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Witch Hunt or Failure of Nerve?

Writing in The American Spectator  (€˜White Collar Witch Hunt,” September 2005) the Cato Institute’s Stephen Moore asked why “Republicans so …

Writing in The American Spectator  (€˜White Collar Witch Hunt,” September 2005) the Cato Institute’s Stephen Moore asked why “Republicans so easily accept Neobolshevism as a cost of doing business.”  Chief among the culprits, he argued, are public policy impediments and the “chilling effect” of the Sarbanes-Oxley Act (SOX). Passed on July 30, 2002 in reaction to the corporate scandals, SOX is also the favorite whipping boy of business leaders.  Moore‘s point is that the Republican party as well as many business leaders themselves—both ostensibly sympathetic to a free market economy—seem to accept a socialist remedy every time there is an apparent “market failure.”

Moore‘s point about Sarbanes-Oxley being poorly conceived and hastily passed is beyond dispute. Congressman Michael Oxley told a London group in July 2005 that the legislation was rushed through in a “hothouse atmosphere” following the Enron and WorldCom scandals. Judge Leo Strine, vice chancellor of the Delaware Court of Chancery, (60 percent of Fortune 500 companies are incorporated in Delaware) fiercely attacked the law, calling it a “strange stew” and charging its Congressional adherents with overstepping their boundaries. (Keep in mind that Sarbanes-Oxley was passed by a Republican-controlled Congress and signed into law by the most pro-business Republican President since Herbert Hoover.)

So why did we end up with this fiasco? Partly it was a reaction to the aforementioned frauds, but corporate scandals are hardly new, appearing almost on cue in cycles. Outrage over financial wrongdoing in the 1930s led to the Pecora hearings in Congress where new securities legislation resulted. In the 1970s there was fraud at Penn Square Bank, Bank of Boston and E. F. Hutton. Later in the decade there was the multimillion dollar fraud at OPM involving 19 financial institutions. This was followed by the BCCI banking scandal which revealed extensive bribery, tax evasion, and arms dealing. And let us not forget the famous S&L scandal led by Charles Keating’s Lincoln Savings (which also had links to BCCI) and which eventually cost the public $3.4 billion. For good measure remember also the events leading up to the stock market debacle in 1987 (“Black Monday”) including the collapse of Drexel Burnham Lambert, and the conviction two years later of junk bond financier Mike Milken of securities fraud.

In most cases these scandals had defined limits. Criminal charges were brought, executives heads rolled, fines were levied and a few characters were sent to jail. (To this day one can argue whether or not justice was ill served when Drexel Burnham’s junk-bond king got jail time.)

What’s different about the post-bubble scandals is that Enron et al struck a deep nerve with the American public. By all accounts Enron was an admired company. Fortune pegged it at number seven in its ranking of the 500 largest companies in America and praised its innovative management. BusinessWeek featured Ken Lay and Jeff Skilling on a glowing cover story just months before the scandal broke.  But revelations about corruption didn’t stop at Enron. A tsunami of fraud and misgovernance followed with Adelphia, Arthur Andersen, Global Crossing, Tyco, AOL-Time Warner, Dynergy, HealthSouth, Hollinger and the granddaddy of them all, WorldCom, which admitted to an $11 billion accounting fraud, the largest on record. These were followed by scandals in the mutual fund industry involving improper pricing and dubious trading.

The catalog of malfeasance from Dennis Kozlowski’s toga parties to Ken Lay’s surreptitious selling of $80 million of stock during Enron’s unraveling, demonstrated that these capitalists had nothing but contempt for the system-meaning contempt for the rest of us who abide by the rules. (The fact that 99 percent of business leaders are law-abiding is beside the point. Gallop surveys showed that 75 percent of the country felt that CEOs in general engage in wrongdoing.) 

So is it any wonder why a Democratic Senator from Maryland and an Ohio Republican congressman conjure a hurried piece of legislation when demands to “do something” were overwhelming.  Moore and others, who rightly criticize SOX, appear not to appreciate the fury that people felt and still feel today. It’s one thing to put up with a scandal where a few jobs are lost, but when entire companies go to the wall (Arthur Andersen employed 98,000 worldwide), people’s confidence is shaken. When one’s pension is forfeit on top of this, fear turns to anger.

Where Were the Champions of Capitalism?

As bad as the situation was, this law and many of the regulations that followed need not have been as bloody-minded if US business leaders– presumably believers in free markets–had not been AWOL at the time. Before he died, former Citibank CEO Walter Wriston wondered aloud why the Business Roundtable, for example, a leading business organization he helped found and chaired, was inexplicably silent during this sordid mess.

