Stepped-up rulemaking, enforcement: keeping SEC busy.

The U.S. Securities and Exchange Commission (SEC) is busier now than it's been since its inception in the 1930s, with much of its increased activities due to stepped-up rulemaking and enforcement. Commissioner Harvey J. Goldschmid spoke recently with Financial Executive's Managing Editor Ellen Heffes about the SEC generally--its role, current activities and also some specifics on what registrants can expect going forward.

Goldschmid is one of five commissioners (including the chairman), who are appointed by the sitting president so that the majority of commissioners are of the same political party that is in office.

An attorney, Goldschmid is on leave from Columbia University School of Law, where he is Dwight Professor of Law. He also served as SEC General Counsel (the SEC's chief legal officer) from 1998-99.

In the full interview on FEI's Web site, Goldschmid discusses the recent SEC mutual fund rulings, its proxy access proposal and more. Read it all at: www.fei.org/mag/articles/9-2004_fr.cfm.

You have called the SEC the "gate-keeper to make the system work." What is your opinion on how effective the SEC has been, and how different is it under Chairman William Donaldson?

HG: The way to think of the SEC today is to ask the question, "Has it ever been busier or in the public spotlight as much as it is now?" The scandals of the late 1990s and early 2000s have been the most serious since the Great Depression. And, not surprisingly, this has been the most active period at the SEC, with the possible exception of the years around 1934, when the Commission itself was formed, and it had to establish new rules and procedures.

The need for this activity has obviously been demonstrated by what went wrong in the public corporation in terms of Enron, WorldCom and others, and what we discovered to be wrong in the mutual-fund area. But there has generally been a need to rethink a number of major areas of concern for the SEC--some caused by scandals, some by just the need for rethinking.

The self-regulatory scheme for stock exchanges certainly had to be looked at in light of certain problems that we've found; and, in general, how people trade--the mechanisms for trade--and the rules for trading on exchanges simply needed review.

In terms of the Commission historically, there are ebbs and flows in its quality. When teaching at Columbia, I've often said that the SEC has been the best of the federal administrative agencies, and I believe that remains true. But, there have been good periods--very early, 1934 through 1940 or so, was a particularly good period--and there were some down periods and slow periods when, for example, the Commission did little and was under-funded.

A very good period was in the 1990s, when Arthur Levitt was chairman, and Richard Breeden before that. But the Commission was badly under-staffed and under-funded in Arthur Levitt's period. Certainly since Bill Donaldson has become chairman, it's been a good time. Bill is a strong, intelligent, decent man. From a low period, he's helped the Commission reestablish itself as the best regulatory agency in government, with the arguable exception of the Federal Reserve.

With the barrage of new rules, talk about the relationships and process between the parties involved. For example, with the Public Company Accounting Oversight Board (PCAOB) concerned with auditors, and the SEC concerned with issuers, does this kind of "pit" these parties against each other?

HG: It's actually been harmonized much more than that. The PCAOB, a quasi-private organization, established by Congress in The Sarbanes-Oxley Act, is subject to oversight by the SEC in all it does of consequence. We select the members of the PCAOB--it's a first-rate group, and Bill McDonough is leading it extremely well--and when the PCAOB makes a rule, we have to approve it, with public notice, naturally. Almost anything it does is subject to our oversight, including its budget. Although there are working relationships still being set up, so far it has been very easy, and the PCAOB has started extremely well.

The SEC has responsibility for accounting, auditing, public disclosure and public issuers, but some of the SEC's responsibilities will be handled (at least in the first instance) by the new PCAOB. Basically, the PCAOB was established because of a failure of self-regulation in the accounting profession. What it brings to the table now is the ability to do serious quality control, and to establish rules in a neutral public-interest way for auditing standards.

It also has the power to discipline auditors when wrongdoing has occurred. Prior to the PCAOB, there was little realistic discipline in the accounting profession's self-regulation, although the SEC itself could and did bring actions.

What we have to work out with the PCAOB, which is in process now, is how to apportion responsibilities. For instance, when a major corporate disclosure failure occurs involving the issuer, lawyers and auditors, how will that be handled? Which piece, if any, does the PCAOB take? What should be the SEC's role? How do we make sure it's done effectively and efficiently, without spinning wheels and creating unnecessary discovery problems for those being investigated?

[ILLUSTRATION OMITTED]

So you don't view it as the PCAOB and SEC each only looking at its narrow "piece of the universe?"

