A Ripe Time for Reform

The ground is shifting beneath the foundations of Corporate America. Fueled by investor resentment and driven by renewed activism by regulators, a new age of reform is radically changing the rules of business in America. There is growing demand for honest numbers, transparent operations, and ethical leaders. Companies that fail to take heed of the new landscape are destined for trouble. Even such icons as General Electric Co. and Merrill Lynch & Co. are stumbling, as their successful '90s strategies fail them in the changed environment.

So deep is post-Enron investor distrust that all companies with opaque financial statements are being categorically punished. Even triple-A-rated corporations such as GE are trading at a discount to the Standard & Poor's 500-stock index. Indeed, the entire stock market may be under a cloud of suspicion. The S&P 500 is up less in this recovery from its low than in the five previous business cycles. While worries over profits are real, investor uncertainty over the quality of earnings may also be weighing on stocks.

No one knows this better than GE Chief Executive Jeffrey R. Immelt. Where once investors admired GE's predictable earnings growth, now they wonder where it comes from. Where once they respected the company's double-digit annual profits growth, now they are wary of it. Immelt has tried to meet demands for greater disclosure of information, but each effort has proved insufficient. Investors are suspicious of GE's nonrecurring earnings, such as overfunded pension plans, asset sales, and lower tax rates. And they want to know how GE Capital, the financing arm of GE, provides 40% of the company's earnings. Immelt inherited the house that Jack Welch built, but he can't run it the same way. As the chief of America's iconic corporation, Immelt should take the lead in making GE such a model of disclosure that it will restore investor confidence in not only his company but in Corporate America.

Nowhere is it clearer that the rules have changed than on Wall Street. An investigation launched by New York Attorney General Eliot Spitzer has revealed e-mails inside Merrill Lynch that indicate that analysts may have deliberately misled small investors in dot-com startups in order to generate investment banking business. It was one thing for people to take a chance placing bets on unknown business models operating within a little-understood technology, the Internet. It's quite another to be suckered by Merrill Lynch tech analyst Henry M. Blodget, who appears to have publicly pushed one tech stock while dismissing it as "garbage" inside his firm. Merrill Lynch is now in negotiations with the New York Attorney General's office to reach a settlement that may entail conceding guilt, paying millions in fines and restitution to clients, and changing the way its analysts operate.

The Securities & Exchange Commission's newly reformist chairman, Harvey L. Pitt, is putting heavy pressure on the New York Stock Exchange and Nasdaq to make analysts honest again. There are a variety of proposals on the table: stopping analysts from owning or trading a stock they cover; ending the practice of tying compensation directly to investment banking transactions; disclosing analysts' stock holdings; prohibiting a firm from threatening to withhold favorable research to get business; or even making research departments independent of investment banking. That these obvious measures to ensure ethical behavior on Wall Street require regulatory action is a sad commentary on our day.

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