In 2002, he and I worked on a platform of voluntary principles, loosely based on the idea of the Sullivan Principles that guided companies doing business in South Africa during Apartheid. We believed that American company leaders should publicly affirm their adherence to a higher level of ethical behavior. Wriston felt, and op-editorialized in The Wall Street Journal, that if a few leading CEOs, say at GE, Johnson & Johnson, P&G, and Coca-Cola had come forward at the time to affirm that American business corporations were committed to higher ethical standards-and enumerated those principles–the public might have been at least somewhat re-assured that the Fastows, Skillings and Kozlowskis weren’t sole possessors of the keys to the store. 

Wriston was dismayed by the tepid reaction from the business community. At the time many CEOs said they didn’t feel like setting themselves up as litigation targets or being seen as holier than thou. Wriston’s response was that if Bill Lerach or Dickie Scruggs wants to sue, they’ll sue you anyway. In 2002, I asked Michael Dell, a highly regarded business leader with a clean public image, if he would consider taking the lead in such a proposal. He said it was too risky particularly if there were other corporate frauds in the wings that had yet to surface. The truth is that such risks are always present, but the time had come for capitalists to defend capitalism, not on legal, but on moral grounds.

Such action may not have forestalled Sarbanes-Oxley, but it could have tempered it with a degree of sanity and reduced some of the more onerous provisions such as Section 404 and PCAOB’s Auditing Standard No. 2.

The True Costs

Just what is the true scale of this burden? Let me offer the following:

In a speech to board directors in September 2005, SEC commissioner Paul Atkins said that he feared that the original SEC estimate of the total first year annual compliance cost of SOX–$1.27 billion-is off by a factor of 20, which puts it over $25 billion. The American Electronics Association estimates that the levy is much higher-$35 billion.

In various surveys the total cost of compliance with Sarbanes-Oxley and related new rules set forth by the SEC and the exchanges is pegged at about $4 million to $8 million for a publicly listed company. Keep in mind that in 2004 GE reported spending $30 million on the internal control requirements (section 404) of Sarbanes Oxley alone. AIG, the multinational insurer, spent $300 million that same year, per then CEO Hank Greenberg, in fulfilling the new requirements. 

Almost certainly this burden cannot stand. The cost of compliance will come down in subsequent years as much of the compliance process becomes automated. But it would be wrong to suggest that there is no benefit whatever. Unfortunately too many companies have had slipshod internal controls and their revenue recognition policies have been far too aggressive resulting in a record number of financial restatements. (According to the independent research firm of Glass, Lewis & Co. the number of restatements for the first six months of 2005 exceeded the total for all of 2004.) Investors were not getting a true picture of what was going on.  While it’s true that CEOs and CFOs are now compelled to sign off personally on the financials, most CEOs will tell you that this merely mandates what responsible CEOs have been doing for decades. One director told me that when his board learned that the CFO couldn’t sign off on the quarterly financial statements, alarms went off in the boardroom leading to immediate managerial action to remedy the company’s internal controls process.  So in its own ham-fisted way Sarbanes-Oxley has forced much needed remedial action.

The Real “bolshevists”

The larger question of what has happened to our legal system in the name of fighting white collar crime cannot be laid at the feet of Sarbanes-Oxley, however flawed it is. The real “bolshevists” are elsewhere. The wealth extracting activities of Bill Lerach and others of the plaintiffs’ bar have been in full force well before SOX became law. What’s different today is that the plaintiffs’ bar is being incentivized by pension funds to go after the personal assets of board directors. Institutional investors such as CalPERS, New York City Employees’ Retirement System and the Alaska State Pension Investment Board are often leaders of class actions and also bring derivative lawsuits and private actions. In some case these institutions promise their outside lawyers up to 50 percent of whatever is recovered from individual directors. Their unrealistic and at times outrageous demands drive up legal costs and raise settlement amounts. As recently as 2001, a settlement of $400 million to $500 million was considered big. It is now relatively common.

(Contrary to conventional wisdom, concerns about liability have not deterred most people from wanting to go on public company boards. What’s drying up is the availability of people who have the bandwidth to be on a board in the first place. It’s the personal demands and time commitment that deters, not the legal liability per se.) 

Despite this battering, the business judgment rule is alive and well. Even when he trashed the Disney board for its cronyism and singled out CEO Michael Eisner for Machiavellian behavior,  William B. Chandler III, chancellor of Delaware‘s business court found the Disney board not guilty of fiduciary neglect. Chandler considerably took the chill off companies by ruling that even stupid decisions are protected as long they are arrived at consistent with a duty of care and good faith.  

Last year Cypress Semiconductor CEO T.J. Rodgers told me that SOX and its attendant regulations have been “trivial and expensive” but will ultimately prove “trivial and cheap,” as its processes become automated and routine.  The real long-term danger to our economic system lies with prosecutorial abuse, pension fund aggressiveness and bounty-hunting politicians like New York‘s Alan Hevesi. Cato’s Moore and others are right to call attention to ambitious cynics such as New York attorney general Eliot Spitzer who made it clear earlier that he wasn’t truly committed to implementing any real reform on Wall Street. The mere fact that his political campaign paid Google to link a search for AIG to a website promoting his gubernatorial bid, speaks for itself.       

