Back in Business
After Enron and Sarbanes-Oxley, an Aggressive SEC Cracked Down. But a Favorable Political Environment Finds Corporations Battling Back.
Posted May 28, 2005 5:40 AM CST
By John Gibeaut
The full-page color newspaper ads that ran March 9 carried a chilling headline: “It destroys your jobs. It raises your taxes. It takes your money. And it’s all legal.”
The subject: the latest ranking of state court systems, from best to worst, by the U.S. Chamber of Commerce’s Institute for Legal Reform. The primary target audience: individual Americans, each of whom loses $845 a year to the cost of lawsuits, according to the ads.
“It’s enough to make you scream,” the ads declare.
While the cause du jour was state court systems, the paid editorials just as easily could have decried any number of sore spots for big business--from federal bankruptcy law to the Securities and Exchange Commission.
As the furor fades over the corporate scandals that rocked the early part of the decade, business groups and trade associations have begun to bite back, saying they have had it up to their ears with restrictions imposed through legislation, litigation and regulation, regardless of the source. Far and away the most aggressive outfit is the chamber and the affiliated institute, which seek nothing short of a business-friendly overhaul of the U.S. civil justice system.
The chamber and its allies scored a big confidence booster in February when Congress easily passed legislation that would steer many class actions into the federal courts, which business assumes will be less accommodating than state-court juries in doling out damages. But besides the highly visible and successful class-action campaign, the business lobby is picking up the tempo below the surface, especially in fights with federal regulators from different agencies.
The chamber has painted a big, red bull’s-eye on the SEC.
“Right now, the SEC is a big deal because every public company in the country has to deal with all their new rules and their new attitude,” says the chamber’s president and CEO, Thomas J. Donohue.
Out In Force
After decades of near dormancy, the agency finds itself in the busiest period of its history, issuing new regulations and hauling white-collar lawbreakers into court at a blistering pace. Part of the tension with business interests arises from the SEC’s authority to direct traffic through an economically crucial intersection where regulated public companies, securities exchanges, analysts, brokers, investment bankers and other market players meet, often with conflicting interests.
SEC Chairman William H. Donaldson says he’s disappointed with the chamber’s rush to confront the agency. While the chamber attempts to declare the corporate crime wave over, Donaldson sees business still occupying a precarious perch when it comes to generating needed public goodwill.
“Many Americans are still disillusioned with the business community,” Donaldson says. “This is an unhealthy situation. In the final analysis, corporate America must have the support of the populace, or there will be an even greater demand for government intervention. None of this can happen overnight.”
For the chamber, it’s merely a question of an SEC staff gone wild. In the chamber’s view, the commission is overreacting to congressional pressure to issue regulation upon regulation to enforce the corruption-fighting 2002 Sarbanes-Oxley Act, as well as to competition from state attorneys general, who have beaten the federal agency to the punch in several high-profile cases.
“Nobody’s against regulation,” says Stanton D. Anderson, the chamber’s chief legal officer, who oversees the legal reform institute and an affiliated in-house law firm, the National Chamber Litigation Center. “Nobody’s against enforcement. Nobody’s against trying to right the wrongs that have been done, and there have been some doozies. But the pendulum has swung too far.”
The chamber hardly stands alone as business draws fresh breath from the November elections, which saw Republican gains in state and federal races. Overcome by mandate fever and toting fat checkbooks, the business lobby already has helped President Bush start to spend some of the political capital he says he earned in his campaign for a second term.
The National Association of Manufacturers announced in January the formation of the American Justice Partnership, a coalition of think tanks and smaller trade groups that supports state office candidates, legislation and court rules that are more hospitable to industry. The Business Roundtable has received credit for killing, or at least severely wounding, an SEC proposal to allow shareholders a greater voice in corporate director elections. Often linked to the chamber by association, the Business Roundtable is composed of CEOs from the nation’s 150 largest companies.
Still, the contest isn’t simply big business vs. the rest of the world.
“I think that a lot of people out there have the feeling that business interests are monolithic, when in fact they are not,” says Thomas J. Lehner, roundtable public policy director. For instance, he points to asbestos litigation, which pits manufacturers against insurance companies.
Lehner and others also distinguish the chamber’s in-your-face style from the roundtable’s more laid-back methods, such as a massive letter-writing drive it waged against giving shareholders a say in director elections.
“It’s not that we don’t have a unified voice, but we do have a different approach,” Lehner says. “We’re more judicious in picking and choosing our battles.”
For pure bluster and big bucks, the ubiquitous chamber remains a breed apart. Whether it’s pouring money into state elections, going to court over encroaching regulation or doing some lapel-grabbing lobbying in Congress, few organizations can match the chamber’s intensity. The image doesn’t trouble Donohue.
