How Good Is Levitt's Endgame?

His methods under fire, the SEC chief tackles market reform

Securities & Exchange Commission Chairman Arthur Levitt Jr. has the accounting industry right where he wants it: On the ropes. The scandal caused by PricewaterhouseCoopers' violations of auditor independence rules--in which half of the firm's partners were found to own stocks in companies it audited--has accountants cowering. The SEC has taken a tough stance, directing Compaq Computer Corp. to drop PWC as its auditor and ordering follow-up probes at seven other top firms. But Levitt is pursuing a more ambitious goal: He hopes to harness public outrage to force big accounting firms to split their audit work from lucrative consulting practices, a move the Big Five have long fought.

The ploy is classic Levitt. From encrusted stock exchanges to overcompensated brokers, the 69-year-old SEC chief holds strong views on industry practices that, based on his long Wall Street career, he believes harm investors. He forces change through a mix of jawboning public speeches and stern private scoldings of industry leaders. He doesn't hesitate to use his bully pulpit or the SEC's considerable powers to steer the financial industry toward reform. If all else fails, he regulates.

And he has gotten results. Levitt's SEC has presided over the biggest expansion of stock ownership in history. His enforcers have cracked down on Internet stock scams, companies and accountants that cook their books, collusion in the Nasdaq stock market, and firms that favor analysts and institutions with exclusive information (table). His long tenure--at almost seven years, the longest in the SEC's 66-year history--has been marked by a drive to protect individual investors and a haunting fear of what might happen if the bull market ends suddenly. "When the market goes down, if the public feels their protectors have been asleep at the switch, business and government will suffer a terrible loss of public confidence," Levitt warns. "It's uppermost in my mind."

But his methods are igniting controversy as he moves into the home stretch of his career. Though he wins bipartisan kudos for his stewardship, Levitt isn't certain of remaining as chairman next year under either a Republican or Democratic President. And his latest plans to reshape U.S. stock and options markets for electronic and increasingly global competition are running into a hailstorm of opposition from the industry and Capitol Hill. "I have a very high opinion of Arthur Levitt, but he has often been too quick to intervene," says Senate Banking Committee Chairman Phil Gramm (R-Tex.), who promises months of hearings to brake Levitt's dash.

AMBITIOUS AGENDA. Levitt concedes that his agenda is ambitious. But his job, as he sees it, is to drive the capital markets' multiple vested interests toward consensus. If he seems overly eager, he makes no apology. "I believe the U.S. markets could lose their supremacy overnight to overseas electronic markets that are more facile," he says. Already, European exchanges have adopted electronics to execute stock orders more quickly and cheaply than the New York Stock Exchange or Nasdaq. Levitt is not alone: Federal Reserve Chairman Alan Greenspan privately shares his concerns. And former Treasury Secretary Robert E. Rubin, now with Citigroup, says that Levitt "has done the country an enormous service by giving this issue a sense of urgency."

The sudden appearance of multiple electronic markets raises sticky questions about "fragmented" trading and investor protection. Dealers or investors who put in the best bids for stocks may end up watching traders in another market selling at their price without ever offering them any shares. One answer is to link competing markets. But who owns the linkage, and what rules apply, are questions that the SEC is debating.

Five of Wall Street's biggest investment banks say they have the answer: Force all markets to display orders in one electronic order book, where the best bids or offers will be filled first-come, first-served. Sounds fair. But electronic markets and retail brokers such as Charles Schwab & Co. say this "central limit order book" will become a captive of the big banks. Markets should forge their own links, they say. Competition among markets "has leveled the playing field--and customers love it," says Schwab CEO Charles R. Schwab. Skeptics also note that the Street's scheme wouldn't require mutual funds, pensions, and other institutions--the most profitable clients of big investment banks--to post their orders in the central book.

For markets and brokers, "this is a life-and-death debate," Levitt says. He maintains that he hasn't made up his mind. But his public remarks emphasize the risks of fragmented trading over the advantages of market competition. That worries Schwab and other advocates of market-driven linkages. Even Levitt's admirers say he should slow down: "I'd hate for him to take [the competition] back a step by overreacting," says Bernard L. Madoff of stock wholesaler Bernard L. Madoff Investment Securities.

Some critics also question whether Levitt is playing fair. He met with top executives of Merrill Lynch, Goldman Sachs, and Morgan Stanley Dean Witter, promoters of the central book, while the SEC was drafting the market-reform options that it put out for public review. Competitors, fearing a fix was in, rushed to Capitol Hill: "We've had a lot of complaints that the SEC's decisions are made in private with a select few, then announced as a fait accompli," says a GOP congressional aide.

OPTIONS INITIATIVE. Levitt insists that he's no more swayed by the big firms than he is by the electronic markets and small brokers whom he also consulted. On Feb. 29, Levitt gave House Government Reform & Oversight Committee Chairman Dan Burton (R-Ind.) a letter listing all the firms with which he met, including Schwab. "Meeting with lots of people is what the chairman of the SEC should be doing as he formulates policy," says Robert C. Pozen, president of Fidelity Management & Research Co., who attended one meeting.

The options exchanges are feeling Levitt's heat, too. Since the early 1980s, when Levitt headed the American Stock Exchange, options in a particular stock have traded on only one of the four major exchanges. At Levitt's urging, the markets have begun to trade each others' options. But that's brought many of the same problems, such as dealers paying kickbacks to win orders, that arise in competing stock markets.

Now, the SEC wants options markets to link up--perhaps in the same sort of central book that the big Wall Street firms propose for stocks. Such rules "would have a destructive impact on investors in the options market," says William J. Brodsky, CEO of the Chicago Board Options Exchange. Another exchange official is more blunt: Levitt is "trying to shove this down our throats."

Levitt insists that his methods are always above-board. His goal has been to "position the [SEC] as the investors' agency," an approach that "gives us the ability to push the industry forward" with a minimum of formal regulation. And even his harshest critics agree that Levitt's drive to put investors first has paid off in public confidence and robust markets. But how much further can he get, with limited time and stiffening industry resistance? For Levitt, that's the trillion-dollar question.

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