Virtually everyone now agrees that a permissive regulatory environment aided the recent wave of corporate accounting scandals. There were insufficient protections to ensure independent, objective accounting, and little in the way of government oversight, with the Securities and Exchange Commission (SEC) woefully underfunded and understaffed. This invited widespread claims of phantom profits, cheating shareholders out of billions. Unfortunately, these same permissive conditions exist in other areas of corporate governance as well, particularly protection of public health, safety, and the environment. Yet in these areas, the Bush administration has continued to exacerbate the problem, stifling new protections, rolling back regulation already on the books, and gutting enforcement. With no cop on the beat, corporate abuses are bound to increase. Bush’s SEC learned this lesson the hard way. During the 1990s, many in Congress openly scoffed at SEC oversight, and the agency’s budget was frozen. In 1995, Congress overrode a veto by President Clinton to restrict lawsuits against companies for misleading their investors, and later rebuffed a proposal from Clinton’s SEC chief, Arthur Levitt, to bar accounting firms from both auditing and consulting for the same company. In June of 2000, the SEC proposed a draft rule to clamp down on such conflicts of interest -- which many now blame for rosy financial statements -- but encountered fierce opposition from the accounting industry and Congress, and ultimately backed down. For the Bush administration, this situation was just fine. In fact, President Bush’s choice to head the SEC, Harvey Pitt, a product of the accounting industry himself, took the job promising an even “kinder and gentler” approach. And at first, that’s what he delivered, actually proposing to cut the SEC’s budget and then, according to a new bipartisan report by the Senate Governmental Affairs Committee, ignoring clear warning signs of widespread accounting fraud that culminated in the collapse of Enron. Enron’s demise, of course, was followed by the discovery of numerous abuses at other prominent companies, including WorldCom, Global Crossing, Tyco, Adelphia, and Rite Aid. Only then did the administration profess a change of heart. With a banner reading “Corporate Responsibility” as a backdrop, Bush unveiled a proposal on July 9 that he claimed would restore integrity to corporate accounting, mostly by increasing penalties for executives found guilty of financial fraud. At the time, many dismissed this as nothing more than window dressing, which failed to address systemic problems of oversight, enforcement, and conflicts of interest. Yet as evidence of corporate fraud grew and political pressure mounted, the president eventually came around, and on July 30, signed comprehensive legislation pushed by Sen. Paul Sarbanes (D-MD). Among other things, the Sarbanes bill directed new standards on conflicts of interest for accounting firms and securities analysts; authorized a 77 percent increase in the SEC’s budget; and created an independent oversight board to oversee corporate audits, establish auditing standards, and investigate and enforce compliance by accounting firms. Underpinning these measures were a series of lessons drawn from the Enron debacle. First, the federal government has an essential role in protecting the public from corporate misbehavior. This includes setting appropriate standards for conduct and vigorously enforcing those standards. Industry self-regulation -- which previously governed the accounting industry -- is not enough. Second, the government must be provided the necessary resources to do the job. Without proper resources, oversight suffers, deterrence is lost, and industry, motivated by profits, will be tempted to ignore the rules. And third, corporate oversight must be free of conflicts of interests, ensuring sound, independent judgment that reflects the best interests of the public. These lessons have broad applicability to all of government’s regulatory activity, from ensuring safe roads and a healthy food supply to protecting workplaces and the environment. Yet in these areas, the administration has been more interested in scaling back regulatory protections than enhancing or extending them, fostering the same conditions across federal agencies that led to troubles for the SEC. The administration has killed a host of protective rules -- including restrictions on hard rock mining, new energy efficiency standards, and “contractor responsibility” standards, just to name a few -- while doing nothing to address regulatory gaps. Since Bush took office, EPA, for instance, has finalized only one major "economically significant" rule -- and this was ultimately weakened by the White House Office of Management and Budget -- while the Occupational Safety and Health Administration (OSHA) hasn’t produced any. This reluctance to address regulatory gaps is precisely what gave rise to accounting abuses, as