“We try to do it with good manners and very high integrity, but we do it in an aggressive way,” Donohue says. “I don’t mind the characterization.”
Victory in class actions came at no small cost. The chamber had pumped $168 million into the lobbying effort, which saw the legislation languish for five years because of Democratic resistance. Significantly, however, 18 Senate Democrats and 50 more in the House wound up voting for the Class Action Fairness Act in the end.
“It took two years out of my life,” says Anderson, who came to the chamber in 2003.
“You can’t do that for every issue.”
But it won’t be for want of money. With Donohue’s arrival in 1997 came unprecedented fundraising for the chamber, which had become a second-tier lobby with a faint voice. Chamber revenue from dues and donations had hovered near the $60 million mark in the early 1990s and had dipped to $52.2 million when Donohue came. Under Donohue, income rose steadily, reaching $135 million in 2004. The chamber also acquired a taste for confrontation, a reflection of the brash and sometimes-abrasive Donohue style.
But it took some finesse to get the business community to maintain a unified front on class actions. Anderson says business managed to keep its eye on the ball by sticking to the jurisdictional aspects of the legislation and avoiding the temptation to load it down with troublesome substantive law changes that could have spelled doom.
For example, the ever-present desire to reverse one unpopular court decision or another through legislation would have to wait for another day. And the bill passed, even though it left a gaping exception for securities class actions and for claims generated under state corporate governance laws. It was Anderson’s duty to keep his folks in line.
“One of my jobs was that of enforcer,” Anderson says. “I cut them off at the knees. My job was to go to those people and say, ‘This is the bill, and you ain’t going to get away with it.’ You have to have a measure of discipline.”
The chamber faces a more formidable opponent in Donaldson and the SEC. A Republican appointed by Bush, Donaldson often has sided with the two Democratic commissioners on the five-member body in breaking deadlocks on regulations and enforcement decisions. Political observers also recognize Donaldson not only for shaping the agency’s newfound hard line against corporate corruption but also for effectively muting the problem as a 2004 campaign issue.
Donaldson came to the job in 2003, replacing Harvey Pitt, who had resigned amid criticism that the SEC was ineffective in investigating corporate fraud. At the time, Donaldson was figured for just another caretaker. He was a former head of the New York Stock Exchange, and president and CEO of the insurance company Aetna and of his own businesses. He was just too close to the people the president appointed him to watch. The critics were wrong. But they should not be surprised, says Donaldson, whose plans for the SEC had become an open book during Senate confirmation hearings. Indeed, many of the actions the chamber now complains of are listed in the SEC’s 2004-09 Strategic Plan, released in the summer of 2003. They include increased public disclosure and structural changes for mutual fund boards and greater shareholder participation in corporate affairs.
With more regulation comes more enforcement, with the SEC handling the civil side and the Justice Department prosecuting criminal cases. “I don’t see how anybody could be surprised that the SEC takes a hard-nosed attitude toward people who break the law,” Donaldson says. “We’re not going to change that.”
Established during the Great Depression, the sec almost immediately won praise as one of the most efficient government agencies to emerge from the New Deal. The boom years after World War II began to tell a different story, with the SEC coming in for harsh criticism over its performance on a budget that couldn’t keep up with the workload. That changed after the 2001 collapse of Enron Corp. Corporate houses of cards began to tumble one after the other, at a cost of billions of dollars to investors.
Before the corporate scandals, the SEC’s budget stood at $514 million. By 2004, the budget had grown to $811.5 million, within an eyelash of the $811.1 million Bush wants to give the agency for the budget year beginning in October. The increases have allowed the agency to add 840 new staff members, many of them lawyers and accountants, expanding its workforce by one-third to nearly 4,000.
Enforcement complaints and inquiries rose from 150,000 in 2001, just before the Enron debacle, to 250,000 in 2003. As Sarbanes-Oxley and its accompanying regulations began to take hold, penalties and disgorgements of illegal profits increased nearly sixfold, from $522 million in the year before Enron’s collapse, to $3.3 billion in 2004.
Donohue says he’s all for putting criminals in jail and doesn’t want to roll back Sarbanes-Oxley.
But the problem with the SEC is twofold, as Donohue sees it. First, though he doesn’t cite examples, he says the SEC and the Justice Department have a knack for finding new crimes where none previously existed. “If every accounting error is seen as a criminal act, then they ought to lock up the SEC and every other government agency.”
Second and worse, in Donohue’s view, is a connection between the SEC and the plaintiffs class-action bar that the chamber tried to stifle in Congress. He blames the lawyers for feeding off SEC enforcement actions, which are routinely announced on the commission’s Web site. “Even if it’s an incidental action, right behind it come the trial lawyers.”
Donaldson acknowledges that he sometimes questions when enough is enough. When does solid regulation and enforcement become nitpicking?
