Investor Worried Reforms Don't Go Far Enough
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Investor Worried Reforms Don't Go Far Enough

Most professional investors believe scandals in corporate America have created a crisis of confidence but are deeply divided over whether new reforms, including the federal law passed two weeks ago, go far enough to improve corporate accountability.

Paul Holmes

Most professional investors believe scandals in corporate America have created a crisis of confidence but are deeply divided over whether new reforms, including the federal law passed two weeks ago, go far enough to improve corporate accountability. Support is strong, however, for vigorous enforcement of anti-fraud laws and harsher penalties for corporate crime.

A survey of 217 portfolio managers and analysts conducted by FD Morgen-Walke, indicates that the adoption of new legislation has done little to restore confidence among a majority of investors. Fifty-four percent of professional investors say recent scandals are not just the work of a few “bad apples,” but representative of a broader crisis of confidence; 40 percent do not believe that reforms included in the Sarbanes-Oxley Act are sufficient to enhance corporate accountability; and 56 percent are yet to be convinced that the creation of a Public Accountability Board to oversee the accounting industry will more effectively curb abuses than the current system.

The harsher penalties contained in the law, however, are viewed as positive steps to rein in corporate malfeasance. Two out of three agree that increasing penalties for CEOs and CFOs who make false statements to the SEC or do not certify financial statements will enhance the accuracy of financial reporting, and some 68 percent think the provision that CEOs and CFOs must forfeit profits and bonuses when earnings are restated due to securities fraud will be an effective deterrent.

“This survey, including the thoughtful commentary offered by many investors, has revealed frustration and even anger over recent corporate fraud and accounting scandals,” said Gordon McCoun, senior managing director of FD Morgen-Walke. “There is also significant doubt that confidence in corporate financial reports will be restored by the recent reforms enacted by Congress.”

Among comments on the current reforms: “I’m not convinced that a lot of the new legislation will have much effect. Cheaters will be cheaters—they may find a new way to do it,” said one respondent. Added another: “More money for the SEC budget is entirely different than granting the SEC more power. Without the power, the money, albeit helpful... will not solve the current problems.”

The results also show support for other reforms under consideration by lawmakers and regulators. Nearly three out of four (73 percent) favor the expensing of stock options, with just over half saying they would be more likely to invest in a company that expenses stock options than peer companies that do not. The expensing of stock options was not addressed in the recent legislation, although a growing list of corporations including General Electric, Coca-Cola, and Bank One have announced plans to adopt such accounting.

On stock options, one respondent commented: The problem is twofold. Not expensing options is fraud as they are clearly an estimable cost (like insurance losses). Options are also an inferior incentive as they are lottery tickets. Management is encouraged to game numbers to get compensated instead of focusing on the bottom line, which is how shareholders get paid.”

Said another, “The current accounting policy for options is a travesty. Given the ‘crisis of confidence’ taking place, the tech industry needs to wake-up and recognize that the options ‘free lunch’ is over. They will be measured by the same yardstick applied to all other companies in all other industries.”

Nearly four out of five (79 percent) favor a rule requiring all companies to have a majority of directors be independent—supporting a change proposed by the New York Stock Exchange.

“A majority of institutional investors favor actions that are not currently required for all public companies,” says McCoun. “At the same time, many investors noted the U.S. already has the most extensive body of securities regulations in the world, and were skeptical that enacting new regulations will achieve the desired results.

“These investors are saying, in effect, that integrity and morality cannot be legislated—but financial manipulation can be deterred if the penalties are severe enough.”

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