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Sen. Daniel Patrick Moynihan has an elegant way to distinguish a liberal from a conservative. He says, “The central conservative truth is that it is culture, not politics, that determines the success of a society. The central liberal truth is that politics can change a culture and save it from itself.” Right now, Arthur Levitt, chairman of the Securities and Exchange Commission, is deciding whether the agency is a liberal or a conservative, and the ultimate result will be important for securities lawyers and in-house counsel to understand. Levitt has recently been on a whirlwind lecture schedule that rivals this summer’s farewell tour by the aging rock band Kiss, minus the flash pots and face paint. The majority of his importunings have been targeted at company executives, accountants and investment bankers, but the themes he has advanced will have an impact on the lawyers who work alongside them. Generally speaking, Levitt is not very comfortable right now. What is the source of his agitation? The state of financial reporting? Yes, but that’s not all. The attitudes of executives, accountants and bankers toward financial reporting? Yes, but it goes a bit deeper than that. How about the state of Western civilization and culture? Ah, now we’re getting somewhere. On May 10, Levitt delivered a lecture at New York University’s Center for Law and Business, and observed: “The essence of our misgivings about the state of financial reporting rests not in a particular disclosure or sales practice or single accounting technique. Rather, it’s an emerging culture rooted more and more in a particular way of thinking; an approach guided by short-term expectations and, quite frankly, driven by an imperative to exceed them. It seems that what really matters in the marketplace is being obscured by a culture, in some respects, almost overtaken by the very drive and optimism that first gave it life.” Until recently, I had taken a somewhat dim view of Levitt’s tent revival tour. Obviously, I have a different perspective because of my role as a general counsel: trying to advise executives what to say and do in the middle of complex fact patterns, a hazardous litigation environment and mixed or vague messages from courts and regulatory bodies. My problem is therefore practical, not theoretical. I am always looking for bright-line rules, and the sermons about sin usually aren’t too helpful to members of the choir. Much more difficult than lecturing is making hard rules that regulate the behavior of company executives and investment bankers. It is really only when Levitt speaks about the cozy relationship between the corporate finance and the sell-side research arms of investment banks that his words resonate with the average investor. Of late, the corporate landscape is littered with companies choosing underwriters not because of their superior access to the capital markets but because they’ve got telegenic analysts who are regulars on CNBC or CBS Marketwatch. It is also rife with analysts who seek the inside track from managements reluctant to alienate favored analysts and banks that are as allergic to sell recommendations as they are to securities lawyers. And the SEC’s latest attempt to regulate all of this is Regulation Fair Disclosure, adopted by the commission on Aug. 10 by a 3-1 vote. Before proposing Reg FD, Levitt had been acting as the conservative in Moynihan’s aphorism. But it now appears that he will play the liberal and propose a host of securities rules, using the rule-making power at his disposal to save our debased culture from itself. Levitt has spoken about three principal themes in 2000. First, he has pressed for auditor independence, with particular emphasis on separating the auditing business from the consulting business. Second, he has deplored what he calls the “gamesmanship” of public companies ever-so-slightly exceeding analyst estimates each quarter. Third, he has questioned the relationship between equity analysis and the corporate finance departments of the investment banks that employ them. Levitt decries pervasive “pressure and focus on short-term results.” The glib response to this, of course, is that the SEC is reaping what it has sown for 65 years. There aren’t many CEOs or CFOs who are thrilled with having to hit quarterly targets, and I can assure you that they are even less excited by having to disclose publicly whether they’ve hit the targets, but these are the rules we all play by. The quarterly reporting rule is probably partially responsible for this cultural issue, but the obvious cure for this (making companies report less often) creates more problems than it solves. He also complains about road shows not being open to average investors, then says in practically the next breath that there’s no simple regulatory or legal fix to this problem. Hmmm. I can think of one: a rule that requires that road shows be open to average investors. Even his focus on divorcing the consulting business of the Big Five firms from their auditing business because the auditors might turn a blind eye to some financial irregularity misses the point. I can’t recall a single instance of my audit firm ever pressuring me to try to use their consulting services, and most CFOs laugh at the idea. Beating up on lawyers and accountants is pretty easy, but I’m not sure how fair it is. The problems that Levitt identifies rarely originate with them. I don’t know any lawyers or accountants (and I know quite a lot of both) who would ever unilaterally say, “Let’s dramatically understate our operating expenses this quarter, capitalize everything, pump up our earnings, exercise our options, sell the stock and screw the public.” It’s unclear whether their reticence arises as a result of moral will or self-interest. I would like to think it’s largely the former, but it could be the latter, too. Typically inside lawyers and accountants don’t stand to profit nearly as much from aggressive accounting or inaccurate disclosure as CEOs and sell-side