Michael Oxley puts regulatory reform in perspective

Almost two years after the start of the global financial crisis, the US government has taken its first real steps toward significant regulatory overhaul. The Restoring American Financial Stability Act of 2010 recently passed initial voting in the Senate and is now being vigorously debated in Congress.

This regulatory focus on corporate behavior is unprecedented: there are currently 12 other acts involving corporate governance reform at various stages of approval before one or both houses of government and the SEC. But the Financial Stability Act is the largest and most significant, and includes many elements of the other proposals.

To get a feel for the current state of play, we thought we would talk to the co-sponsor of the last major piece of corporate reform – the Sarbanes-Oxley Act (SOX). It’s been eight years since the passage of SOX, but Michael Oxley, partner at Baker Hostetler, still knows more than most about getting this type of regulation written into law.

The Restoring American Financial Stability Act had a hard time getting through the Senate, needing three separate attempts. Why was it so difficult?
The early votes and the initial failure to get the motion to proceed, as well as the obvious partisanship involved, are a reflection of the atmosphere in Congress and the Senate today, which is different from how it was eight years ago. They are also indicative of the highly complicated nature of the process.

The delay that took place in getting the votes in late April was all Kabuki; it was pure politics. The Democrats were spitting into the wind on the healthcare bill for a year and a half. They were really trying to roll that ball up the hill, but in this case they have the wind at their backs and they are going to push for the advantage.

I think the Republicans are doing the right thing in terms of trying to come to a compromise on some of the more key points, and this is the only real leverage they have, but at some point they are going to have to move forward and then it is going to be a free-for-all on the floor in terms of amendments.

Are there any parallels between what is happening now and the passage of SOX back in 2002?
Ultimately, SOX was relatively simple in terms of trying to deal with accounting fraud, and the issues were a little less complicated, whereas this bill is fully faceted and very complex. Frankly, Paul Sarbanes and I get criticized sometimes for not foreseeing this recent meltdown and doing something about it. My response is that I didn’t even know what a collateralized debt obligation (CDO) was back in 2002, and I suspect none of my colleagues in Congress did either. Our goal was to deal with what we found, which was massive accounting fraud. Now they are dealing with what appears to be unethical behavior on behalf of Goldman Sachs and other Wall Street firms. There is a big difference between then and now.

It was a different time. Enron and WorldCom produced some particular characters like Ken Lay, Jeff Skilling, Dennis Kozlowski, Bernie Ebbers and Andrew Fastow. So you basically had a media concentration on these executives doing the ‘perp walk’, and the public could really get into it because they could put a face to the name and blame specific people for what happened to their savings.

In this case, until Goldman managed to fall into that trap, we didn’t really have any discernible bad guys at whom to direct our anger. So for the victims and from Congress’ perspective, Goldman Sachs could not have come along soon enough. This reform circus is going to have an enormous impact on the legislation – not only the speed of what is going to pass, but also the content of that legislation.

Congress is going to pass this bill, and it is probably going to pass it before Memorial Day. There is little doubt that this will dramatically change business on Wall Street and in the financial sector. Whether that is a good thing or a bad thing remains to be seen, but no one should go away thinking that everything will be business as usual. There is just no way that is going to be the case.

What are the problems with the current bill?
I think the basic thrust is going in the right direction. Obviously we need to deal with the ‘too big to fail’ issue. This is being addressed, although there are a number of different opinions on how best to do it – pre-funding it or using a fund-it-after-the-fact model. Some people are making very bold declarations about no taxpayer dollars being used to bail out banks.

As for the consumer part of it, while I would have written it differently, I think based on the fact that the Democrats control Congress and the administration, it is inevitable. We are going to have some kind of a consumer agency because the consumer groups and many others are saying, ‘You bailed out the banks and you have taxpayer money involved; what have you really done for the basic consumer?’

On the issue of over-the-counter (OTC) derivatives, I don’t think I have spoken with anyone who does not believe the market ought to be brought out into the open. It needs more transparency, and we need to run as many of these products through clearing houses as we possibly can to minimize risk. Ultimately, we may have some of these things traded over the regular exchanges. I don’t think the average person realizes that the OTC market amounts to some $600 trillion worldwide.

Do you think the bill should include such broad governance rules as proxy access and curbs on executive compensation? How do you think these proposals will fare in floor debate?
I think proxy access will probably have to come out. It has never really caught on in the Senate and, frankly, neither has say on pay, although that is in the Dodd Bill. If I had to guess I would suggest that say on pay will stay in, but proxy access and some of the other stuff will fall by the wayside.

Do we really need proxy access, or are there more important things we should be thinking about?
I just don’t think the votes or enthusiasm are there in the Senate for proxy access. Let’s not forget that this is an idea that has been bouncing around for a long time; it has been to the SEC, to the courts, back to the SEC, and passed in the House, but no one has ever managed to complete the circle. I don’t support it anyway, so perhaps I am somewhat biased in that respect.

Why don’t you support proxy access?
It’s mostly a philosophical thing. I am reasonably pleased with the status quo in terms of selecting directors, and I think proxy access has been a perennial around Congress but has never really happened. In my opinion it’s unnecessary and would cause significant heartburn for the corporations.

How do you address concerns that some of the rules in the bill that are designed to be applied specifically to the financial sector may well be expanded to corporate America in general?
I think it’s mostly just smoke, other than some of the governance things like say on pay. If the worst that can happen to companies on compensation is say on pay, they ought to thank God for small favors. As for the rest of the stuff in there, I don’t think it will stand.

The content of this bill is almost all directed toward the financial sector. Some of the end-users, like the airlines and power companies, are concerned about the OTC derivatives going to clearing houses. Some of the banks have really hidden behind the end-users in order to lobby for that, but so far they have not made a lot of progress. As a matter of fact, you could argue that the compromise between senators Blanche Lincoln and Chris Dodd actually made it tighter in terms of those trades.

With more transparency and the use of clearing houses, and ultimately perhaps exchange trading, I think the cost to the end-user will go down because you will have more competition and more interest in the clearing house field. Right now the five banks control 97 percent of the trades at the clearing house level, so they basically have a cartel, but there are a lot of entities, including NASDAQ OMX and the Chicago Mercantile Exchange, that would fill the space and provide some serious competition for the first time.

If you were involved in the process, what do you think would be the best way to get this done without being overly prescriptive and unnecessarily damaging corporate interests?
There will be some collateral damage and some unexpected consequences – I think that’s natural for a bill of this magnitude – but I think that the more transparency you have, the less regulation you need.

For example, if we had more transparency in the OTC market we wouldn’t have had this problem in the first place because the market would have taken care of the situation, but frankly the people involved in the market like the darkness and for a while it made them a lot of money. Those days are over, though, and things are going to be a lot more transparent. I think the more transparent the law is, the less people need to worry about unnatural consequences.

On a different note, how do you feel about the recent ruling that excludes some companies from Section 404 of SOX?
The House decided that non-accelerated filers that have been exempt from Section 404 until now will be exempt permanently. They have been exempted by the SEC for the last eight years, anyway. I for one do not have any problem with that. SOX was originally passed to deal with a catastrophic systemic risk resulting in the loss of some $8 trillion in market cap.

The market cap for those companies that are being exempted, compared with the rest of the companies listed, is miniscule, so I would support it at that level. If you raised the level of market cap, I think it would be a problem, especially if you take some companies that have been complying for the past few years and tell them that they no longer have to. That would be a mistake and could lead to some bad results.