Too Many Rotten Apples

Will Bush's reforms be enough to calm the Investor Class?

If there's one thing George W. Bush detests, it's being behind the curve. As revelations of a corporate crime spree broke over the past months, the President stuck to his modest reform plan and turned a cold shoulder to critics demanding more aggressive action. He discouraged talk on Capitol Hill of re-regulating industry. He stood by embattled Securities & Exchange Commission Chairman Harvey L. Pitt. And through it all, he prayed that the economy would withstand the hits to the stock market and investor confidence.

Then along came WorldCom.

When WorldCom Inc. disclosed that it had uncovered nearly $4 billion in expenses counted as capital expenditures--a bookkeeping deception that dwarfs Enron Corp.'s misstatement by a factor of six--Bush finally latched on to what the rest of the country already knew: We have reached the tipping point.

The President reacted by hastily arranging a July 9 visit to Wall Street to give a major address on corporate accountability. He also signaled his willingness to work with Democrats on a tougher version of accounting reform than the one Pitt supports.

Bush's top priority is to prevent the economy from spiraling back into recession. And by doing so, he hopes to avoid losing control of the House in November. "He's acutely sensitive to the economy," says Mark McKinnon, media adviser to Bush's 2000 campaign. "He has seen its impact on people. He has seen its impact on Presidents." Among them is Bush's father, who was voted out of office after the 1991 recession.

The younger Bush has been struggling to deal with the fallout from the corporate scandals since March, when he unveiled a 10-point plan to address what then seemed to be a problem confined to a handful of rogue CEOs. His proposal: create an accounting oversight board, require additional disclosures by companies, and force executives to repay stock options and bonuses inflated by false profits. But investor groups immediately complained that Bush's solutions lacked teeth.

Now, the President is prepared to raise the stakes. In his upcoming speech, he intends to call for criminal penalties for executives who certify incorrect financial statements. He also will request an infusion of funds for the Justice Dept. and the SEC--though he's not likely to lift the $487 million he's O.K.'d to anything like the $776 million Congress wants (chart).

Still, there is tension among the President's team over just how tough the criminal sanctions should be. Some Bush advisers are happy with Pitt's call for executives of companies with more than $1.2 billion in revenues to swear by the accuracy of their financial statements. If the numbers prove false, execs could be personally liable. Others want Bush to go further by calling for criminal sanctions against execs who abuse the public trust by issuing financial statements that are misleading--not necessarily false.

The internal debate also extends to whether Bush should describe the rash of corporate scandal as systemic or confined to a few bad apples, as he originally claimed. The President wants to let the Investor Class know that he feels its pain--without further spooking the markets. And he wants to push Congress to act--without scorching Republicans in upcoming elections. "It's a fine line," says Bush adviser McKinnon, "but it's a fine line he's prepared to walk."

Despite Bush's "lock 'em up" rhetoric, he is expected to resist new reforms that might tie the SEC's hands or hamstring honest CEOs. He is unlikely, for example, to call on Wall Street to cooperate with state regulators looking to sever links between investment bankers and analysts. He is unlikely to call for strengthening auditor independence by banning consulting for accounting clients. And he is highly unlikely to call for measures that would limit the use of stock options, such as requiring that their cost be deducted from earnings. Pro-investor groups say that without these reforms, wary investors aren't likely to head back into the market. "What we're looking for is acknowledgment that there are deeper problems than just trying to punish a few bad apples," says William Patterson, director of the AFL-CIO's Office of Investment.

Still, Bush's Wall Street speech won't come quickly enough for many CEOs, who are mad as hell and want Washington to do something--anything. Oracle Corp. CEO Lawrence J. Ellison told a company conference in Copenhagen on June 26: "There are crooks out in the street who will take your purse, and there are crooks in the boardroom. They should go to jail." Adds John C. Bogle, founder of mutual-fund company Vanguard Group Inc: "It looks like we were wrong to rely on the moral integrity of our corporate leaders. If we sent a white-collar criminal to Attica, I don't think we'd have another white-collar crime in this generation."

Angry execs share the President's concern that corporate chicanery is dragging down an economy trying to right itself. The ethical bankruptcy of some corporate leaders and a string of company failures are sapping investor confidence. And there are signs that Americans are growing restive over Bush's handling of the economy. A June 19-23 Pew Research Center poll found that just 33% of Americans believe he is doing as much as he can to improve the economy; 62% said he could do more.

