THE SEC TURNS THE SCREWS ON 'GATEKEEPERS'
By Carol J. Loomis

(FORTUNE Magazine) – WATCH THIS WORD: GATEKEEPERS. IN the world of corporate governance, the term refers to auditors, inside and outside lawyers, outside directors--and now, so we've learned in one recent Securities and Exchange action, to a range of corporate executives. The point is, you don't have to do wrong yourself; you can be in trouble if you're in a position to detect wrongdoing below you and don't move forcefully to prevent it. It doesn't even matter if you've been lied to. You still have the responsibility to cut through the lies and try to root out the truth.

And this is a message the SEC, trying these days to attack corporate fraud any way it can, is pushing broadly. Linda Thomsen, deputy director of the commission's enforcement division, speaks of "deterrence" and the need to reach people who facilitate wrongdoing: "If you can get the one person who helps 100 people do something, you've stopped 100 things, not just one."

The SEC's recent blast on this front came in March as the agency partially wound up its multiyear investigation of Time Warner (owner of FORTUNE's parent) and, most specifically, bad stuff that went on at its subsidiary AOL. What AOL did was use every possible scheme it could think of to turn financial transactions into online advertising revenues. Exhibit A was the so-called Bertelsmann transaction. Here, $400 million passed from Bertelsmann to AOL. But instead of AOL's calling this money what it was--a payment to secure amendments in a contract relating to the ownership of AOL Europe--AOL called it ad revenues.

For this piece of dishonesty and others, Time Warner, signing a consent decree, was penalized $300 million. But the SEC also issued a cease and desist order against three Time Warner financial executives: CFO Wayne Pace, controller James Barge, and assistant controller Pascal Desroches. Their misstep was, in effect, bad gatekeeping--even though they had been lied to in some instances. "They failed," said the SEC's order, "to pursue facts and circumstances that evidenced the true economic substance of the transactions." A particular irony is that some years ago both Barge and Desroches worked in the SEC chief accountant's office as what are called "practice fellows."

This appears to be the first SEC gatekeeping action that, leaving aside lawyers, zeroed in on corporate officers. But there have been at least two relatively recent cases that pinioned audit committee board members, one at retailer Royal Ahold and one at leasing company Chancellor. And none of that counts the gatekeeping actions that the SEC has brought against investment bankers, notably in connection with Enron. Here, Merrill Lynch, Citigroup, J.P. Morgan, and CIBC were all sued by the SEC for entering into transactions that they either knew or should have known were aimed at obscuring Enron's true financial picture. That cost the firms close to $400 million.

The overall moral: Katy, bar the gate.

-- Carol J. Loomis