Speaker 1: This is Bloomberg Law with June Bresso from Bloomberg Radio.
Speaker 1: As a response to several corporate and accounting scandals in
Speaker 1: the early two thousands, Congress past the Sarbanes Oxley Act
Speaker 1: in two thousand two with bipartisan congressional support. As Sarbanes
Speaker 1: Oxley celebrates its platinum anniversary, we'll look at how effective
Speaker 1: it's been. Joining me a securities law expert James Park,
Speaker 1: a professor at u c l A Law School. His
Speaker 1: new book is called The Valuation Treadmill, How securities fraud
Speaker 1: threatens the integrity of public companies. Jim tell us about
Speaker 1: Sarbanes Oxley in a nutshell uh. Sarbanes Oxley basically says,
Speaker 1: if you're a public corporation with stock that's trading in
Speaker 1: public markets, you have to invest in measures to prevent
Speaker 1: securities fraud. So there's a wide number of provisions or
Speaker 1: passed as part of the law, and I think some
Speaker 1: of the more important ones are certification requirements, where the
Speaker 1: CEO and CFO have to basically certify that there's no
Speaker 1: material misrepresentations in the company's disclosures. A public company also
Speaker 1: has to establish a system of internal controls um that
Speaker 1: will help inform the company's managers about the company's financial condition,
Speaker 1: and every year they are obligated under Sarbane Boxley to
Speaker 1: evaluate the effectiveness of those internal controls and then importantly,
Speaker 1: a independent auditor um has to review and attests to
Speaker 1: the management's evaluation of the internal controls um. Those to
Speaker 1: me are the core provisions of Sarbane Zoxley as they
Speaker 1: relate to public companies and tell us about the reasons
Speaker 1: for the law why it was passed. In my view,
Speaker 1: the law was the culmination of years of securities fraud.
Speaker 1: Case is that the sec basically pursued starting in about
Speaker 1: n or nine nine and basically towards the end of
Speaker 1: the nineteen nineties, there was significant pressure on public companies
Speaker 1: to deliver quarterly results to meet analysts projections of their
Speaker 1: revenue and earnings, and many of them were cheating. They
Speaker 1: were cheating by violating accounting rules so that they could
Speaker 1: report revenue that was a little bit higher profits that
Speaker 1: were a little bit higher. And this structural pressure to
Speaker 1: maintain your evaluation, in my view, was the main reason
Speaker 1: for the law. The best justifications for the law, you know,
Speaker 1: in terms of the events that led up to the law.
Speaker 1: I think it's worth talking about those a little bit.
Speaker 1: You know, I started practicing law around this time, about
Speaker 1: twenty years ago, and then this is the time when
Speaker 1: security fraud was national news. It was really one of
Speaker 1: the major national concerns. You have the December two thousand
Speaker 1: and one bankruptcy filing of Enron, and then the next
Speaker 1: month in January of two thousand and two, Global Crossing
Speaker 1: files for bankruptcy. That spring, in April two thousand and two,
Speaker 1: Elliott's sister bring major case against Merrill Lynch for issuing
Speaker 1: false research recommendations with respect to stocks that it was
Speaker 1: promoting as part of its investment banking business. June two
Speaker 1: thousand and two, Adelphia files for bankruptcy. And then what
Speaker 1: really prompted the passage of the law is July two
Speaker 1: thousand into World Cops files for bankruptcy. So you have
Speaker 1: a string of major public company bankruptcy that really pushes
Speaker 1: Congress to act. And the law was passed virtually with
Speaker 1: unanimous approval, and it was zero in the Senate, foy
Speaker 1: three to nine in the House, and President George W. Bush,
Speaker 1: a Republican, signed the law on July. Do you think
Speaker 1: it's worked. Has it been successful? I think it has
Speaker 1: been successful. It is a tough law, though to gauge
Speaker 1: with expect to how well it is working. Um, it's
Speaker 1: very hard to really measure exactly what the impact of
Speaker 1: the law has been. But we do have anecdotal evidence
Speaker 1: where public company managers report that they are more careful,
Speaker 1: more systematic about investing in internal controls to prevent securities frauds.
