In addition to his role as an advisor to such esteemed companies as The Carlyle Group, Goldman Sachs and Promontory Financial, the 25th—and longest serving—chairman of the Securities and Exchange Commission is now an eloquent elder statesman whose knowledge and experience are without peer. Speaking at the Annual Audit Committee Issues Conference, Arthur Levitt took both a backward glance and a forward look at the regulatory landscape now bedeviling corporate directors, and, in particular, those who serve on audit committees. Levitt, who prior to being appointed to the Commission by President Clinton in 1993, owned Roll Call, a newspaper that covered Congress, and served as chairman of the New York City Economic Development Corp. and the American Stock Exchange, now also serves on the board of Bloomberg. What follows is an edited transcript of his speech.
Let’s talk about steps that need to be taken by corporate boards on their own. In general, I favor elements that improve transparency and accountability. Basic improvements, like giving investors access to the proxy, would push boards to be more proactive, and more sensitive to investor concerns.
But being more accountable is a lot easier when you have the right expertise. Right now, independent board members often don’t have the base of knowledge they need. When someone working every day inside a corporation is presenting information and analysis to the board, there will always be a gap between what they know and what the board knows. This gap is inevitable, but it need not be permanent. That is why I would strongly favor that boards of directors include individuals with financial market experience, and especially expertise in understanding, pricing, and managing risk. With even one member regularly raising challenging questions and issues, boards would be able to press management to think far more creatively about issues such as counter-party risk, operational risk, and so on.
Board service is not an entitlement for retired politicians and executives. It’s a responsibility, and compensation should be earned for meeting that responsibility. I would suggest board members be expected to work much harder for their annual salaries, and that those salaries be paid in some kind of cash-and-stock package that incentivizes the board to think about the long-term. And if executives are subject to clawback provisions, the board should be as well. If we think of board service as a difficult and time-consuming job—which it is, when done well—then let’s pay board members accordingly.
Governance in the Governmental Realm
Of course, none of what you do in your own boardroom will have broad impact unless improved corporate governance is mandated, in certain clear ways, by Washington. For all the headlines on compensation, the real problem is with a fundamental lack of disclosure and meaningful transparency, especially of what is now considered non-material events and issues.
These are matters that investors need to decipher and understand: issues like how companies manage risk in their operations, use leverage, and monitor loan performance. Much of this information, as well as information on key performance metrics—plant utilization, store sales per square foot, and revenue generated from new products and per employee—can be kept comfortably from investors.
Lacking an across-the-board requirement, no companies will offer this information unilaterally, so Congress may need to take such action. Some suggest that the SEC should create stronger disclosure rules forcing company boards to describe how they fulfill their shareowner stewardship roles, including oversight of corporate strategy, risk management and executive succession. The guiding principle is this: Companies can’t over-inform their boards or investors. Except in situations where disclosure would compromise a significant competitive advantage, boards should press management to issue more information to the marketplace.
The Real Governance Problem
For all the failures of corporate governance during the financial crisis, the real failure was in Washington, where a failure of regulatory oversight led to the problems we now are dealing with. The most notable failure wasn’t in the governance of individual businesses, it was in the governance of government.
Reasonable regulation of derivatives, for example, got shelved. Regulatory efforts to keep banks from taking on too much risk were jammed. We had good people in the regulator community trying to do their jobs, but they were not allowed to. We had standards-setters in the accounting profession who were being browbeaten to change the way mark-to-market rules affected bank income statements. We had career SEC investigators who were not allowed to set fines and penalties on corporations unless politically appointed overseers gave their okay– which created an avenue for those same corporations to avoid meaningful punishment. We had bank overseers making reassuring statements about banks they knew to be fundamentally unhealthy, just to avoid further credit panics.
The fundamental architecture of our regulatory system was deeply compromised, and we paid a heavy price. Now, we have work to do.
- First, it is essential that no matter what the president and Congress do, they must coordinate their proposals with those of other major financial markets to maintain high standards and minimize regulatory arbitrage.
- Second, the president and Congress must define clearly the kinds of institutions and markets requiring oversight, and the extent to which regulators should be empowered to do their work.
- Third, the president and Congress need to establish a resolution authority to handle the failure of financial institutions. The president may think that the end of proprietary trading at banks will minimize the risk of such failures. Not true. We need a resolution authority with the power to do just about anything to put a failing bank in order or close it down in an orderly way. This would permit banks to fail safely, but with clear implications to bondholders, equity owners, and management.
- Fourth, the president and Congress need to divide regulatory responsibility into four major areas and keep these regulatory responsibilities separate. The four areas should be: prudential regulation and supervision (which applies to deposit-taking banks); market regulation and supervision; consumer and investor protection regulation; and systemic risk oversight.
Separating Banks From Systemic Risk
I would argue that bank examination and supervision be kept separate from systemic risk regulation. Clearly, if these two roles are done by the same entity, such as the Federal Reserve, they won’t both be done well at all times. Congress can help this process by nudging together regulatory agencies where possible. Among the most obvious opportunities for regulatory reform would be a merger of the SEC and the Commodities Future Trading Commission – a combination I have long supported.
Guessing the Future
What’s the likelihood of us getting these essential reforms or anything meaningful out of Congress? Sadly, I’m not optimistic.
Congress, for its part, is now focused almost entirely on blame shifting, whether the matter is the economy and jobs, or healthcare, or something else. If Congress is going to exert pressure on standards-setters, it should be the kind of pressure that improves the stability and consistency of standards. Instead, the pressure of last summer reduced that consistency—and the damage was incalculable. I fear that in the absence of the courage to lead, Congress may try to do only “easy” things to change the regulatory structure. But what looks easy in the end carries great cost, and represents a lost opportunity to do reform right.
My hope is that in the absence of strong regulatory action out of Washington to improve corporate governance, you will do your best to raise standards in your own boardrooms. You will continue to carry forward the governance revolution of the last decade. You will continue to press management to be more transparent. You will elevate on your boards the importance of financial market expertise, especially the ability to evaluate risk.
You will, in short, meet the responsibilities that the shareholders have trusted to you, and be the leaders of the next major stage of regulatory reform.
ADDITIONAL COVERAGE FROM THE AUDIT COMMITTEE ISSUES CONFERENCE: