[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
                     THE ENRON COLLAPSE: IMPACT ON 
                    INVESTORS AND FINANCIAL MARKETS
=======================================================================


                             JOINT HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                    CAPITAL MARKETS, INSURANCE, AND 
                    GOVERNMENT SPONSORED ENTERPRISES

                                AND THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                              COMMITTEE ON
                           FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION
                               __________

                           DECEMBER 12, 2001
                               __________

       Printed for the use of the Committee on Financial Services

                       Serial No. 107-51, Part 1





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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD, Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSELLA, New York               JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missiouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director








            Subcommittee on Capital Markets, Insurance, and 
                    Government Sponsored Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman   PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
CHRISTOPHER COX, California          NYDIA M. VELAZQUEZ, New York
PAUL E. GILLMOR, Ohio                KEN BENTSEN, Texas
RON PAUL, Texas                      MAX SANDLIN, Texas
SPENCER BACHUS, Alabama              JAMES H. MALONEY, Connecticut
MICHAEL N. CASTLE, Delaware          DARLENE HOOLEY, Oregon
EDWARD R. ROYCE, California          FRANK MASCARA, Pennsylvania
FRANK D. LUCAS, Oklahoma             STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia                    MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, North Carolina      BRAD SHERMAN, California
STEVEN C. LaTOURETTE, Ohio           GREGORY W. MEEKS, New York
JOHN B. SHADEGG, Arizona             JAY INSLEE, Washington
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
JIM RYUN, Kansas                     CHARLES A. GONZALEZ, Texas
BOB RILEY, Alabama                   HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
GARY G. MILLER, California           RONNIE SHOWS, Mississippi
DOUG OSE, California                 JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      STEVE ISRAEL, New York
MIKE FERGUSON, New Jersey            MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
MIKE ROGERS, Michigan
                                 ------                                

              Subcommittee on Oversight and Investigations

                     SUE W. KELLY, New York, Chair

RON PAUL, Ohio, Vice Chairman        LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              KEN BENTSEN, Texas
ROBERT W. NEY, Texas                 JAY INSLEE, Washington
CHRISTOPHER COX, California          JANICE D. SCHAKOWSKY, Illinois
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      MICHAEL CAPUANO, Massachusetts
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
ERIC CANTOR, Virginia                WILLIAM LACY CLAY, Missouri
PATRICK J. TIBERI, Ohio








                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    December 12, 2001............................................     1
Appendix:
    December 12, 2001............................................    67

                               WITNESSES
                      Wednesday, December 12, 2001

Berardino, Joseph F., Managing Partner/CEO, Arthur Anderson, LLP.    47
Herdman, Robert K., Chief Accountant, U.S. Securities and 
  Exchange 
  Commission.....................................................    17
Hill, Charles L., Director of Research, Thomson Financial/First 
  Call...........................................................    49
Trumka, Richard L., Secretary-Treasurer, AFL-CIO.................    52

                                APPENDIX

Prepared statements:
    Kelly, Hon. Sue W............................................    68
    Oxley, Hon. Michael G........................................    72
    Bentsen, Hon. Kenneth E., Jr.................................    75
    Boehner, Hon. John...........................................    77
    Ford, Hon. Harold E. Jr......................................    80
    Gutierrez, Hon. Luis V.......................................    81
    Jones, Hon. Stephanie........................................    84
    Kanjorski, Hon. Paul E.......................................    85
    Moore, Hon. Dennis...........................................    86
    Berardino, Joseph F..........................................   113
    Herdman, Robert K............................................    90
    Hill, Charles L..............................................   125
    Trumka, Richard L. (with attachments)........................   135

              Additional Material Submitted for the Record

Baker, Hon. Richard H.:
    Enron Insider Trading chart..................................    89
    Enron Stock Value Over Time chart............................    88
Kelly, Hon. Sue W.:
    Financial Regulators letter to Speaker Hastert, October 31, 
      2001.......................................................    70
Berardino, Joseph F.:
    Letter of clarification to Hon. Richard Baker, December 13, 
      2001.......................................................   122
    Written response to a question from Hon. Michael Oxley.......   123








