US view: Corporate hot seat awaits new names

Worried finance chiefs understand that the fallout from the corporate scandals that wracked Wall Street investment banks and major accountancy houses could continue for years.

But the broad shape of the final settlements has been revealed in recent weeks amid some controversial posturing from Wall Street bosses and promises of more resolute action from the regulators.

Eliot Spitzer, the New York attorney general who stole the limelight from the federal regulators in the pursuit of egregious excesses on Wall Street, is already warning that winning the war might have been easier than the battle for peace.

What attracted Spitzer’s renewed ire was Merrill Lynch chief executive Stanley O’Neil’s claim that regulators wanted to take the risk from the market by creating an attitude that ‘if they lose money in the market then they are automatically entitled to be compensated’.

Then Morgan Stanley chief executive Philip Purcell appeared to contradict the regulator’s finding that his bank had failed to disclose to investors that it had paid $2.7m (£1.6m) to other Wall Street firms to publish research on companies whose shares Morgan Stanley had underwritten.

Spitzer was quick to slap down what he believed was another sign of Wall Street in denial about its sins, reaching for a halo when it should have been contrite.

After a torrid start, the new board overseeing the accounting industry finally got underway, with major moves in terms of new appointments and new policies. After an attempt to repair the damage caused by recent accounting scandals, particularly the collapse of Enron and Tyco, the board got off to a torturous start when its first choice as leader, William Webster, was forced to quit.

His replacement, William McDonough, retiring president of the Federal Reserve of New York, has the gravitas to fill the job, while the board’s new chief auditor Douglas Carmichael, who has inveighed against low standards in the profession, should give it a cutting edge.

Even the New York Stock Exchange, the world’s largest, has launched an effort to clean up its image amid scandals of unscrupulous profiteering by traders and the abortive attempt to appoint disgraced billionaire Citigroup chief Sandy Weill as consumer representative on the exchange board.

Whether the combined impact of these efforts will be enough to rebuild Main Street’s trust in Wall Street remains to be seen. We do know that Wall Street’s $1.4bn settlement is equivalent to about 5% of the 10 banks’ annual revenues, or the equivalent of a $750 fine for someone earning $150,000 a year.

It is a windfall for the federal and state governments, but another blow to the banks’ shareholders as only two individuals have yet been ordered to pay restitution. It is also a fraction of the losses suffered by investors and profits made by the banks during the boom years. For example, Citigroup, hit by the biggest payment of $400m, made about $10.5bn from investment banking between 1999 and 2001.

But the banks are circling the wagons as swarms of contingency fee lawyers start their attacks – armed with all the evidence collected by the securities chiefs who worked on the probe – for investors who claim investment losses were caused by the tainted research of the banks.

The Securities and Exchange Commission released nine fat volumes of evidence alone. What is already known of the candid emails exchanged between bank staff should be enough to keep a lot of senior Wall Street executives, accountants and analysts awake at night.

Some informed estimates put the final bill for civil and criminal actions – already being compared to the welter of legal actions that have hit the tobacco industry – at $20bn.

Regulators are also looking at the chain of command that allowed analysts to distort their analysis and ignore the firm’s research rules, a potential basis for criminal actions against the banks’ chiefs.

There are other changes afoot concerning initial public offerings, particularly at how underwriters hand out coveted initial public offering shares. Other reforms, such as compelling analysts to attest in writing that their opinions are their own and not forced by management, might make life easier for those under threat of being strong-armed into a ‘buy’ recommendation.

More protections will be afforded by some banks sealing off investment banking from that part of the company that does research for public customers, or spinning off research departments into separate companies to improve independence.

The accounting industry has its share of cynics, particularly concerning moves by the regulators that would force companies to treat grants of stock options to their executives as expenses on their corporate books.

Congressional opponents of the measure – many rewarded for their concern with fat campaign cheques – want it delayed for three years while more views are sought on the impact.

It is more ammunition for the critics who claim that powerful financial interests got off lightly. But that’s not the view in the finance profession, where there are concerns about continued investigations and new liabilities.

They fear the meter is running and no one knows when it’ll stop.

• Duncan Hughes writes regularly from the US on business matters for Accountancy Age.