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Tough Enough

Despite speculations of a kinder SEC, Harvey Pitt is cracking down on business.

It didn't take long for Harvey L. Pitt, the new Securities and Exchange Commission (SEC) chairman, to win over those hoping to see a more moderate regulatory agency and rile up the fans of his predecessor, Arthur Levitt. Soon after Pitt took office, critics grumbled that his new vow to the American Institute of Certified Public Accountants Governing Council (AICPA) of "a new era of respect and cooperation" signaled the coming of a toothless SEC more likely to respond to overly aggressive accounting practices with a frown than with a harsh penalty.

After all, Pitt had spent years fighting the SEC as a top defense attorney for individuals and companies charged with securities violations. And when Levitt fought for auditing process reform-arguing against accounting firms acting as independent auditors of companies for which they perform consulting work-it was Pitt who served as a central attorney on behalf of the accounting industry.

"You don't fight the rule for two years then turn around and adopt it," notes John C. Coffee Jr., professor of law at Columbia Law School in New York City. Coffee points out that, in a speech given before the AICPA Governing Council, Pitt reassured "the [accounting] industry that they are fairly safe from regulatory change."

Then came the Enron Corp. debacle. As soon as the Houston-based energy trader filed for bankruptcy amid whispers of financial improprieties, hopes for a kinder, gentler SEC began to dissipate. In a December 2001 Wall Street Journaleditorial, Pitt promised that the SEC was "investigating Enron's meltdown and its tragic consequences" and would "deal with any wrongdoing and wrongdoers swiftly and completely."

The investigation has sparked predictions of an about-face in Pitt's SEC strategy. "Enron has made everyone more sensitive to the possibility that there is too much discretion in a number of accounting principles, and it has been exploited," asserts Coffee. "Earnings management was not a priority for Harvey Pitt. But I think he is beginning to sense that the SEC can't stand on the sidelines."

Already, Pitt is proposing radical changes in current financial reporting processes. In December, he issued a cautionary statement to public companies hinting that the SEC would use federal securities law anti-fraud provisions to take on firms issuing pro forma earnings reports, or financial reports that do not use Generally Accepted Accounting Principles (see next month's "Money Buzz" for more on pro forma reporting). Intended to allow a company to present what its financial performance would have been if a one-time event-an acquisition or the cost of a lawsuit, for example-were excluded from sales and earnings calculations, pro forma financial reports have come under fire for distorting performance.

Pitt is also pushing for more frequent earnings reports to provide "real-time" material information, but the measure has its drawbacks. "For a Fortune 500 company, that kind of reporting is probably within the bounds of their capability," says Stephen Sammut, a venture partner at San Francisco-based private merchant bank Burrill & Co. and management lecturer at the Wharton School of Business at the University of Pennsylvania. "But for smaller companies, not only could it be a significant administrative burden, but it may be asynchronous with the pace and growth of the company."

On the business-friendly front, Pitt is pushing to allow companies to include "intangible assets," such as patents and intellectual property, on balance sheets. While such a change would help new, knowledge-based companies present themselves more favorably to investors, implementation could be problematic.

"Putting intellectual property on balance sheets is as attainable as 18 on a golf course," says Peter H. Knutson, associate professor emeritus of accounting at the Wharton School of Business. "There are no ways of measuring these things."

The proposed measures may sound grim to entrepreneurs, but there is a plus to a strong regulatory environment. "The SEC is one of the great bastions of capitalism. Through regulation, it makes markets attractive and lowers the cost of capital for companies trying to raise funding," he notes, pointing out that a laissez-faire approach would only heighten apprehension among already-nervous investors. And let's face it, investors now need all the comfort the SEC can offer.


Jennifer Pellet is a freelance writer who lives in New York City and specializes in business and finance.

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This article was originally published in the April 2002 print edition of Entrepreneur with the headline: Tough Enough.

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