                   JOINT HEARING: THE ENRON COLLAPSE: 
              IMPACT ON INVESTORS AND FINANCIAL MARKETS

                              ----------                              


                      WEDNESDAY, DECEMBER 12, 2001

             U.S. House of Representatives,
        Subcommittee on Capital Markets, Insurance 
              and Government Sponsored Enterprises,
                                     joint with the
      Subcommittee on Oversight and Investigations,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittees met, pursuant to call, at 10:50 a.m., in 
room 2128, Rayburn House Office Building, Hon. Richard H. 
Baker, [chairman of the Subcommittee on Capital Markets, 
Insurance, and Government Sponsored Enterprises], and Hon. Sue 
W. Kelly, [chairwoman of the Subcommittee on Oversight and 
Investigations], presiding.
    Present from Subcommittee on Capital Markets, Insurance, 
and Government Sponsored Enterprises: Chairman Baker; 
Representatives Shays, Paul, Bachus, Royce, Oxley, Shadegg, 
Weldon, Fossella, Miller, Ose, Toomey, Rogers, Kanjorski, 
Bentsen, Sandlin, J. Maloney of Connecticut, Hooley, Mascara, 
S. Jones of Ohio, LaFalce, Capuano, Sherman, Inslee, Moore, 
Ford, Lucas, Shows, Israel, Ross, and Hinojosa.
    Present from Subcommittee on Oversight and Investigations: 
Chairwoman Kelly; Representatives Cantor, Gutierrez, 
Schakowsky, W. Jones of North Carolina, Tiberi, and Clay.
    Also Present: Representatives C. Maloney of New York, 
Jackson-Lee, and Sanders.
    Chairman Baker. I would like to call this hearing to order.
    To begin our proceedings this morning, there are a couple 
of matters of business, procedural matters to which I would 
like to attend. The first is that by prior agreement with Mr. 
LaFalce and Mr. Kanjorski, each Chair and Ranking Member of the 
subcommittees and Full Committee will be recognized for opening 
statements of 5 minutes. Then each side will be given an 
additional 10 minutes for a delegation of opening statement 
time for whichever Members each side so chooses. By utilizing 
this method, we will still consume at least 45 minutes of 
subcommittee time before we begin discussion with the 
witnesses, so I think it very important that the subcommittees 
will adopt, without objection, this plan for proceeding.
    Any objection?
    Without objection, so ordered.
    In addition, we have two Members here present, Mr. Sanders, 
as well as Ms. Jackson-Lee from Texas, who will be recognized 
in regular order pursuant to recognition of all Members of the 
subcommittees for purposes of questions. Without objection, 
there is agreement on that matter.
    We are here today to examine and begin the process of 
understanding the most stunning business reversal in recent 
history. At one moment, an international corporation with a 
diversified portfolio enjoying an incredible run-up of stock 
prices, the darling of the financial press and analysts which, 
by the way, contributed to the view that Enron had indeed 
become the new model for the business of the future, indeed a 
new paradigm. One edition of Fortune Magazine called it the 
``best place in America for an employee to work.'' Analysts 
gave increasingly creative praise while stock prices soared.
    The corporate mission statement perhaps says it best, I 
take from page 53 of Enron Annual Report 2000: ``We are 
satisfied with nothing less than the very best in everything we 
do. We continue to raise the bar for everyone. The great fun 
here will be for all of us to discover just how good we really 
can be.''
    Enron even redefined fun. The sad fact, while having too 
much fun, it was really all too good to be true. Not only were 
investors and creditors left with lawsuits as their only 
assets, lifelong employees lost their jobs, retirement and 
savings, virtually left to start completely over in the midst 
of a national recession.
    While there were apparent indicators of potential 
difficulty to a few insiders, virtually all observers were 
shocked by a surprising statements of earnings expectations and 
then the incredibly fast demise of the huge enterprise. Now, in 
retrospect, it is clear, at least to me, that while Enron 
executives were having fun, it actually became a very large 
hedge fund, which just happened to own a power company. While 
that in itself does not warrant criticism, it was the 
extraordinary risk-taking by powerful executives which rarely 
added value, but simply accelerated the cash burn-off rate. 
Executives having Enron fun were apparently very costly.
    All the while, they were aggressive in the exercise of 
their own stock options, flipping acquisitions for quick sale. 
One executive sold a total of $353 million in the 3-year period 
preceding the failure. What did he know? When did he know it? 
And why didn't we? Again, referring to the mission statement of 
the corporation's annual report 2000, on communication: ``We 
have an obligation to communicate. Here we take time to talk 
with one another and to listen. We believe that information is 
meant to move and that information moves people.''
    Apparently so. It moved this executive to sell $353 million 
worth of stock.
    Then we learned of the multiple special purpose 
enterprises, SPEs, as they are known, in which some executives 
apparently set up businesses which contracted with Enron, 
usually on exceptionally profitable terms. Everyone seemed to 
have their own place to go for self-dealing at great cost to 
employees and shareholders. Another concern, even though I must 
admit when times were good, single stock 401K seemed to be an 
advantageous thing to do when stock prices were soaring. Have 
you actually ever met a financial advisor who would tell you to 
have the most fun, be sure to put all your eggs in one basket?
    Some things are too risky, even for the purpose of having 
fun. We are here today to begin to grapple with just how all of 
this could happen. A lot of smart people with no conflicts of 
interest just missed it. Our task is to establish the facts, 
change the rules where needed, and assist the SEC in the 
pursuit of those who apparently have violated the law. This 
will not be fun, and it won't happen as quickly as Enron's 
demise. We will do this the old fashioned way, with a lot of 
hard work and a lot of time.
    In the end, our goal is to assure individual investors that 
there is real value in the marketplace, credibility and 
professional conduct and consequences for those who abuse the 
system. I wish to express my appreciation to Chairman Oxley and 
Ranking Member LaFalce for their significant interest in these 
matters, to Chairwoman Sue Kelly, who Chairs the Oversight and 
Investigation Subcommittee of Financial Services, who has 
graciously agreed to join with us in this hearing today, and 
use their subcommittee resources to take on important aspects 
of this inquiry, and to announce on our return in late January, 
and possibly early February, the subcommittees will continue a 
series of hearings to look at a number of elements.
    One, this certainly rekindles prior subcommittee interest 
in the conduct of analysts and their role in this matter to 
evaluate the potential for an SRO for the CPA profession. A 
review of the 1933 and 1934 Securities Acts to determine where 
there are inadequacies, to examine Reg FD and its' failure to 
protect investors in this current debacle.
    And a special word to Mr. Kenneth Lay, the CEO of Enron 
who, after numerous requests by the subcommittees, sent a 
letter, which I do not have in my possession at the moment, but 
will be entered into the record at a later time, indicating 
that his appearance before a bankruptcy proceeding today 
obviated his ability to respond to the subcommittees' request. 
On the record, I wish to make it clear the subcommittees will 
have additional meetings should Mr. Lay's social obligations 
preclude his participation, the subcommittees also have the 
power to subpoena. At such time as we deem it appropriate, the 
subcommittees will take action to get the appropriate 
information from Mr. Lay and other executives of Enron.
    I do have a letter dated December 11th, which I will enter 
into the record at this time without objection.
    When we're finished, I hope we will establish a methodology 
in which all participants will understand when a corporation is 
just having too much fun, it won't result in the loss of 
personal fortunes for innocent third parties, investors, 
shareholders, and most importantly, innocent employees.
    At this time, I'd like to recognize Mr. Kanjorski for an 
opening statement.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Today's hearing will help us understand at least some of 
the factors that contributed to the downfall of Enron, a once 
mighty international conglomerate that recently filed the 
largest corporate bankruptcy in American history. Our hearing 
will also help us to discern whether Congress needs to take 
steps to restore the faith and trust of investors in the 
American dynamic capital markets.
    Although I have not yet arrived at any conclusions about 
the disturbing downfall of a corporate icon, I have already 
identified a number of concerns that I expect we will address 
during our investigations.
    First, I would like to learn more about the serious 
financial harm done to thousands of Enron employees and the 
many others who owned Enron stock. Some press reports suggest 
that the company rules blocked rank-and-file employees from 
selling Enron stock in their 401K retirement plans in the days 
and weeks following the announcement that Enron had overstated 
its earnings by $583 million in the past 4 years. Those 
hardworking Americans had to watch helplessly as their savings 
shrank without any recourse while Enron's executives could 
apparently sell their stock options and avoid the financial 
pain. That is wrong.
    Second, I have concerns about whether the accounting 
industry experiences any conflicts of interest in serving its 
customers. In recent years, many have noted that an accounting 
firms' consulting fees from one company may exceed its auditing 
receipts from the same company. This practice calls into 
question whether shareholders can rely on earnings reports and 
other indicators of the company's health and its future stock 
price. In order to provide transparency for investors, auditors 
should actively work to limit potential conflicts.
    Third, we return today to the issue of analyst 
independence, a topic we have closely studied this last year. 
From our past hearings, we have learned that an analyst working 
for a firm that handles investment banking for a company the 
analyst covers could receive a more favorable rating to attract 
new business. I am therefore interested in learning why of the 
15 analysts covering Enron on the day following the failed 
merger with Dynegy, only one had a ``sell'' rating on the 
company stock. These ratings misled investors.
    Finally, in hindsight, it appears that the Enron board of 
directors failed to serve Enron's shareholders. Several news 
stories have detailed how gifts, contributions and other 
activities may have compromised some members of Enron's board. 
I expect that, as time goes on, we will learn that Enron is not 
the only company where these questions arise. Members of a 
corporate board must retain their independence and hold 
management accountable.
    In closing, Mr. Chairman, I typically prefer private sector 
regulation to Federal regulation. But if the private sector 
fails in its responsibilities and creates a vacuum, then the 
Federal Government has a duty to protect its citizens by 
addressing the market failure. More Americans than ever have 
their savings invested in the stock market, and we have an 
obligation to protect them from the conflicts of interest we 
are investigating in the Enron collapse.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 85 in the appendix.]
    Chairman Baker. Thank you, Mr. Kanjorski.
    At this time, I recognize the Chairwoman of the Oversight 
and Investigations Subcommittee, Mrs. Kelly.
    Mrs. Kelly. I want to thank Chairman Baker and Ranking 
Members Kanjorski and Gutierrez for agreeing to hold this joint 
hearing on the recent collapse of Enron and its impact on 
investors and the financial markets. In this hearing, I hope we 
can all gain a better understanding of why Enron collapsed so 
quickly, and why Enron's public filings and Andersen's audit 
reviews failed until it was much too late to give any 
indication of the problems they were experiencing.
    Transparency is the goal of the disclosures a company is 
required to make, and a fundamental necessity to a properly 
functioning open market. Unfortunately, the disclosures made by 
Enron did not give any indication of the problems they were 
experiencing until October 16th. News reports have had many 
different versions of what may or may not have happened.
    I've read about a partnership that hid the level of 
leverage the company had incurred, mistakes and misstatements 
that may have occurred in the audits, certain Brazilian 
investments that also may have contributed to Enron's fall.
    What is clear is that people have been hurt by the collapse 
of Enron, from the thousands of investors whose retirement and 
other investment savings have been devastated to the thousands 
of employees who now find themselves without a job and with a 
jeopardized pension plan.
    We have on our hands what appears to be the largest 
bankruptcy ever, which could have far-reaching implications for 
our economy. We have the duty and the responsibility to ensure 
that safeguards are in place to prevent a disaster of this 
magnitude from ever being repeated. We must determine when the 
accountants, executives and regulators knew what was happening, 
what they did to rectify the problems. While it would be 
impossible to ever have in place a system that would prevent 
failures in the future, we always must try to improve on the 
current system of disclosures and enforcement that is the 
responsibility of the SEC.
    Enron's collapse underscores how important it is for 
Congress to act immediately to pass the netting provisions of 
the bankruptcy bill which have already passed the House 
numerous times.
    For the record, Mr. Chairman, I would like to ask unanimous 
consent to have a letter signed by seven financial regulators 
who support the netting provision made part of the record. This 
legislation would reduce the uncertainty for financial market 
participants about the disposition of their contracts in the 
event one of their counterparts becomes insolvent. In this 
letter, the financial regulators state that ``failure to enact, 
these financial contract netting provisions would unnecessarily 
place the financial system at greater risk.''
    Chairman Oxley has been working on this. I want to add my 
strong support for enacting these needed provisions before we 
adjourn this year. I want to thank all the witnesses for taking 
time out of their busy schedules to share their views with us, 
and I look forward to discussing these issues with them.
    I yield back the balance of my time, and I do thank those 
Members of my subcommittee who are here today.
    [The prepared statement of Hon. Sue W. Kelly can be found 
on page 68 in the appendix.]
    Chairman Baker. Thank you very much, Mrs. Kelly. We 
certainly appreciate your cooperation and assistance in this 
important matter.
    The Ranking Member, Mr. Gutierrez.
    Mr. Gutierrez. Good morning Chairman Baker, Chairwoman 
Kelly and the Ranking Member Mr. Kanjorski, and I want to thank 
Mr. LaFalce for joining us also here this morning, and for 
holding this hearing.
    We are gathered here today because of a series of 
unfortunate events that culminated on December 2nd with the 
filing for bankruptcy of Enron. In Houston alone, Enron has 
laid off more than 4,500 of its 7,500 employees as part of a 
corporate restructuring program. The victims of this 
catastrophe, Enron's employees, have been left wondering how 
bankruptcy will affect their severance pay, health insurance, 
and financial futures. For the vast majority of them, the 
spectacular collapse of their company causes a financial and 
personal tragedy. Many feel betrayed and angry. Sadly, many 
workers didn't even know they were about the lose their jobs. 
They just came in one day to work, and were simply given 30 
minutes to pack up their belongings and leave.
    In addition to the layoffs, a great number of Enron 
employees lost, in a matter of months, almost all the value of 
the stocks they owned, which plunged into levels below one 
dollar. Enron employees may have lost 70 to 90 percent of their 
retirement funds, which translates into more than $1 billion. 
Many of Enron's employees had invested all of their 401K funds 
into Enron stock. And why shouldn't they? Just months ago, 
Enron was the country's seventh-largest company in terms of 
reported revenue, I say reported revenue. Enron was a fast-
rising star that had turned the dreary business of energy 
trading into one of the world's vastest corporate empires. It 
reported quarterly revenues of nearly $47 billion.
    The Enron case brings to the fore an issue that has long 
worried pension and benefits experts: a retirement plan hugely 
dependent on the health of the company that provides it. 
Although the Employee Retirement Security Act of 1974 states 
that an employer with a traditional pension plan cannot invest 
more than 10 percent of the plan's assets in the employer's 
stocks, traditional pension plans are rapidly falling out of 
favor, with the newer 401Ks replacing them. Currently, there 
are no limits yet on how much an employee's pension plan may be 
comprised of the employer's stock, nor are there any caps on 
investments in employer stock with employer-contributed funds.
    Enron's own stock accounted for more than 60 percent of the 
assets in the $2.1 billion defined benefit 401K plan several 
months ago. It is widely known that some companies have even 
higher levels, creating an even worse scenario should these 
companies fail. Indeed, these amounts are situated well beyond 
what would be described as prudent diversification.
    The dangers of over-concentrating company stock in a 401K 
plan have been made vividly clear by Enron Corporation's 
debacle. But despite the perils, millions of American workers 
have little choice but to bet their retirement savings, as well 
as their jobs, on the fortunes of their employers.
    However, Enron is hardly alone in its high exposure to its 
own stock. Almost 120 of the largest U.S. companies, as 
represented by the Committee on Investment of Employee Benefit 
Assets, have seen their own stock rise to an average one-third 
of plan assets.
    Hardest hit will be Enron's 21,000 workers. For 3 weeks, 
starting in late October, all Enron retirement plan 
participants were locked into their current allocation when the 
firm decided to go ahead with a switch to new plan 
administrators. Enron's stock lost 35 percent of its value 
during the freeze, but the workers' pain was not shared by top 
executives. According to press reports, many of them cashed in 
millions of dollars worth of Enron stock while the employees 
were locked into those stocks.
    For instance, Enron Chairman, Mr. Kenneth Lay, who refused 
to come before these subcommittees, alone took $23 million of 
Enron stock and sold it in the year 2001, a year in which the 
price of the stock plummeted from $82 to 26 cents a share, 
while the employees were stuck with the stock.
    The only mistake these employees have committed was being 
loyal to their company and wanting their own small, but well-
deserved, share of the riches Enron executives habitually 
pocketed during their years at the company. Of Enron's 21,000 
employees, the approximate 12,000 who participated in the Enron 
401K plan now have virtually nothing.
    Another source of problems is the companies that make their 
own matching contributions in stocks, and usually place 
restrictions on the trading of these shares by the employees. 
Generally, workers cannot sell their shares until they are near 
the age of retirement, making them captive investors.
    Enron prevented its workers from selling the shares they 
had accumulated until they reached the age of 50. Although this 
did not save the stock from collapse, it did major harm to the 
employees. It's alarming to consider that Enron is not alone in 
such a requirement. Other big companies lock workers into their 
401K company shares until a certain age. We all know that you 
are not supposed to put all your eggs in one basket.
    Mr. Chairman, to conclude, I would like to touch on an 
issue that I think is key to this affair. Under my perspective, 
transparency of information must be enforced in publicly-traded 
firms, such as Enron.
    Transparency in financial reporting plays an essential role 
in making financial markets fundamentally efficient. This is 
absolutely necessary if we want to have healthy markets.
    Last, Mr. Chairman, we should give them what Members of 
Congress have. I can pick up the phone and today I can change 
my 401K, we all can, as Members of Congress. All of our 
employees can make one simple phone call and we can change our 
investment strategy at an instant. The employees of America 
should have the same right and the same prerogatives that 
Members of Congress and Federal employees have.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Hon. Luis V. Gutierrez can be 
found on page 81 in the appendix.]
    Chairman Baker. Thank you, Mr. Gutierrez.
    The Chairman of the Full Financial Services Committee, 
Chairman Oxley.
    Mr. Oxley. Thank you, Mr. Chairman. Thank you for chairing 
this subcommittee hearing, as well as Chairwoman Kelly. Today, 
we'll begin the subcommittees' investigation of the facts and 
circumstances surrounding the largest corporate failure in 
history. Today, we will hear about the dramatic collapse of 
Enron Corporation, once the seventh largest company in the 
United States, riding high as recently as 6 months ago. The 
company has since lost more than 99 percent of its market 
capitalization, and now trades below $1.
    Until all the facts are known, it is prudent for these 
subcommittees to avoid reaching sweeping conclusions about the 
causes and persons responsible for Enron's collapse. But that 
does not mean we should refrain from asking the difficult 
questions that demand answers.
    We will ask the difficult questions. We will delve 
thoroughly into the facts and circumstances surrounding Enron's 
collapse. And we will get answers.
    This subcommittee, and the Subcommittees on Capital Markets 
and Oversight, will vigorously pursue this matter to ensure 
that the Congress, and the American public, know who to hold 
accountable.
    We need to learn whether millions of investors were 
intentionally misled by Enron's financial engineering and 
reluctance to disclose information.
    We need to learn why financial statements that provided 
less than a complete picture of Enron's financial situation 
were certified.
    We need to learn why almost all of the securities analysts 
following Enron failed to warn investors, and why exactly half 
of them continued to rate the company a ``buy'' or a ``strong 
buy'' even after it had plunged below $1.
    We need to learn whether the current reporting and 
financial disclosure system needs to be overhauled.
    We need to learn why the accounting rules permit companies 
to keep important information off their balance sheets.
    Above all, we need to reduce the likelihood that this will 
happen again.
    The effects have been devastating, as one might expect, 
when a $75 billion company files for bankruptcy. Hit hardest by 
the meltdown, of course, were Enron's employees. Thousands have 
already lost their jobs, and more will undoubtedly follow. And 
the 11,000 employees who participated in the company's 401K 
plan have seen their retirement savings practically eliminated.
    In addition, beyond the impact on Enron employees 
themselves, Enron's collapse has drained the investment savings 
of investors across the country who put their retirement and 
other investments into mutual funds, pension funds, and other 
vehicles that invested in Enron. Thankfully, at this point, 
there does not seem to be a systemic threat to the financial 
markets as a result of Enron's collapse, but the damage the 
collapse has done to the financial position of thousands of 
Americans will be very difficult to quantify.
    Some may use Enron's bankruptcy as a vehicle to make big 
Government arguments against electricity markets. But it wasn't 
the electricity consumer who was hurt by Enron's fall, it was 
their workers and investors.
    Furthermore, Congress must pass the netting provisions of 
the bankruptcy reform legislation. Enron and its subsidiaries 
were party to tens, if not hundreds of thousands, of different 
financial contracts. The identification of these contracts and 
verification that they are eligible for netting will require 
vast expenditures of time and money and divert the attention of 
Enron and the court from the task of reorganizing. Meanwhile, 
creditors will remain uncertain as to the enforceability of 
their contracts and the ultimate status of their claims against 
Enron.
    Let's eliminate the uncertainty, the waste of valuable 
court time and estate funds, and allow institutions to 
eliminate exposure more thoroughly.
    We are pleased to welcome the distinguished Chief 
Accountant of the Securities & Exchange Commission, Bob 
Herdman, to discuss the reporting and financial disclosure 
system mandated by the Federal Securities laws. I'm 
particularly pleased that Mr. Herdman is here today, because 
the central issues that the Enron collapse raises are issues of 
investor protection and accounting rules, about which there are 
few better experts than the Chief Accountant of the Commission 
on which to opine.
    Mr. Herdman, welcome to the subommittees for your first 
appearance since you've been appointed.
    I would like to remind the Members of the subcommittees 
that Enron, as well as Arthur Andersen, are the subjects of a 
formal investigation by the SEC, so Mr. Herdman will not be 
