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Shining light on the markets
Oct 26th 2000 | NEW YORK
From The Economist print edition
Arthur Levitt’s chairmanship of the Securities and Exchange Commission may be ending with a fight over one of the most fundamental issues in American capitalism: who should be in the know
THE resignation letter is not yet signed, but Arthur Levitt is likely to step down as chairman of the Securities and Exchange Commission (SEC) around the end of the Clinton administration. If so, America’s top markets regulator will depart with all guns blazing. Mr Levitt is currently embroiled in furious battles with Wall Street’s most powerful companies and with the world’s biggest accounting firms. His goal is to improve the quality of information flowing to investors, particularly to the many ordinary members of the public who have recently become participants in the financial markets. With time running out, much remains to be done.
First, Mr Levitt wants to ban accounting firms that audit a company’s books from selling that company other, more lucrative, services. How much is at stake? According to Mr Levitt, it is the very integrity of financial statements. There is plenty of evidence that financial statements often fail to come up to scratch. The number of companies restating their accounts—never in ways that make them appear healthier—has been rising so fast as to have become almost commonplace. Well-known firms whose audited profits shrunk in a restatement include Waste Management, Sunbeam and CUC International, during its merger with Cendant. Investors have lost billions of dollars, and much of their faith in auditors.
How many of these problems are due to conflicts of interest within auditing firms is hard to say. But Mr Levitt is rightly concerned about the way accountants currently sell their services. For instance, it is typical to charge a rock-bottom price for the audit and then huge fees for supplementary consulting contracts to install information systems. Every audit involves many fine judgment calls. Could hopes of a lucrative consulting contract lead to a gentle audit?
Of course not, say the accounting firms. But there is little doubt that nothing worries them more than the prospect of profits forgone through being locked out of consulting. Andersen Consulting produced revenues in excess of $7 billion last year—before its acrimonious split from its accountancy brothers at Arthur Andersen. The prosperous consulting arm of PricewaterhouseCoopers is being sold to Hewlett-Packard for $18 billion.
Congress, which has never been known for valuing straightforward accounting but which does appreciate the value of a well-heeled constituency, has been heavily lobbied on this issue and may soon intervene on behalf of the poor bean-counters (see article). Negotiations between industry representatives and the SEC are in progress, with an eye to a settlement based on disclosure, which Mr Levitt would probably regard as better than nothing.
In a move with even wider implications, on October 23rd the SEC put into effect Regulation FD (for fair disclosure), requiring companies to provide the public with information at the same time as favoured security analysts and portfolio managers. It is hard to imagine a position more consistent with the underlying rationale for American securities law, which was based upon the belief of the late Supreme Court Justice Louis Brandeis that “sunlight is the best of disinfectants” for market and societal failures. Indeed, given the 70-year-old thrust of American financial regulation towards fairness and transparency, it is remarkable that this kind of selective disclosure has been tolerated at all.
Wall Street, however, is feeling aggrieved. The Securities Industry Association, its lobby, issued a letter signed by current or former top executives at 15 major firms blasting the proposal for providing special privileges to rating agencies and the media (to which companies can disclose anything they like, on the presumption that they are conduits to the public). Worse, says the SIA, the result would be less disclosure by companies, which will no longer feel comfortable talking to anyone. Privately, asset managers worry about losing crucial access to extra information. Merely knowing that earnings will come in a bit over or under expectations is a way to earn pots of money.
Collectively, these moves by the SEC are a powerful attack on the Wall Street tradition of trading to benefit a small group of insiders. Mr Levitt aims to eliminate conflicts of interest in the production of financial information and barriers to distributing it. The surprise is that none of the more overt populists in Washington has hopped on the bandwagon. Not that Mr Levitt needs much help in proselytising. Last Sunday night he was on national television decrying stock manipulation; on Monday, he debated before a panel of accountants in New York, then on Tuesday, October 24th, he gave a speech to the accounting-industry trade group at its annual meeting in Las Vegas, of all places, where he appealed to, of all things, its members’ virtue.
