Assembly Committee on Corporations, Authorities and Commissions,
Senate Committee on Investigations and
The Senate Committee on Higher Education
September 27, 2002
Chairman Spano, Chairman LaValle, Chairman Brodsky, and other distinguished members of the Legislature:
We appreciate the opportunity to participate in these very important hearings to address some of the issues you raised regarding corporate responsibility.
You correctly state in your invitation to testify that corporations are created by state law and their powers and duties are prescribed by state law. In New York State, those powers and duties are prescribed in the Business Corporation Law. We believe these laws have served corporations, shareholders, employees and other communities well.
Its provisions have been interpreted by the courts over many years and provide guidance to the parties that fall under its jurisdiction.
Today, I would like to talk about another court - the court of public opinion. Corporations are also held accountable in this court.
Our capital markets are built upon trust. Once trust is undermined, the foundations of our free-enterprise system suffer a loss of confidence.
There is no more important mission to the business community than restoring trust. It is vital that the American public believe, as I do, that the vast majority of corporations are run by honest, dedicated, and ethical leaders who are striving to do the right thing for their corporation, their employees, their shareholders and the communities where they do business.
The question before us is what we can do to restore that trust.
The United States has the best corporate governance, financial reporting, and securities markets systems in the world. New York, as the home of many of the leading companies in the United States and the world, is at the center of those systems.
We have been shocked and appalled at the substantial, and in some cases massive, corporate wrongdoing that has been reported over the last year. We believe these actions are unacceptable breaches of the public trust and clear deviations from the ethical norms of behavior that must guide the leaders of America's public companies.
In response to these events, the U.S. Congress, the Securities and Exchange Commission (SEC) , the major stock exchanges, and the business community have moved swiftly and forcefully to produce broad initiatives to improve corporate practices and to implement far reaching reforms in the areas of corporate governance, regulation of the securities markets, and oversight of the accounting profession.
I would like to spend the balance of my testimony describing the more significant reforms.
The Role of Congress: The Sarbanes-Oxley Act of 2002
Without question, the most significant reform is the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act was passed overwhelmingly by Congress and signed into law by President Bush on July 30, 2002. This law represents the most sweeping reform of corporate governance, securities laws, and the accounting profession since the initial passage of federal securities laws in 1933 and 1934. This law applies, in almost all respects, to all public companies and the accountants who audit their financial statements.
The legislation instituted a wide range of reforms, from oversight of the accounting profession to the information public companies are required to file with the SEC to enhanced civil and criminal penalties and enforcement of the securities laws. Specifically, the Sarbanes-Oxley Act.
- Establishes a powerful oversight body for the accounting profession with authority to set and enforce standards and improve the quality of financial accounting and disclosure.
- Contains strong restrictions on auditors performing non-audit services for their clients to promote auditor independence.
- Requires CEOs and CFOs to certify the accuracy of their companies' SEC filings.
- Bans loans to officers and directors.
- Improves the transparency of corporate disclosures.
- Requires expedited disclosure of securities transactions by corporate insiders.
- Enhances the role of audit committees, and requires that they be composed exclusively of independent directors.
- Expands the SEC's enforcement tools, including giving it the power to bar officers and directors in administrative proceedings.
- Provides new criminal penalties to create a comprehensive federal criminal regime for securities-related offenses, and increases penalties under prior law.
- Extends the statute of limitations for private rights of action based on securities fraud.
- Provides whistleblower protection.
- Increases funding for the SEC.
The role of the Securities and Exchange Commission
The SEC has an important role in implementing the provisions of the Sarbanes-Oxley Act, and it has undertaken a number of initiatives to promote corporate governance and accounting reform. It also has intensified its efforts to protect the investing public by vigorously exercising its broad enforcement powers under the federal securities laws.