able to provide any specific information about those 
investigations, and I'd ask the Members to please phrase your 
questions accordingly.
    On the second panel, we will hear from the Chief Executive 
of Arthur Andersen, Joseph Berardino, who serves as Enron's 
auditor. We welcome back Chuck Hill to the subcommittees to 
discuss the performance of Wall Street research analysts in 
this matter. Finally, we will hear from the AFL-CIO on the 
impact to investors.
    Unfortunately, Enron's Chief Executive, Kenneth Lay, was 
not able to testify before the subcommittees today. Mr. 
Chairman, you entered the letter into the record. He is 
participating in the first hearing of creditors in the 
bankruptcy proceeding.
    I want to assure the Members of these subcommittees, as 
well as the public, that I am confident Mr. Lay, and Enron, 
will provide answers to us and to the public as the 
subcommittees continue their investigation into this matter.
    Mr. Chairman, I yield back the balance of my time.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 72 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Chairman.
    Ranking Member of Financial Institutions, Mr. LaFalce.
    Mr. LaFalce. Thank you very much, Mr. Baker. Thank you also 
for acceding to my request to have a representative of the 
employees, Mr. Trumka, testify at today's hearing. He's also a 
1974 graduate of Villanova Law School, and I had the pleasure 
of graduating from the same law school just a few years 
earlier.
    Enron is a wake-up call. Enron gives us a very important 
glimpse of what is necessary to hold our markets together. The 
integrity, the adequacy, the clarity of information provided by 
public companies to the public. When the adequacy and accuracy 
of that information is compromised, devastation can and does 
occur, devastation to large and small investors alike. And how 
many more Enrons are out there? And what are the systemic 
factors that made this collapse and may make other future 
collapses possible?
    Today, we will get but a small glimpse of that. But when 
our committee returns in January, we must, and I'm confident we 
will, conduct a comprehensive review of all of the policy 
issues this debacle raises, including at least the following:
    First, earnings management or earnings manipulation. To 
what extent did Enron's management bend or break accounting 
conventions to distort their financial condition? And most 
important, is this practice widespread? And are there more 
Enrons out there?
    Second, corporate governance. The board of directors, and 
particularly the audit committee and the compensation 
committee, have a fiduciary responsibility to the shareholders. 
Did they meet that responsibility in this case? Are audit 
committees in corporate America meeting their responsibilities 
to vigorously review the financial statements of companies and 
hold management accountable to the standards of the law, as 
well as sound business practices? And what reforms should the 
SEC, SROs, and this Congress consider?
    Related party transactions: What was the nature of the 
related party transactions in what was basically a publicly-
traded hedge fund? Were those transactions proper? Were they 
properly disclosed to investors and to the board of investors?
    Accounting and auditing: Are the accounting standards, as 
they apply to a company of this type, too difficult to apply, 
and do such rules incentivize companies to exploit unintended 
loopholes? To what extent, if any, should we rely on the 
accounting industry to protect shareholders and assure that 
companies disclose the true nature of their financial 
conditions, or the desire to keep clients affect accountants' 
ability to conduct their audit objectively and their 
willingness to bring accounting irregularities to the attention 
of management, the board of directors, and the SEC?
    Analysts and market expectations: It's clear that the Enron 
collapse was in large part due to a crisis in confidence 
throughout the market after Enron made material adjustments to 
the financial statements. Should financial analysts have known 
by their own critical analysis of the company's financial 
statements at their regular meetings with management that 
something was fundamentally wrong?
    Data analysts, whose firms have significant business with 
Enron, maintained a favorable rating even after it became clear 
that the company was in serious trouble. It would be useful, in 
fact, I think imperative, for our subcommittees to hear 
testimony from independent research analysts not affiliated 
with investment banks, and then with research analysts from 
investment banks to compare their ratings on Enron at different 
points in time over the last several years.
    For it is my understanding that there were some independent 
analysts issuing negative recommendations on Enron. What did 
they know that others did not and should have known? We need to 
understand the quality and objectivity of their research and 
how well such analysts communicated with investors.
    Employee pension plans: People didn't have money in their 
401Ks, they had their lives in the 401Ks. Were they encouraged 
to invest in those 401Ks by management to buttress the stock? 
Did management tell them what they knew, or did management tell 
them what they thought was necessary to stabilize the price of 
the stock? What laws exist under ERISA? Is it possible for a 
company to say ``we will contribute matching moneys only if you 
invest in our stock,'' as opposed to others? If that's true, 
should the law be changed?
    Lastly, the sufficiency of regulation. Has the SEC 
fulfilled its oversight obligation in this case? Is the current 
framework of self-regulation adequate? Does the SEC have 
sufficient resources to effectively fulfill its oversight 
responsibility, whatever it perceives its oversight 
responsibilities to be? There was a day when people had 
virtually all their money in a bank, in a thrift, in a credit 
union, and we mandated that the Federal Reserve, the FDIC, the 
OTS, the OCC basically live with those institutions examining 
the books. But today, people have most of their wealth in 
publicly-traded companies. And there is very little 
governmental oversight, if any at all. Should this change?
    Mr. Chairman, I look forward to pursuing all these 
questions very aggressively in the future. Thank you.
    Chairman Baker. Thank you, Mr. LaFalce.
    For the record, Mrs. Kelly had a letter that she wished to 
have introduced in the record relative to contract netting. 
Without objection, it is included.
    [The information referred to can be found on page 70 in the 
appendix.]
    Chairman Baker. I have two charts distributed to Members. I 
just realized the charts are mine relative to Enron's stock 
value over time, and the trading record of those documents I've 
had distributed to the Members, and are also being made part of 
the record without objection.
    [The information referred to can be found on page 88 in the 
appendix.]
    Chairman Baker. At this point, we will begin to recognize 
Members on each side for opening statements to be limited to no 
longer than 2 minutes with 5 Members per side. The first I have 
on my recognition list is Mr. Shays for 2 minutes.
    Mr. Shays.
    [No response.]
    Chairman Baker. The next I have is Mr. Paul. This is by 
time of arrival. Mr. Paul, no statement?
    [No response.]
    Mr. Fossella, we're on a roll here.
    [No response.]
    Chairman Baker. Mr. Ose.
    [No response.]
    Chairman Baker. Mr. Toomey.
    Mr. Toomey. Thank you, Mr. Chairman. It appears that the 
complex nature of the large volume and some question reporting 
of numerous transactions introduced uncertainties, significant 
uncertainties as to the leverage and the nature of the risks, 
even the solvency of Enron, and the market responded. It 
responded severely, shutting off credit, allowing Enron to 
collapse with breathtaking speed. But I would remind my 
colleagues that we tolerate another kind of uncertainty, that 
is the legal uncertainty that credit exposures could be 
properly netted and resolved according to the documents under 
our Bankruptcy Code.
    I want to join with some of my colleagues who have 
emphasized the importance of passing the netting bill. I 
introduced a bill that would make the necessary changes to the 
bankruptcy code, and we should do that this year.
    I would just briefly like to make one other point. Several 
of my colleagues have strongly criticized the practices that 
cost employees of Enron to lose large sums of the money that 
they invested in Enron stock. I share that criticism generally. 
But I would remind all of us that we contribute to that very 
problem in some respects when you consider that last year, we 
passed a bill that forbids people of ordinary means from 
engaging in the very transactions which could have allowed them 
to hedge their exposure. Retail swaps would allow people to 
preserve the value of their retirement savings, and these 
subcommittees and the Federal Government should not continue to 
restrict the use of these vital risk management tools only to 
institutions and to the very rich, as we do today.
    With that, I yield the balance of my time.
    Chairman Baker. Thank you, Mr. Toomey.
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman. This hearing today 
will begin the process of unraveling the reasons for the 
collapse of the Enron Corporation. While the impact of Enron's 
collapse will be felt in many quarters, not the least of which 
is Houston, where thousands of employees have lost their jobs, 
and apparently their savings, this hearing will focus on the 
failure of the company's corporate governance structure to 
properly oversee management, along with serious questions 
regarding the performance of Enron's outside auditor. The 
subcommittees need to begin to understand whether the fall of 
Enron from its perch, as one of the largest public corporations 
in the United States, with its market capitalization at $75 
billion, and stock trading at $84 a share a year ago, to 
bankruptcy and the stock at about 25 cents today was a failure 
wholly inside the company with its outside advisors within the 
financial market, or our regulatory and legal structure.
    As a Houstonian, this is not just a failure within the 
marketplace, but also a tremendous loss to our community. 
Thousands of employees have been laid off just before Christmas 
into a down economy. Their savings and pensions wiped out. Our 
city has lost not just a corporate icon, but a corporate 
partner in civic affairs, a company which transformed the 
Nation's energy markets from a State-regulated structure into 
an innovative efficient marketplace, collapsed under its own 
weight, apparently due not to the new trading markets that it 
helped create and nurture, but apparently because of old 
economy corporate mistakes.
    While it is doubtful in my mind that Enron will survive, 
the energy marketplace it helped to found will, and it is 
telling that throughout its fall, those markets still have 
remained steady and calm. The scope of our hearing today must 
determine whether Enron's management knowingly violated 
securities laws regarding disclosure or whether those laws 
allowed for the company to limit disclosure of certain 
financing structures which have the effect of understating 
liabilities and overstating assets and revenues. We must 
determine whether the corporate governance structure of Enron 
broke down or whether the laws providing for outside directors 
of public companies are flawed. We must determine whether 
Enron's auditors properly stated its financial condition or 
ignored warning signs to the detriment of investors and 
employees.
    The increasing volume of corporate earnings restatements, 
not just Enron, should be alarming to the investing public, 
capital markets and the Congress. Are the disclosure laws 
lacking in providing investors and regulators with accurate 
data regarding a company's true financial condition?
    Is Enron an anomaly or a preface of the things to come at 
the end of the roaring 1990s and its period of so-called 
``irrational exuberance,'' and I hope we have many more 
hearings on this and the pension effects of this. And I ask 
unanimous consent to present my whole statement for the record.
    Chairman Baker. And don't forget to yield back the balance 
of your time.
    [Laughter.]
    Chairman Baker. Mr. Shays has returned. Mr. Shays.
    Mr. Shays. Thank you, Mr. Chairman. I want to associate my 
remarks with the remarks of the Full Committee, your remarks 
and Mrs. Kelly's. They express my views quite well. I would 
then yield to my colleague, Mr. Ose.
    Mr. Ose. Thank you, Mr. Shays.
    Mr. Chairman, if I might, I do have a couple of questions 
before I make a statement. There was a comment about the 
defined benefit plan at Enron, which was another means by which 
people could protect their retirements. We've checked that out 
through the Pension Benefit Guarantee Corporation and those 
assets are guaranteed by the Pension Benefit Guarantee 
Corporation. That's the defined benefit plan.
    I appreciate the gentleman from Connecticut yielding. My 
particular interest has to do with the special purpose entities 
and the rules that govern them. I read the various statements. 
As near as I can tell, that 3 percent threshold is considered 
on the basis of each separate transaction rather than in 
aggregate. I'm hopeful that in the course of these hearings, 
we'll get into that a little bit further.
    I yield back the balance of Mr. Shays' time.
    Chairman Baker. Thank you very much, both you gentlemen.
    Ms. Jones. Thank you, Mr. Chairman. Good morning to 
Chairmen Baker and Kelly, Ranking Members Kanjorski, Gutierrez, 
and LaFalce. I'm glad to have an opportunity to give a brief 
opening statement this morning. We are here to find out, as 
best we can, within the public view, what happened with Enron. 
I would suggest Chairpersons and Members that our efforts must 
run deeper than that, and that is to find out not just what 
happened, but how did it happen and where did our regulation 
policies and opportunities to oversee this particular public 
company went wrong. Never before in our recent memory has a 
company's stock fallen so quickly. I'm concerned about the loss 
of jobs and the possibility of pension loss that will come as a 
result of the loss of dollars from people's investments.
    I'm as concerned about Enron as I am concerned about a 
company called LTV still in the City of Cleveland in bankruptcy 
with 3200 employees being laid off and the steel workers stand 
on Capitol Hill today saying to the Congress, ``pass some 
legislation that would help us and save our industry and give 
us some legacy fees.''
    So today, as Members of Congress, we're asked to do a 
number of things, and one of those would be to look at some of 
the agencies and organizations that are responsible for 
providing oversight over the accounting methods of this company 
and what people have to rely upon when they make investments. I 
trust that at the end of the day, we will be able to move 
forward and say that we're doing all within our power as 
Members of Congress to provide oversight, to provide 
regulation, and give insight and protection to the American 
public that uses Enron and any other company to do their 
investments and save for the future.
    I yield the balance of my time, Mr. Chairman.
    Chairman Baker. Thank you very much. I thank the 
gentlelady.
    Mr. Bachus.
    Mr. Bachus. I thank the Chairman. I commend you and 
Chairwoman Kelly for holding this important hearing. We have 
very transparent and strong capital markets so when a failure 
of this magnitude comes, it takes all of us by surprise. I 
think it's important that, as opposed to pointing fingers or 
rushing to judgment, that we take a hard look at this and study 
it, and not really rush to conclusions until we've done that. 
In studying what happened, I want to first commend Arthur 
Andersen for bringing their CEO today. I wish that Enron had 
done the same thing. The fact that Arthur Andersen's Mr. 
Berardino is here, I congratulate Arthur Andersen. I wish Enron 
had done the same thing. It would have made it easier for us.
    I would like to focus on three real quick things. First of 
all, we know that Enron was at one time a very successful 
company. They were willing to take risks, they had creative 
business planning, aggressive expansion. That contributed to 
their growth. Obviously, on the flip side, that contributed to 
their demise because they grew too fast, got into areas they 
didn't understand.
    Second, quite apart from the accounting, whether they 
complied with accounting rules, we know that this company, I 
think this is part of the bottom line, had a history of not 
being forthcoming about their business operations. I just want 
to give you one quote that I think shows this. This is from the 
former CFO of Enron, Andrew Fastow. He told Fortune Magazine in 
March, 7 months before he was forced out, ``We don't want 
anyone to know what's on our books. We don't want to tell 
anyone where we're making money.'' Obviously, we didn't need to 
wait till today to find that out. Their lack of transparency 
was a significant contributor to what happened. We owe it to 
the shareholders, to the pension holders, to get to the bottom 
of this, and I feel under your leadership, Chairman and Mrs. 
Kelly, and with the help of our witnesses, we'll begin to do 
that.
    Thank you.
    Chairman Baker. Thank you very much, Mr. Bachus.
    Mr. Mascara.
    Mr. Mascara. Thank you, Mr. Chairman. Thank you for calling 
these hearings. What I'd like to say in my 2 minutes is to pose 
some questions that hopefully I'll have an opportunity to do 
later, but if not, they'll be on the record.
    One is whether the SEC approves the prospecti filed by 
Enron on the various SPE filings in an attempt to ascertain 
whether complete financial disclosure was revealed. The other 
is, given that the SEC representative here, the CEO cannot 
disclose, according to his statement anyway, that I read--is 
that information that has to deal with this investigation? And 
if not, apparently we're not going to get many answers today--
is whether a grand jury should be formed and empaneled to 
investigate this economic calamity.
    Regarding the pensions, I'm looking for answers. Whether 
the large number of Enron employees who had 401K pension plans 
and Enron stock, why they could not sell their stock. We call 
it down here a thrift plan, open season. And at the same time, 
the management people were cashing in their 401Ks. And now that 
Enron has declared bankruptcy, does the bankruptcy law provide 
any special protection to employees in the pension plan. I 
understand that before Enron declared bankruptcy, the stocks in 
these 401Ks were traded, and whether the SEC required that the 
accounting firms involved complied with all of the FASB, 
Financial Accounting Board Standards.
    Those are some of the questions that I need to have 
answered, and hopefully I'll have an opportunity to ask those 
questions. If not, I would hope that the respective firms and 
the SEC involved will provide those answers to me.
    Thank you, Mr. Chairman, I yield back.
    Chairman Baker. Thank you, Mr. Mascara.
    Mr. Miller.
    Mr. Miller. Thank you, Mr. Chairman.
    To be honest, I'm less interested in what we have to say 
and more interested in listening to what the witnesses have to 
say. I'm personally going to focus on questions following that. 
I would yield back my time.
    Chairman Baker. Thank you very much, Mr. Miller.
    Mr. Sherman.
    Mr. Sherman. Thank you. I'm interested in the pension plan 
issues where workers invest their entire work life and their 
retirement savings in the same basket, but I would point out 
that we in this Congress are very much promoting the ESOP 
concept which encourages the same thing, but with an additional 
element, and that is worker control. And I think ERISA should 
require in a pension plan diversification or worker control, if 
the workers are over invested in the stock of their employer.
    I am a CPA and I am particularly interested in the 
accounting issues. Fundamentally, responsibility rests with 
Enron management which engaged in highly complex and 
questionable transactions and then misstated them in their 
financial statements. But we need to see whether Generally 
Accepted Auditing Standards were sufficient to allow the 
accounts, the outside auditors to know what the facts were and 
whether the auditors applied those standards correctly. And if 
the auditors did know the facts, then we need to look at 
whether Generally Accepted Accounting Principles serve were 
employed, and if so, whether they need to be changed. I'm 
particularly interested in these special purpose entities which 
seem a wonderful way to enrich management through self-dealing 
and conflict of interest, plus a method of manipulating 
financial statements. The only legitimate use that I'm familiar 
with for SPEs is to shift risk from the public shareholders to 
a special purpose entity. But you hardly shift risk when the 
chief asset of the SPE is stock in the company that they are 
supposedly ensuring or protecting against risk.
    Also, I have to wonder whether the 3 percent independent 
equity rule is sufficient. It seems to beg for manipulation 
with insufficient risk protection for the company. I think we 
have a bit of an analogy here--wrap it up?--and that is we may 
discover not only that the auditors did not apply the 
accounting standards correctly, but that the company actually 
came very close to complying with those standards and that it 
is the standards that need to be changed even more than making 
sure that we had adherence, what I think will worry us most as 
we discover that Enron, had they just been a little different, 
could have complied with all the technical rules and still gone 
down the drain.
    I yield back.
    Chairman Baker. Thank you, Mr. Sherman.
    Mr. Weldon.
    Mr. Weldon. Thank you, Mr. Chairman. I want to thank you 
and the Ranking Member and all those involved in putting this 
very important hearing together. This failure of this company 
has shaken the American confidence in our investment system and 
I feel very strongly that we will need to, either through a 
self-regulating process or a legislative process, make changes 
in the way accounting practices and stock analysts operate in 
the United States. I would like to particularly associate 
myself with the remarks made by Mr. Gutierrez. I think we will 
seriously need to consider modifying ERISA legislation to 
prohibit the situation that we had with Enron. It's tragic 
enough that these employees had been laid off, but the fact 
that their entire retirement savings was wiped out, is totally 
unacceptable.
    I yield back.
    Chairman Baker. Thank you, Mr. Weldon.
    Our last participant opening statement is Mr. Sanders for 2 
minutes.
    Mr. Sanders. Thank you, Mr. Chairman. Thank you for holding 
this hearing. It seems to me that Enron's collapse raises 
several very important issues, some of which have already been 
discussed by my colleagues. Clearly, we must protect employees 
from seeing their retirement funds ripped off and their life 
savings go down the tubes. We've got to look at this in terms 
of the implications on the privatization of Social Security as 
some would have us do, and also understand that other companies 
around this country in different ways are ripping off the 
retirement plans and the pensions of their workers.
    Second of all, we want to examine the role of accounting 
firms like Arthur Andersen. As many know, Andersen recently 
settled a suit brought against them by the SEC for $7 million 
as a result of a failed audit at Waste Management Incorporated. 
The question arises, what was Arthur Andersen doing when Enron 
was cooking its books. How much confidence should the American 
people have in companies like Andersen?
    But the third issue, Mr. Chairman, that has not yet been 
raised, it seems to me perhaps to be the most important. That 
is the role of big money in the political process and the need 
for real campaign finance reform. Since 1992, Enron has 
contributed over $5 million to Republicans and Democrats. 
During the last 2 years, Enron has spent $4 million lobbying 
Congress and the White House. The Chairman of Enron, Kenneth 
Lay, his wife contributed close to $800,000 to the Republican 
party since 1988. During the 2000 presidential campaign, Enron 
made available its fleet of corporate jets for political travel 
by candidate Bush.
    What did Enron get in return for their campaign 
contributions from the Federal Government? Amazingly enough, as 
far as I understand, Mr. Chairman, they are still in line today 
for a $254 million tax rebate if the Republican House version 
of the Economic Stimulus Bill becomes law. Thank you Enron, for 
all the good work you are doing, and you're going to get a 
check for $254 million from the American people. Clearly, 
that's an outrage.
    Several months ago, the Bush Administration refused to 
assist California and other States cope with severe energy 
crises.
    Chairman Baker. If you can begin to wrap up, Mr. Sanders.
    Mr. Sanders. Costing consumers tens of millions of dollars. 
There is no question but Enron, through their political 
contributions and influence, has had an enormous impact on 
energy policy and the way this Government does business. That's 
wrong and it's got to be changed.
    Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Sanders.
    For the record, I have several documents relating to 
political contributions by the Enron Corporation to Republicans 
and Democrats. I will admit those for the record as well, just 
to keep balance in the hearing record. Thank you, Mr. Sanders.
    At this time, I would like to finally turn to our esteemed 
witness on our first panel, Mr. Robert K. Herdman, Chief 
Accountant of the Securities & Exchange Commission, your first 
appearance before these subommittees, Mr. Herdman. I am very 
pleased to learn of your acceptance of this position. Your 
reputation for good work is outstanding, and we are pleased to 
hear your comments. Welcome.