Speaker 1: So we have that sort of qualitative evidence that would
Speaker 1: support the idea that the law is working. We also
Speaker 1: have evidence from accounting leak statement re statements are basically
Speaker 1: when a company acknowledges that there's a material misrepresentation in
Speaker 1: its financial statements. And we see accounting lead statements of
Speaker 1: SEC filing company steadily declining. I'm over the last fifteen
Speaker 1: twenty years. In two thousand and six, seventeen percent of
Speaker 1: SEC filers we stated their financial statement was five percent,
Speaker 1: and that may indicate that internal controls are catching some
Speaker 1: of these mistakes earlier. There may be an upsurge. In
Speaker 1: two thousand and twenty one with SPACs there were a
Speaker 1: lot of spacty statements, But after that, Bliss I expect
Speaker 1: we might see that trend to continue to fall. The
Speaker 1: other evidence that it has worked is we have not
Speaker 1: seen another end Ron or World Top. We have seen
Speaker 1: some securities frauds over the last fifteen to twenty years
Speaker 1: by public corporations, but we have not seen as many
Speaker 1: of them as we saw around that time. And if
Speaker 1: you look at the data on private securities class action filings,
Speaker 1: the percentage of those lawsuits that alleged a financial misstatement
Speaker 1: has the client over the last decade or so. Coming up,
Speaker 1: I'll continue this conversation with you cel A law professor
Speaker 1: James Park, and we'll talk about how securities fraud threatens
Speaker 1: the integrity of public companies. This is Bloomberg. I've been
Speaker 1: talking into u c l A law professor James Park.
Speaker 1: He's got a new book coming out entitled The Valuation Treadmill,
Speaker 1: How securities fraud threatens the integrity of public companies. Give
Speaker 1: us the broad outlines. What's your book about. It's a
Speaker 1: history of securities fraud regulation and it basically goes from
Speaker 1: the nineteen seventies until the present. There are a lot
Speaker 1: of books that look at individual frauds. You know, you
Speaker 1: think of the book on Enron's modest guys in the
Speaker 1: room really delved into that particular fraud in death. What
Speaker 1: I wanted to do was I wanted to see and
Speaker 1: explore how securities fraud has changed over time UM, and
Speaker 1: so I look at five or six major frauds over
Speaker 1: the decade. Each fraud is meant to be representative of
Speaker 1: a particular period in time. So I start out in
Speaker 1: the nineteen seventies with the collapse of the Penn Central Railroad,
Speaker 1: and that was a really significant event because before UM
Speaker 1: that particular scandal, there's sort of a belief that large
Speaker 1: companies did not commit securities fraud and that it was
Speaker 1: really a problem for smaller companies. But when you have
Speaker 1: the sort of nation's largest railroad filing for bankruptcy, that
Speaker 1: really shapes the assumption that large companies are not vulnerable
Speaker 1: to securities frauds. In the nineteen eighties, you have cases
Speaker 1: against technology companies. Apple, for example, was hit with a
Speaker 1: hundred million dollar verdict or it failed Lisa Computer, and
Speaker 1: that case raised a lot of similar issues as we
Speaker 1: saw in the Sarano's case recently with Elizabeth Holmes. At
Speaker 1: what point do you say that a product has failed
Speaker 1: and to what extent is a failure to reveal the
Speaker 1: failure of a product fraudulent to investors. And of course
Speaker 1: I talked about Enron and a lot of the cases
Speaker 1: around that period, such as the zero accounting fraud, which
Speaker 1: was the first time the sc SEE impose a substantial
Speaker 1: civil penalty on a public corporation. And then I talked
Speaker 1: about the financial prices of two thousand and eight, why
Speaker 1: were there not more security spout cases filed after that crisis?
Speaker 1: And then I moved to the present and talked about
Speaker 1: how security spout theories are now being applied in the
Speaker 1: E s G context. When there's an E s G disaster,
Speaker 1: there's often allegations of securities frauds. So I really try
Speaker 1: to walk the reader through the decades and explain how
Speaker 1: securities fraud has changed and evolved over time as a
Speaker 1: problem for public corporation. Has securities fraud gotten more sophisticated?
Speaker 1: As you know, technology has improved or is the same old,
Speaker 1: same old, It has evolved, It has changed in many respects.