“There are certain regulations that are clearly needed and must be absolutely enforced,” Donaldson says. He cites the ban on late trading, the criminal practice of buying and selling mutual fund shares after hours, based on the official price set just before the market closes. That way, investors avoid the risk of the price falling overnight if they wait for it to be set again the next day, as the law requires.
“There are other areas where it’s a little grayer,” Donaldson continues. “Coming at it from the other side, it is impossible to regulate every point of conflict. Therefore, my theory is that we must have a corporate DNA, or embedded ethical philosophy, that says companies should stop well short of the line rather than skate right up to it or even over it. We don’t have that yet.”
While he is careful not to issue a blanket condemnation of corporate America, Donaldson wonders why the chamber has become an adversary rather than an ally. “I would have thought that the Chamber of Commerce, that huge organization, would be more on the side of helping business do the right thing.”
Though Chamber leaders insist they don’t want to turn back the clock, some SEC members and other observers say they find the organization’s actions perplexing from time to time. They wonder aloud why the chamber inserted itself as an amicus early this year in an agency enforcement action against Siebel Systems Inc., a software maker based in San Mateo, Calif.
The SEC accuses Siebel of violating a pre-Sarbanes regulation issued in 2000, commonly called FD, for fair disclosure. FD is supposed to level the playing field for small investors by preventing companies from selectively passing along confidential information to securities industry professionals and institutional investors, which in turn could trade on that knowledge before it became public. Besides maintaining that the SEC lacked the authority to issue the regulation, the defendant company and the chamber, through its in-house law firm, also argue that the regulation violates the First Amendment, though courts regularly separate and restrict the commercial speech at issue from artistic and political expression, which receive higher protection. Some experts say the argument is a loser.
“The chamber clearly has taken some more extreme positions in securities regulation than other business lobbies,” says Joel Seligman, law school dean at Washington University in St. Louis. The co-author of an 11-volume treatise and a securities law casebook, Seligman also is widely regarded as the leading historian of the SEC. “That is a triumph of ideology over good lawyering,” he says.
Seligman and 21 other securities law professors filed a second amicus brief on March 10 opposing the chamber and Siebel in the FD case.
And in an indication that it may not be so closely aligned with the chamber after all, the Business Roundtable sent a letter to the SEC on March 2 supporting the challenged regulation. The letter, signed by roundtable corporate governance chairman Steve Odland, also stated that “a very large majority of our member companies” already had been following similar disclosure procedures even before the SEC adopted FD.
Democratic SEC member Harvey J. Goldschmid, a close friend of Seligman’s, found it curious that the chamber rails against frivolous litigation, then involves itself in the Siebel matter, which Goldschmid also described as frivolous.
“It’s very strange and unproductive,” says Goldschmid, a former SEC general counsel who leaves his seat this summer to resume teaching at Columbia Law School. “This First Amendment stuff is nonsense.”
Even more baffling to SEC officials is the chamber’s headfirst plunge in September 2004 as the plaintiff in a lawsuit challenging the agency’s authority to impose stricter independence requirements on mutual fund directors. It was the first time the chamber had sued the SEC. The new rule requires that at least 75 percent of fund directors, including the person chairing the board, maintain independence from management--an increase from a simple majority. The SEC says it adopted the tough new rule in response to evidence that some manager-directors for leading funds abused their positions to favor themselves, at an estimated $500 million cost to investors.
Donaldson says the chamber’s actions suggest it doesn’t really represent its claimed core constituency of small businesses because mutual funds account for only a minuscule number of the some 3 million businesses the chamber claims as members. Indeed, finance, insurance and real estate firms accounted for only 6.6 percent of the 1,140 businesses responding to the chamber’s 2005-06 National Business Agenda Survey, which ranks members’ legislative concerns.
“I don’t challenge the chamber’s right to question whether we have authority,”
Donaldson says. “But to pick that issue is disappointing.”
OK, so the First Amendment case may not be the best, Donohue concedes. But he says it nevertheless raises a significant issue of just what a company can and can’t say about its business and to whom when its affairs spill into the public arena. And, OK, mutual funds do account for a teensy segment of the chamber’s membership. But Donohue says they are an important segment.
Mutual funds “own stocks of all the major companies that are members here,” Donohue says. “Everybody wants a fair return on their money.”
Ballot Battle Brewing
The SEC, however, likely would face a considerably tougher court fight if it were to revive the shareholder ballot question.
Though the question once was believed dead, Donaldson says he still expects the SEC to continue consideration of whether to give shareholders a greater say in corporate board elections. And Donohue promises the chamber will be right there to do the heavy lifting for the opposition.