    STATEMENT OF ROBERT K. HERDMAN, CHIEF ACCOUNTANT, U.S. 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Herdman. Chairman Oxley, Chairman Baker, Chairwoman 
Kelly, Ranking Members LaFalce, Kanjorski and Gutierrez, 
Members of the subcommittees, thank you for the opportunity to 
testify today on behalf of the Commission regarding recent 
events relating to Enron. Your letter of invitation asked me to 
address the regulatory matters and accounting issues that have 
been publicly raised by Enron's collapse. My written testimony 
does address those matters. I ask that it be included in the 
record.
    As you know, the SEC is investigating the Enron matter. The 
Commission appreciates the subcommittees' recognition of the 
non-public nature of its investigation, and as Chairman Oxley 
alluded to, the Commission also asks that in light of its 
ongoing investigation, the subcommittees understand our 
reluctance to address specific issues relating to compliance 
with the Federal Securities Laws at this time.
    If I might add, the reason for this, as I understand it 
from my General Counsel, Mr. Becker, behind me, is that if 
there is public disclosure about the particulars of an 
investigation, while it's still in process, that runs the risk 
of appearing to prejudice the outcome and it might, in fact, 
jeopardize the investigation. But let me assure you that at the 
conclusion of this investigation, we will deal swiftly and 
completely with any wrongdoing and wrongdoers to ensure full 
protection of investor interests. I want to assure the 
subcommittees that the Commission shares your grave concern 
over these events.
    The sudden collapse of a Fortune Ten company gives pause to 
all of us who care about financial reporting and the tragic 
consequences of these events for Enron investors, including the 
many Enron employees whose retirement savings have been 
decimated, simultaneously with losing their jobs, is a sober 
reminder to all of us of the importance of reliable and 
transparent financial reporting. It is axiomatic that 
confidence in our markets begins with the quality and 
transparency of the financial information available to help 
investors decide whether, when and where to invest their hard-
earned dollars. The goal of the Federal Securities Laws is to 
promote honest, efficient markets and informed investment 
decisions through full and fair disclosure of all material 
facts.
    The SEC is tasked with ensuring that markets are 
transparent and hospitable to all investors. Congress wisely, 
in the Federal Securities Laws, adopted the philosophy that 
investors have the right to be fully informed of all material 
facts, and choose markets that are free from fraudulent, 
deceptive and manipulative conduct.
    Transparency in financial reporting, that is the extent to 
which financial information about a company is visible and 
understandable to investors and other market participants, 
plays a fundamental role in making our markets the most 
efficient, liquid and resilient in the world. Transparency 
enables investors, creditors, and the markets to evaluate any 
publicly owned entity. Transparency helps investors make better 
decisions and by doing so, it increases confidence in the 
fairness of markets. It is critical that all public companies 
provide an understandable, comprehensive, and reliable 
portrayal of their financial condition and performance. If the 
information in financial reports is transparent, then no one is 
surprised by unknown transactions or events.
    It also is critical that auditors, standard setters, audit 
committee members and the SEC perform our respective roles with 
respect to financial statements. My written statement includes 
information on the accounting standards setting process that 
exists in our country, the self-regulatory process in the 
accounting profession, and the role of the SEC in reviewing 
filings.
    As you know, last month Enron disclosed several errors in 
its' previously issued financial statements and announced its 
intention to restate its financial statements dating back to 
1997. As the subcommittees have requested, my written statement 
provides an explanation of the accounting and auditing 
literature and several of the issues discussed in Enron's 
recent filing. Specifically these deal with restating 
previously issued financial statements account for special 
purpose entities or SPEs, and the $1.2 billion reduction in 
shareholders' equity.
    Also at the request of Members of the subcommittees, my 
written statement explains the mark-to-market accounting 
applied to contracts for the purchase or sale of energy 
contracts. As I said at the outset, the Commission will move 
expeditiously in its investigation in the Enron matter and will 
take appropriate actions.
    Regardless of the outcome of the issues surrounding the 
Enron situation, the SEC is working to improve and modernize 
our financial disclosure system. Our goals are to make 
financial statements more transparent, easier to understand, to 
foster private sector standard setting that deals appropriately 
with current and immediate needs, and to work with the 
accounting profession to ensure comprehensive and effective 
self-regulation.
    Chairman Pitt's op-ed piece in the Wall Street Journal 
yesterday outlined these and other of the Commission's planned 
improvements to our current reporting and financial disclosure 
system. We believe these are extremely important initiatives 
that will constitute much of the Commission's work in the 
coming weeks and months. And I am pleased to advise you that 
today the Commission is issuing cautionary advice regarding the 
need for corporations to make full and fair disclosure about 
what we're calling ``critical accounting policies.'' As we 
continue to move forward, the Commission looks forward to 
working closely with the Congress on these and other issues of 
importance to the investing public.
    Thank you for the opportunity to appear today. I'm happy to 
try to respond to any questions Members of the subcommittees 
may have.
    [The prepared statement of Robert K. Herdman can be found 
on page 90 in the appendix.]
    Chairman Baker. Thank you, Mr. Herdman.
    The Committee will return next month to review practices 
which have been initiated in the last session. There has been 
ongoing staff work and research effort and efforts to come to 
closure with my staff on recommendations which should be 
forthcoming early next year. I hope we will be initiating a 
similar process with regard to at least consideration of the 
SRO approach with regard to the CPA industry, or whatever might 
be the appropriate recommendation from the SEC to consider.
    Although the current body of law, in my view, would seem to 
be adequate, I think the complexity of modern business 
structures may have surpassed the rules we currently have in 
place, which would then lead us to a discussion of a rewrite of 
the 33-34 codes, which would be a long-term, obviously 
extensive process. The short term issue for me, though, is 
without regard to a fact finding in the matter of Enron, does 
current law provide sufficient penalty and what is the nature 
of the penalty for self-dealing either inaccurate disclosure or 
withholding disclosure or violation of meeting the duty of care 
standard or your fiduciary responsibility.
    Can you tell us without making a statement as to a finding 
relative to the performance of Enron officials not related to 
the question. If someone were found to violate those standards, 
what would be the penalties available to the Commission today 
in pursuit of bringing someone to responsible justice?
    Mr. Herdman. Mr. Baker, I'm aware that the Commission has a 
wide range of sanctions that it can impose against companies, 
and in certain cases against individuals. I really have to 
defer the discussion of the specifics, because that is not my 
area of expertise.
    Chairman Baker. We've got a couple more and we may get back 
to this, but let me just save that for the record, and at an 
appropriate time, to keep us moving, perhaps a response 
pursuant to the hearing would be helpful.
    With regard to regulation in the current environment, it 
seems an element that works for compliance is simply not to 
disclose if there is a question in your mind if you can do it 
properly as opposed to an affirmative responsibility in the law 
to make disclosure of material elements without having to make 
the judgment. If it's material, you disclose it. Had we had 
that standard, in fact, would that have helped with the 
transparency concerns and the current concern.
    Mr. Herdman. I really can't speculate about how things 
might have affected the particular matters with respect to 
Enron. The entire question of moving to a system of current 
disclosure with affirmative obligations to disclose is one of 
the important parts of our program to improve financial 
reporting coming up----
    Chairman Baker. Let me characterize it this way. A 
statutory or regulatory requirement for affirmative disclosure 
certainly would not have made the matter more difficult. It 
possibly could have helped.
    Mr. Herdman. Certainly.
    Chairman Baker. With regard to the adequacy of current 
disclosures, and they are extraordinarily sophisticated, in 
trying to wade through the financial statement of Enron, well, 
it put me in my place. I don't know--is there anybody within 
the SEC that really goes through, from A to Z, the entire 
document on their own without outside help who can read these 
things and understand what business risks are presented? Or 
have we gotten information that's so convoluted that a person 
in good faith, who is reasonably educated still is rather lost. 
Make me feel better, please.
    [Laughter.]
    Mr. Herdman. I assure you that we have on the staff of the 
Commission people who are quite expert in these matters and do 
go through documents filed with us from A to Z. Having said 
that, I won't deny that at times that can be a daunting task, 
because financial statements today are very complicated.
    Chairman Baker. Let me ask it this way. If you had had the 
time and the staff available and someone in the casual review 
of the data currently required under law to be disclosed, could 
they have determined that financial reversals were in the 
future from the current disclosure format, or do we need to be 
looking at a different way of making relevant information more 
understandable?
    Mr. Herdman. Without commenting on Enron here, Mr. 
Chairman, I think most financial statements today are not 
designed to provide information about the future. However, our 
rules for disclosure and management's discussion and analysis 
does require a certain forward looking focus particularly with 
respect to matters that have occurred in the past that might 
not be reasonably expected to occur in the future.
    Chairman Baker. For example, we're going to buy a 
waterworks company in England--I'm just making up something 
here--and we don't know much about waterworks and we're going 
to spend a lot of money, that's a material thing, it doesn't 
necessarily mean it's adverse, but disclosures of where you 
might be going in business judgment could have been helpful to 
people trying to understand the scope of business which a hedge 
fund-like business might engage in.
    Mr. Herdman. Disclosure is designed to provide 
transparency.
    Chairman Baker. Lastly, because I've exhausted my time, 
with regard to pro forma reporting, as opposed to cap 
standards, will there be recommendations, further 
recommendations with regard to revision of the pro forma 
methods of accounting or reporting as opposed to the current 
Generally Accepted Accounting Principles?
    Mr. Herdman. At the present time, I'm hopeful and expect 
that the cautionary advice that the Commission issued just 
several weeks ago will take care of any abusive practices that 
have existed in the past.
    Chairman Baker. Let's assume we're going forward without 
looking historically. There would be pro forma reporting, which 
would have led to a misunderstanding in the marketplace. Under 
current rule, given your recent advisory, what would be the 
consequences for a corporation or a CFO issuing those pro forma 
advisories that were found to be inappropriate?
    Mr. Herdman. I can't generalize, but if such disclosures 
are made in a way that violates the anti-fraud provisions of 
the Securities Laws, then I expect that there will be vigorous 
enforcement action taken.
    Chairman Baker. I can surmise, given the sensitivity of the 
response to the current environment, you feel adequately armed 
to respond to inappropriate conduct in current circumstance 
once you have made a factual determination of wrongdoing?
    Mr. Herdman. I believe that that's correct. I'm not sure 
that I can speak for the entire Commission.
    Chairman Baker. We want to make sure you have the tools you 
need to do the job that's ahead of you. If that is not the case 
on further reflection, please advise the subcommittees as to 
areas of concern that you can identify that may warrant the 
subcommittees' assistance.
    Mr. Herdman. We will certainly do that.
    Chairman Baker. Thank you very much, Mr. Herdman.
    Mr. Kanjorski.
    Mr. Kanjorski. Mr. Herdman, looking over the overall 
policy, is it your belief, as a professional accountant of the 
SEC, that we have sufficient transparency or as the 
sophistication and possible manipulation of disclosure 
statements by corporations becomes so fuzzy as to really not 
constitute true transparency.
    Mr. Herdman. Congressman, I think that our capital markets 
are clearly the best in the world, and our accounting and 
financial reporting are widely acclaimed as the best in the 
world as well.
    Mr. Kanjorski. So is it your interpretation that this is a 
singular occurrence that occurred because of economic 
situations, or did this occur because of stock being 
artificially bid up and played because of an over accentuation 
of revenues and the hiding of debt?
    Mr. Herdman. I really can't say at this point what has led 
to Enron's demise with any certainty. That's something that we 
certainly hope to learn as part of our investigation. As that 
progresses, as we learn things, we'll be looking to see whether 
there are indications that there may be other problems out 
there.
    Mr. Kanjorski. Are there other Enrons out there or do you 
feel this is a unique situation?
    Mr. Herdman. I think at this point, it is premature for me 
to answer that question one way or the other.
    Mr. Kanjorski. I may assume there may be other Enrons out 
there?
    Mr. Herdman. There may be.
    Mr. Kanjorski. What is the SEC doing to determine whether 
that's the case, and how will you disclose that to the public 
or to the Congress?
    Mr. Herdman. Well, when problems are found in a particular 
industry, the staff of the Division of Corporation Finance, 
which does review filings, makes it a practice to take a look 
at the filings made by other companies in that industry and 
proceeds, if there are indications of non-compliance with 
Generally Accepted Accounting Principles, unclear disclosures, 
and so forth, enters into a common process back and forth with 
the registrant. If there's not a satisfactory resolution of 
those matters, and if the staff of the Division of Corporation 
Finance believes that it's warranted, there are instances where 
a referral is made to the Division of Enforcement for follow-up 
by them.
    Mr. Kanjorski. With regard to the special purpose entities, 
is this a widely used methodology in large corporations, 
specifically to avoid disclosure of the true nature and 
condition of the main corporation?
    Mr. Herdman. It's not an uncommon practice, Congressman, 
for special purpose entities to be engaged. While special 
purpose entity transactions have the effect of excluding 
certain things from a corporation's financial statements, there 
are a number of very valid reasons why corporations do enter 
into them, including the fact that they often offer the 
potential for reduced interest costs as well as certain tax 
advantages in some instances.
    Mr. Kanjorski. So from your general overall view of the 
occurrence here at Enron, you would say that the investing 
public doesn't have to have a fear that this may be endemic to 
the system, but this is just a unique, separate situation that 
just happened?
    Mr. Herdman. I don't think any of us can say that at this 
point, Congressman. I think that the Enron situation raises 
questions about an entire system of financial reporting and 
confidence in that system.
    Mr. Kanjorski. I notice, as I looked at the Chairman's 
chart of Enron Insider Trading, you can almost see a picture 
that the insiders were getting out at the absolute top point, 
and they did it in several instances. They took their life 
rafts and got out about 6 months ahead of when the ship was 
finally going down. Are you looking at insider trading to be an 
indicator that there may be something that the insiders are 
aware of that the investing public isn't aware of?
    Mr. Herdman. With respect to Enron, I can't comment 
obviously. With respect to whether that's a procedure that 
might be useful, that's something that we would consider. I 
don't have any personal knowledge of whether that's an accepted 
practice today among the staff of the commission.
    Mr. Kanjorski. I'm just trying to see what we can do as a 
Committee in the Congress to make sure there aren't other 
innocent investors out there in the public. Should they be 
somewhat alarmed when they start seeing the insiders getting 
out in large bulk? They may not want to go in. Obviously, the 
analysts didn't bring this to anybody's attention. The 
accountants didn't bring this to anybody's attention and the 
SEC didn't bring it to anybody's attention. So there are a lot 
of babes in the woods out there that own stock, and they are 
trading in these securities thinking that they were a very 
secure corporation, and all the insiders are handing out life 
jackets.
    Mr. Herdman. I think the question of whether shareholders 
should pay particular attention to trading by insiders is an 
interesting one, but frankly, Congressman, that's outside of my 
area of expertise, really to comment.
    Mr. Kanjorski. Do you clearly by the disclosures made on 
insider dealing disperse that information to the general public 
sufficiently?
    Mr. Herdman. I can't answer your question.
    Mr. Kanjorski. If I were on a boat and I saw some water on 
the floorboards and I saw the captain and the crew jump off the 
boat real fast, normally at sea I think I'd grab a life jacket 
and jump too, because they must know something I don't know. It 
seems to me in stock transactions it's somewhat similar. And if 
it isn't, if we're not getting that disclosure out there, the 
fact that the captain and crew are jumping overboard, then 
we've got to find a vehicle to alert people.
    Mr. Herdman. I am aware that there are requirements for 
disclosure determined by insiders, and that information is made 
public.
    Mr. Kanjorski. I yield back my time.
    Chairman Baker. Thank you, Mr. Kanjorski. I'm sure those 
dispositions were purely coincidental and in time will prove 
there was no relationship.
    Mrs. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman.
    Mr. Herdman, I'm interested in the mark-to-market 
accounting standards that energy traders are given. It's a 
sophisticated kind of thing. A lot of people who invest are not 
really, I think, aware of what's going on there. I wonder, 
given the difficulties in ascribing a value to some of these 
transactions with this policy, don't you think it's led to some 
misleading information that's been provided to investors? I'm 
not asking specifically about this, but investors in general?
    Mr. Herdman. I don't know that there's any evidence to 
indicate that mark-to-market accounting has led to misleading 
information to investors. The broker-dealers in this country 
have used mark-to-market accounting to account for their 
activities for many, many years. They have sophisticated 
financial instruments that aren't quoted on exchanges that need 
to be accounted for at market value. And so estimates need to 
be made of value in order to accomplish the mark-to-market 
process. Energy trading contracts can be and are very, very 
complicated and they sometimes go on for periods of time as I 
understand it that go beyond the period of time where there are 
quotes, either for purposes of forward contracts, or broker-
dealer type contracts, and therefore they require that a model 
be developed that takes into account recency of other 
transactions and mechanics such as that, leading to an estimate 
of fair value.
    That really is the difficult part of it. It's fairly easy 
to mark-to-market a financial instrument that is traded on the 
New York Stock Exchange. Even I can calculate that. But the 
calculation of the market value of a third year contract to 
supply electricity requires a great deal of specialized 
expertise.
    Mrs. Kelly. Is the SEC looking into changing any of these 
rules with regard to the energy policies, the energy companies?
    Mr. Herdman. As I said at this time, Chairwoman, we haven't 
seen any indication that the mark-to-market accounting has 
caused problems for companies within the energy industry. If we 
do, we would certainly expect that there might be a need to 
tighten up the accounting rules here.
    Mrs. Kelly. Do you think that the investors and 
transparency would be helped if the SEC and the FASB clarified 
the principles of mark-to-market accounting?
    Mr. Herdman. I think the principles of mark-to-market 
accounting are quite clear in the accounting literature that 
exists today, and the circumstances under which it should be 
done.
    Mrs. Kelly. Yes, you said earlier that this was a bit murky 
with regard to energy.
    Mr. Herdman. What's not rigid in the accounting rules today 
is a specified methodology for how to calculate the market 
values.
    Mrs. Kelly. And perhaps you might be looking into that.
    Mr. Herdman. That's a possibility.
    Mrs. Kelly. I also understand that FASB has been reviewing 
standards related to the consolidation of the financial 
statements by parents and the SPEs for 10 years. Do you find it 
a little troubling that FASB still is looking and has taken 
that long to address this?
    Mr. Herdman. The policy FASB has had on consolidations 
includes considerations of the treatment of special purpose 
entities. We are encouraged at this point that the FASB 
announced just recently that it is refocusing its project on 
consolidations to address a number of issues that really are at 
the heart of the SPE question, and we're very hopeful that they 
will proceed apace with that and get it done, however, subject 
to all of the due process procedures.
    Mrs. Kelly. Perhaps, sir, you could at the SEC make sure 
that it's sooner rather than later. It has been. We need to see 
a little sooner on this, I think. If I understood your 
testimony correctly, you said you've issued new cautionary 
advice with regard to critical accounting policies today. Could 
you describe that for us?
    Mr. Herdman. Certainly. What we're doing is getting 
something out for this year end to encourage companies to make 