conflicts of interest were allowed to fester. For standards that remain on the books, the administration has moved to curtail enforcement efforts, threatening to render them meaningless -- exactly what happened at the SEC. In place of strong enforcement, President Bush has instead emphasized “voluntary compliance” programs that rely exclusively on a company’s goodwill -- and indeed, this is the centerpiece of his plan to deal with global warming, as well as ergonomics hazards, which looks willfully na�ve following the spectacular failure of accounting-industry self-regulation. Meanwhile, the administration continues to propose budget cuts in agency regulatory activity -- again, just like what happened at the SEC -- while stacking scientific advisory panels with conservative ideologues and industry allies, rife with the sort of conflicts the Sarbanes bill legislates against. Indeed, the president’s professed commitment to corporate responsibility has proven incredibly shallow, and seems to extend only as far as accounting reform -- and now even that’s in question. Pitt was reportedly ready to appoint John Biggs, a strong proponent of accounting reform, as chairman of the new oversight board, but caved to accounting-industry pressure. Instead, he tapped ex-FBI and CIA chief William Webster, who chaired the audit committee of U.S. Technologies Inc., which now stands accused of fraud in lawsuits filed by investors. Pitt neglected to disclose this fact to commissioners before their contentious 3 to 2 party-line vote over Webster’s nomination, spelling the end of Pitt's short but tumultuous tenure. He submitted his resignation to President Bush on election night, Nov. 5. At the same time, the administration is urging Congress to appropriate only $568 million to the SEC, more than $200 million less than what the Sarbanes bill authorized. It seems there are some lessons this administration is simply not prepared to learn. For more details, see how the administration’s recent efforts in the following areas mirror the conditions that led to widespread accounting fraud:

• Relaxing Protective Standards
• Ignoring Regulatory Gaps
• Limiting Inspection and Enforcement
• Relying on Industry Self-Regulation
• Supplying Insufficient Resources
• Appointing Foxes to Guard the Henhouse

Relaxing Protective Standards From the very first day, when it immediately issued a freeze on all regulatory activity, the administration has moved to kill a host of public health, safety, and environmental protections at the behest of industry lobbyists -- including restrictions on hard rock mining, new energy efficiency standards, ergonomics rules to protect workers, and “contractor responsibility” standards, just to name a few. As the administration peels back these protections, we are exposed to greater risk of corporate abuse, as the recent accounting scandals show. In the case of Enron, the SEC relaxed efforts to protect against fraud, which the company eagerly exploited to hide billions in losses. Most notably, in early 1992, the SEC granted Enron’s request to radically shift its accounting practices (to “mark-to-market” accounting), but then never bothered to investigate whether these changes were being implemented objectively. This allowed Enron to manipulate and exaggerate estimates of future profits, and book them as representing the company’s present-day value. The SEC also granted Enron an exemption from the Investment Company Act of 1940, which governs companies that engage primarily in investing, reinvesting and trading in securities, without following up as Enron evolved and became more of a trading company. This allowed Enron to avoid limits on its numerous investment activities overseas -- a number of which were used in fraudulent accounting schemes -- as well as the law’s disclosure requirements designed to protect shareholders. Ignoring Regulatory Gaps The administration is doing nothing proactive to address gaps in regulatory protections. A number of important new standards were still in development at the end of the Clinton administration. This included, for instance, regulations to reduce air pollution in national parks, limit runoff from animal feeding operations, and prevent workplace Tuberculosis, as well as head and neck injuries in automobile crashes. The administration has yet to move any of these standards to completion. In fact, the administration is doing the absolute bare minimum in terms of new regulation, answering only to statutory and judicial mandates with the weakest possible standards. EPA, for instance, has finalized only one “economically significant” rule since Bush took office -- in response to a judicial settlement and weakened by the White House Office of Management and Budget -- while the Occupational Safety and Health Administration (OSHA) hasn’t produced any. This reluctance to address regulatory gaps is precisely what gave rise to accounting abuses. As mentioned earlier, former SEC chief, Arthur Levitt, sought