Hearing witnesses blame crisis on failed reform and low standards

The push for a "lowest common denominator" set of international accounting standards, along with the failure of Sarbanes-Oxley Act reforms to curb last year's financial meltdown, are among the factors contributing to the ongoing global recession, experts in corporate governance told Congress.

The finger-pointing took place during recent hearings of the Senate Banking Subcommittee on Securities, Insurance and Investment, which is seeking new ways to protect shareholders by improving corporate governance.

Expert recommendations ranged from a forced separation of the chief executive and board chairman positions at large corporations, to new rules entitling stockholders to nominate director candidates on the proxy cards issued by corporate management.

But a number of the reforms suggested during the hearing struck closer to the hearts - and wallets - of the nation's accountants.

Organized labor pension specialist Richard Ferlauto, for one, called for a crackdown on accountants and other corporate insiders who knowingly participate in fraudulent schemes against investors.

Ferlauto, who is director of corporate governance at the American Federation of State, County and Municipal Employees, urged Congress to protect the legal rights of defrauded shareowners by ensuring that accountants and others who, in his words, "play a role in committing frauds bear their share of the cost for cleaning up the mess."

Although aiding-and-abetting liability is well-established in criminal law, in cases of civil securities fraud, judicial decisions have eliminated the private liability of such "secondary actors" as corporate accountants, even when they knowingly participated in fraud schemes, Ferlauto told the Senate subcommittee.

This immunity from aiding-and-abetting liability has proved disastrous for shareholders and the economy, he maintained.

Ferlauto also placed some of the blame for the global economic downturn on acceptance of less-than-rigorous international accounting standards.

"Part of the problem has been a race to the bottom in favor of a more flexible international accounting standard that would decrease disclosure protection for the average investor," he told lawmakers. "The current crisis makes a compelling case for why we need to slow down the movement toward the use of international accounting standards that could provide another backdoor route to financial deregulation and further erode confidence in corporate bookkeeping."

Other witnesses at the House hearing cited the failure of Sarbanes-Oxley reforms to prevent the current financial crisis as evidence that corporate governance reforms are unlikely to prove successful.

Although SOX represented "an unprecedented shift in corporate governance designed to prevent poor management practices," during the six years following its enactment, "the managerial decisions that led to the current crisis were in full swing," said John Castellani, president of the Business Roundtable, an association of 160 chief executive officers of leading U.S. companies.

"I won't argue that Sarbanes-Oxley caused the crisis, but this suggests that corporate governance reform does a poor job of preventing crisis," he testified.

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