disclosures of a type that really have not been made before. 
We're doing this with a view toward accomplishing better 
disclosure in the 2001 annual reports, as well as facilitating 
work that we're going to be doing in 2002 to move to very 
definitive rulemaking in this area. But what these particular 
disclosures would relate to, critical accounting policies, 
which we are characterizing as those that really make a 
difference in a company's financial statements, but also 
require extremely complex and subjective judgments to be made 
by management in their application. And often the complexity 
and subjectivity is due to the fact that there needs to be very 
sophisticated estimation processes in order to take into 
account the fact that a lot of accounting has to grapple today 
with the uncertain effects of the future. So better disclosure 
about those kinds of things we think will help to mitigate the 
potential for surprises in the future.
    Mrs. Kelly. My time is up. Thank you very much.
    Chairman Baker. Thank you, Mrs. Kelly.
    Mr. Gutierrez.
    Mr. Gutierrez. Thank you very much. Thank you for 
participating this afternoon with us. Some in the accounting 
industry have argued that the accounting rules have become too 
complicated for companies to apply rationally and for auditors 
to apply in connection with their audit. Do you believe this is 
true?
    Mr. Herdman. Congressman, accounting rules have become 
very, very complicated, but let me also point out that the 
world is very, very complicated in terms of the types of 
transactions that are engaged in today which are also very 
complicated. At the same time, I think that the fact that the 
FASB is in the process of studying a project that they want to 
put on their agenda to deal with complexity in the accounting 
rules is very encouraging. I think that's terrific, because the 
accounting literature we have today rivals--in fact, exceeds--
the size of the Internal Revenue Code and all the various 
regulations that pertain to that. Ultimately the accounting 
rules have to be applied by people. Simplification would be a 
good thing.
    Mr. Gutierrez. Is the goal of a meaningful disclosure to 
provide investors with an accurate and complete picture of a 
company's financial condition? And has the SEC considered a top 
down review of accounting disclosure rules? You talked about 
them a little bit earlier on today.
    Mr. Herdman. One of the critical projects we're going to be 
working on in the coming months is a real look at the nature of 
financial information that is conveyed to shareholders. 
Certainly at this point, we are considering things in addition 
to the current system of periodic disclosure, and we'll be 
working with many, many people that are interested in this and 
are providing and will provide input to us about things like 
disclosure by companies of trend information on a more current 
basis than just quarterly disclosure about changes in those 
types, those kinds of trends that might give earlier warnings 
about the company's prospects of going up or going down, and 
all those kinds of things.
    Mr. Gutierrez. I think that's excellent. I look forward to 
working with your team, and obviously, the Members of these 
subcommittees on doing that, because an accurate picture might 
have helped a lot of people at Enron, because given what we 
know today, we didn't get an accurate picture.
    I would just suggest that maybe--and this is a humble 
suggestion on my part, Mr. Herdman--as you look at the 
situation, the specific situation with Enron, that you look at 
the relationship--it's simply a suggestion on my part that you 
simply look at the relationship between insiders and selling 
their stock options. The Chairman has been very, very kind to 
share with us this form, this graph. I mean, January of 2001, 
you've got the insiders at Enron selling over $160 million 
worth of stock. Maybe you should look at that, and maybe we 
could find a way so that, as Mr. Kanjorski said, because it 
sounds to me that's kind of like the captain jumping off the 
ship, when the insiders are selling all their stock options, 
they are obviously not keeping them. And as we look at the 
sheet, they sold it at the highest point and then they went in 
May is the next time, and it seems that they sell things at the 
highest point. They know what's going on, they're inside 
obviously. That's why we call them insiders. Those are the 
executives.
    And if you have a CEO, as in the case of Enron, that's 
going to sell $100 million worth of his own stock, and it would 
be good and prudent, in my humble opinion, it would be good and 
prudent and advisable for the public to know, hey, the CEO is 
selling all the stock, selling $100 million and we know about 
it in January so that everybody knows, at least to that extent, 
what he knows. We can't put him there like his wife wanted a 
new yacht or his college kid's tuition came up, although I 
don't know what college you would send someone to for $100 
million, but you never know.
    We don't have to know why they did it, but at least know 
that they did it and when they did it. It's a simple 
suggestion, because I think that way we would all know.
    Mr. Ose. Would the gentleman yield?
    Mr. Gutierrez. Sure, I would.
    Mr. Ose. The insider trading by the Board of Directors of a 
Fortune 500 who are members of the management team are in fact 
tracked by the SEC. You can read them in the Wall Street 
Journal on a regular basis.
    Mr. Gutierrez. I would yield, but you know something, if 
you can read them, then it's interesting that nobody knew about 
it, and nobody read about it and nobody made a note about it, 
and maybe our friends here should take a note about it and what 
kinds of action they can take when somebody's doing 
specifically that. I know there are Members of these 
subcommittees that want capitalism to thrive at any extent. I'm 
certainly a capitalist, but when you have tens of thousands of 
employees losing their jobs, I think it's a regrettable 
situation and we should look at ways to correct that situation.
    Chairman Baker. Thank you, Mr. Gutierrez. You will note on 
the form that the document made reference to in the left hand 
corner, this source is the insider and Form 144 filings, so to 
support Mr. Ose, there are mechanisms by which this information 
is publicly available. The real question is as to timing and 
understanding and I think that perhaps is the bigger concern.
    Mr. Herdman. Congressman Ose is correct. It's published in 
the Wall Street Journal periodically, but certainly I'll follow 
up on your suggestion, Congressman.
    Chairman Baker. Chairman Oxley.
    Mr. Oxley. Thank you, Mr. Chairman.
    Mr. Herdman, the Enron collapse clearly points out the need 
for Congress to act on netting legislation. Our good friend 
from Pennsylvania, Mr. Toomey, has that legislation ready to 
go. Does the SEC have a position on that issue, and if so, what 
is it?
    Mr. Herdman. The Commission is in favor of the netting 
provisions of the Bankruptcy Bill. Chairman Pitt did sign that 
letter in November that was also signed by the Chairmen, I 
believe, of six other regulatory agencies. He signed it on 
behalf of the SEC and the Commission is very much in favor of 
that legislation.
    Mr. Oxley. Mr. Herdman, is it your understanding that if 
we're able to pass the Toomey legislation before Congress 
adjourns for the year, that the court would be able to use the 
netting provisions in the law in the Enron case specifically?
    Mr. Herdman. I can't answer that question, Mr. Chairman. 
I'm not an expert on that in bankruptcy law.
    Mr. Oxley. We'll follow up. Thank you very much.
    Mr. Herdman, as you know, there have been a series of 
accounting shortfalls. Waste Management, ZZ, Sunbeam, and now, 
of course, Enron--the grandaddy of them all. Does this suggest 
a systemic problem? If it may, what is the SEC planning to do 
to alleviate that systemic problem?
    Mr. Herdman. I think it's premature, Mr. Chairman, to 
conclude about whether there are systemic issues here. I also 
believe that it would be premature to look to only one 
potential source of whether there might be a systemic issue. 
Instead, there's work that needs to be done by all concerned in 
these processes.
    Like Chairman Pitt's op-ed piece in the Journal the other 
day points out that things need to be done with respect to 
faster standard setting. Things need to be done with respect to 
the analyst community, the Big Five accounting firms and the 
NCPA have already stepped up and said they're going to take a 
look at self-regulation, the self-regulatory structure that 
exists today to determine what types of improvements might be 
needed so there are issues here. The SEC can and will work hard 
to improve our review process for the review of filings with 
us, so there are lessons to be learned here for everyone.
    But, I think it's premature to say that that translates 
into a particular, or a series of particular, systemic issues.
    Mr. Oxley. I too read the op-ed piece in the Wall Street 
Journal by Chairman Pitt. I was most impressed with the breadth 
and scope of what recommendation that he gave. Obviously we 
will be pursuing that as a committee, particularly when we take 
up SEC reauthorization early next year. But indeed, it's fair 
to say that even before all of the bad news came out of 
Houston, that the Chairman had already put on the table 
numerous modernization efforts, and indeed, as you know, many 
of the regulations date back to the 1934 Act in a modern world 
of instant communications. In many ways, we still rely on the 
quarterly report, and I think one of the best ideas he had was 
more timely disclosure. And obviously the technology and the 
infrastructure is there today to do that. Maybe even Mr. 
Gutierrez will be able to pick up some insider trading 
information electronically instead of having to leaf through 
the Wall Street Journal.
    My friend from California here is apparently flogging the 
Wall Street Journal for whatever reason, but I think it does 
point out that the new Chairman has recognized that we are in a 
new environment here, and that modernization of our structural 
regulation is clearly called for. And for that end, we thank 
you and the Chairman for their aggressive work in that area, 
and I yield back.
    Chairman Baker. Mr. Chairman, I would just point out that 
if it is not a systemic regulatory problem in the matter of 
Enron, then one would not have a large leap to assume that 
there's at least significant fraud or criminal conduct. I can't 
imagine that every person in Enron engaged in that activity. 
It's got to be one or the other. I would hopefully land on the 
systemic side for necessary reform and review, and then assume 
than everybody engaged in activities there was not aboveboard.
    Mr. LaFalce.
    Mr. LaFalce. With respect to netting, this is not a new 
issue. The House of Representatives has passed netting 
legislation not only in this Congress, but in the Congress 
before this and in the Congress before that, and so has this 
Senate. But the leadership of the House and Senate has put this 
in a bankruptcy bill that is destined to go down to defeat. We 
need to extricate the netting provisions that have passed three 
successive Congresses and simply pass it independently if 
there's such bipartisanship in support of netting. And I was a 
co-author of all the bills. Let's do it.
    Mr. Herdman, you recently came from the private world of 
accounting from Ernst & Young, and you are the Chief Accountant 
now for the SEC. My first question is, very briefly, what are 
your responsibilities as opposed to the Chief Accountant within 
the Enforcement Bureau?
    Mr. Herdman. The chief accountant in the Enforcement 
Division works strictly on enforcement matters. As the Chief 
Accountant of the Commission, I am the principal advisor to the 
Commission on accounting and auditing matters and----
    Mr. LaFalce. Would you be more involved with policies, 
procedures, and general practices, and your counterpart would 
be more involved with the specifics of individual situations?
    Mr. Herdman. That's a fair generalization, Congressman.
    Mr. LaFalce. Let's go back to your days at Ernst & Young. 
There are basically five big accounting firms worldwide I 
believe. You vie with each other. You want to represent clients 
because that's the only way you make money, so you have to be 
competitive. But there's a tension that exists, because you 
have certain fiduciary responsibilities as members of the 
accounting profession, and you have other fiduciary 
responsibilities either to your clients or to the public at 
large. Tell me a little bit about what you do when a CFO is 
engaging in practices that are not black and white, but are 
very grey and make you feel ill at ease. And how could the 
system be improved to make sure that the grey comes out white 
rather than black?
    Mr. Herdman. First of all, Congressman, auditors have a 
code of ethics that they follow. As part of doing that----
    Mr. LaFalce. Accountants do, lawyers do, and doctors do, 
and virtually every professional organization does. One of the 
difficulties is sometimes that the code is not too clear or 
it's not enforced too well.
    Mr. Herdman. The code in this case is quite clear, 
Congressman. Accountants and auditors owe a duty and care and 
professionalism to their client, and also a duty to make sure 
that the financial statements that they certify are according 
to Generally Accepted Accounting Principles and that their 
audits are performed in accordance----
    Mr. LaFalce. The CFO is about to do something or is doing 
something and the audit committee is either unaware of it or 
goes along with it. And you really don't think they should, 
although you suppose they could push the envelope that far. 
What do you do under those circumstances?
    Mr. Herdman. You should keep in mind that recently the 
accounting profession, as part of its part to implement the 
recommendations of a blue ribbon panel on audit committees from 
several years ago, implemented a requirement that auditors meet 
and discuss with audit committees and management the audit 
partner's assessment of the quality, not just the acceptability 
of the accounting principles that companies are following.
    Recently in a speech that I gave last week----
    Mr. LaFalce. You know, sometimes there's a tendency to say 
what you think they want to hear, especially if you want to 
keep them as clients. I'm not saying that it's never once done, 
but when you're dealing with a firm, and Arthur Andersen I 
believe is the smallest of the big five, 85,000 employees, how 
many employees worldwide does Ernst & Young have?
    Mr. Herdman. One-hundred-and-fifty-thousand.
    Mr. LaFalce. I would imagine it's difficult to monitor the 
activities of 150,000 people, try as hard and best as you can. 
I'm just wondering how we could improve the system. I know Mr. 
Pitt wants to improve the system. I'm just wondering if self-
regulation is going to be good enough.
    Mr. Herdman. Congressman, that certainly is a topic that 
has to be considered at this point. I also would encourage you 
to think about the fact that big public accounting firms do 
have numerous controls and procedures to ensure that their 
people do follow the firm's policies and positions.
    Mr. LaFalce. But every now and then, there's a little bit 
of a slip that amounts to $90 billion, and an awful lot of 
people get hurt. And I'm not sure how many more $90 billion 
blips are out there. I do know that your predecessor, Mr. Lynn 
Turner, referred to the restatements that existed thus far as 
the tip of the iceberg, and I'm wondering whether Enron is the 
tip of the iceberg.
    Mr. Herdman. I think it's premature to come to that 
conclusion.
    Mr. LaFalce. I think it might not be.
    Mr. Herdman. I think it's very important at this point that 
we recognize the seriousness of the Enron matter, but at the 
same time we should neither under react to it, nor should we 
overreact to it.
    Mr. LaFalce. We ought to react to it very aggressively.
    Chairman Baker. Thank you, Mr. LaFalce.
    Mr. Shays.
    Mr. Shays. Thank you, Mr. Chairman.
    Enron's collapse is obviously heartbreaking for the 
investors and the employees and the retirees who are dependent 
on it. I don't invest in these individual stocks if I'm not 
going to do due diligence, but it amazes me that the people who 
do due diligence--I'm interested in Enron, but I'm also 
interested in the implications for other investments in other 
companies. I'm particularly interested in the special purpose 
entity and I'm new at this and I'm trying to understand it.
    I gather that if you have more than 3 percent ownership, 
you have to consolidate and I gather that one of the values of 
these funds is that it enables you to apply assets.
    What I want to understand first is basically the 3 percent 
rule was established by the SEC. FASB declared it, but it was 
SEC generated. And the issue of the controlling test or the 
risks versus rewards your people in the SEC have been over the 
last 10 years trying to describe different tests with 
qualitative factors as well as quantitative factors. I'm 
looking at one speech that was delivered to the 28th Annual 
Convention of the current SEC Development by Dominick Ragone, I 
guess who works for you, a professional accounting fellow. And 
he went through all of these, which seems to me to almost set 
up a confusing process for the accounting firms and others.
    And one is I want to know why the SEC doesn't just step in 
and get this resolved and why it doesn't do it sooner. And I 
carry with me the basic view that it used to be ``the large ate 
the small,'' but now it's ``the fast eat the slow.'' And it 
seems to me you can't have a system that takes so darn long to 
resolve.
    Mr. Herdman. I think, Congressman, actually the first 
statements that were made by the SEC staff with respect to 
special purpose entities were directed particularly toward 
certain leasing transactions.
    Mr. Shays. Towards what?
    Mr. Herdman. Towards leasing transactions. Those statements 
were made in the late 1980s. The Emerging Issues Task Force of 
the FASB put together a working group which I chaired.
    Mr. Shays. So what's your point?
    Mr. Herdman. We got rules that were pretty quick with 
respect to special purpose entities back in 1990. There have 
been some ongoing comments by the staff with respect to that, 
but on balance, I think that the special purpose entity 
accounting is working as well as could be expected right now, 
but it does cry out for the FASB to finish their project and 
conclude whether a different set of rules should be enacted.
    Mr. Shays. I'm a little confused. What confuses me is my 
sense is the SEC has been injecting itself in this debate and 
looking at a standard different than the 3 percent. Isn't that 
accurate?
    Mr. Herdman. Congressman, I'll have to look into that. I've 
been on board for 2 months. In the time that I've been here we 
have not been injecting ourselves particularly in that debate.
    Mr. Shays. In his speech he said the staff believes that 
the registrant should not apply any specific factor to 
determine the sponsor of an SPE and believes that all the facts 
and circumstances of each transaction should be considered 
carefully. In this regard, the staff believes registrants 
should consider the following qualitative and quantitative 
factors in evaluating who was the sponsor, who the sponsor is 
of an SPE. And then basically it has a number of qualitative 
factors and then you have a few quantitative factors.
    Bottom line, do you think we're going to be able to 
continue to exist with FASB and the SEC not resolving issues 
more quickly?
    Mr. Herdman. We do need to and it's one of the major points 
that was made the other day in Chairman Pitt's op-ed article. 
We need to foster an environment where private sector standard 
setting moves quickly and decisively to deal with the important 
issues.
    Mr. Shays. Tell me to someone like myself who isn't an 
investor, tell me what the purpose is of a special purpose 
entity. I mean, I look at it and I think, why does it exist?
    Mr. Herdman. Special purpose entities exist in order to 
finance--this is a generalization. There are many types of 
special purpose entities that engage in different types of 
things. As you may be aware, the banking industry, the credit 
card aspect of the banking industry relies extensively on 
securitization, thus providing for the bank a source of 
liquidity to carry on their ongoing operations.
    This is a huge market. It's done with a great deal of 
transparency, and there are other types of special purpose 
entities that are created perhaps to finance particular 
investments. There are special purpose entities that are 
created to provide leasing facilities to a company. It's a way 
to achieve financing, and oftentimes there are some tax 
advantages associated with the use of these types of entities.
    Chairman Baker. Would the gentleman yield?
    Mr. Shays. Yes.
    Chairman Baker. I think there are structural reasons why 
SPEs have a legitimate purpose, but I think the analysis should 
be, and I don't know that it has been, does the creation of the 
SPE create real value for the underlying shareholder of the 
principal corporation, or in this case, were the SPEs used for 
self-dealing of the official to profit at the expense of the 
taxpayer? That's what hasn't been determined.
    Mr. Shays. And then the question would be does this happen 
in other companies and in other areas? I thank the gentleman.
    Thank you, Mr. Chairman.
    Chairman Baker. I thank the gentleman for yielding.
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman, Mr. Herdman. I want 
to follow up on what Mr. Shays was talking about. But I also 
want to say, a moment ago--and I can't remember who was asking 
the question--on the issue of restatements--and I think you're 
trying to be sincere of just being there for 2 months and 
looking at this, I think the increasing--it may have been the 
Chairman's question--I think the increasing volume of 
restatements is somewhat alarming. And I hope that the SEC is 
taking a harder look at that.
    Now I don't know if it's systemic or not, and the more you 
look at the Enron case, it really does seem to me this is not--
it's not certainly not--they didn't fail because of a cyclical 
reason or a recessionary reason or an economic reason. It 
certainly appears to me that they failed because of some severe 
structural reasons in their corporate governance.
    And I think the Chairman is right about the SPEs, and your 
comments are as well. They can be an attractive, an efficient 
financing vehicle. But in this case, isn't it a problem or 
shouldn't it be a problem for the SEC or the auditors, which 
the auditors did apparently find at one point, when on the one 
hand you're calling debt an increase in equity and you're 
really swapping what you're doing. They were double counting 
notes receivable and double counting equity when it was going 
the opposite direction. And the restatements were quite severe.
    And isn't it also a problem in having a restatement of a 
billion dollars plus of equity that's not just going back to 
the beginning of the quarter that you were filing the 10-Q for, 
