ARCHIVES :: SEPTEMBER 2002 :: LAW & POLITICS

Laying Down the Law
Crackdown on Fraud Signals New Relationship Between Government and Business

By Jeanne Cummings, Jacob M. Schlesinger and Michael Schroeder
Staff Reporters of The Wall Street Journal

A new law to crack down on business fraud marks a dramatic shift in the balance of power between the U.S. government and American corporations.

photograph: Corbis

The president says the new law is aimed at restoring confidence in the stock market

Just two years ago, during his campaign, President Bush courted business leaders by promising to scale back Washington's interference in their affairs, with less regulation and more encouragement of free-market competition. But that effort has been hurt by the stream of corporate scandals in the past year, especially those in industries where the government had reduced its regulation, such as energy and telecommunications.

Now, the oil-executive-turned-politician, who filled his cabinet with former CEOs, is signaling a new direction. This summer, he signed legislation that sharply boosts fraud penalties -- including longer prison terms for white-collar criminals -- and requires corporations to be more forthright in their reports to investors. Mr. Bush said the new law was needed because the corporate fraud had undermined investor confidence in the stock market and threatened the economy.

"America's system of free enterprise, with all its risk and all its rewards, is a strength of our country and a model for the world," Mr. Bush said during the bill-signing ceremony. "Yet free markets are not a jungle in which only the unscrupulous survive or a financial free-for-all guided only by greed. The fundamentals of a free market -- buying and selling, saving and investing -- require clear rules and confidence in basic fairness."

The new law is the culmination of a drive triggered by Enron's colossal collapse late last year. It advanced in fits and starts and appeared at a number of points to have died. At first, concerns about corporate scandals were confined to Enron and its accounting firm, Arthur Andersen. But as corporate-governance scandals spread to Global Crossing, Tyco International, Adelphia Communications, WorldCom and others, and the stock market plunged, momentum built quickly for broader reforms.

'Era of False Profits'

While the White House initially pressed for more-intense enforcement of existing laws, Senate Democratic leaders pushed for tougher legislation. But they had difficulty winning support until late June when WorldCom disclosed its nearly $4 billion accounting fraud, cementing broad bipartisan support for tough reforms.

Among its provisions, the law:

• Establishes a five-member board to oversee the accounting industry, with investigative and disciplinary powers
• Prohibits auditors from offering certain types of consulting services to corporate clients, in order to reduce conflicts of interest
• Raises the maximum penalty for securities fraud to 25 years from 15 years
• Creates a new crime for destroying, altering or fabricating records in federal investigations, punishable by a 20-year prison sentence
• Requires CEOs and chief financial officers to certify financial reports -- that is, sign under oath that the contents are true -- and forfeit their own profits and bonuses when earnings are restated due to securities fraud.

"This law says to every dishonest corporate leader: You'll be exposed and punished," Mr. Bush said. "The era of low standards and false profits is over. No board room in America is above or beyond the law…. There will not be a different ethical standard for corporate America than the standard that applies to everyone else."

The president's harsh tone is just the latest example of the changing relationship between Washington and Corporate America, and the shift away from the government's historically laissez-faire, or "let them be," attitude. Mr. Bush's choice to head the Securities and Exchange Commission, former Wall Street lawyer Harvey Pitt, last year pledged a "kinder and gentler place for accountants." These days, Mr. Pitt says, "criminal charges may be too good for the people who brought about this mess," and he boasts about the number of fraud cases the SEC has launched and the severity of penalties it has imposed.

The Justice Department, which until recently focused mainly on the war on terrorism, is joining the fray, prosecuting Arthur Andersen and heading what Mr. Bush describes as a new interagency "financial-crimes SWAT team, overseeing the investigation of corporate abusers and bringing them to account." Congress is moving ahead with its own investigations into corporate wrongdoing at several companies.

In sum, the early 21st century may be turning into one of those periods in American history -- such as the populist and progressive eras at the turn of the last century, and the New Deal of the 1930s -- where exposure of corporate excesses spurs new government control over business.

Now, as then, the changes are promoted to conservatives and business leaders as the only way to instill confidence in free markets and ensure their viability. "At this moment, America's greatest economic need is higher ethical standards, standards enforced by strict laws," Mr. Bush said.

'Responsible Investment'

The political stakes are high: Not only does Mr. Bush want to keep Americans in the stock market, he wants to persuade them to put their Social Security retirement funds there as well. "Buying stock gives them opportunity to build wealth over the long term, and this is the very kind of responsible investment we must promote in America," he says.

Business and accounting lobbyists have been assessing the damage from the new law. "We know the changes demanded by the legislation will be dramatic and challenging for the CPA profession," the American Institute of Certified Public Accountants says. For decades, accounting firms donated heavily to both political parties, and easily fended off new regulation.

Now, it will be much harder for auditors to look the other way in approving faulty corporate bookkeeping. The new five-member oversight board will have the power to examine audit firms and discipline wrongdoing.

The question now is how much farther the pendulum will swing from big business to big government. Much of that will depend on how badly financial markets and the economy perform over the next few months.

Franklin Roosevelt's reforms, including the creation of the SEC, weren't enacted until 1933, four years after the stock market crashed and at a time when the economy was mired in the Great Depression. The U.S. today is nowhere near that state, and if the economy starts to rebound, the momentum for far-reaching changes could quickly dissipate. The benefits of laissez-faire will still be seen to have outweighed the costs.