By Susan Feyder
Star Tribune Staff Writer

Star Tribune, July 27, 2002

Congress this week passed legislation that provides the most sweeping regulation of business since the 1930s.  The bill creates an independent board to oversee accountants, makes executives more accountable for their companies’ financial statements and increases criminal penalties for corporate fraud.

The following is an excerpt from an interview with John Stout, a partner at the Minneapolis law firm of Fredrikson & Byron, who advises executives, boards and board committees on governance, risk assessment and legal compliance.  He is a member of the advisory board of the National Association of Corporate Directors and president of its Minnesota chapter.

John Stout, a partner at Fredrikson & Byron, a Minneapolis law firm, said that under the new legislation “there’s a whole list of services” the accounting and legal professions won’t be able to do anymore.

Q:        Will this legislation have as big an impact as the 1934 act that created the Securities and Exchange Commission?

A:        No, partly because this is as much a political event as it is a corporate governance event.  I think it clarifies enforcement powers that already exist.  What’s being created here are some practice standards.  I don’t know if they’re the best practice standards, but they’re better practice standards.

Q:        How significant is the requirement that CEOs certify their companies’ financial results?  Don’t you think that most people assumed that CEOs already were doing that?

A:        It’s like a focusing moment.  I think CEOs felt they could hand that responsibility off and rely on the CFO.  In large, complex organizations that are global, it’s not humanly possible for CEOs to take full responsibility for the financial reports.  You wouldn’t think of paying a CEO to spend his time going over all these things in great detail.  What the requirement means now is that CEOs are going to figure out how to underscore this responsibility in the organization.  They’re going to have people certifying the results to them all the way up the line.

            Could somebody downstream fall out of bed and mislead?  Yes, the CEOs know that they’re going to be accountable for that, but they already are accountable for that in the context of being accountable for the organization.  Are they personally liable for it?  No, I think you would have to find them grossly negligent.

Q:        How profoundly will this legislation change the accounting profession?

A:        I think it’s going to change it big-time.  There’s always been a supervisory board and what they want now is a supervisory board that focuses on some problems and one that’s less controlled by the accounting profession.

            But you’re talking about [turning around] the Queen Mary here -- tens of thousands of pages of accounting standards.  You’re talking about auditors and an understanding of their responsibilities that has evolved over many decades.  That stuff isn’t going to be tossed out.  But if you look at what’s happened among major firms in the accounting industry, there’s been tremendous consolidation -- they’ve added other services, like legal services and consulting.

            There’s a whole list of services this new law says they can’t do anymore.  What we’re seeing with this law is a system of checks and balances.  It helps to have a law firm or a consulting firm that is unaffiliated with an accounting firm.  I always have thought that companies and boards should want to have multiple providers.

            Another thing that’s important is that these accounting firms are going to get hired and evaluated by an independent audit committee of a board.  They aren’t going to depend on management for the length of their engagement to a firm.  That won’t take all the pressure off accountants, but it will take off some.  There’s no question that management, in an effort to make its numbers, sometimes put tremendous pressure on auditors.

Q:        Do you think this law signals the beginning of more government regulation for the accounting and legal professions?

A:        I think it signals the willingness of the government to step in if the professions don’t do a good job regulating themselves.  I think both professions have been put on notice that they have to be effective at self-policing if they want the right to self-police.

            Look at the medical profession -- it has suffered huge government intervention.  Why did that happen?  There are lots of reasons, but part of it is that at one point people became very critical of the medical profession’s willingness to look at itself.  When that goes on long enough, and things happen that heighten the sense of public grievance, the politicians will be there.

            I have a concern over that.  If you look at the big picture, what’s really made this country great is entrepreneurial activity, which is there partly because of the notion of limited liability.  It’s very much at the heart of the capitalist system and the willingness of people to take risks.  We have to preserve that for investors but also for officers and directors.

Q:        How do you think this law will affect how companies choose directors?  Given the added responsibilities of directors, do you think companies will be less likely to hand out directorships to family members or retired executives?  Conversely, how do you think it will affect executives’ willingness to take on outside directorships?

A:        There will be less and less of that with public companies.  Companies will look more and more to search firms [to find outside directors].  The process of choosing directors will be less controlled by management and more controlled by independent committees of the board.

            As far as executives go, I think they will take fewer board spots.  The heightened awareness of board responsibility is going to mean that.  That’s already true in the best companies -- you already hear of executives, given their own responsibilities, backing off of outside directorships.  You’re not finding any highly respected executives with a half-dozen board spots.

Q:        This legislation has provisions that could improve investors’ chances of recovering their losses in cases of corporate fraud.  Do you think this will trigger more shareholder lawsuits?

A:        There’s always going to be a tension between how much leeway to give the plaintiffs’ bar and how much you want to manage the number of lawsuits, especially those that are seen as unproductive.  We’re already seeing a significant number of shareholder suits.  I don’t feel this legislation is going to open a floodgate.  The floodgate gets opened when stock prices collapse and everybody looks for a way to get their money back.  The down market and restatements [of financial results] will be what causes a flood of lawsuits.