White-collar witch-hunts come and go; opportunistic politicians will always be with us. What’s more troubling is that business leaders as a  

Group no longer stand up and be counted either because they have lost

faith in themselves or in the system that enables them.

If CEOs do not stand up and take action to reform the “reform” U.S. capitalism may face a greater calamity as the center of global capital markets shifts its focus from New York City to places such as London. Twenty four of the last 25 major IPOs took place in markets outside the U.S. (mostly in London). Many of these share offerings expressly prohibit American shareholders from participating in capital-raising for fear that they will be drawn into America’s litigation vortex or the extra-territorial reach of the SEC. London is rapidly becoming far more robust, in part due to its freedom from  the dead-hand of over regulation. If present trends continue its sheer size and liquidity will be attraction enough. 

When this very point was put to SEC Chairman Christopher Cox at the New York Financial Writer’s Association dinner in New York last week,

he gamely recognized the problem but allowed only that the SEC will “continue to study this closely.”  By the time Cox and his crew get around to a conclusion, the outcome will no longer be in doubt.

It still not too late for business leaders to stand up and speak out. If you would like to speak out, please eMail me at: jpdonlon@chiefexecutive.net


Great piece.

I’m hopeful there are exceptions, but the sad truth is that most CEOs did not reach the corner office by sticking their necks out in public. I wonder if Mr. Wriston would have stepped up to the plate if the Enron era had occurred during his tenure at Citibank.

Gordon G. Andrew
Highlander Consulting
Princeton, New Jersey

Mr. Donlon,

You can assert that Sarbox is less than perfect and that it was passed in haste. But you know quite well if the legislative process had been more drawn out, the eventual result would have been some toothless clauses that would have allowed the thieves to continue their actions. The hordes of lobbyists within the beltway would have seen to it-and been well paid by the thieves.

Your quoting Hank Greenberg is ludicrous. Why should anyone believe his undocumented assertions?

I cannot wait to vote for Eliot Spitzer for Governor. Can you name one other public official with the guts to go against the largest investment banks for phony research and win? Or do you have some “free market logic” to support the pressure by investments bankers on researchers to issue “feel good reports”?

As far as Alan Hevesi, I hope he stays in New York State Government until he gets appointed to the Federal bench. He’ll know when executive ringers show up in his courtroom.

Assume for a moment that a relative of yours beseeched you to invest his or her funds in “small companies.” Wouldn’t be a tad more confident in investing in companies with capitalizations of $75 million and above instead of investing in those companies with capitalizations of less than $75 million in which the same old nonsense could well be taking place? If not, your relative would be well advised to go elsewhere.

If today’s capitalists prefer London to float issues, fine. At some point, investors will get burned by companies not adhering to Sarbox standards and desert that market. It will probably take several incinerations, however, before investors wake up. Then they will not put up their money unless the prospective investment is flying a Sarbox flag 24 hours a day in front of its headquarters.

I’d be curious to hear your opinion as to what actions should be taken with respect to executives who, mirabile dictu, managed to be granted options at several successive bottoms for their company’s stock. Or would investigations on the part of public officials constitute interference in the free market? Nothing could be finer than for officials to round up the evidence and then arrest the miscreants while they are in the midst of a very important social event at their country clubs. The more members who see them led out in handcuffs, the better. Prima facie case, anyone?

Interestingly, the hastily passed Sarbox Act appears to have stuffed out that practice by requiring far more prompt reporting. Would you call the requirement for more expeditious reporting to be “interference in the free market for information”?

Best regards,
Daniel P. Doyle, MBA, Finance
Former Treasurer and Chief Financial Officer
And soon to be a CFO again

P.S. What you say that you and I obtain the prison photos of the various executives serving time and publish them as a book? We could research their backgrounds so as to be able to name their prep schools, their graduate schools, their country clubs and all their affiliations in bios under each photo. Every institution should get its place in the sun. The patterns that we see will be fascinating, don’t you think?

The interesting thing about Sarbox is that most of the provisions in it were already in place, so say many CFO friends and associates of mine.  What was missing was enforcement.  I think that people in responsibility and are compensated appreciably for that responsibility should fear the negative side of their performance as they should benefit from the positive.  Their compensation should not be based solely on market performance as it has become today.  A good portion of it should, but some of it needs to be held over the head of each executive for how he/she performs and how they generate the numbers.  As you should well know, figures lie and liars figure. 