but going back not just 4 quarters, but 4 years? And does it 
appear--and I know you have to be circumspect on your comments 
with respect to Enron because it's under investigation. But it 
seems to me to have every appearance of either using the SPEs 
as an artifice or self-dealing of some sorts. Even your own 
chronology in your statement.
    Mr. Herdman. I think, Congressman, you referred to the 
double counting of the notes receivable in the stockholders' 
equity. What has been disclosed with respect to that indicates 
that it does not go back 4 years. About $170 million of it 
arose in 2000 and the other $830 million arose in 2001.
    Mr. Bentsen. But they reduced their net income going back 4 
years as it related to----
    Mr. Herdman. Reduction of that income----
    Mr. Bentsen. ----as it related to--I think as it related to 
both Jedi and Chewco. Right. In those they restated it going 
back to 1997----
    Mr. Herdman. That's correct.
    Mr. Bentsen. ----to the point where they would have, 
instead of having net income, they would have had a net loss, 
which is somewhat substantial to the investing public.
    Let me ask you this. When they went through the transition, 
the CFO was out, the CEO was out. The chairman of the board 
resumed the role of CEO. In a conference call with analysts, 
the issue sort of came up, if I understand the chronology 
correct, that $1.2 billion of equity basically had washed away, 
no longer existed.
    The chairman and now CEO states in response to a question 
from analysts, ``Well, that's over my head. I'm not sure I know 
the details of that and the special purpose entities.'' Isn't 
it a problem when you have the chairman of the board of a 
Fortune 500 company, publicly-traded company, and not a penny 
stock company. It is today. But it certainly wasn't a penny 
stock company then--who doesn't understand the financing 
mechanisms of the company as it's operating?
    Is there a question here of corporate governance and is the 
SEC looking at that issue? Was the audit committee functioning 
properly? Are we through the 1933 and 1934 Acts or through the 
tools you have, are we sure that the boards of public companies 
are operating efficiently for the benefit of shareholders and 
the investing public and the pensioners, for that matter?
    Mr. Herdman. Congressman, your question carefully weaved in 
and out of Enron, and to the extent that it pertains to Enron, 
as you understand, I can't address that.
    Mr. Bentsen. Well, address it as a hypothetical.
    Mr. Herdman. As to a generality, of course chairmen of 
boards and audit committees should understand the important 
elements, the material elements of financing for the entities 
with which they're associated.
    Mr. Bentsen. Is the SEC doing enough? I mean, obviously, 
you can't sit and review every company's board minutes and all 
of that. But, I mean, do you think that the SEC is providing 
enough oversight in that area? I mean, if everything that has 
been said turns out--or if half of everything that's been said 
turns out to be true, the collapse of Enron is going to be one 
hell of a story and what happened and a huge miss on the part 
of the board and potentially its auditors.
    I mean, I can see where certain things can be missed and 
certain, you know, the contract with the copying machine 
company maybe wasn't the best deal you could get----
    Chairman Baker. Could you begin to wrap up, Mr. Bentsen?
    Mr. Bentsen. But this is a pretty big deal.
    Mr. Herdman. The processes that the SEC uses to review 
filings have been basically based on a selective review process 
now for 20 years. And we don't talk about the particulars of 
that process in public, because we don't want companies to 
know, frankly, when they'll be subject to review and when they 
won't be subject to review.
    I can assure you, Congressman, that continuous improvement 
has been the hallmark of working with that review process. And 
I can certainly assure that going forward, we will continue to 
do that. We will learn the lessons that are out there to be 
learned from what we might discern from the Enron matter, and 
we'll apply those to improving our processes.
    Mr. Bentsen. Thank you. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Bentsen.
    Mr. Toomey.
    Mr. Toomey. Thank you, Mr. Chairman.
    A question on the SPEs if I could. First of all, maybe you 
could correct me if I have this wrong. But my understanding is 
that if you own 2.9 percent of the equity, you as some 
corporate entity own 2.9 percent of the equity of an SPE and 
you meet the other criteria regarding the control of the SPE, 
then your balance sheet is essentially silent on that fact. It 
doesn't reflect it in any way. Is that incorrect?
    Mr. Herdman. No. Congressman, the 3 percent doesn't have to 
do with what the company that enters into a transaction with 
the SPE owns. It has to do with the fact that many SPEs could 
be formed and providers of capital would be quite comfortable 
to provide 100 percent of the financing of an SPE in the form 
of debt securities. Let's say that that SPE was formed to carry 
out a sophisticated leasing program for a major program. This 
SPE could be formed. It's a legal entity. It could borrow 100 
percent of the money from banks or private.
    What these rules say that in order for there to be enough 
substance to the SPE, in order for it to be viewed as an entity 
independent from the sponsor, somebody has to put in some 
common equity to it.
    Mr. Toomey. Right.
    Mr. Herdman. And that common equity has to be at least 
equal to 3 percent of the total capitalization of the SPE.
    Mr. Toomey. OK. That's an important clarification. Thank 
you. If the corporate entity that wants to create the SPE 
provides a certain amount of that 3 percent equity and other 
entities provide the rest, then is there a requirement that the 
be represented on the balance sheet at all?
    Mr. Herdman. Yes. That would have to be on the balance 
sheet.
    Mr. Toomey. That would have to be?
    Mr. Herdman. If the 3 percent isn't owned by independent 
entities, and the other conditions are met, of course, then the 
SPE would have to be consolidated on the balance sheet.
    Mr. Toomey. It would have to be consolidated when the sort 
of sponsoring corporation has less than 3 percent?
    Mr. Herdman. No. It has to be consolidated if the SPE 
doesn't have at least 3 percent of its total capital owned by 
outsiders.
    Mr. Toomey. I understand.
    Mr. Herdman. Independent third parties who have common 
equity-type capital.
    Mr. Toomey. Right. I understand that. I guess what I'm 
getting at is there is a set of criteria, there are rules that 
allow for someone to create an SPE. They follow all the rules 
and they are allowed to change not to consolidate that SPE or 
in fact they're required not to consolidate it, right? And my 
question is, if the contribution, if you've made some kind of 
contribution, say you've contributed your own equity to part of 
the capitalization, but not so much that you would consolidate, 
but if you do it in a fashion that has the additional proviso 
that you'll top up that contribution in the event that the 
value of your stock declines, then that creates a contingent 
liability on the part of the sponsoring company, correct? Would 
you consider that?
    Mr. Herdman. In the rare event when a sponsoring company 
would be part of the capital structure of an SPE, that's 
potentially--you could view it as a contingency. I don't think 
that it would consider it to be a contingent liability.
    Mr. Toomey. Do you think it should be?
    Mr. Herdman. It would have to be recognized on the 
financials.
    Mr. Toomey. Right. Well, it seems to me it certainly is a 
contingent liability. It's equivalent to having sold a put 
option on your own stock, and therefore it would be required to 
be reported. Is that correct?
    Mr. Herdman. They're really very complicated rules on the 
accounting for put options and call options on your own stock. 
And I'd be glad to get back to you on these issues if you'd 
like to explore this further.
    Mr. Toomey. Yes, I think I would, because it seems to me--
--
    Mr. Herdman. There's a lot of detail here.
    Mr. Toomey. And it seems to me that this was part of what 
was going on with at least one of the SPEs that Enron had 
created. And I'm just wondering whether that had contributed to 
a larger exposure than perhaps was evident.
    Mr. Herdman. I can't comment on the Enron aspect of it.
    Mr. Toomey. I'll yield the balance of my time to my 
colleague, Mr. Ose.
    Mr. Ose. Thank the gentleman from Pennsylvania. Mr. 
Chairman, I do want--it's ironic. I was reading through the 
Wall Street Journal as I listened to some of the comments about 
the insider trading spotlight, and in fact today, Wednesday, 
December 12th, there's the most recent report on insider 
trading listing the top eight or ten individuals, both on the 
buy and the sell side and the top six or eight companies, both 
on the buy and sell side. And there's a little footnote down 
here. It's a Wall Street Journal link. ``See a list of 
companies with the highest number of insiders filing Form 144 
with the SEC disclosing their intention to sell restricted 
stock.''
    So it would seem to me that the information is being 
collected at the present. It's in the public domain. There may 
be some people who perhaps aren't aware of that fact. But as it 
relates to any directorships or managerial positions 
liquidating stock, it's a matter of public record by rule, if I 
understand, that has to be disclosed.
    Mr. Herdman. That's correct, Congressman.
    Mr. Ose. Now there's also a secondary cut, if you will, and 
that is that--correct me if I'm wrong, Mr. Herdman--that 
members of the board of directors or members of a management 
team only have specific windows during which they can sell 
stock that they receive. Is that correct?
    Mr. Herdman. I understand that to be true. But I couldn't 
give you the particulars on that, because that is a matter of 
law.
    Mr. Ose. The reason I asked that is somebody put together a 
very red document here that highlights the sales seemingly on 
a--for some purpose, but I wonder whether the windows 
correspond with the dates showing the large amounts of sales. I 
think that's worthy of being checked out.
    Chairman Baker. I can help you, Mr. Ose, because if you 
look down at the left-hand corner it says ``Source: Insider and 
Form 144 filings.'' That's all the corporate records. And what 
happened is there were two different types of actors here, a 
Mr. Lay who sold--I don't have the correct pronunciation--who 
sold in large blocks. Mr. Lay, however, sold in $10- to 
$100,000 blocks virtually every week, some every day. So if 
there were windows that were closing, they took a long time to 
close in the case of this particular matter.
    Mr. Ose. But there are windows during which they----
    Chairman Baker. Apparently so. There were a goodly number 
of them in this case.
    Mr. Ose. Are there different types of stock? This is where 
I get beyond my level of knowledge. And that is, with respect 
to senior management, do they hold restricted stock and 
unrestricted stock? Is that what you're saying?
    Chairman Baker. They were exercising stock options. 
Normally they would be in an acquisition on the morning of the 
day and the disposition of that same stock that afternoon, and 
there were various classes of stock being exercised, I'm 
assuming in accordance with their contractual relationship with 
Enron, whatever their employment agreement guaranteed them, 
they were entitled to receive and therefore make disposition 
of.
    Mr. Ose. And they were eligible to do that because they met 
certain minimum financial requirements on a personal basis?
    Chairman Baker. I'm certain that was----
    Mr. Ose. Which are not necessarily available to someone 
working lower down in the company?
    Chairman Baker. It was clearly a benefit of their 
contractual relationship as an employee of Enron, as an 
officer.
    Mr. Ose. OK. I understand I'm on Mr. Toomey's time. I want 
to come back to that question. Because the issue of why certain 
people are eligible to hedge their exposures and others aren't 
has been the substance of significant debate in these 
subcommittees and over in the Agriculture Committee on which I 
sit, relative to the minimum financial standards a participant 
must meet.
    And coincidentally and quite interestingly, there's been a 
lot of argument that people who are going to participate in 
hedging of exposures must meet certain minimum financial 
requirements. And in fact, that has been a demand from one side 
of the aisle in particular. And I think that merits 
investigation, because it's at the heart of people 
participating in the 401Ks getting stuck, if you will, when 
stock collapses. And I'm hopeful you'll come back to me, 
because I know I'm on Mr. Toomey's time. So thank you, Mr. 
Chairman.
    Chairman Baker. And Mr. Toomey's exhausted time. Thank you, 
Mr. Ose.
    Mr. Sandlin.
    Mr. Sandlin. Thank you, Mr. Chairman. Just briefly. And 
thank you, Mr. Herdman, for being here today. The goal of 
meaningful disclosure is to provide the investors and the 
market with an accurate and complete picture of the financial 
condition of the company. Is that correct?
    Mr. Herdman. That's correct.
    Mr. Sandlin. And the public is protected at least in part 
by an independent audit and by SEC oversight. Is that correct?
    Mr. Herdman. That's correct.
    Mr. Sandlin. It's already been brought out today the issue 
about the partnerships with SPEs. But it's not been brought 
out--it's my understanding in this particular case, the 
partnerships were run by the officers of the company. Is that 
correct? Of Enron.
    Mr. Herdman. That's what's been reported, yes.
    Mr. Sandlin. And it's my understanding that these 
partnerships also were unnamed partnerships. Is that correct?
    Mr. Herdman. What kind of partnerships?
    Mr. Sandlin. Unnamed. That they were not identified by 
name.
    Mr. Herdman. I believe that's correct from the disclosure 
I've seen, yes.
    Mr. Sandlin. Would this not cause--that's not in accordance 
with normal business practice or generally accepted accounting 
principles, is it?
    Mr. Herdman. Congressman, I don't believe that there's a 
generally accepted accounting principle requirement with 
respect to related party transactions that specifically calls 
to name the names of the partnerships.
    Mr. Sandlin. So, you think it's fine, then, just to list 
partnerships, but not by name and not to indicate that the 
partnership is run by an officer of the company?
    Mr. Herdman. No, that's not what I said.
    Mr. Sandlin. That's what I'm asking.
    Mr. Herdman. If that is the related party, is the officer, 
and generally accepted accounting principles does require 
disclosure of certain things with respect to----
    Mr. Sandlin. That's what I thought. Disclosure of----
    Mr. Herdman. ----the transactions.
    Mr. Sandlin. Now these partnerships were treated in this 
particular case as a separate entity, correct, from Enron?
    Mr. Herdman. We're now starting to get far too specific.
    Mr. Sandlin. OK. In the event that a SPE is set up or a 
partnership is set up in this sort of situation, then that 
partnership is considered as a separate entity from the 
original company. Is that correct?
    Mr. Herdman. An SPE or a partnership that meetings the 
applicable accounting rules to be considered is separate.
    Mr. Sandlin. And that allows debt to be moved away from the 
original company. Is that correct?
    Mr. Herdman. What that does, Congressman, is it says that 
the debt that's incurred by the SPE doesn't have to be 
consolidated in the financial statements of the company that 
does business with the SPE.
    Mr. Sandlin. But in the event that the company or SPEs are 
set up properly or do not meet accounting principles, then 
you're allowing the liabilities and equities of the company and 
ultimately the stockholder be distorted. Is that correct?
    Mr. Herdman. Could you repeat that question?
    Mr. Sandlin. My point is, you're allowing debt of an 
original company to be spun off into an SPE that's run by an 
officer of the original company in order to move debt away from 
the original company so that the stockholder equity appears 
much higher than it is. Is that correct?
    Mr. Herdman. My experience, Congressman, with respect to 
SPEs is that they normally do their own borrowing.
    Mr. Sandlin. Should auditors be involved in auditing 
partnerships or SPEs that they have a part in setting up?
    Mr. Herdman. I don't know what auditors would be doing in 
terms of setting up partnerships. They're not lawyers.
    Mr. Sandlin. If an auditor that's a part of an accounting 
firm or a law firm is a member of that same firm and helps set 
up an SPE or a partnership, should that same firm then 
regardless of your artificial restrictions within the firm, 
should that same firm be involved in auditing that setup?
    Mr. Herdman. I don't think there would be any prohibition 
against doing that.
    Mr. Sandlin. You don't see a problem in the fact that an 
accounting firm or a law firm would set up a partnership and 
then turn around and audit its own work? You think that's fine?
    Mr. Herdman. Accounting firms don't practice law, so they 
don't set up partnerships.
    Mr. Sandlin. I'm very aware of that. Well, let me ask you 
this. Should it raise a red flag for an auditor, if a firm is 
setting up a special purpose entity transactions in the firm's 
own stock? Is that a red flag?
    Mr. Herdman. If the transactions are material to the 
company's financial statements and if the auditor is aware of 
them, I would expect that that would be something that the 
auditors would pursue diligently.
    Mr. Sandlin. Now the press reported that the enforcement 
division of the SEC sent a letter in October to Enron about 
having questions about their disclosure. Could you tell us what 
disclosures raised the red flags for you?
    Mr. Herdman. The disclosures that prompted the letter were 
those that were made in an October 16th press release in which 
Enron released the results of its operations for its third 
quarter of 2001.
    Mr. Sandlin. What factors does the SEC consider to 
determine what filings it's going to review?
    Mr. Herdman. Congressman, as I said earlier, the selective 
review process that's used by the staff of the Commission to 
determine filings for review is not a topic that we discuss 
publicly, because it would take what element of surprise is in 
it out of it, and companies might know better when they might 
expect to be reviewed.
    Mr. Sandlin. I'm being tapped, and I think that means I'm 
done. Thank you for your response.
    Chairman Baker. Thank you, Mr. Sandlin.
    Just make a brief announcement for the subcommittees. I 
have to step out for a moment. Mr. Bachus will assume the 
chair. We'll proceed with questions of Mr. Herdman until--I 
understand there's a likely vote on the floor about 1:30. It's 
my hope that all Members could get their questions in before 
that vote.
    And I'm making this announcement for our second panelists. 
Pending that vote, we would take a few minutes for a lunch 
break and probably try to come back around 2:15 if the vote 
occurs around 1:30, which is a guess at this point. But to let 
our panelists know they will have a few minutes from whenever 
that vote occurs, and Members, a little time to grab a sandwich 
and come back. Let's just make it 45 minutes from whenever the 
bells first sound so we can get a vote in, get some lunch, and 
then come back for the second panel.
    Mr. Bachus. [Presiding.]
    Mr. Royce.
    Mr. Royce. Thank you, Mr. Chairman.
    Mr. Herdman, are you troubled by Enron's use of 
partnerships to keep significant liabilities off of the balance 
sheet?
    Mr. Herdman. Congressman, I can't comment about any of the 
particulars of the Enron matter because of the pendency of our 
investigation.
    Mr. Royce. OK. Well, let me ask you then in a broader scope 
here. Do you see ways in which the SEC can encourage or maybe 
compel companies to provide financial information that's useful 
to investors on more of a real time basis? Let's say for large 
corporations monthly rather than quarterly financial 
statements. Would that be helpful in your view?
    Mr. Herdman. I don't necessarily think that a requirement 
for monthly financial statements would be helpful. But the 
things that we're going to be considering with respect to 
improving the totality of financial reporting could very well 
lead to disclosures of financial and other types of performance 
indicator information on a more frequent basis than quarterly.
    Mr. Royce. Well, we've had accounting problems now that are 
almost systemic. Waste Management. We've had Sunbeam. We've now 
had Enron. It would seem to me that there would be need to move 
quickly on developing such changes.
    Let me ask you a question about the ongoing investigation. 
Let us say that fraud is discovered in this investigation with 
respect to Enron in terms of insider trading. What is the 
likelihood that the profits made through fraud through insider 
trading would then be compelled to be paid back to Enron so 
that the assets held by the employees of Enron and shareholders 
of Enron who did not have access to this insider information 
could then be at least partially benefited?
    Mr. Herdman. That's beyond my personal expertise, 
Congressman. I just don't know all of the particulars about the 
specific remedies the SEC has available, including the 
potential for disgorgement.
    Mr. Royce. Well, let me just close by saying it seems to me 
that investors need current information that is, in fact, true 
on a real time basis, and we have not developed to date 
apparently an effective system to make sure that it's delivered 
on a timely basis to them, and I would suggest that the SEC 
look at changing its procedures in a way that effectively does 
that, because the Congress is certainly going to look at 
finding ways to prod just such changes.
    Mr. Herdman. Congressman, Chairman Pitt, since the time 
he's assumed office, has been talking about modernization of 
the financial reporting system, including more current 
information. Congressman, if you'd like, I could ask our 
general counsel, David Becker, to respond to your question 
about remedies and recoveries.
    Mr. Royce. Certainly I'd be happy to hear from the general 
counsel. Thank you, Mr. Herdman.
    Mr. Becker. Congressman, on remedies, we do have a variety 
of remedies in cases in which we can go to court and get 
disgorgement of ill-gotten gains. If the folks who misbehave 
still have the proceeds of the fraud, we'll get them and 
we'll----
    Mr. Bachus. If you could lean a little closer to the 
microphone.
    Mr. Becker. Sure. If the folks who violated our anti-fraud 
rules still have the proceeds of the fraud, we'll get them, and 
we'll make them give it up.
    Mr. Royce. Well, I would suggest that besides changing the 
ground rules so that we can get this information to investors 
on a more timely basis, that the other part of the equation is 
to aggressively pursue just such actions so that there will be 
a deterrent effect in the future. And I thank the gentleman for 
