By Matt Elsner

The West Coast dockworker’s lockout, historically elevated oil prices, and uncertainty over Iraq have all contributed to the malaise that Wall Street hasn’t been able to shake.

So, how’s your 401k doing these days? I barely have the stomach to look at my quarterly statements anymore, and with good reason. Even after a few bullish weeks, the NASDAQ is still down about 35% for 2002, and the DOW is down an equally depressing 20%. There are numerous reasons why the markets are still suffering as much as they are. Corporate profits have shrunk, many industrial firms aren’t working near capacity, economic growth is low, investments in technology have been minimal, our foreign trade deficit continues to expand, and our budget surplus has turned into a deficit once again. The West Coast dockworker’s lockout, historically elevated oil prices, and uncertainty over Iraq have all contributed to the malaise that Wall Street hasn’t been able to shake. However, there is one other, underlying reason that may be depressing share prices as much or more than all of these reasons. Investors have not yet fully regained confidence in the veracity of the financial statements that underpin our equity markets and therefore our entire financial system.

From Enron to WorldCom, the list of companies that have restated their financial statements because of accounting irregularities continues to grow. Even after the additional scrutiny that has been paid to financial accounting and auditing of late, investors still are skittish. Quite honestly, they have every reason to be nervous. A number of the actors that were such vocal supporters of reform this past summer are now undermining some of the measures that were supposed to address problems within the accounting industry.

"Corporate misdeeds will be found and will be punished," President Bush said this past July at the White House signing of the Sarbanes-Oxley Act. "This law authorizes new funding for investigators and technology at the Securities and Exchange Commission to uncover wrongdoing," he remarked in support of the legislation. The 77% budget increase for the Securities and Exchange Commission that the Sarbanes-Oxley Act called for was one of the Act’s highlights and was pointed to as an example of how seriously the government was taking accounting and auditing reform. For years, there had been concern within Congress and within the SEC over their miniscule budget. The SEC often could not take action against companies simply because they didn’t have the resources. Their lawyers and accountants make roughly half of what their counterparts in the private sector make and their computer systems are seriously outdated. To put the proper David and Goliath perspective on the situation, Merrill Lynch (just one Wall Street institution the SEC has investigated) has a larger legal and compliance staff than the SEC’s entire enforcement staff.

The White House has now reversed itself, however. The $776 million that the SEC was to receive under Sarbanes-Oxley has been slashed to $568 million. This ludicrous sum would not even bring the SEC’s budget in line with its needs before the recent accounting crisis. Given its increased enforcement responsibilities and the larger number of cases it is now pursuing, the amount seems stunningly low. Senior officials within the SEC are disappointed and realize the gravity of the situation and the impact it will have on their enforcement capabilities. Paul Sarbanes, whose name is on the legislation Bush had initially supported this summer, called the President’s decision "disheartening" and said that "the costs of increasing pay, hiring new staff and increasing the volume of their business presents a case for a higher budget that is overwhelming." Part of the additional financing that has now been cut would have been used to pay for the new accounting oversight board that Sarbanes-Oxley called for. But lack of financing is hardly the worst blow to affect this new mechanism.

Formally known as the Public Company Accounting Oversight Board, it has a wide-ranging directive to set ethics as well as conflict-of-interest standards. It was also set up to conduct annual reviews of the nation's accounting firms and to discipline accountants. The SEC’s Chairman, Harvey Pitt originally supported the candidacy of John H. Biggs to head up the board, as did current and former Fed Chairmen Alan Greenspan and Paul Volcker, Treasury Secretary Paul O’Neill, and the man who wrote the legislation, Sen. Paul Sarbanes (not to mention Business Week, The Wall Street Journal, and The New York Times). John H. Biggs is a man who has substantial experience in accounting and audit issues. He favored restricting accounting firms from performing consulting work for firms they are auditing. He also wanted to force companies to regularly rotate auditors, a policy he enforced while head of pension giant TIAA-CREF. He has also supported stricter accounting for stock options for executives.

Meaningful accounting reform is all but stillborn, thanks to the
actions of Harvey Pitt and President Bush.

These views, however, are not popular with the White House or the accounting industry, and as such have caused a reversal by SEC Chairman Pitt. After intense lobbying from the accounting industry (with whom he is extremely close - he represented the American Institute of Certified Public Accountants while in private practice, as well as top accounting firms), Pitt withdrew support for John H. Biggs, simply stating that he had never been promised the job. Now, former CIA and FBI director William Webster has been tapped to head up the board by Pitt, even though he has little relevant accounting experience and has been publicly silent on all of the issues that John H. Biggs has been vocal about.

So why shouldn’t investors be nervous? The SEC and the White House have done little to assure them that accounting reform is going to be pursued in a meaningful fashion. The real issues facing accounting (and by extension our equity markets) will remain. Accounting firms will still be able to perform extremely lucrative consulting services for their audit clients and the concomitant conflicts of interest will therefore remain. A lack of auditor rotation will only reinforce that fact. And the SEC’s budget will hardly allow them to pursue cases in a way that would worry anyone who has been cooking their books or the auditors who have been collaborating with them.

Meaningful accounting reform is all but stillborn, thanks to the actions of Harvey Pitt and President Bush. We had a shot at ensuring that investors could trust corporate financial statements once again and thus restore much of the lost confidence in our equity markets. The next time you can’t bear to open that envelope with your quarterly statement or to look at how the Dow did that day, remember why.