to prohibit accounting firms from both consulting and auditing for the same company, but met fierce industry and congressional opposition. In fact, Enron itself wrote to Levitt opposing the commission’s proposed auditor independence rules (which were ultimately abandoned). Knowing what we do now, it’s easy to understand why. In 2000, Arthur Andersen earned $52 million from Enron. Less than half of that, $25 million, came from audit work; $27 million derived from consulting services. This created a powerful -- and obvious -- conflict of interest, which encouraged Andersen to validate Enron’s accounting abuses. Yet only after shareholders lost billions did Congress move to correct this problem through the Sarbanes bill. Limiting Inspection and Enforcement For standards that remain on the books, the administration has moved to curtail enforcement across federal agencies, threatening to render them meaningless. For instance, in June 2002, the administration announced that it would halt enforcement and litigation efforts initiated under President Clinton to force pollution-control upgrades in aging coal-fired power plants. The administration has also proposed to slash EPA’s enforcement budget and devolve many responsibilities to states (though the Senate continues to block this effort), which are generally cozier with industry and reluctant to take enforcement action. Meanwhile, inspections remain amazingly paltry. OSHA, for instance, inspects less than 1 percent of all workplaces each year; in fact, the number of inspections remained relatively flat through the Clinton administration, and actually fell in the first year of the Bush administration, even as the labor force grew by 11.9 percent. This mirrors the situation at the SEC, which is unable to examine the vast majority of filings it receives, reviewing only 2,280 out of 14,060 (16 percent) annual financial statements in 2001. Enron submitted more than 300 filings to the SEC in the decade preceding its collapse, mostly annual and quarterly financial reports. Yet the SEC reviewed only four of Enron’s annual reports -- in 1991, 1995, 1996, and 1997 -- and the last three reviews were largely cursory, conducted as part of other transactional reviews (associated with an Enron acquisition and the public offering of two Enron affiliates). This was hardly unusual; the SEC does not regularly review the annual reports of even large companies. Even in the late 90s, when the SEC became aware of a possible breakdown in the accounting system -- with more frequent filings of financial restatements -- the commission remained largely passive, with no increase in reviews. Not surprisingly, the remote threat of enforcement served as no deterrent to accounting abuses. The commission initiates about 500 enforcement cases a year, about 100 of which involve financial fraud. Generally, these actions are reactive, taken after damage has already been done -- as in the case recently brought against Enron. Before catastrophe strikes, a company that cooks its books has little to worry about. Relying on Industry Self-Regulation In place of strong enforcement, President Bush has instead emphasized “voluntary compliance” programs that rely exclusively on a company’s goodwill -- and indeed, this is the centerpiece of his plan to deal with global warming, as well as ergonomics hazards, which looks willfully na�ve in light of the recent corporate accounting scandals. Honest accounting has depended almost entirely on a system of industry self-regulation. The accounting industry sets its own standards for accounting through an umbrella organization; private accounting firms audit corporate financial statements for consistency with these standards; and corporate boards of directors -- which have a legal responsibility to shareholders, creditors, and the investing public -- must review and sign off on financial filings with the SEC. As discussed earlier, the SEC rarely reviews these filings, and when it does, it merely looks for required disclosures and makes sure that statements are facially accurate; the commission does not perform its own audits. This system of self-regulation failed spectacularly in the case of Enron. For example, Enron’s board members each raked in about $350,000 annually for their service, which included only five annual meetings. This left the board compromised and pliant in the face of Enron’s fraudulent dealings -- nothing more than a rubber stamp for management, according to investigators. The Sarbanes bill seeks to restore public confidence through the creation of the new Public Company Accounting Oversight Board, which will take on many of the responsibilities previously left to the accounting industry. This includes setting standards for auditing practice and independence, monitoring accounting firms for compliance, and issuing fines for misbehavior. Amazingly, before the Sarbanes bill, the accounting industry’s trade association, rather than the SEC, had prime responsibility