analysts. Most in-house lawyers and accountants both value and need their careers and their professional licenses more than their current jobs, and they understand that their reputations and integrity are paramount. Because CEOs and other executives have more at stake, and because one “home run” can mean a lifetime of leisure, they have much greater incentives to pressure CFOs, auditors and general counsel into uncomfortable financial reporting and optimistic disclosure. For most CFOs and general counsel, Reg FD seems like an excellent idea because it offers to remove doubt and replace it with certainty. In a nutshell, Reg FD requires that, when public company officers intentionally disclose material information to market professionals and stockholders, they do so through broad public channels and, when they inadvertently disclose material information selectively to this audience, they promptly and publicly disclose that information through the same channels. The rule does not fall under the antifraud provisions of the securities laws, so there would be no private securities litigation for violations — only SEC enforcement actions. The degree of enthusiasm for Reg FD seems to depend largely on geography and clientele. Comment from the West Coast technology companies and their law firms has been largely favorable but distinctly muted. San Francisco’s Brobeck, Phleger & Harrison checked in with a few proposed technical changes and one suggestion that an affirmative defense be turned into a rebuttable presumption. Intel wrote a more or less supportive letter, seeking mostly some clarification on how the new rule would treat Web access. Wilson Sonsini Goodrich & Rosati’s David Priebe, writing as an individual and not on behalf of the firm, sought a couple of changes regarding establishing patterns of selling. Perhaps unsurprisingly, the brokerage firm that broke ground leveling the playing field for all investors, Charles Schwab, is the most supportive: “We respect the role played by analysts. In the past, when retail investors and issuers could not communicate directly, analysts played a critical role in disseminating information to the market. We respectfully suggest that in the Internet age, this function has changed.” And, “We believe legitimate analysts do not want or need to receive selective disclosure of material nonpublic information to perform their jobs.” In contrast, the East Coast law firms and the banking shops they represent sank thousands of hours into sky-is-falling responses. Most of these are some variation of the following theme: We know that good, high-quality, top-shelf information is flowing from companies to analysts — but of course, you understand, it’s never material information — and this new rule would choke off that flow. The lawyers are wrestling with language to show just how critically important, though certainly not material, this selective disclosure is. The kind of gutsy, throw-everything-you’ve-got-against -a-wall-to-see-how-much-of-it-will-stick arguments they’ve made remind me a little of high school debating tournaments. Arguing that Reg FD will reduce information flow, Salomon Smith Barney delicately said, “A perfectly legitimate conversation between a corporate officer and a pre-eminent analyst that causes the analyst to reconfigure his or her ‘mosaic’ may result in a change in estimate or recommendation, which could cause the company’s stock to move significantly.” Of course, three paragraphs later Salomon argued against the new rules because they will cause increased stock price movement. Consistency is the hobgoblin of little minds. Joseph McLaughlin of Brown & Wood, on his own behalf and not on behalf of the firm, stretched to find some constitutional (specifically, First Amendment) problems with Reg FD. He also pooh-poohed Levitt’s arguments that Reg FD is needed to restore investor confidence in the markets, stating that “the equity markets are not far off record highs, and there have never been more investors in U.S. equities.” It is a little surprising that McLaughlin does not point out that these conditions also obtained in 1929. Sullivan & Cromwell expressed touching concern about the careers of young equity analysts: “Why should a talented analyst spend time studying the business of the issuer if his or her only occasion to speak to management is a meeting or phone call with scores of other participants during which there may not be time to answer all questions and where the analyst’s most important function may be the taking of notes? How does such an analyst distinguish himself or herself from others?” Well, they could try the way Charles Schwab suggests: “Legitimate analysts compete on the basis of their superior analysis of publicly available information.” In a piece of baffling logic, Salomon even argued that a company that guides earnings estimates “to mitigate surprises or bring in outlying estimates” actually “serves a valuable market function,” and this behavior “is not tipping the current quarter’s results to the street; rather, it typically involves the company expressing its views on longer term macro-economic or company-specific trends which ultimately impact the street’s one- or two-year estimates.” So what of Levitt’s cultural determinism? I think most people are in violent agreement with his basic themes that auditors should be independent, disclosure should be more robust and so forth. However, the opposite positions that the opposite coasts have adopted on Reg FD tell us that there is no cultural consensus right now, and the rule maker has stepped in to fill the breach. The question that Sen. Moynihan might ask is, will sufficiently good behavior evolve out of our culture or will we try to change the culture by changing the rules? Until Reg FD, Levitt’s answer had been clear: “Edict can never replace ethic.” With Reg FD, Levitt is hedging his bet on culture by backing it with the force of law. David Schellhase is general counsel at Linuxcare Inc. in San Francisco.

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