Review: Gatekeeper Failures: Why Important, What to Do

Abstract

The States was hit by a wave of corporate scandals that crested between late 2001 and the end of 2002. Some were traditional scandals involving insiders looting company assets the most prominent being Tyco, HealthSouth, and Adelphia. But most were what might be called scandals: attempts by an issuer to maximize the market price of its securities by creating misimpressions as to what its future cash flows were likely to be. Enron and WorldCom were the most spectacular examples of these financial scandals. In scores of additional cases, the companies involved and their executives were sued by the Securities and Exchange Commission (SEC), and, in a number, executives were criminally prosecuted (p. 15). Hundreds of issuers were forced to restate their financial statements (p. 15). Why did this rash of financial scandals occur and what lessons for reform can be learned from the explanation? These are the questions addressed by Professor John Coffee1 in Gatekeepers: The Professions and Corporate Governance. Coffee's focus is on what he calls the gatekeepers: auditors, lawyers, securities analysts, and credit ratings agencies. Each of these professions can serve as a watchdog for the public. Each, at least in theory, has a particular position that allows for the acquisition of more information than the investing public has about an issuer's prospects and that provides them an opportunity to warn the public when that information is different than the impression given by management in the issuer's disclosures. In each of these financial scandals, the watchdogs failed to bark when the issuer's disclosures obscured the less favorable underlying reality of its economic situation. Because of this en masse gatekeeper failure, Coffee contends, the United States' much vaunted system of corporate governance was suddenly compromised (p. 15). Coffee begins his book by demonstrating that gatekeeper failures played a large role in permitting the Enron and WorldCom disasters. He goes on to