For SEC, tech switch spurs stock option
"crooked accounting" take dramatic leap forward with combination of
real-time reporting, programming language.
Donna Block and
Published: February 19, 2007, 6:00 AM PST
The head of the U.S.
Securities and Exchange Commission is crediting the incorporation of
interactive data into SEC filings for the discovery of "a pandemic of
crooked accounting" linked to stock option backdating.
Practising Law Institute's annual "SEC Speaks" event earlier this month,
SEC Chairman Christopher Cox said
XBRL, the Internet programming language newly adopted by the agency, is
helping his staff root out fraud by tagging financial data so computers can
track it and sift through it quickly.
The chairman even
compared his team of enforcers to the characters in the hit TV show
Heroes--everyday people with extraordinary abilities they didn't know
they had. Cox said his enforcement staff comprise a group of otherwise
ordinary people with extraordinary talent and dedication.
"In other words,
'Save the cheerleader, save the world,'" Cox said, intoning the show's
He added that while
his staff may not possess superpowers, "by sheer willpower and hard work,
they routinely accomplish great deeds. And, to all the Americans who depend
on them, they are very real heroes, in every sense."
More than 170
companies have been investigated by the SEC or have conducted internal
whether option dates were changed to benefit executives.
Cox said the timing
option-backdating scandal coincided with the SEC's decision to begin
converting Form 4 submissions--the form companies use to report stock option
exercise transactions--into interactive documents.
information filed on the SEC's Form 4 was analyzed the old-fashion
way--retyped into SEC databases and spreadsheets before being scrutinized.
"Not surprisingly, for all of that time, the backdating phenomenon was never
uncovered," Cox said.
however, the SEC started collecting Form 4 data in an interactive format,
which made analyzing the information easier. The SEC also issued new rules
around the same time requiring real-time reporting of option awards--within
two days of the grant. "Once real-time disclosure was combined with
interactive data...we began to find clues that had previously gone
undetected. That led directly to the discovery of what we now know were
billions of dollars of backdated stock option awards," Cox said.
Cox advocates using
technology to improve disclosure, and regulation is pressing companies to
use the interactive system. The SEC has invested $54 million into its
development this year.
But many companies
have been slow to adopt XBRL for a variety of reasons, including cost.
Cox said other
technology initiatives are also in development at the agency. He said the
SEC is using new technology to "help accurately track, collect and
distribute billions of dollars of penalties and disgorgements."
The agency is also
introducing new software tools to manage its enforcement cases and be
prepared to operate in a disaster or emergency.
officials said at the conference that regulation should have a global
perspective in which authorities engage with each other on international
and innovation will challenge us even more to be responsive and thoughtful
in adjusting market regulation to market needs and realities," SEC
Kathleen Casey said at the conference.
The pending $14
billion merger of NYSE Group, parent of the New York Stock Exchange, with
Euronext, which operates the Paris, Amsterdam, Brussels and Lisbon
exchanges, will result in the first trans-Atlantic exchange and has the SEC
collaborating with European regulators to oversee the merger and coordinate
their supervisory efforts.
In January, the
exchanges signed a memorandum of understanding with respect to their
regulation whereby the SEC and the College of Euronext Regulators pledged to
cooperate "to promote investor protection, foster market integrity, and
maintain investor confidence and systemic stability in connection with the
regulation of the combined group."
confirmed that the deal will not result in foreign companies being subject
to the domestic laws of any of the countries where the exchanges are based.
Some foreign investors worried that companies traded on the European
exchange would be subject to provisions of the Sarbanes-Oxley
Annette Nazareth, a Democrat, said at the conference that she is seeing
other markets adopt similarly tough rules over financial reporting, even
though Sarbanes-Oxley, most notably its internal-control requirement
contained in Section 404, has been greatly criticized.
"It is interesting
that several jurisdictions are adopting regulations similar to SOX in an
effort to improve investor protections, encourage private investment and, as
a result, increase the depth of their markets," she said.
However, Casey, the
newest commissioner and a Republican, said the SEC needs to continue
reaching out to regulators both at home and abroad, and regulators "need to
needs to continue in its efforts to engage cooperatively with other
regulators both domestically and internationally," she said.
Questions about new
rules for investing in hedge funds were also raised at the conference. SEC
staffers were grilled on the agency's proposal to raise the requirements
investors must meet to invest in hedge funds. Existing regulations call for
an individual hedge fund investor to have $1 million in assets or an annual
income of $200,000 for at least two years prior to making the investment. In
December, the commission introduced a draft rule that would change the net
worth threshold to $2.5 million in invested assets, excluding a primary
residence, with the SEC adjusting the new investment minimum every five
years for inflation.
Steven Wallman, CEO of Vienna, Va.-based brokerage and consulting
business Foliofn, said the SEC sought to prohibit investors with lesser
means from investing in hedge funds but hasn't produced concrete evidence
that the strategy is more risky than investing in mutual funds.
But Doug Scheidt,
SEC associate director and chief counsel for the Division of Investment
Management, defended the proposal. He argued that many hedge funds lack
sufficient disclosure and aren't required to open up their books to
commission examiners for periodic inspections. "Hedge funds are notoriously
untransparent," Scheidt said.
however, that he couldn't say definitively that investing in hedge funds is
riskier than mutual funds. After Wallman pressed him on the subject, Scheidt
declined to comment on whether the agency would produce a study examining
the risks associated with each type of investment.
Laura Unger, a former SEC commissioner, pointed out that critics of the
measure argue that the new prohibition would reduce the numbers of people
investing in hedge funds, reducing the diversification of the funds, thus
increasing the risks for those remaining.
"A smaller pool of
investors has the perverse effect of making it riskier to invest in hedge
funds, because the funds are spread out among fewer investors," Unger said.
Scheidt said the
new limits made sense, in part, because hedge fund managers aren't seeking
to raise investment capital from the people that the measure will exclude.
investors and managers have until March 6 to comment on the proposal. So
far, the SEC has received about 200 comments, most of which have been from
investors and managers deriding the agency's proposal on grounds that it
will have a chilling effect on competition in the industry and prohibit
sophisticated investors with fewer assets.
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