How To Avoid Over-Regulation: Two Suggestions

Wednesday, October 1, 2008 - 01:00

Al Driver,Editor

Some things are clear - the financial sector is challenged by unprecedented illiquidity. This not only jeopardizes the availability of loans that businesses need for economic growth but also loans required to carry on their ongoing business activities.We applaud the efforts of Treasury Secretary Paulson and Federal Reserve Chairman Bernanke to right the economic ship.Two related issues are of special concern to all corporate counsel. One relates to how companies in the financial sector can minimize the effect of unnecessary and counterproductive regulation that can hamper their ability to contribute to the dynamic growth of our economy. The other recommends actions that can be taken to help all companies fight off such regulation.

Major players who originated subprime mortgages or bundled them into securities and sold them or sold credit default swaps relating to those securities are primarily responsible for our current liquidity crisis. They engaged in behavior that by 20-20 hindsight exposed their companies to unacceptable risks, which is precisely the kind of behavior that Sarbanes-Oxley was designed to prevent. As a result, all businesses suffer.

In contrast to the massive risk-management failure that infected major players in the financial sector, there have been very few newsworthy compliance failures affecting U.S.-based companies in the general business sector.Yet, the pages of the business press are filled with accounts of scandals affecting foreign-based companies whose compliance systems failed.It is interesting that one of the few financial giants to dodge the subprime bullet well before it became lethal was GE.But, notwithstanding its big financial footprint, GE's compliance culture does not rely on regulators to do its risk management homework for it - it does its own homework.

The great virtue of Sarbanes-Oxley is that it spurred self-regulation in the general business sector that has kept compliance violations to a minimum.After much initial wringing of hands, the general business sector now views the new compliance regime not as one that would inhibit and nullify growth - but perhaps a very positive development to be welcomed.The great virtue of Sarbanes-Oxley is that it promotes self-regulation in businesses that have traditionally not been highly regulated.

I remember attending a compliance seminar just after then-New York Attorney General Spitzer launched his campaign against the insurance industry. I was sitting with a friend who assured me there was likely to be very little fire behind Spitzer's smoke because that industry is so highly regulated.Could it be that the regulatory regime under which the financial sector currently operates itself discourages the intense focus on compliance that characterizes companies like GE in the general business sector? Does it need an overhaul?

Efforts to resolve the current crisis are playing out against the backdrop of a presidential election in which control of both houses of Congress is at issue. Politicians in both parties are looking for scapegoats and to greater regulation as a panacea for all problems - and in September the two remaining large investment banking houses had decided to become bank holding companies - in effect, volunteering for greater regulation.

Who knows how far the effort to impose more regulation will spread?The general business sector is not immune even though it is the victim and not the cause of the crisis that infects the economy.Overreaching regulations are not a panacea for any sector of our economy. Excessive regulation not only places limits on the competitiveness and innovation that has enabled our global companies to dominate world markets, but it also causes the financial sector to make smaller investments in their own compliance efforts because they feel that they can rely on the regulators to guide their efforts- the same regulators who ignored the subprime problem until it became a national disaster.

We can't afford to hamstring any part of our economy, including the financial sector.In the wake of the junk bond crisis in the mid-'80s state insurance commissioners put additional restrictions on the ability of such fine institutions as TIAA-CREF to lend to smaller but highly successful businesses and to take warrants for their stock. This misguided decision deprived many such companies of needed capital and prevented teachers from sharing in the benefits of their growth.

Two suggestions: First, to avoid future disasters that affect not only their companies, but also our entire economy, the major players in the financial sector who contributed to the current crisis should bring in qualified independent investigators to conduct investigations to identify where within their organizations the breakdowns occurred and to make recommendations that would prevent such breakdowns in the future.The investigators selected would only be deemed qualified if they were experienced in addressing compliance and governance issues.

Second, in order to discourage the adoption of unnecessary and counterproductive regulation that can hamper their companies' ability to contribute to the dynamic growth of our economy, the CEOs of companies that achieve high performance with high integrity should speak out about their companies' economic and social contributions to the communities in which they operate and their dedication to the principles of integrity and compliance that govern their performance.