his answer.
    Mr. Herdman. I agree with you very much, Congressman.
    Mr. Bachus. I thank the gentleman.
    The lady from Ohio.
    Mrs. Jones. Thank you, Mr. Chairman. Lots of questions, not 
enough time. You stated earlier that we should not overreact to 
a situation such as Enron. What would be an overreaction, sir?
    Mr. Herdman. An overreaction might be to say that financial 
reporting is not trustworthy in this country. I think that 
would be an overreaction.
    Mrs. Jones. What should we say, then, if based on Enron, 
financial reporting in this country is?
    Mr. Herdman. I think we should say that financial reporting 
in this country is challenged and appropriate steps need to be 
taken to learn what needs to be done to improve it, and that 
should be done quickly.
    Mrs. Jones. OK. The filings that we're talking about on the 
chart over there on insider trading, these insider and Form 144 
filings. How often are they filed, sir?
    Mr. Herdman. I'm not an expert. I believe that they're 
filed on a transaction basis. In other words, if an insider 
sells----
    Mrs. Jones. Can your general counsel answer that question 
for me?
    Mr. Becker. I hope so. On the Section 144(a) transactions, 
they have to be filed fundamentally contemporaneously on 
general sales of stock they have to be filed, I believe, 
monthly or within 10 days.
    Mrs. Jones. Say that again, please. I didn't hear you.
    Mr. Becker. Fundamentally, they all have to be filed within 
30 days.
    Mrs. Jones. Is there a level of insider trading that would 
cause the SEC to say hello?
    Mr. Becker. Well, the short answer is depending on what 
else is going on, yes. If there's an extraordinary transaction 
and folks have traded and we want to know why.
    Mrs. Jones. OK. I'm Company Outwalk, so you don't have to 
talk about Enron. And in January I had $180 billion million 
worth of insider trading. Would that make you go ``Wooo''?
    Mr. Becker. I suspect that that's something that we would 
look at. I will tell you, though, that the fundamental 
philosophy of the Federal securities laws is get the 
information out and have investors evaluate the wisdom of their 
investment decisions. We do look at a variety of sources, 
including visual patterns of trading, to see if there is any 
fraudulent conduct going on.
    Mrs. Jones. But, the goal and purpose, Mr. Herdman, the 
Chief Accountant, U.S. Securities and Exchange Commission, is 
you have an oversight obligation over all these different 
accounting firms and auditing firms and the OAB, which was the 
office of--the POB, excuse me, the Public Oversight Board, to 
sit with them and give advice and counsel on the standards of 
what becomes appropriate accounting procedures. Wouldn't 
something like that be part and parcel of something that you 
would say to the world? Well?
    Mr. Becker. This information--our fundamental mission is to 
see to it that information relevant to investors is out in the 
public and that financial statements and disclosures are fully 
transparent to the public. And this type of information is 
information----
    Mrs. Jones. You know what? You could sit down if you'd 
like.
    Mr. Becker. Oh, thank you. Mr. Herdman's got his briefcase 
here, so I wouldn't. So, in fact, this type of information is 
information that's pushed out to the public quickly. One of the 
paradoxes--not talking about Enron in particular--one of the 
paradoxes, and this is where the role of analyst comes in, is 
that often that there is information out in the public, but 
people don't necessarily focus on it and take it as seriously 
as in hindsight they should.
    Mrs. Jones. Let me ask this, then. We've got a company--I 
called myself Outwalk. And Outwalk, my company, not only is 
showing $180 million worth of insider trading, but is--let me 
back up. Is there an obligation to also show how many 
subsidiaries or partners that you have as they become 
partnerships under your or become what do you all call them? 
The SPEs or something?
    Mr. Becker. I think this is one for Mr. Herdman.
    Mrs. Jones. OK. I'll take him.
    Mr. Becker. But, the basic answer is, sometimes yes, 
sometimes no.
    Mr. Herdman. SPEs sometimes are accounted for as 
subsidiaries, in which case there would be information about 
them, and sometimes if they meet the appropriate standards, 
they're not accounted for as subsidiaries, in which case there 
wouldn't be information about them.
    Mrs. Jones. Based on what we know about my company--
Outwalk--and perhaps it would not be an overreaction for us to 
look how do we let the public know that there are a number of 
FPEs or SBEs operating within a company that could, in fact, 
camouflage the economic condition of a company such that poor 
little me, who doesn't know anything about this area that I'm 
investing in, might think twice before I would invest my money 
in Outwalk Company?
    Mr. Bachus. The lady's time has expired.
    Mrs. Jones. Thank you, Mr. Chairman. Can I get a quick yes 
or no on that question? Can I get quick yes or no on that 
question?
    Mr. Herdman. I'm sure that's something that the FASB, when 
they finalize their rules on SBEs, will take into 
consideration.
    Mr. Bachus. Thank you.
    Mr. Herdman, there's been some disturbing allegations with 
respect to the failure of the board of Enron to monitor the 
activities of management, in particular related to the special 
purpose entities, the SPEs, as you've referred to them, and the 
related party transactions. What would you recommend to 
increase board oversight for these kinds of transactions and 
entities?
    Mr. Herdman. Congressman, there have been significant 
developments in the various structures about audit committees, 
about boards in recent years, particularly about audit 
committees. And the Commission really has no plans to do 
anything further with respect to rulemaking in that regard. And 
once again, this is an area where I believe that if we learn 
something as a result of our investigation that should be 
applied more broadly, we'll move ahead aggressively with that.
    But at this point, there have been significant changes in 
what audit committees do, in the amount of their interaction 
with auditors, and so forth. And those are all fairly recent 
within the last year or two. And right now there's no 
indication that that's an area that needs something to be done 
with it.
    Mr. Bachus. OK. How should a board react when they think 
that generally accepted accounting principles or GAAP-compliant 
disclosures are inadequate?
    Mr. Herdman. Well, under the conditions today to be a 
member of an audit committee--and these are encompassed in 
rules--as I say, they were not that long ago enacted by both 
the New York Stock Exchange and Nasdaq, is that members of 
audit committees have to be quote/unquote: ``financially 
literate'' and each understand enough about accounting and 
about financial reporting and financial statements to be able 
to critically engage management and the auditors in discussions 
about the accounting principles that are used, the disclosures 
that are made, and so forth.
    That being the case, when these discussions occur, if there 
are instances where the financial statements or where 
management doesn't intend to follow generally accepted 
accounting principles for some reason or it doesn't want to 
make a disclosure that is required by generally accepted 
accounting principles, the discussion has to be with the 
members of the audit committee if discussions just between 
management and the auditors haven't yet resolved the problem. 
That's not to say that if the right accounting doesn't get used 
and the right disclosures don't get made that the accountants 
would give a clean opinion in dialogues that occur, these 
sometimes are iterative, and the audit committees do have an 
important role in those types of matters.
    Mr. Bachus. Thank you.
    Yesterday, Chairman Pitt called for a self-regulatory 
organization for CPAs. Does the commission intend to issue a 
rule proposal for public comment on this? Or do you know what 
the timeline is?
    Mr. Herdman. Actually, Congressman, the article today that 
indicated that Chairman Pitt called for a self-regulatory 
organization, I think, misspoke. And where the Chairman and 
where the Commission are at this point is we've begun a 
dialogue with the accounting profession, with the major firms 
in the AICPA. They've indicated that they're going to take a 
look at what changes are needed to the self-regulatory process. 
We're eager to continue to work with them on that, and we're 
not predisposed at this point to either a continuation of the 
current system of self-regulation or to a statutory self-
regulatory organization.
    Mr. Bachus. OK.
    Mr. Herdman. If that were to go in the direction of an SRO, 
I believe that in order to be enacted it would have to be a 
matter that was put out for notice and public comment.
    Mr. Bachus. Now are you also considering something like an 
enhanced FASB or an enhanced AICPA or something like that? Or 
are you talking about just an entirely new body?
    Mr. Herdman. What we're talking about is the self-
regulatory structure that currently is housed within the AICPA 
in its Division for Firms and is overseen by the Public 
Oversight Board, which is comprised of individuals of high 
integrity that are not practitioners of accounting and what 
have you. That's the structure that exists today. It does 
certain activities. They're outlined in my testimony. And the 
questions have to do with are those activities sufficient? Does 
more need to be done? Does discipline need to be more 
transparent, and so forth. Those kinds of issues.
    Mr. Bachus. OK. Thank you.
    Mr. Mascara.
    Mr. Mascara. Thank you, Mr. Chairman.
    Mr. Herdman, when did the SEC suspect there was a problem 
at Enron? And what action did the SEC take? And how soon 
afterwards? I heard you mention in an earlier question the 
third quarter, October of 2001, was it?
    Mr. Herdman. The first letter Congressman, was a letter 
that was sent to Enron on October 17th of 2001.
    Mr. Mascara. And what action did you take?
    Mr. Herdman. We sent them a letter requesting that they 
provide more information about the losses that had been 
reported in their earnings press release the prior day.
    Mr. Mascara. What role does the SEC play in SPE filings? I 
would imagine there is some kind of a filing someplace that 
someone's required to file. Did you say earlier that these 
liabilities do not appear if they have 3 percent invested in 
the total offering? On a consolidated statement, do these 
numbers appear there?
    Mr. Herdman. What I said earlier was they do not appear on 
the consolidated financial statements if the owner of the 
special purpose entity has invested in equity capital of that 
entity in an amount that's equal to 3 percent or more of its 
total capitalization, and its total capitalization would 
include the amounts that the entity borrowed from various 
sources.
    Mr. Mascara. It's my understanding that Enron had a 
plethora of SPE filings. So if they invested a minimum of 3 
percent, they would not be required to place that liability on 
their balance sheet? I think that's outrageous if the answer is 
yes.
    Mr. Herdman. It's not, as I said earlier, Congressman, this 
is complicated, but it's not how much Enron has invested in the 
SPE or another sponsor of it. Let's not talk about Enron. When 
a sponsor of an SPE invests it's--because they can't invest 
anything. It's how much is invested in by independent third 
party investors.
    Mr. Mascara. So if any independent investor invests at 
least 3 percent, Enron or any other company would not be 
required to list the liability on their balance sheet on a 
consolidated balance sheet?
    Mr. Herdman. That's correct, Congressman. The sponsor 
before the 3 percent requirement was put in place was quite 
willing to lend 100 percent of the capitalization of SPEs in 
order to effect these transactions.
    Mr. Mascara. How is your staffing at SEC? Is it sufficient 
to oversee the financial world of risk that's many times out 
there? Do you have enough employees to oversee those 
activities?
    Mr. Herdman. I'm certain we have enough employees in the 
Office of the Chief Accountant. With respect to the other 
divisions, we're constantly looking to see where and how we can 
use our resources better and to redeploy resources to 
particular issues that--you know, radiate attention at a 
particular point in time.
    Mr. Mascara. I have an accounting license. I'm asking you 
this question because I can't answer it. Does any of this have 
to do with what went on recently in the dot.coms where people 
were looking at anticipated revenues rather than anticipated 
earnings? Is there any similarity between the----
    Mr. Herdman. Based on what, Congressman, I don't see any 
similarity at all to the dot.coms. The dot.coms were 
speculative entities that generally didn't have much history in 
their business. They frequently have enough cash to carry out 
their money-losing activities as a result of the public 
investing the cash. Notwithstanding the fact that there was 
clear and transparent disclosure that these companies were 
vulnerable, that they didn't have any, and so forth. That was 
all out there on the table, and yet a lot people bought those 
stocks and I guess today wished that they hadn't.
    Mr. Mascara. Thank you, Mr. Herdman. I think we've just 
touched the tip of the iceberg. I'm afraid what's coming. But I 
thank you and I thank you, Mr. Chairman.
    Mr. Bachus. Thank you, Mr. Mascara.
    We intend to recognize Mr. Inslee and then Ms. Jackson-Lee. 
There's probably about 7 minutes left on the floor, so for such 
time as we have, I'm going to recognize Mr. Inslee first and 
then Ms. Jackson-Lee.
    Mr. Inslee. Thank you, Mr. Chair. I represent a district up 
in the State of Washington. I can tell you that my constituents 
have a lot of real hard questions here. And the reason is is 
that they think of Enron as sort of a financial octopus with 
tentacles not only just into the investor community, but that 
touches Americans in a lot of different kinds of ways.
    And one of those kinds of ways is in the energy field, the 
energy prices and the like. And I heard one of my colleagues 
say something I guess I'll take a little issue with to say that 
somehow Congress should not get to the bottom of the question 
of how this company hijacked America's energy policy. Because 
it appears from the press reports that I'm reading that there's 
good reason to believe that Enron's fingerprints are all over 
the American energy policy that exposed my constituents in the 
State of Washington to millions of dollars of overcharges last 
year in the electrical market and have led us into the 
situation where the country has huge failures in our energy 
policy.
    And there are questions that I think--and I hope you and 
others help us answer--like, is the reason that we're giving 
Enron $254 million in tax relief instead of investing in clean 
energy is the answer Enron? We'd like an answer to that 
question. Is the reason that the Administration is doing 
nothing about global climate change, is the answer Enron? Is 
the reason the Federal Government is not taking action to 
improve automobile mileage standards, is the answer Enron? 
Because there's a lot of evidence that at least we've been 
hearing about, about the ability of Enron to affect our 
Government's policy, and we're very concerned about that.
    And there's a relationship between this financial world and 
the energy world. I was just reading, I think it's in the Los 
Angeles Times, it's talking about Mr. Lay's role in the 
replacement of one of the FERC commissioners. And it says, as 
the New York Times reported, ``Ebert [phonetic] had barely 
settled into his new job this year when an unsettling telephone 
conversation with Kenneth Lay prodded him to back a faster pace 
in opening up access to electricity transmission grid to 
companies like Enron.'' Lay admits making the call, but in an 
unctuous defense of his influence peddling said: ``the final 
decision on Abrams [phonetic] job was going to be the 
President's, certainly not ours.'' Soon after, Ebert [phonetic] 
was replaced by Texan Pat Wood, who was favored by Lay.
    I think that there are a lot of questions here that are 
going to be related to the abuse of stockholders to also the 
abuse of energy payers, consumers, and those who care about our 
whole energy world. And we encourage you and others to engage 
in trying to answer those questions that Americans have.
    And I want to ask you one specific question about abuse of 
stockholders and employees. And I know you can't comment on the 
investigation, so I'll ask you in a hypothetical form. If a 
company on October 17th, the very same day the SEC announced it 
was investigating that company, chose to change plan 
administrators of their 401K, which thereby automatically 
locked in their employees so they couldn't sell their product. 
And then the insiders, including some of the executives that 
were partially, in my view, responsible for the pathetic energy 
policy we have in this country, to go on this binge of selling 
their stocks to jump ship and leave their employees in a 
sinking ship, is that, number one, legal? And number two, is 
there disclosure required for that activity?
    Mr. Herdman. Congressman, I think what happened to the 
employees with that 401K plan is just one of the most terrible 
things I can imagine. However, nothing about 401K plans comes 
under the jurisdiction of the Securities and Exchange 
Commission. Those are matters that have to do with the 
Department of Labor. And as to whether there would be a need 
for disclosure in SEC documents, I don't believe that there 
would be.
    Mr. Inslee. Well, should we consider requiring disclosure 
that if executives are going to treat their employees, of 
essentially getting into the lifeboat and leaving them on a 
sinking ship, should we consider requiring disclosure on that 
in some regard?
    Mr. Herdman. I don't know whether there was disclosure made 
to the employees in advance about the fact that the change in 
administrator was going to prevent them from changing their 
investment elections for a period of time. I just don't know.
    Mr. Inslee. Let me ask a little broader question.
    Mr. Bachus. I thank the gentlemen for his questions.
    Mr. Inslee. Thank you, Mr. Chairman.
    Mr. Bachus. Thank you.
    Ms. Jackson-Lee. And at the end of her questioning, we're 
going to recess for 45 minutes.
    Ms. Jackson-Lee. Thank you very much, Mr. Chairman. I'm a 
guest in this hearing and I want to thank the Chairman. I want 
to thank the Chairman of the Full Committee, Mr. Oxley, the 
Ranking Member, the Chairman and Ranking Members of the 
subcommittees as well.
    I am here because Enron is in the 8th Congressional 
District of Texas, my District in Houston. The eyes of the 
Nation, Mr. Herdman, are on these particular hearings, and more 
specifically the eyes of Houston are on this particular hearing 
because, of course, Enron was a very good civic and corporate 
anguish in Houston, Texas now and I believe as it moves across 
the Nation, in the Nation. As the SEC's responsibilities, if, 
for example, in 2000 December a stock price of $84 and then 
around October of 2001 it had a stock price of $33, why did the 
SEC do more to that particular company--and particularly if 
there was a loss of about $600 million?
    Mr. Herdman. As I understand it, the loss that you may be 
referring to wasn't reported until November when Enron 
announced that it planned to restate its financial statements 
back to 1997. Once again, as Mr. Becker pointed out earlier, 
the purpose of the securities laws is to require disclosure, to 
provide disclosure to investors so that they can make informed 
decisions about whether to invest, when to invest, when to 
sell, and so forth. And the fact that a stock price changes--
we'll look into this, but I'm not persuaded that that would be 
an effective means for the SEC to screen filings and determine 
whether a particular company's filings should be looked at as 
contrasted to some other procedures that are applied in our 
selective review process. But we'll certainly look into that.
    Ms. Jackson-Lee. I appreciate your assessment on that. I 
would think with the overwhelming--you just answered my 
question. Wouldn't you think it's now time to reassess or to 
look into what might be additional resources, regulations and 
laws that might assist in that review on behalf of the SEC?
    Mr. Herdman. We'll be taking a look at ways to improve our 
processes as well.
    Ms. Jackson-Lee. Let me close on this question because my 
other duty is to cast my vote on the floor of the House, and I 
will return for the second panel. I thank the Chair. With 
respect to the law, the difficulty that they provide in 
camouflaging the acts of a particular company. How do we 
address that and treat that? I'm not using the correct 
terminology, but truth in information. That is not truthful.
    Mr. Herdman. Ma'am, I don't think you can conclude that 
it's always not truthful. This is why we have the Financial 
Accounting Standards Board to develop the appropriate criteria 
as to when those assets and liabilities should be part of the 
consolidated financial statements and when they should not be 
part of their consolidated financial statements, and we will 
urge them on to the swift completion of that task.
    Ms. Jackson-Lee. Let me leave you just with this. Maybe we 
will heighten the standards on the utilization or the 
proctoring of those kinds of companies. It may not be a 
question of truth in information, but maybe there needs to be a 
higher bar.
    Mr. Herdman. Perhaps.
    Ms. Jackson-Lee. Thank you very much.
    Chairman Baker. Thank you, Congresswoman Sheila Jackson-
Lee. We are now going to dismiss this panel. We want to thank 
the witness for testifying today, and we also want to give the 
Members of the Congress 30 days in which to put together any 
additional questions that they might want to ask you. So I'd 
like to acknowledge that for the record.
    We are going to reconvene with the second panel at 2:15 
after this vote is over. So, thank you again for your testimony 
here today.
    Mr. Herdman. Thank you.
    [Recess.]
    Chairman Baker. By way of advisory, Members will be 
returning momentarily. I thought it would be helpful to proceed 
with the receipt of testimony so that by the time we have a 
full complement and get to our questions there will be 
sufficient Members here to engage our panel.
    Our first participant this afternoon is Mr. Joseph 
Berardino, Chief Executive Officer, Arthur Andersen.
    Before I recognize you for your comments, Mr. Berardino, I 
just want to, by way of personal acknowledgment, express my 
appreciation to you in the manner in which you have responded 
to the subcommittees in this difficult manner.
    I wish all officials who had similar participation in the 
issues before the subcommittees had exercised your judgment and 
expressed your willingness to cooperate with the subcommittees 
in seeking a commonly beneficial resolution to this matter. So 
I do appreciate your openness and your willingness to be here 
today.
    Thank you, sir.