HG: No. Our responsibilities overlap, and we must work together in an efficient and collaborative way. For example, consider perhaps the most important and most controversial thing that the PCAOB has done: the internal auditing standards. The PCAOB got the draft out; the SEC reviewed the draft and provided comments. It's the same type of rulemaking process that we have with the New York Stock Exchange, Nasdaq and the other self-regulatory organizations (SROs).

We kept attuned to what they were doing, and we tried to work it out so that the disclosure aspects, the management reports and the attestations from the auditors were coordinated. That is why we extended the time for when reports were due. The date now in effect for large companies is November 15, [and] for annual reports after that.

All of our steps reflect a kind of coordination--the need to harmonize--and an understanding that the auditing and disclosure aspects had to be consistent. I think we are working very hard to make the whole process smooth, and not fragmented or inconsistent.

You were at the SEC when Regulation Fair Disclosure (Reg FD) was launched, and you were instrumental in pushing it through. How it is working?

HG: I do bring a certain bias to the subject, but my sense is that there is an overwhelming acceptance today of the idea that Reg FD has been very good for the markets. It's made them fairer, and much more publicly acceptable in terms of trust. Reg FD also got rid of some of the perverse effects that went with analysts being given special information, and at times, persuaded not to write critical reports because they wanted to be in line to get the advance information.

When it first came out, there was a lot of, "this is going to be terrible; it's going to change everything"-type comments. It doesn't seem to have turned out so bad.

HG: I think everyone has learned to live with it, as we knew they would. I consider Reg FD an enormous regulatory success. It has made our financial markets and disclosure system fairer and more effective.

So, is this phenomenon expected? New rules--like Sarbanes-Oxley and Section 404--upset users at first, but then get integrated into the way things are done?

HG: Yes, there is a tendency to think "the sky is falling." It's natural for those in the business community, and almost everywhere else, to often want to do things the way that they have been doing them in the past. But when there are important public values involved and changes which can make things significantly better--if you've thought them through and worked to avoid counterproductive effects--very often changes, which do frighten people, become widely accepted, and work extremely well.

In the 1980s I worked on a project for The American Law Institute on corporate governance, which was quite controversial at the time. There were "radical" proposals, such as having a majority of independent directors on a public company board, and having an independent audit committee. All of that is common wisdom today and generally accepted; there is no real debate.

When Arthur Levitt was SEC chairman, there was a Blue Ribbon Committee established to look at audit committees. Again, in 1998-99, some of the proposals were very controversial. Just about all have wide acceptance today.

As we discussed earlier, the same thing is true with respect to Reg FD. People worried there wouldn't be information out there, that corporations would clam up, etc. What's perfectly clear, from the best empirical work done, is that there is more information out to the public; the information is now more evenly distributed and it's better information. We've had excellent compliance. The corporate community, in general, has been terrific in implementing Reg FD with common sense, skill and diligence.

On a personal note, looking at your career history, what brings you back to the SEC again? And with your skills, where do you expect you can make your biggest impact?

HG: All of the Commission's major decisions are made collectively, by the commissioners, with three out of five needed to carry a vote. But almost always--and I think it's healthy--we tend to be unanimous. I work heavily on rule-makings; the rulemakings that went into implementing Sarbanes-Oxley, the mutual fund reforms and the establishment and first activities of the PCAOB. All of those have been priorities for me, as well as some things coming up, such as access proposals for proxies and hedge funds.

I've taken a relatively large hand in enforcement activities. Those are all done in confidential meetings. The Commission has to authorize formal investigations, cases to be brought and settlements; at the same time, it has to think about strategies. In part, because there are only three lawyers out of the five of us on the Commission now, it seemed a good place for a law professor, who has also been a general counsel, to spend a good deal of time.

In summary, what would you say are registrants' biggest challenges in light of this more aggressive SEC and many new regulations coming out?

HG: There is a big challenge in adjusting to all of the new things out there. For CFOs, there is an awful lot to digest. On the other hand, if anything, the new regulations and the establishment of the PCAOB, have indicated the pivotal nature of the function CFOs carry out. The corporate system is dependent on high-quality CFOs, and, I suspect, their stature in the corporate community has grown as all this focus has occurred.

Certainly, in the short run, the internal controls rulemaking by the PCAOB (approved by the SEC), and the reports that CFOs now have to prepare, will take time and effort, and, in some companies, a fair amount of cost. My view is that it is worth every penny to have high-quality internal controls in place. But there is no doubt we are asking a lot.

Additional changes will be made, and we'll try to work with the corporate community to make certain that the changes will come about effectively with as little wheel spinning or unnecessary cost as possible. The other basic part of the challenge is for CFOs to keep a sense of decency and integrity and make this system work as well as we all want it to work.