Man Without Qualities

Wednesday, July 10, 2002

The Talented Mr. Levitt

In the weeks following the breaking of the Enron scandal, Arthur Levitt pointed to his proposed "accounting reforms," such as greater separation of the audit and consulting services of accounting firms, thereby cleverly obtaining laudatory media coverage for his tenure as head of the Clinton SEC. Business Week, among many, provided this obligingly guileless February thought:

"During his tenure as chairman of the Securities & Exchange Commission, Arthur Levitt Jr. took a lot of heat from the accounting industry and Corporate America for his plan to strengthen enforcement of securities laws and require far greater disclosure from companies. At the time, Levitt's comments sounded alarmist to many. Levitt, of course, was right."

It is time - and it has now long been time - to stop listening to Mr. Levitt's clever spin and to call him to account.

Under the management of Harvey Pitt, its current chief, the Securities and Exchange Commission has uncovered quite a few very large irregularities originating in the Levitt years. Mr. Pitt has not required whatever enhanced legislation or regulation or accounting rules or practices Mr. Levitt said he needed to do the job.

Nor do most of the alleged or apparent irregularities have much to do with any of the supposed "reforms" Mr. Levitt hides behind. No one is saying that WorldCom or Xerox or Global Crossing or whatever company hits the screen tomorrow were themselves led astray by consultants, nor is anyone seriously suggesting that the auditors for any of these companies were compromised by imprecations from their consultant partners in need of business (Mr. Levitt's big hobgoblin), nor are we hearing that fancy off-balance-sheet "structured finance' transactions (or the accounting therefor) were the problem. No.

The most serious alleged problem is the old fashioned problem: deliberate fraud and simple lies. WorldCom isn't said to have deliberately and nakedly misstated its expenses because of some nuanced accounting rule or subtle conflict of interest. WorldCom is thought to have just lied. And WorldCom is said to have started doing that a long time ago - while Mr. Levitt was at the helm of the SEC announcing that he was deliberately diverting that agency away from "established companies" to tend to the IPO boom.

The term "established companies" for Mr. Levitt included companies such as Enron, whose stock rocketed upwards because Mr. Lay chatted about e-commerce and broadband trading - and then didn't come down when the Internet boom went bust. Is that the way the stock of an "established" company behaves? Was there anything in any of the public circumstances of Enron that might reasonably have attract Mr. Levitt's attention? What the recent scandals prove is the almost unbelievably bad judgment Mr. Levitt employed in adopting his crude "established/non-established" dichotomy in allocating SEC resources.

While the financial world has known for a while that some new forms of businesses (such as trading in electricity or rentals of telephone wires or broadband sales) have created opaqueness, gaps, quality-of-earnings issues and opportunities for abuse in the financial reporting of companies involved in such businesses. As Pat McConnell, a Bear Stearns accounting expert puts it:

There is little doubt that the financial reporting system needs improvement and likely always will. There are still important areas of accounting, such as some revenue recognition practices, that became generally accepted before there was a conceptual framework for accounting or indeed before there were even any recognized accounting standard setters. These areas need to be brought in line with the FASB's conceptual framework, and updated for our modern business environment. To its credit, the FASB is attempting to do this as its time and budget permits. The natural evolution of business practices will also require constant modification of the financial reporting system. It is almost inevitable that new business transactions will emerge before rigorous rules to account for them. The existence of a conceptual framework helps answer questions in areas where rules have not yet been established, but it is desirable for there to be a formal accounting standard to deal with the situation sooner rather than later.

The SEC had a clear awarness that such problems, and opportunities for problems, had developed in areas of the economy serviced by established companies. Indeed, much of the FASB rules reform in this area was prompted by SEC action. But the SEC's investigatory and enforcement actions did not follow suit. There is no indication that Mr. Levitt directed the attention of his enforcers and investigators towards such companies. It is hard to imagine a more misquided application of agency resources - and Mr. Levitt is responsible for that misapplication. Paying increased attention to such businesses might have made a real difference in some of these cases, unlike Mr. Levitt's mostlky irrelevant "reforms." Enron's collapse prompted much of the Levitt spin regarding his defeated "reforms," but notably lacking from the evidence adduced at the recent Andersen trial was any indication that the consulting/audit threat that Mr. Levitt's "reforms" purported to address played any role in the Enron/Andersen disaster. Nor has that dichotomy surfaced as a contributing cause in any of the other recent scandals.

In short, Arthur Levitt himself has some serious personal media reporting issues. The mounting corporate reporting irregularities are much too widespread to written off as inevitable - especially since Mr. Pitt is finding them and it is increasingly obvious that Mr. Levitt's proposed and rejected "reforms" are and were irrelevant to the real problem at the SEC: Under Mr. Levitt, enforcement of existing laws using standard techniques did not catch or prevent a lot of very serious fraud that is surfacing now. Congress and the media should be asking for a serious explanation from Mr. Levitt - and not settling for his mantra that he proposed reforms that were not adopted.

Rather, Congress and the media should all be asking: "MR. ARTHUR LEVITT. WHAT WERE YOU DOING WHILE ALL THIS WAS GOING ON?"

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