors.  To repeat: ENRON MANAGEMENT AND ARTHUR ANDERSEN LIED TO INVESTORS!

Mr. Pitt should remember this the next time he is debating reporting standards with Fannie Mae or discussing new audit controls with the Big 5.  Furthermore, investors should remember Harvey Pitt's actions, or lack thereof, after the next Enron occurs. 
Playing the part of the pawn in order to restore near term investor confidence is a most regrettable pursuit for Harvey Pitt to pursue.



* There is some debate as to whether or not Pitt contacted the POB prior to announcing his new plans on Jan 17.  The POB claims he did not, while "SEC spokeswoman Christi Harlan says that Pitt informed Bowsher ''in at least one conversation'' that he intended to create a new panel."

Resources Used:
http://www.house.gov/financialservices/ * ~ http://banking.senate.gov/*
http://www.publicoversightboard.org/  ~  http://www.sec.gov/  ~  http://www.aicpa.org/index.htm

Specific Opinions/Articles
http://www.washingtonpost.com/ac2/wp-dyn/A58900-2002Mar20?language=printer
http://www.washingtonpost.com/ac2/wp-dyn/A59004-2002Mar20?language=printer
http://story.news.yahoo.com/news?tmpl=story&u=/ap/20020321/ap_wo_en_bu/us_enron_investigation_309
http://story.news.yahoo.com/news?tmpl=story&u=/usatoday/20020319/bs_usatoday/3950863

 

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