TCS Daily

Retoothing the Tiger

By Duane D. Freese - January 16, 2003 12:00 AM

The Security and Exchange Commission's looming Jan. 26 deadline for issuing its final rules that will implement the Sarbanes-Oxley Act on corporate responsibility. A co-author of the bill on Wednesday touted it as vital to renewing confidence in the nation's financial markets.

Rep. Michael Oxley, R-Ohio, keynoted a Heritage Foundation and New Millennium Research Council forum, Retoothing the Tiger: Restoring Confidence in the Security and Exchange Commission, that included Tech Central Station Host James K. Glassman as a panelist.

The 11-term congressman argued his act increased "disclosure and transparency" of corporate finances. And that was vitally important, he argued, after corporate scandals that erupted with Enron's bankruptcy and ended with the biggest corporate fraud in history, the $9 billion WorldCom debacle, shook investor confidence.

Rep. Oxley announced that a recent agreement to significantly boost SEC funding means the Commission will have the resources it needs to enforce its new rules, among them a ban on both loans to and stock compensation for executives, new standards for auditor independence and lawyer's conduct, and additional oversight of corporate audit committees. He indicated that he now hopes to put a spotlight on mutual funds, sending a request Wednesday to Congress' General Accounting Office to review transparency and disclosure of fees, expenses and financial adviser relationships.

Glassman praised Oxley for his efforts to improve disclosure. But he doubted that stuffing the SEC with greater authority and more money, while burdening corporations with a host of new legal requirements, would do investors or the economy much good.

Quoting the 19th Century economist Federic Bastiat: "In the economic sphere, an act, a habit, an institution, a law produces not only one effect, but a series of effects."

"Usually, one effect is seen," said Glassman. "The others are unseen."

In the case of the Sarbanes-Oxley Act, a new corporate-accounting board, criminal penalties for misleading investors and other measures to "increase investor confidence" are what the politicians, pundits and the public focus upon - what they "see".

"What is 'unseen'," Glassman said, "are the effects these reforms have had and will have on the economy". Among these are the costs of compliance; movement of companies out of public markets where regulations have increased; the decline in risk-taking and animal spirits that "as another dead economist, John Maynard Keynes pointed out, are necessary to prosperity"; and the "moral hazard" for investors in the siren song of politicians who suggest that falling stock prices are a result of criminality that the politicians can address - when almost always the falling prices aren't and the politicians' can't.

The SEC, according to Glassman, doesn't need new laws, money or authority to have bite. Instead it needs to reinvigorate its three key missions - to inform investors, fight fraud and promote free capital markets. Lately, he said, it has failed in all three areas.

On the information front, he suggested that Oxley's effort to get out information about mutual fund fees is exactly what the SEC and lawmakers should do - use "the bully pulpit" to educate investors about what's going on. Instead, he said, the SEC "has become obsessed with the wrong things - like proxy voting by mutual funds and forcing lawyers to rat on their clients."

In enforcement of fraud laws, he wondered why "WorldCom is still walking around?" Instead of being "punished with brutality" for promoting phony profits of $9 billion, WorldCom in its settlement with the SEC was not even required to admit any wrongdoing, just go out and sin no more. "What kind of example is this for investors and other corporate managers?" Glassman asked.

And, finally, in the promotion of capital markets, Glassman noted that "a real scandal" was the SEC's failure to approve exchange registration for Nasdaq, an obvious way to deepen and broaden capital markets for the benefit of all investors.

In conclusion, Glassman argued: "We need an SEC that will encourage sensible risk taking - first by broadly educating the public on ways to mitigate the worst kinds of risk through intelligence and diversification; second, by enforcing anti-fraud laws vigorously; and finally by doing all it can to broaden and deepen our capital markets ... and to realize that it is almost always the unseen effects of government regulation that stand in the way of progress that hurts citizens, investors or not, the most."

A second panelist, Lawrence E. Mitchell, a law professor at George Washington University Law School, called for new incentives for executives and corporations to look at the "long term", rather than the "short term". He claimed that the failure to do so threatened the future eminence of the U.S. economy. To turn priorities around, Mitchell suggested setting up depreciation schedules for each industry for the taxation of capital gains. Short term holders would face high rates, as much as 75 percent; after fully depreciating the gains over seven to 10 years, depending on the industry, holders could face a zero tax.

But Glassman noted that the "long-term" is made up of many "short-term" decisions. And while investors should invest in good companies for the long term, they shouldn't be punished if based on new information - such as come out during the Enron scandal - they decided to sell early. Punishing trades in that way would encourage poor management, as executives might figure that they could do what they wanted in the short term as investors were locked in by high taxes for several years, he said.

A more important reform is the elimination of the double taxation of dividends, as dividends can provide a powerful signal to investors about the health of their company and its long-term prospects, Glassman said.

Given accurate information without a load of government tax and regulatory disincentives to investment and the free market can take care of most wrongdoing the best.

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