Recent Columns By Former SEC Chairman Harvey L. Pitt

I’m pleased to be participating—for the fifth time—in Compliance Week’s annual conference. Saying that makes me feel a bit like Phil Connors, the weatherman played by Bill Murray in the movie “Groundhog Day,” who had to repeat the same day over and over again, until he finally got it right. In my case, I hope the folks at Compliance Week keep inviting me back, based on their assumption that, while I still haven’t gotten it right, I eventually might!

In signing the Gold Standard Act of 1900, President William McKinley declared that gold, not silver, would underlie the U.S. monetary system. That Act didn’t last long, predictions to the contrary notwithstanding, and today, our nation’s economy is based on only two things expected from Washington, D.C.: promises and trust. The former is found in great quantities, while the latter is definitely a dissipating asset!

In the 1996 movie “Mother,” Albert Brooks plays John Henderson, a writer of questionable talent, who’s just been through his second divorce, due to his fundamental inability to relate to women. To probe his back-to-back marital failures, Brooks moves in with his mother, Beatrice, played by Debbie Reynolds, to examine his most important female relationship, and the source (he believes) of his problems. John and Beatrice’s relationship is unlike any mother-son relationship with which most of us are familiar, perhaps epitomized by Beatrice’s unthinking reference to John, when introducing him to friends, as her “other” son. At one point, Beatrice reassuringly offers John a rote platitude, saying, “I love you.” Not missing a beat, John caustically replies, “I know you think you do, Mother!”

When civil litigants agree to settle their disputes, they expect judicial approval, if not praise. The rubric of our judicial system is that litigation should be discouraged, and settlements of filed lawsuits should be encouraged.

Editor’s note: Harvey Pitt recently provided a keynote address at Compliance Week’s 4th annual conference at the Mayflower Hotel in Washington, D.C., June 3-5. Below is an abridged version of the text of the speech.

Back in the halcyon days of June 2006, the Dow was 11,000, unemployment was 4.6 percent, and our collective mood was best described by the title of the movie, “On a Clear Day, You Can See Forever.”

Our financial and capital markets are going to hell in a hand basket. Among other things:

Editor’s note: Harvey Pitt recently provided a keynote address at Compliance Week’s annual conference at the Mayflower Hotel in Washington, D.C., June 4-5. Below is an abridged version of the text of the speech.

During the Revolutionary Era in this country, Benjamin Franklin printed an old English rhyme in his Poor Richard’s Almanack that touted the benefits of preparedness and preparation:

In modern times, in the aftermath of business difficulties, many of us often exclaim, “That’s no way to run a railroad.” What we mean, of course, is that leadership was lacking, or that leaders made critical errors. The phrase is derived from the caption of a Depression-era cartoon that showed a signalman peering out of his box as two trains below him collided, exclaiming “What a Way to Run a Railroad.” Either way, that caption may well be an apt description of the way many business leaders have handled the current sub-prime mortgage crisis. As the impact of the crisis rattles financial markets and reverberates through the rest of the economy, observers are left to ponder how some supposedly financially sophisticated firms could be so ill prepared for this manmade disaster, while other firms have managed to weather the storm quite successfully thus far.

In Mel Brooks’ brilliant 1968 movie, “The Producers,” a timid accountant named Leo Bloom (played by Gene Wilder), off-handedly suggests that his client, Broadway producer Max Bialystock (played by Zero Mostel), could actually make more money by producing failures than hits. By overselling investment interests in truly bad plays, a short-running failure would leave the producer with excess cash, which he could theoretically pocket (instead of refunding), with no one the wiser. Of course, the one fly in the ointment, Bloom advises Bialystock, would be if the play were to succeed. In that instance, everyone would go to jail.

In the movie “Syriana,” a lawyer investigates irregular payments by a U.S. oil company to secure concessions in Kazakhstan. When the lawyer confronts Danny Dalton, one of the oil company’s directors, Dalton retorts: "Corruption? Corruption ain't nothing more than government intrusion into market efficiencies in the form of regulation … We have laws against it precisely so we can get away with it. Corruption is our protection … Corruption is how we win." Dalton’s appalling and cynical characterization of bribery and corruption is, unfortunately, not that far-fetched. It’s widely believed that a 2003 Justice Department investigation into payments made by oil companies to the president of Kazakhstan and other senior officials in connection with their purchase of an oil field were the movie’s inspiration.