Speaker 1: And you know, if you look at some more recent
Speaker 1: securities frauds that we're seeing, they are not like the
Speaker 1: end rons and world times. They are doing things that
Speaker 1: are more subtle than violating accounting rules, and they are
Speaker 1: changing operational decisions in certain ways to generate additional cash
Speaker 1: flow in ways that are facially legal but could be
Speaker 1: deceptive to investors. At the end of twenty twenty, the
Speaker 1: SEC filed a big case against General Electric. General Electric,
Speaker 1: as you may know, revealed massive losses about five years
Speaker 1: ago in various businesses that investors were very surprised at.
Speaker 1: And you know, once the losses were revealed, the value
Speaker 1: of the company declined by an amount greater than the
Speaker 1: combined value of Enron and World Times. And what the
Speaker 1: SEC discovers is they're they're not really violating accounting rules,
Speaker 1: but they are doing things like selling more and more
Speaker 1: of their receivables in order to generate cashflow now to
Speaker 1: create the appearance that their businesses are strong, when in
Speaker 1: fact they were weak. And so this is a bit
Speaker 1: more of a subtle type of securities frauds that we
Speaker 1: see in that case. Another example of this type of
Speaker 1: earnings management fraud is under Armour. They basically we're trying
Speaker 1: to maintain the appearance that they were growing every year
Speaker 1: by about so one of the ways they tried to
Speaker 1: create the appearance of such growth is that if they
Speaker 1: had to hit a certain number at the end of
Speaker 1: a quarter, they would ask their customers to take products early.
Speaker 1: Products they had ordered later on, they asked them to
Speaker 1: accept it early so they could count it as revenue
Speaker 1: right away. And so that technically does not violate accounting rules,
Speaker 1: but it does create a deceptive portrayal of the company's
Speaker 1: condition and prospects. So we've seen a recent collapse in
Speaker 1: technology stock prices. Will that lead us to the next
Speaker 1: endron or world come very possible? You know, security s
Speaker 1: frauds tend to be revealed in bad times because at
Speaker 1: some point you're not able to maintain the fiction that
Speaker 1: your company is not performing as well as you have
Speaker 1: been portraying it as performing. And if you think about
Speaker 1: another recent event in the news, the Elon Musk and
Speaker 1: Twitter battle, in some ways, he's alleging that Twitter has
Speaker 1: committed a type of security fraud against him. Um. He's
Speaker 1: saying that they're published estimate of dam accounts is to
Speaker 1: love um and that he was essentially misled into buying
Speaker 1: this company that has, you know, a higher percentage of
Speaker 1: fake accounts, which might affect your assessment of their future prospects. Now,
Speaker 1: I personally don't think that this is a strong argument.
Speaker 1: The real reason why Twitter stock prices declined is that,
Speaker 1: you know, with interest rates rising because offense trying to
Speaker 1: head off inflation, that means that valuations of companies with
Speaker 1: future earnings tend to go down. But you know, this
Speaker 1: is a type of securities fraud argument that Musk is
Speaker 1: asserting partly because he wants to get out of the deal.
Speaker 1: And I think the reason he wants to get out
Speaker 1: of the deal is because he has offered to pay
Speaker 1: too much for Twitter um and so I expect that
Speaker 1: we will start seeing more securities frauds if the market
Speaker 1: keeps going down and the economy keeps deteriorating. Is the
Speaker 1: enforcement of the securities laws rigorous enough? Is it heading
Speaker 1: off problems? It's always a great question. And you know,
Speaker 1: the Securities and Exchange Commission does the best that it
Speaker 1: can with its limited resources. I think it could always
Speaker 1: use more resources. They have been fairly active in bringing cases,
Speaker 1: and I think they have, you know, just in the
Speaker 1: last month or so, filed some good cases, some interesting cases.
Speaker 1: But in my view, it's only a small fraction of
Speaker 1: the fraud that is actually happening, that the sec has
Speaker 1: the ability to really investigate and bring a case. Again,
Speaker 1: I do think that private investors and their attorneys who
Speaker 1: are bringing securities class actions play an important role in
Speaker 1: enforcing the law against securities fraud, and they are often
Speaker 1: very active. UM. One other thing that has helped, and
Speaker 1: this is part of Sarbanes Oxley, is the protection for
Speaker 1: whistleblowers within the company as well as the incentive to
Speaker 1: come forward, which were put in place by Dodd Frank.
