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. Last Updated: 07/27/2016

The Free Market Needs New Rules

In a string of corporate failures and scandals from Enron to WorldCom, we have seen the first principles of free markets -- transparency and trust -- fall victim to corporate opportunists exploiting a climate of lax regulation. I have long opposed unnecessary regulation of business activity, mindful that the heavy hand of government can discourage innovation. But in the current climate only a restoration of the system of checks and balances that once protected the American investor -- and that has seriously deteriorated over the past 10 years -- can restore the confidence that makes financial markets work.

Congress and the president must move quickly to frame legislation and reform corporate governance and government oversight. And I would add one more suggestion: They should ask for the resignation of Harvey Pitt, chairman of the Securities and Exchange Commission. While Pitt may be a fine man, he has appeared slow and tepid in addressing accounting abuses, and concerns remain that he has not distanced himself enough from former clients.

The need for government action and oversight is clear. Corporations fabricated revenues, disguised expenses and established off balance-sheet partnerships to mask liabilities and inflate profits. Executives maximized their compensation with stock option plans that burdened their companies with huge costs hidden from investors. Venerable accounting firms, having looked the other way as companies cooked the books, shredded documents to hide their misdeeds. Although U.S. tax policy encouraged them to do so, corporations that move their legal headquarters offshore to avoid taxes appear conspicuously ungrateful to the country whose young men and women are risking their lives today to defend them.

Reforms must ensure a complete separation of the auditing and consulting services provided by an accounting firm; a firm that audits a company must be prohibited from providing any consulting service -- ever -- to that company. Legislation sponsored by Senator Paul Sarbanes would create an Accounting Oversight Board to establish and enforce the standards for audits of publicly traded companies. But this oversight board should be completely independent from the industry, financed either as part of the SEC or a separate agency.

Stock options, while a legitimate and valuable form of employee compensation, must be identified as an operating expense in a public company's financial reports. Top executives should be precluded from selling their own holdings of company stock while serving in that company. Executives should be allowed to exercise their options, but their net gain after tax should be held in company stock until 90 days after they leave the company.

Executives should be required to return all compensation directly derived from proven misconduct. Also, a corporate compensation committee should be made up of members of the board who have no material relationship with the company or personal relationship with its management. Indeed, the entire board should be similarly independent, with the exception of the chief executive.

Top executives should be required to certify personally that the company's public financial reports are accurate and that all information material to the financial health of the company has been disclosed. If their certification is false, they should go to jail.

Government should remove egregious conflicts of interest in "full-service" financial institutions. Investment services, including research, should be separated from lending, underwriting and securities trading.

Even as we take these and other necessary measures, asking for the resignation of Pitt would help show the public our seriousness. During his first 10 months as SEC chairman, he did not participate in 29 of the commission's votes, most of which involved his former clients.

To address corporate misconduct, he seems to prefer industry self-policing to necessary lawmaking. Government demands for corporate accountability are only credible if government executives are held accountable as well.

What is at risk is the trust that investors, employees and all Americans have in our markets and, by extension, in the country's future. To love the free market is to loathe the scandalous behavior of those who have betrayed the values of openness that lie at the heart of a healthy and prosperous capitalist system.

John McCain is a Republican senator from Arizona. He contributed this comment to The New York Times.