In the movie, “Groundhog Day,” Bill Murray plays Phil Connors, a self-absorbed, egotistical, and determinedly obnoxious Pittsburgh TV weatherman, who finds himself in Punxsutawney, Pa., to cover Groundhog Day. Phil doesn’t like this assignment, but his unwelcome endeavor turns into a spectacular nightmare, as he’s required to repeat Groundhog Day over and over again until he finally inculcates the true meaning of life and figures out the proper way to engage in human relations. Phil goes from anger, to frustration, to deception, to learning finally how to behave.

Unfortunately (at least in the view of public companies), the Securities and Exchange Commission has been very successful in its mission to create the illusion of three dimensions, or seemingly being everywhere at once.

Movie fans surely will recall Paul Newman’s stellar performance as Frank Galvin, a down-on-his-luck, often inebriated, ambulance-chasing, trial lawyer, in the 1982 film, “The Verdict.” What may not be recalled is that the movie provides an interesting backdrop for current considerations of the Hewlett-Packard Saga.

As a practicing lawyer, my clients were all well aware of the infamous “Pitt’s Postulate”: Whenever you think you’ve destroyed the last copy of any document, there’s always one more that exists, and it will surface at exactly the most inopportune time. The only exception, of course, is if you really need the document, at which point you’ll discover that you actually did destroy the very last copy.

As executive officers return from their summer vacations, many may be suffering from the “Compensation Blues.” No, this isn’t a new “love-gone-bad” heartache captured by Billy Holiday in a ballad you somehow missed. This is a real-life corporate heartache, as painful as any about which Lady Day sang, arising from the ever-widening stock options backdating scandal, and related developments.

One hears a lot these days about the “tone at the top”—that is, the message a company’s leaders communicate about how their company and its employees should comport themselves. In practice, a company’s tone is set by its leaders’ deeds, not merely their words. There are some practical suggestions corporate leaders can consider to establish a “culture of discipline” and integrity.

In the movie “City Slickers,” three depressed friends leave their troubled urban lives behind to spend two weeks moving a herd of cattle across the plains, and perhaps, in the process, rediscovering what can give their lives more meaning. The trail boss, Curly (JackPalance), tells mid-life crisis plagued Mitch (Billy Crystal), that the secret to happiness is a single extended index finger, or “One Thing.” Mitch asks Curly what that means, and Curly cryptically responds, “That’s what you’ve got to find out.” Mitch’s depressed funk only lifts when he finally understands Curly’s meaning—each of us has to focus on the things that are most important, rather than diffusing our focus.

With Nasdaq announcing its acquisition of nearly 25 percent of the shares of the London Stock Exchange, and the concomitant pressure on the NYSE to make a comparable foreign exchange acquisition, it’s now readily apparent that we’re moving toward global, and away from national, capital markets. In more prosaic terms, what this means is that decisions where to “list” a stock will be significantly less important in the future. What will be of paramount importance is where securities are traded, and who owns them.

“Information wants to be free” was a phrase bandied about during the Internet stock market bubble. Well, it turns out you get what you pay for. Despite being the so-called mantra of the Internet, the concept that “information wants to be free” was never internalized by the bubble companies that promoted it. Had they told us everything we really needed to know to make an accurate assessment of their performance and future prospects, most of us wouldn’t have invested in sock monkeys!

In the movie Midnight Run, Robert De Niro plays a tough Chicago ex-cop whose refusal to take mob bribes cost him his job. Instead, he becomes a bounty hunter because, as he says, when he finds someone who’s jumped bail, he can just bring him in and “not worry about anybody taking a payoff.” But when De Niro agrees to find and bring back an honest accountant—played by Charles Grodin—who has jumped bail, De Niro struggles with his strict rules-based approach to life, which has already cost him his police job, wife and family. Grodin was a Mob accountant before realizing he was working for criminals; once he realized for whom he was working, he stole $15 million of their money, as well as their incriminating books. De Niro’s conflict is palpable: If he returns Grodin, it’s almost certain the Mob will kill Grodin before he ever testifies against them; if he doesn’t bring Grodin in, he’ll be aiding him in evading his legal obligation to testify.

When Lee Iacocca joined Chrysler in 1978, he immediately went to work on engineering the company’s fiscal turnaround. One of his first, and most visible, measures was announcing to shareholders that, to reduce costs, he had lowered his own salary to one dollar. When a shareholder questioned Iacocca about this drastic reduction, he responded, “Don’t worry. I’ll spend it carefully.”