 I am a senior executive with years of experience in both Fortune 100 arenas and also small, entrepreneurial enterprises.  I have seen corruption that due to lack of enforcement has been allowed to flourish and have results reflected in the numbers, or should I say buried.  Who pays the price?  Shareholders and employess 99% of the time.  Why has there been a large departure from the CFO ranks? They don’t want the responsibility, more importantly, the accountability. But they sure wanted the compensation.  Executives should think about how they can run a business within the rules and please the shareholders and employees and make a buck  If they cannot do all three then they should not aspire to such positions of accountability. 


 The increase in whining about that legislation is deafening.  It is not perfect, but it is better than what was there and not being enforced.  The SEC was formed for a reason and that reason was reinforced gratis Mr. Lay et al.  We can certainly have better executives, under the surface, that what Lay represented ultimately.


William Holbrook

Eagle Wing Strategies

J.P. –

Great article

There is definitely a failure of nerve among large corporate CEOs to stand up to this witch hunt. Another example is in the securities industry – take the Putnam market timing issue for example. Market timing is not illegal, never has been illegal yet how many billions has Mr. Spitzer gotten out of the fund companies? How many cases have actually been brought to trial and won by Mr. Spitzer and Mr. Galvin on this? As far as I know, the only cases who have gone to trial have been won by the defendants.

Giving these regulators the benefit of the doubt, assuming the crime in question is as heinous as they say. In Putnam’s case four bad apples and something like $700,000 in trades started the issue. The fallout from the regulators ended up costing shareholders over $2 billion not to mention 2000 people who lost their jobs in layoffs having never been accused of any wrongdoing. Can Mr. Spitzer go on record and say that not even four people in his own division have not done market timing? Mr. Spitzer claimed that one problem with the market timing situation was that large billionaire investors were getting a better deal than small investors. Yet state pension funds are notorious for using their billions for exactly the same thing- including specially negotiated mutual fund pricing.

There is a double standard and a witch hunt with Sox and with securities industry compliance as well as other industries. Litigation has become less of a way to protect the small investor and more of a way to build political name recognition and boost the budgets of the regulators. People cant say these things in public because they are viewed as somehow in cooperation with the accused. The best bet for a CEO, particularly of a public company is to simply roll over, play dead pay the hundreds of millions in fines (rather than twice that in legal defense costs) and hope that they can spin PR to come out ahead.

Its good to see someone in the media speaking about these issues.

Bruce Fenton, President

Atlantic Financial Inc.

Mr. Donlon

Good article and I certainly agree with most of your analysis. I am a senior executive with over 25 years of experience in both Fortune 25 arenas and small, privately held high technology businesses. The limited corruption I have witnessed in contemporaries has largely been the result of greed and the axiom that power corrupts absolutely, but it has been infrequent at best. The real crime occurs after discovery in that there has historically been a lack of enforcement that has been allowed to flourish. This has been largely out of a desire to “protect the shareholder interests by avoiding the public display of that greed and the lack of governance. The price, however, is most often paid by those same shareholders and unaware employees who become victims. Now through SOX, many pay that price twice or more. We who are blessed to have the opportunity to lead an organization from in the executive suite should focus upon how to manage the resources we are provided with honest leadership as our guide, not the manipulation of operating results for our own benefit. For those who cannot run a business within the rules and largely meet most of the desires of the shareholders and employees should not aspire to or retain such positions of accountability. Those who are caught in the insidious game of fraud and at the flagrant abuse of the privilege of commanding from the executive suite need to be prosecuted through enforcement of the statutes we have on the books. SOX was/is an overreaction to the lack of prosecution for which those who are already victims, must pay yet again for the sins of the greedy few. We did not need SOX, maybe the closure of a few loopholes, but not a legalized Salem style witch hunt.

There is also a failure of nerve among CEOs and many board members to stand up to this legalized ‘witch hunt’ and point to the historical lack of enforcement as the real culprit that should be used liberally on that greedy few. There is clearly a double standard and an unbounded and now legally sanctioned witch hunt with the implementation of SOX. Litigation is not the way to protect the small investor or employees but more of a way to leverage and enlarge the budgets of the regulatory bodies for more and expanded witch hunts. Executives in today’s politically correct environment cannot easily vocalize such opinions in a public forum as they are then equated to be in sympathy with, if not in cooperation with, the accused. It all too often perceived as “the severity of the charge” despite the facts and not the level of complicity or degree of guilt as one politician recently opined. Today’s executives and many board members often bow to this artificial remedy and all too often roll over, play deaf, dumb or dead and hope that they can spin the PR and come out ahead when the dust settles.

I am pleased to see someone in the media with an executive background speaking about these issues. Go for it!!!

Dennis A. Grahl

About J.P. Donlon

J.P. Donlon
J.P. Donlon is Editor Emeritus of Chief Executive magazine.