Pension funds, labor unions and other large institutional investors long have pushed for access to the corporate election process, both to select directors who represent their interests and, at the same time, to make the rest of the board more sensitive to their concerns. Management’s beef with the idea envisions special interest groups taking over boards with agendas that ignore the welfare of other shareholders or the company itself.
The commission released for public comment in October 2003 a proposal to force corporations to include in their proxy materials the names of shareholder board nominees if certain conditions existed and if the shareholders and nominees met specified eligibility requirements. But what conditions and what eligibility requirements? Would a company’s refusal to enact shareholder proposals that receive majority votes trigger access to the proxy? How much stock would a shareholder have to own to participate? “If it’s the thing that’s on the table, and if they brought it out tomorrow, we’d sue them tomorrow night,” Donohue says.
Supporters and opponents alike had believed that the SEC effectively killed shareholder access in February. That’s when staffers indicated they would not recommend a commission lawsuit against Verizon Communications, Qwest Communications International and Halliburton Co. for spurning shareholder attempts to place nominees on the corporate proxy ballot. The October 2003 proposal had gone stale, staffers suggested in telling the companies not to worry. Editorial writers took it as a sign that Donaldson had knuckled under to the business lobby, possibly to save his job.
Though Donaldson voted with the other four commissioners to put the proposal out for comment, he says he never endorsed it as it was written. But he says he learned from the public input that granting shareholder access is much more complicated than he at first imagined. He also says he is in no rush.
“Nothing has been done on the issue of shareholder access for 40 years,” he says. “We have put it on the table and have had a healthy debate for the past year. I continue to believe that something must be done, but it will take time.”
While critics give the chamber at best a 50-50 chance to prevail in the other cases, a federalism-based argument could wipe out shareholder access. That’s because, with the major exception of Sarbanes-Oxley, matters of corporate governance historically have been left to the states. The SEC can succeed in cases challenging its authority in other areas because it usually can trace the power source to a federal statute that gives it a long reach over public companies and professionals who deal in securities. That same kind of statutory authority for shareholder access may be lacking at the federal level, SEC staffers concluded in a report examining different alternatives for wider participation.
Meanwhile, interest has arisen in amending state laws to transform typically sham corporate elections into the real thing. Currently, most states require only a plurality vote for a director to win or retain a seat. So even if the director casts the only vote in an uncontested election, he or she still would be entitled to take the seat. An ABA task force is examining the possibility of amending the Model Business Corporation Act to require majority votes. About 30 states follow the act.
“Some of us thought the SEC approach, and the federal approach, is the wrong approach,” says former Delaware Supreme Court Chief Justice E. Norman Veasey. “This is a matter of state law.”
Now in private practice, Veasey appointed the task force as Corporate Laws Committee chair for the ABA Business Law Section. Though majority voting sounds simple, it’s not. The task force must address basic yet knotty policy questions before it can arrive at any recommendation. Not the least of those asks what happens if no candidate receives a majority. “The complexity arises from the what-ifs,” Veasey says.
To be sure, the Chamber will be dealing with a different SEC once Goldschmid leaves. By law, his seat must go to another Democrat.
Bush, however, could leave it open and effectively paralyze the commission because the two remaining Republicans could team up and defeat by a tie vote any proposal that comes down the pike, regardless of Donaldson’s position.
But, given perceived public mistrust of corporate America, a neutered commission probably won’t fly. Indeed, Goldschmid expects Bush to follow tradition and allow the Democrats to submit candidates for his seat to the president.
Still, political and ideological unity on the commission is something Donaldson didn’t have when he arrived and something he isn’t necessarily looking for now.
“The unifying factor should be shareholder protection,” he says. “That’s our mission: shareholder protection and prevention of fraud. It’s not to protect Republican and Democratic shareholders. I believe this is an independent agency. It seems to me that extreme political views should be left at the door.”
Donaldson is circumspect about his own future, described by some commentators as shaky after the fall election. But if anyone wants Donaldson to go, Donohue says it won’t be the chamber. It’s a case of better the devil you know than the one you don’t. “It’s a dumb idea,” Donohue says about getting rid of Donaldson. “Who’s going to replace him? You never know. We don’t want to destroy Bill Donaldson. We just want the pendulum to swing back to the middle.”
Two years into his five-year term, Donaldson says job security isn’t important to him. He didn’t take the job for the money. Instead, he says, he wanted to be a part of perhaps the most exciting period in the SEC’s history. Still, while recognizing that he serves at the pleasure of the president, Donaldson says his own job satisfaction also counts.
“I get pleasure out of accomplishing these things,” he says. “Stay tuned.”
As long as he remains in the chairman’s job, Donaldson can be assured of plenty of company. After all, the chamber isn’t going anywhere soon either. “You’re going to see a lot more of the chamber, not less,” Donohue promises.
John Gibeaut is a senior writer for the ABA Journal.