for investigating and disciplining unethical accountants. Not surprisingly, it had a reputation for leniency. Supplying Insufficient Resources The president’s 2003 budget proposed cutting resources for regulatory activities across federal agencies. For instance, it proposed to cut EPA’s budget by $300 million, including $4 million for federal enforcement work, and OSHA’s budget by $9 million, eliminating 64 full-time enforcement positions. Similarly, Pitt’s first SEC budget proposed axing 57 staff positions, as Robert Borosage of Campaign for America’s Future points out in a Washington Post op-ed on July 9. However, with the wave of accounting scandals, the folly of these cuts became apparent to everyone. According to the Governmental Affairs Committee report, “The SEC’s Division of Corporation Finance employs approximately 330 people, of whom approximately 144 are lawyers and 107 are accountants; together, they are charged with reviewing the public filings of more than 17,000 public companies in the United States.” Needless to say, this leaves much that falls through the cracks. As pointed out above, the SEC reviewed only 16 percent of the annual financial statements it received in 2001. Likewise, because of staffing shortages, the SEC’s Division of Enforcement -- responsible for investigations and prosecution of violations -- cannot be proactive in uncovering fraud. Instead, as noted earlier, investigations are generally initiated only after fraud exposes itself and damage is apparent. The Sarbanes bill recognized the need for additional resources at the SEC, authorizing $776 million in fiscal year 2003 -- significantly more than the $438 million appropriated in FY2002. Yet in recent budget negotiations, the administration is urging Congress to appropriate only $568 million, according to the New York Times. Pitt, to his credit, has publicly acknowledged that the administration’s request will not allow the SEC to undertake important technology upgrades and enforcement initiatives, leaving the commission unable to review the vast majority of corporate filings. “I can’t understand why they are taking this position,” Sarbanes told the Times at the time. “We didn’t pull the $776 million out of a hat. The costs of increasing pay, hiring new staff and increasing the volume of their business presents a case for a higher budget that is overwhelming.” More recently, OMB Director Mitch Daniels has indicated the administration is open to additional appropriations to the SEC, telling CNN’s Lou Dobbs, “If Harvey Pitt needs that amount of money to do the job, we will find it.” Whether this happens remains to be seen. Appointing Foxes to Guard the Henhouse Like Pitt, many Bush appointees were drawn from industries they are now responsible for regulating. For example, Jeffrey Holmstead, now in charge of clean air standards, lobbied on behalf of the chemical industry, and the Department of Interior’s deputy secretary, former coal-industry executive J. Stephen Griles, lobbied to open protected land to oil exploration. These appointees cannot be expected to exercise vigilance over their former employers. As noted above, Pitt came in promising a “kinder and gentler SEC” at precisely the moment the exact opposite was needed. Indeed, he lobbied to oppose the very reforms adopted in the Sarbanes bill, most notably measures to limit conflicts of interest at accounting firms. Pitt has subsequently declared his independence and disavowed himself from his previous views, held only months ago. Yet Pitt's recent actions suggested that the accounting industry still held considerable sway. In particular, Pitt was reportedly set to name John Biggs -- head of a large pension fund and committed proponent of accounting reform -- as chairman of the SEC’s new oversight board, but caved when the accounting industry weighed in strongly against him. Instead, Pitt chose ex-FBI and CIA chief William Webster, who chaired the audit committee of U.S. Technologies Inc., which now stands accused of fraud in lawsuits filed by investors. Amazingly, Pitt neglected to disclose this fact to commissioners before their contentious 3 to 2 party-line vote over Webster’s nomination, spelling the end of Pitt's short but tumultuous tenure. Pitt had become a huge political liability for the administration, and on election night, Nov. 5, he submitted his resignation. Clearly, the fox could not be trusted to guard the henhouse. Nonetheless, the Bush administration has also been stacking scientific advisory boards with conservative ideologues and industry allies. For example, the administration nixed the nominations of a number of accomplished doctors to serve on a panel on childhood lead poisoning, and instead put forth four nominees who are closely allied with the lead industry. The Sarbanes bill, by contrast, directs that only two members of the accounting industry can serve on the new accounting oversight board, ensuring independent judgment in the best interests of the public.