In 621 B.C., the Athenian legislator Draco wrote the first national judicial code. Justice, which had previously been a private matter, for the first time was meted out publicly, through proclamation of the code and public trials. Although this was a significant accomplishment, Draco is remembered instead for the code’s stringent penalties. Athenians claimed he wrote “not with ink but with blood.” In the Fourth Century B.C., the Athenian statesman Solon was tasked with revising the code. And so, in English a “Solon” is a wise lawgiver, while things perceived as exceedingly harsh are referred to as “Draconian.”

Over 500 years ago, while anchored off the coast of Jamaica, Columbus found his food supplies running low, but locals were unwilling to sell him any more. Planning ahead, Columbus noticed that his almanac predicted a lunar eclipse a few days later. On the day of the anticipated eclipse, Columbus warned the leaders that he would blot out the moon that very evening, if he was refused the opportunity to purchase more food. The locals reiterated their position. But that evening, as the eclipse began, they sought out Columbus in a state of high anxiety and extracted an agreement from him to cease their lunar deprivation in return for the sale of food supplies. Columbus’s foresight and planning afforded him the opportunity to stave off starvation and ruin.

In 1949, an engineer at Edwards Air Force Base created a harness for a rocket-powered sled designed to test how much acceleration and deceleration a human being could tolerate. Unfortunately, the test failed and the sled’s passenger was temporarily blinded. The engineer, Captain Edward A. Murphy Jr., later discovered the cause of the failure: improper wiring. Exasperated, Captain Murphy snidely observed—apparently, to no one in particular—that if there were two ways to do something, and one way could result in catastrophe, the route that would produce disaster would invariably be chosen. According to the military publication Desert Wings, Murphy’s Air Force colleagues heard his protracted harangue and adopted it as their mantra. Before long, “Murphy’s Law” entered the common American vernacular; the term became a dictionary entry nine years later, in 1958.

There’s an old story about a championship basketball game in the animal kingdom between the Ants and the Elephants. Late in the game, with the Elephants up by one, the Ants had possession, and were heading down the court looking to score. As the star Ant dribbled forward, the Elephant guarding him lifted his foot and crushed the Ant. The referees blew their whistles, called a foul and one official asked: “What’s the big idea? What did you think you were doing, stomping on an opposing player?” The offending Elephant shrugged haplessly and said he wasn’t trying to crush the ant, “I was merely trying to trip him!”

The Walt Disney Company has transformed many engaging fairy tales and stories into fantastic animated and live-action movies. Unfortunately, over the last decade, the most intriguing Disney productions have emanated from its corporate executive suite. From the highly-publicized trial in Delaware Chancery Court regarding Michael Ovitz’s compensation and termination packages, to James Stewart’s gripping and revealing recent book, DisneyWar, the public has watched a number of board-level dramas unfold at the Not-Always-So-Wonderful World of Disney.

Although our marketplace is increasingly global, cross-border acquisitions aren’t simple—if they ever were—especially in the wake of Sarbanes-Oxley. At a minimum, SOX heightens the level of due diligence required in any merger or acquisition involving at least one company subject to U.S. jurisdiction, and alters the disclosure dynamic applicable to such acquisition efforts.

As thoughts turn toward summer vacations, and then the ultimate re-emersion into “office normalcy,” this may seem like a good time to take a break from compliance cares, litigation woes and regulatory and prosecutorial initiatives. But, alas, that might be short-sighted. While business men and women can take vacations, and relegate their problems to the proverbial “back burner,” their critical business issues and problems won’t be taking a vacation from them. This makes it critical to plan ahead, and also to consider what lies ahead.

In the broad arena of compliance, no area is fraught with more potential difficulties than asset management. It’s axiomatic that any time one group of individuals entrusts property or liquid assets to another, the potential for recriminations runs high. This is especially true with respect to retirement funds, since nothing is more likely to provoke feelings of anger and instability as telling those who’ve worked a lifetime that money they counted on to care for themselves and their families after they retire has disappeared.

In Shakespeare’s The Tempest, Antonio prompts his friend Sebastian to action by telling him, “What’s past is prologue.” By this, he meant that the events of the past set the scene for what’s to come, and what’s to come is within our control to influence and even determine. The same advice is applicable to corporations wondering how to develop and facilitate healthy relationships with their institutional investors. By taking the time to get to know their institutional investors and their issues, corporations can anticipate and meet their concerns and thereby best adapt to the increased activity of institutional investors.