“In what other profession is it one’s duty to tell the customer when he’s wrong?” asked Mr Levitt. “What other profession is enshrined in our nation’s securities laws to serve no interest but the public’s? What other profession so directly holds the key to public confidence—the life-force of our markets?” Alas, he added, “it has become clear that the perceived value of the audit is being put at risk.” Was there a cad in the room in favour of such debasement?
Mr Levitt certainly knows what he is talking about. His early education in financial markets came from discussions between his schoolteacher mother and the man who was the custodian of her retirement savings in what was then the second-largest pension fund in the country—her husband, Arthur Levitt Sr. As Arthur Jr likes to point out, his mother never left his father in doubt about who was working for whom.
Mr Levitt helped found an investment firm that is now part of Citigroup, where he fell out with current Citi boss, Sandy Weill. He then ran a stock exchange and part-owned a paper devoted to Congress, Roll Call (since bought by The Economist). A former consultant to his old firm is the Federal Reserve chairman, Alan Greenspan, with whom he often plays golf. He also crossed professional paths over the decades with Robert Rubin, once of Goldman Sachs and the Treasury. It is a peculiar, and under-analysed, feature of the Clinton administration that oversight of the economy and markets has been left to a few old pals from Wall Street.
“He probably has the greatest breadth of knowledge of any chairman of the SEC,” says Michael Lipper, former head of the eponymous investment-management tracking firm, who in the 1960s shared a stock-ticker with Mr Levitt’s nascent brokerage firm.
As early as 1972, Mr Levitt blamed his industry for mistreating small investors. “The issuance of common stock and other securities is predicated on broad public owners,” he said. “Our entire system of broad-based American capitalism is based on this condition.” Yet Wall Street provided plenty of reasons for wise individuals to stay away.
Mr Levitt was considered a possible SEC head under President Reagan but, given his predilections, perhaps it was appropriate that his tenure began in 1993, just as popular enthusiasm for investing, and technology for doing so efficiently, was emerging (see charts). Avoiding turf wars, Mr Levitt used his personal relationships with other regulators to settle inter-departmental spats, spent a third of his time nurturing ties with Capitol Hill, and then devoted his remaining energy to solving issues that could have been taken directly from that speech 20 years earlier.
Top of the list was better disclosure. This included providing details of how brokers are compensated; how exchanges disclose customer orders; revealing a firm’s exposure to derivatives; and spelling out what fees are charged to mutual-fund customers. In none of these areas is disclosure perfect yet. In 1996, a landmark collusion case against the Nasdaq stockmarket resulted in much fuller disclosure to customers of prices that were hitherto open only to brokers. A free SEC website featuring corporate filings has opened up oceans of good information for investors who need to know more than share prices. Disclosure rules and outright prohibitions on political contributions by underwriters have had a huge impact on the municipal bond market, a business that was once driven not by providing cheap financing for local governments but by large campaign contributions for politicians.
For the first chairman of the SEC, Franklin Roosevelt chose Joseph Kennedy, a man widely believed to have had first-hand experience in every dastardly scheme Wall Street had ever thought of, on the theory that a fox was best suited to guard a henhouse.
Mr Levitt’s more honourable background in the industry has probably served him even better. The investment world has often recoiled at his criticisms, and, to be fair, he does sometimes hector and has an overly paternalistic streak. But it never becomes mutinous, if only because the transgressions he attacks are quite widely acknowledged. On the other hand, his frequent use of the “bully pulpit”, rather than binding rules, may mean that his reforms will be easily reversed if he is replaced by somebody with less moral certainty and clout on Wall Street.
Mr Levitt has hinted that he is ready to step down after his record stretch in the job— though the next administration, whatever its bent, might try to keep him on to finish what he started. He has said he would like to head a museum or a newspaper. Failing that, he could, like many successful Americans, retire to Florida where he already has a home, and sail his boat named, appropriately enough, Full Disclosure.