Democrats see an opportunity in those numbers. Their logic: GOP attempts to thwart government oversight led to an atmosphere conducive to crime. In addition, the Dems are eagerly pointing out the close ties among Bush, Vice-President Dick Cheney, and many alleged corporate crooks, especially those from Enron. "The economy is falling down around their ears," says House Minority Leader Richard A. Gephardt. "If people want these problems solved, they'll want a Democratic Congress."

Senate Majority Leader Tom Daschle (D-S.D.) plans to rush a wide-ranging accounting-reform proposal by Senate Banking Committee Chairman Paul S. Sarbanes (D-Md.) to the floor the week of July 8. Business lobbyists predict Daschle will get 80 votes. And House Dems hope to maneuver Republicans into voting against strong reform efforts. "There'll be some tough votes for the Republicans," says Democratic pollster Mark S. Mellman. "This divides their campaign contributors from their voters."

That's just the beginning of the GOP's worries. Despite one of the briefest recessions in history, the stock market, which should be rebounding nicely at this point in the recovery, is back to its post-September 11 lows. Unable to distinguish honest companies from dishonest ones, investors are choosing to sit on the sidelines. While they aren't dumping their stocks, they aren't buying, either. Overseas investors, however, are bailing out, says investment managers Bridgewater Associates Inc. in Westport, Conn. As they sell off their holdings, foreign investors are driving down the dollar, which has slipped 9% against the euro since February.

The White House also worries that companies are delaying capital investments and waiting to rebuild inventories. While such moves may help bring a short-lived surge in profits, they also delay recovery. Any capital-spending rebound is likely to be postponed further because the bond market is demanding a "risk premium" in higher interest rates from many companies.

A possible retreat into recession seems to be on the Fed's mind, too. After the Fed cut rates 11 times in 2001, growth in the first quarter was a sizzling 6.1%. Normally, Fed Chairman Alan Greenspan would be ready to ratchet up interest rates at this point in an expansion. Instead, on June 26, the Fed kept rates steady out of concern that the second half might not be as robust as the first.

This recovery has always depended on free-spending consumers. But the comatose stock market--and dwindling 401(k) retirement accounts--are giving consumers pause. In June, for the third month in a row, the University of Michigan's consumer confidence survey showed Americans losing faith in the future. Consumers said their financial situations are the most dire since the early 1990s. "If people get nervous that the stock market isn't doing anything, then they may postpone buying that new car or house," says Steve Slifer, co-chief U.S. economist at Lehman Brothers Inc. "What started out as a financial market event can become a real live economic event." Slifer has pared his third-quarter growth prediction to 2.5% from 3%.

On the firing line is SEC Chairman Pitt, a lawyer who has represented all of the big accounting firms. Daschle and former Vice-President Al Gore have lashed out at Pitt as the wrong person for the job. For now, Pitt has the support of Bush and House Republicans, whose vision of corporate reform closely parallels his. GOP House leaders also see no need to toughen the reform package they approved earlier this year. "Legislation is the worst thing you can do to solve this problem," says Chief Deputy Whip Roy D. Blunt (R-Mo.).

Such comments could come back to haunt House Republicans. Already, Bush is signaling that he will compromise with Senate Democrats over the much tougher Sarbanes accounting-reform measure. Veteran business lobbyists are warning Republicans not to stand in the way of the reform locomotive. "The public is going to hold somebody responsible," says Bush confidant Dirk Van Dongen, president of the National Assn. of Wholesaler-Distributors. "Shame on the Republicans if they don't take bold and effective leadership on this."

Overreaching is the danger for Democrats. Like the GOP, they have received millions of dollars from business. And if they go on a business-bashing spree, they risk alienating pro-growth suburban moderates. "We have to be careful to avoid class-warfare rhetoric that makes us seem antibusiness," says Al From, CEO of the centrist Democratic Leadership Council.

But the risks to the President seem far greater. Corporate scandals and the lagging economy could undermine Bush's agenda for the second half of his term. His plan to create Social Security private investment accounts remains in deep freeze. Further tax cuts seem unlikely amid a growing federal deficit. And Bush's push for sweeping deregulation of business will be a hard sell on Capitol Hill.

For now, the President sees his job as prosecutor-in-chief--making sure a few high-profile CEOs land in jail. But he'll need to do more than that to restore America's confidence in capitalism.

By Paula Dwyer and Richard S. Dunham, with Laura Cohn and Mike McNamee, in Washington, Amy Barrett in Philadelphia, and Arlene Weintraub in Los Angeles

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