Over the past 18 months, I’ve written periodically in this Compliance Week column about how directors should direct. For the most part, those columns were written for directors and their advisors. But building effective relationships between management and directors is a two-way street. Smart corporate officers will assume the responsibility for assuring a relationship with their boards of directors that is productive, proactive, disciplined, personally rewarding, and neither adversarial nor unduly deferential.

Socrates taught that “the unexamined life is not worth living.” Although a penniless philosopher who lived centuries ago, his advice has useful application in the 21st century corporate boardroom. Why is the unexamined boardroom life not worth living? For the same reasons Socrates advanced at his trial—it’s our responsibility to be independent, critical thinkers, and it’s our duty to raise and discuss challenging issues. This activity, in Socrates’ words, “is really the very best thing that a [person] can do, and life without this sort of examination is not worth living.”

In the final analysis, it’s really up to the business community, not government, to restore investor confidence. After all, the problems we’ve seen emanated from the private sector, and should be solved there. More importantly, companies that wait for the government to tell them what they can or can’t do, have only themselves to blame if they don’t like what they’re told.

Over the past several years, the liability landscape for corporate directors has been changing dramatically. This process has been exacerbated by the seemingly endless string of corporate scandals, involving the implosion of some of our largest companies. Most recently, three events are causing greater focus by directors on the thorny issue of personal liability, and suggest the need for outside directors to adopt a proactive stance in performing their oversight functions: The Emerging Communications case in the Delaware Chancery Court, and the recent settlements—by directors—of WorldCom and Enron class action litigation.

In the second in an occasional series of “how to” columns on directing, former SEC chairman and Compliance Week columnist Harvey Pitt considers how independent directors can be proactive, but in a constructive way. The guidance is intended to assist directors in striking the correct balance between two unacceptable extremes—being unduly compliant toward management, or unduly adversarial.

I’m frequently asked when the proverbial pendulum will swing back and business-bashing will cease. My unpopular response is: What we’re seeing is real and isn’t going away. A lot of credibility the business community once had has been squandered and eroded. It’s going to take a lot of time and effort to rebuild that credibility.

Being an effective director is a learned, not innate, skill. Nor is it a static proposition. Standards for directors change over time, especially as we consider more about what directors should do, and as we learn what happens when there are important things they don’t do. To ensure and improve their effectiveness, directors must continually evaluate how best to meet their fiduciary, legal, ethical and corporate governance responsibilities. To help in this undertaking, this is the first of an occasional series of “how to” columns on directing.

The corporate scandals of 2001-2003 are presumably behind us, but their aftermath lives on. Shareholders’ perception of American business is at an all-time low, as businesses scurry to decipher and satisfy a myriad of complex new regulatory requirements, many engendered by Sarbanes-Oxley.

Effective Nov. 1, as a direct result of Sarbanes-Oxley’s mandate to the US Sentencing Commission, public company directors and senior executives will assume significantly greater responsibilities to ensure the existence of effective corporate compliance and ethics programs.

While there are sound reasons for undertaking corporate internal investigations, two recent law enforcement cases demonstrate that there are also perils in incorrectly determining whether, why, when, with whom and how to do so.

The word “salary” comes from the Latin word for salt, reflecting ancient times when Roman soldiers were paid part of their wages in salt. In former SEC Chairman Harvey Pitt's latest column for Compliance Week, he offers some practical guidance on how to assure that your company’s executives are worth their “salt.”

Focus on risk management has become clouded and diffused amid Sarbanes-Oxley and "shocking corporate defalcations."

For some companies, the newly amended Form 8-K rules simply mean new checklists to satisfy minimal requirements. But to the savvy, the changes are an important call for companies to assess the strength and effectiveness of their current disclosure methodologies, practices and policies.

The standard knee-jerk reaction to allegations of wrongdoing may be too facile, and "can be inconsistent with an outside director's obligation to the company."

Most companies are adopting one of two diametrically-opposed approaches to SOX 404.

Many independent directors fall into one of two extreme camps: those unduly deferential to management who are "barely exercising any realistic oversight," and those unduly adversarial "for fear that partnering with management will somehow taint them" in the eyes of regulators and prosecutors.

Harvey Pitt outlines the various types of performance-based option plans that may become prevalent when new FASB rules become effective.

Companies made aware of indications of wrongdoing — even mistaken and misguided indications — must know how to respond.