The TSC Streetside Chat: Former SEC Investigator Seth Taube

With the markets focusing as never before on what goes on beneath those green eyeshades, we took some time to discuss accounting shenanigans with attorney Seth Taube, who has worked both sides of the aisle during his career.

Throw together a softening economy, a dusty trail of complex financial practices, a growth-obsessed investor class and a great deal of poor judgment, says Taube, and you have the makings of a groundswell for accounting reform -- not to mention a mudslide of legal and criminal liability.

Taube has a ringside seat on the issue. He defends corporate clients accused of securities fraud for McCarter & English, a Newark, N.J.-based law firm. Previously, Taube served as branch chief of enforcement for the Securities and Exchange Commission in New York and was also a former assistant U.S. attorney in Manhattan.

Taube says that while many questionable accounting maneuvers are arguably legitimate, investor discontent will force the adoption of more conservative practices across corporate America. Even if many investors don't truly understand the inherently subjective nature of most accounting judgments, the capital markets will see to it that companies roll back the excesses of years past and that those seen as transgressors are punished.

TheStreet.com: What does your group do?

Seth Taube: We defend class actions and handle SEC investigations, insider trading cases, internal investigations and various other business litigation. Generally we are the defense attorneys, not plaintiff's lawyers.

TheStreet.com: Is it fair to say you have gone from one side to the other in your career?

Seth Taube: Certainly. When I was with the SEC I was typically on the top of the caption -- on the plaintiff side on behalf of the United States or the SEC. And now I generally defend. I've jumped to the other side of the caption in these cases. I've seen both sides and have worked them aggressively.

TheStreet.com: From your perspective, why are we seeing so many more apparent corporate frauds and accounting scandals?

Seth Taube Ex-SEC investigator turned white-collar defense lawyer.

Seth Taube: Historically, I think there has always been a fairly intense fudge factor in accounting. It's an art, not a science. A classic example is, how much do you estimate for loss reserves on the potential for your buyers being able to pay you? There is a fair amount of estimation in accounting, and that has allowed public companies some flexibility in their numbers. This flexibility has led to some less stringently honest insiders being able to be more aggressive with the numbers. And when you are walking the edge of what is an estimate, it is easy for someone to see it as fraudulent or misleading even when it is in the permissible range.

But having said that, there is no question that some CEOs go over the edge.

TheStreet.com: Are we seeing a predictable cycle? Do these scandals come and go in some fashion?

Seth Taube: Clearly the downturn in the economy always squeezes out the criminals. In good times a senior executive can dip his hand in the till, and the flush of profits hides the defalcation or theft. As times tighten, pencils are sharpened and money falling through the cracks is identified.

In times when profits are hard to come by, the scrutiny by the public and regulators brings these problems to light. So it's a function of the downturn of the economy -- but also a function of increased complexity. There has been the use of more aggressive -- though not illegal -- accounting by public companies in the past decade.

TheStreet.com: Are boards of directors adjusting their scrutiny of business practices?

Seth Taube: Since Enron, I think America's corporate boards get it. I think the impulse of Congress and the SEC to impose new regulations is necessary for public confidence, but not necessary for corporate boards to understand the need to be more conservative in their accounting methods.

They understand that more conservative accounting is necessary to rebuild investor confidence. They also understand that new regulatory scrutiny is needed -- not to accomplish more honest reporting but to gain investor confidence.

Ultimately, the force of the market, the desire of companies to raise capital from the public, mandates that they take action to gain confidence. Action by government will help restore investor confidence and therefore it's a necessary evil.

TheStreet.com: So, WorldCom (WCOME Quote) ... Do you do any work for them?

Seth Taube: They are not clients of ours.

TSC: You follow the case, I take it -- what do you make of it over all?

Seth Taube: There are two aspects to WorldCom from my view. There are the issues of Bernie Ebbers taking a huge personal loan from the company to cover his margins; that was aggressive on the part of Ebbers and the company and bad for investor confidence. That may not have been illegal, but it was poor judgment in a post-Enron environment.

The second issue, the $4 billion accounting error, is the nuclear bomb of accounting problems. To have so dramatically mistaken expenses for capital spending must lead to a significant reorganization of the company.

It may come down to the problems of one or two people, but just like Arthur Andersen, the mistakes of a few people are sometimes unfortunately visited on what might otherwise be a wonderful company that provides excellent service to the community.

TheStreet.com: In your mind, is WorldCom an anomaly?

Seth Taube: No, the use of judgment in accounting has come to light for all companies, and more conservative accounting judgment will be necessary. We will see many many more companies make decisions to be more conservative in the way they account.

This is not an indication, as the public perceives, that companies are bereft of integrity. They are not. This is a misperception that accounting is nothing more than adding up a stack of jellybeans and reporting how many beans are in the jar. It's just not that easy.

TheStreet.com: Are you saying this from the standpoint of your current position or from your experience as a fraud prosecutor?

Seth Taube: I say that both as a defense attorney and as someone who has prosecuted these claims. Liabilities are going to be there; class-action action lawyers are going to get rich in this environment. These accounting decisions won't lead to simple changes in accounting methods. They will lead to liabilities, regulatory problems and class-action settlements. People will be prosecuted and go to jail.

In the WorldCom case, there's no question there will be criminal as well as civil action taken. But the truth is accounting is much more complicated than how many jellybeans are in the jar. Reasonable people can differ. It doesn't always mean people won't go to jail.

TheStreet.com: So we might see more WorldCom-type admissions of aggressive accounting?

Seth Taube: Yes, and in some cases it will be fraud, but in many cases it will be merely seen as the safer road, which is to report it as if it hits the bottom line even if there's an argument that you don't have to.