Before passage of the Sarbanes-Oxley Act, the SEC implemented "real-time" disclosure rules and required CEOs and CFOs to certify their companies' most recent SEC-filed financial reports. Within weeks of passage of the legislation, the SEC promulgated rules requiring CEOs and CFOs to certify the accuracy of their companies' SEC reports on an ongoing basis. SEC also created rules to enhance and expedite reporting of the securities transactions by corporate insiders. The SEC is scheduled to release rules addressing a number of other areas in the near future. And it must appoint in October the members of the auditor oversight board required by the Sarbanes-Oxley Act.
The role of the stock exchanges
The stock exchanges also have been very active in promoting corporate governance reform for their listed companies. At the request of the SEC, both the New York Stock Exchange and The Nasdaq Stock Market have conducted comprehensive reviews of their corporate governance listing standards and proposed significant enhancements.
The New York Stock Exchange convened a Corporate Accountability and Listing Standards Committee to recommend comprehensive changes to the NYSE's corporate governance listing standards. These changes, which will apply to all companies listed on the NYSE, were approved by the NYSE board of directors and filed with the SEC in August. They will take effect upon approval by the SEC following a public notice and comment period. The reforms require:
- Boards of directors composed of a majority of independent directors.
- Increased responsibilities for audit committees.
- Corporate governance and compensation committees composed entirely of independent directors.
- Shareholder approval of option plans.
- Adoption and disclosure of corporate governance principles.
- Adoption and disclosure of codes of business conducts and ethics.
The NASDAQ Listing Council also developed a set of corporate governance reform proposals, which have been approved by the NASDAQ board of directors. The proposed rule changes would require
- Boards of directors composed of a majority of independent directors.
- An increased role for independent directors in compensation and nomination decisions.
- An increased role for audit committees.
- Adoption and disclosure of codes of conduct.
- Shareholder approval of options plans.
The role of the business community
The business community also has responded with reform proposals and guidance on best corporate practices. The Business Roundtable, an association of chief executive officers of leading corporations, many of whom are active in The Business Council, has long been recognized as an authoritative voice on matters affecting American business corporations. They recently updated their previous statements on corporate governance with the publication of its Principles of Corporate Governance (2002).
These guiding principles are intended to assist corporate management and boards of directors in their individual efforts to implement best corporate governance practices. The principles call on companies to adopt a number of best practices in corporate governance, including:
- Require stockholder approval of stock options and restricted stock plans in which directors or executive officers participate.
- Create and publish corporate governance principles so that everyone from employees to potential investors understand the rules under which the company is operating.
- Provide employees with a way to alert management and the board to potential misconduct without fear of retribution
- Require that only independent directors may sit on the board committees that oversee the three functions central to effective governance - audit, corporate governance and compensation.
- Ensure that a substantial majority of the board of directors comprises independent directors both in fact and appearance.
- Ensure prompt disclosure of significant developments.
- Establish a management compensation structure that directly links the interests of management to the long-term interests of stockholders, which includes a mix of long- and short-term incentives.
- Require the audit committee to recommend the selection and tenure of the outside auditor and consider what policies should be adopted by the company with respect to changing the outside auditor, rotating the audit engagement team personnel or limiting the hiring of such personnel.
These reforms, as well as those being pursued by the Financial Accounting Standards Board and others, address all aspects of corporate governance and financial reporting, and are intended to bring an end to corporate wrongdoing. For those to whom it was not obvious before, it is now abundantly clear that anything less than total honesty in corporate financial reporting and ethical conduct will not be tolerated.
As you consider additional potential reforms applicable to New York companies, please keep in mind that additional reforms on a state-by-state basis risk a patchwork of uneven and confusing standards for companies already undergoing extensive efforts to ensure compliance with a large number of changes. New York-specific changes also could make New York a less attractive place to incorporate and do business, and could inhibit the ability of New York companies to compete, create jobs, and generate economic growth for our state.
We also urge you to keep in mind that despite the reports of corporate misconduct over the past six months, the vast majority of businessmen and businesswomen in this state and across the country are honest, hardworking individuals who are committed to generating economic growth through ethical means. Moreover, the substantial reforms that have been, and are being, mandated by the US Congress, the SEC, and the stock exchanges have positioned the United States and New York State, in particular, to retain their positions as the best, and most honest, places in the world to invest and to do business.