Speaker 1: I think that's been very helpful to the Securities in
Speaker 1: Exchange Commission in finding securities fraud, and it deters securities
Speaker 1: fraud as well, because UM, if you know that your
Speaker 1: employees have incentive to report fraud, that might make it
Speaker 1: more difficult to actually commit a fraud. And so I
Speaker 1: think that the system has improved over the last twenty
Speaker 1: years and that regulation UM has a rest security s
Speaker 1: fraud in many ways. But I do suspect that we
Speaker 1: are not catching all of it. Is there any way
Speaker 1: to quantify how much more than they've caught, It's hard
Speaker 1: to quantify. I suspect that there are a lot of
Speaker 1: questionable practices that just never come to light because you know,
Speaker 1: a company might you know, have questionable accounting, but no
Speaker 1: one ever really discovers it because the company ends up
Speaker 1: doing pretty well for other reasons. So I think that,
Speaker 1: you know, I would guess that maybe at most were
Speaker 1: catching half of it. And I think that's just a
Speaker 1: very rough, rough guess. I think there are a lot
Speaker 1: of other questionable practices that you don't really know about
Speaker 1: it until there's some crisis at the company or a
Speaker 1: whistleblower finds it, you know, And part of the thesis
Speaker 1: of the book is that there's always this pressure on
Speaker 1: public companies to commit securities frauds because they are always
Speaker 1: is pressured to deliver short term results. And I do
Speaker 1: think a lot of companies resist the pressure and temptation
Speaker 1: and are honest and they do report accurate financial results
Speaker 1: that issue correct disclosure. But there are a lot of
Speaker 1: others I think that give in to the pressure, and
Speaker 1: we may not discover all of them. Is there a
Speaker 1: lesson that you want readers to take away after reading
Speaker 1: your book? You know, I think the main point, to
Speaker 1: tip it back to Sarbanes Oxley, is that you know,
Speaker 1: there's a good reason we have Sarbanes Oxley I think
Speaker 1: that's the one point I'm trying to make in the book,
Speaker 1: that security fraud is a structural problem. You know, one
Speaker 1: perception is that it's it's just bad people who commit
Speaker 1: securities fraud from time to time, people who are trying
Speaker 1: to trade on inside information, people who are trying to
Speaker 1: sell their stocks before the company collapses. And I think
Speaker 1: that is an important part of security fraud. But you know,
Speaker 1: to me, what's more interesting is when otherwise law abiding
Speaker 1: executives to see investors. And I think they do so
Speaker 1: because there's a structural pressure on public companies that we
Speaker 1: see in modern times. And cb azoxy has been criticized
Speaker 1: quite a bit over the years. It's costly, it reduces
Speaker 1: the incentive of companies to go public, and Congress has
Speaker 1: tried to implement various laws to try to reduce the cost,
Speaker 1: but it is still somewhat of a deterrence of being
Speaker 1: a public corporation. And so I think we continually have
Speaker 1: to justify a law that basically says, if you're a
Speaker 1: public corporation, you have to spend significant amounts in preventing
Speaker 1: security frauds. And I think that this book makes the
Speaker 1: case that Sarbanzoxy is a necessary claw for all public
Speaker 1: corporations because securities fraud is a threat to all public corporations.
Speaker 1: Thanks for being on the show, Jim. That's u c
Speaker 1: l A Law professor James Park. The book is called
Speaker 1: The Valuation Treadmill, How Securities Fraud Threatens the integrity of
Speaker 1: public company knees. And that's it for this edition of
Speaker 1: the Bloomberg Law Show. Remember you can always get the
Speaker 1: latest legal news on our Bloomberg Law Podcast. You can
Speaker 1: find them on Apple Podcasts, Spotify, and at www dot
Speaker 1: Bloomberg dot com, slash podcast Slash Law. I'm June Grosso
Speaker 1: and you're listening to Bloomberg