  STATEMENT OF JOSEPH F. BERARDINO, CHIEF EXECUTIVE OFFICER, 
                      ARTHUR ANDERSEN, LLP

    Mr. Berardino. That is very kind of you, Mr. Chairman.
    Good afternoon. Thank you for inviting me to appear before 
you today. I am here because faith in our firm and the 
integrity of the capital market system has been shaken. What 
happened at Enron is a tragedy on many levels. We are very 
aware of the impact this has had on investors and the pain this 
business failure has caused for Enron's employees and others.
    Many questions need to be answered, some involve accounting 
and auditing. I will do my best today to address these.
    I ask you to keep in mind that the auditing and accounting 
issues are very complex and are part of a bigger picture. None 
of us yet know all the facts. Today's hearing is an important 
step in enlightening all of us.
    If there is one thing you can take away from my testimony, 
I hope it is this: Andersen will not hide from its 
responsibilities. That is why I am here today.
    The public's confidence is of paramount importance. If my 
firm has made errors in judgment, we will acknowledge them. We 
will make the changes needed to restore confidence.
    In my written testimony, I have addressed two issues that 
go to the heart of concerns about our role as Enron's auditor: 
did we do our job, did we act with integrity?
    To aid the subcommittees in their inquiry, I have provided 
detailed answers to these questions in my written statement and 
I would like to touch on a few of the key points.
    On the accounting issues, Enron has said it will restate 
its financial statements back to 1997 as a result of issues 
with two special purpose entities or SPEs. These are 
sophisticated financing vehicles used by many companies. They 
are well known to the investment community.
    On the larger of these which was responsible for 80 percent 
of the SPE-related restatement, it appears important 
information was not revealed to our team. We have notified the 
audit committee of possible illegal acts within the company.
    On the smaller of the SPEs responsible for 20 percent, we 
now believe, based on a second look, that our team has made an 
error in judgment. An honest error, but an error nonetheless. 
But I do believe we did a professional job overall and that 
this error did not cause Enron's collapse.
    There have been questions about the sufficiency of Enron's 
disclosures. It is true that Enron did not disclose every 
transaction or every contingency. It was not required to. 
Accounting rules also do not require a company to disclose 
losses, such as the sudden rapid decline we witnesses in 
Enron's stock price and credit ratings.
    Finally, let me spend a minute on fees. We were paid $59 
million by Enron, including $25 million for our audit. There is 
a perception that the remaining $27 million was for traditional 
management consulting work such as installation of computer 
systems. In fact, the bulk of that $27 million was for audit-
related work, tax work and work that could only be done by 
auditors; $13 million was for consulting work done by Arthur 
Andersen.
    Some may assert that even $13 million in consulting work is 
too much, that it weakens the backbone of the auditor. There is 
a fundamental issue here. Whether it is consulting work or 
audit work, the reality is that auditors are paid by their 
clients.
    For a system to work, you and the investing public must 
have confidence that the fees we are paid, regardless of the 
nature of our work, will not weaken our resolve to do what is 
right and in the best interests of investors. I do not believe 
the fees we received compromised our independence. Some will 
disagree and I have to deal with the reality of that 
perception.
    I am very aware that our firm must restore the public's 
trust. I do not have all the answers today, but I can assure 
you we are carefully assessing this issue and will take the 
steps necessary to reassure you and the public that our 
backbone is firm and our judgment clear.
    Andersen will have to change to restore the public's 
interest and confidence and we are working hard to identify the 
changes we need to make. The accounting profession will also 
have to reform itself. Our system of regulation and discipline 
has to be improved and others will have to do things 
differently as well: companies, boards, audit committees, 
analysts, investment bankers, credit analysts among others.
    I believe we can work together to give investors a more 
meaningful, relevant and timely information. My firm, and I 
personally as CEO, will do our part.
    Thank you, Mr. Chairman.
    [The prepared statement of Joseph F. Berardino can be found 
on page 113 in the appendix.]
    Chairman Baker. Thank you very much.
    Our next participant is Mr. Charles Hill, Director of 
Research, Thomas Edison Financial/First Call.
    Welcome, Mr. Hill.
    Mr. Hill. Thank you.
    Chairman Baker. And grab that microphone and yank it around 
toward you there. It needs to be pretty close.

  STATEMENT OF CHARLES L. HILL, DIRECTOR OF RESEARCH, THOMSON 
                      FINANCIAL/FIRST CALL

    Mr. Hill. Chairman Oxley, Chairman Baker, Chairwoman Kelly, 
Ranking Members LaFalce, Kanjorski and Guttierez, and Members 
of the subcommittees, I welcome the opportunity to again 
testify in front of the House Financial Services Committee. I 
believe these subcommittees have been addressing substantive 
issues that are important not only to the future health of the 
investment community, but important to the general public's 
perception of and confidence in the overall capitalist system.
    The excesses associated with Enron that led to its 
bankruptcy are more far-reaching than just their impact on 
Enron. There is plenty of blame to go around in the mistakes 
made in the Enron situation. I am here today to focus on the 
role of the broker analysts in the debacle.
    In my previous testimony before these subcommittees, I did 
not tread lightly on what I thought were some serious problems 
in analyst behavior that needed to be remedied. I am here this 
afternoon, however, to say that analysts to some degree were 
more victims rather than culprits in the Enron situation. Not 
that they were without blame, particularly in the late stages 
of the Enron collapse, but they were not the underlying cause 
of the excessive rise in Enron's stock that later proved to be 
irrational.
    The performance of the analysts should be judged on two 
fronts. The first is their analysis of Enron's fundamentals, 
particularly in regard to earnings. The second is their 
valuation assessment and recommendations of Enron stock.
    The thing that stands out most visibly about the analysts' 
analyses of Enron is over the 3 years up to October 2001, their 
estimates at the beginning of each year for that year had 
minimal changes. The few changes that did occur were always 
upward and usually followed the guidance given by the company 
when they reported quarterly earnings.
    The narrowness of the spread of estimates among analysts 
was remarkable, especially for an energy company. The 
coefficient of variance for Enron estimates was consistently 
below the average for the S&P 500 during the same period.
    This pattern is highly suggestive that the analysts were 
being spoon fed as to what Enron expected earnings to be. The 
analysts might have been willing to accept company guidance, be 
it overt or inferred, as long as the company kept meeting 
expectations each quarter. Since at least the beginning of 
1998, Enron has met or exceeded analysts' estimates every 
quarter.
    One reason that analysts may have been more willing than 
normal to accept company guidance for Enron was that it was 
becoming increasingly difficult to understand how Enron was 
achieving its revenue growth and profitability. Extensive use 
of derivatives, particularly when the company is using mark-to-
market accounting, is extremely difficult in the best of 
situations.
    We now know that a big additional reason for the 
difficulties in analyzing Enron's financials was that there 
were significant parts of Enron's business that were hidden 
from the balance sheet.
    Often, the way out for analysts when faced with difficult-
to-analyze situations like Enron is to drop coverage. Why take 
the risk when there are plenty of companies that are 
transparent enough to do meaningful analysis with confidence?
    The problem with dropping Enron was that it had become the 
giant in the industry. If you were an analyst covering that 
industry, you essentially had to cover Enron. That was further 
reinforced if your firm was one of Enron's investment bankers 
or investment banker wannabees.
    The real problem, though, was having sufficient information 
about the off balance sheet items. Whether the accounting for 
each of these items was within FASB rules or not is not yet 
clear, although the announced restatement of prior periods 
earnings is a strong signal that at least not all was kosher.
    But what is clear is that Enron was not providing what 
could even be considered minimum transparency in its financials 
and that the analysts did not have all the tools necessary to 
make a reasonable analysis.
    In evaluating the analysts' performance on recommending 
Enron stock, one first has to understand how the brokerage 
community's recommendation system really works.
    As I have testified before to these subcommittees, the 
investor needs a two-level decoder. The first level of the 
decoder gets all the brokers on a common recommendation scale. 
The most common scale is a five-tiered one, where the top 
category is a ``strong buy''; the second is a ``buy''; the 
third is ``hold''; fourth, ``sell''; fifth, ``strong sell.'' 
Most brokers have a five-tiered scale, some have a four-tierd 
one, and a few have a three-tierd scale.
    In addition, many have very different terminology. The term 
``buy'' may be the term used for the top category at some 
brokers, or for the second-best category at many brokers, or, 
in at least one case, for the middle category. There are more 
than a dozen different terms used for each of the top three 
categories and almost as many for the bottom two.
    Unfortunately, getting all the firms on a common scale is 
not the end of the decoding. Analysts are overly biased on the 
positive side in their recommendations. The typical 
distribution is about 33 percent of all recommendations are in 
the top or ``strong buy'' category, about 33 percent in the 
second or ``buy'' category, about 33 percent in the middle or 
``hold'' category, and only about 1 percent in the remaining 
``sell'' and ``strong sell'' categories combined.
    If the recommendations are put in numeric terms where 1 is 
a ``strong buy''--or whatever the broker's term is for that top 
category--2 a ``buy,'' and so forth, using this numerical scale 
consensus recommendations can be calculated for each company.
    Most of the time, the average consensus recommendation for 
either the companies in the S&P 500, or for the roughly 5,000 
companies that analysts cover, is a 2.1. Occasionally, the 
average may be a 2.0 or 2.2.
    Therefore, the second level of the decoder would move the 
recommendations into three more meaningful categories--those in 
the 1 or ``strong buy'' category would really be saying 
``buy,'' at least in relative terms. Those in the 2 or ``buy'' 
category would really be saying they were neutral on the stock, 
and those in the 3 or ``hold,'' the 4 or ``sell,'' and the 5 or 
``strong sell'' categories all would be saying sell the stock.
    For Enron, the consensus recommendation, as shown on a 
graph that is in the handout, was about a 1.5 from May 2000 
until the end of September 2001. Even if we had our decoder to 
compensate for analyst optimism, it is clear that the analysts 
covering Enron were very positive with their recommendations.
    But, during that same period, the analysts had similar or 
higher consensus recommendations on competitors like Calpine 
and Dynegy. While a consensus recommendation for Enron was much 
better than the average for S&P 500 companies, their enthusiasm 
was not limited to Enron.
    In early October 2001, the consensus recommendation spiked 
up from a 1.5 to a 1.3 as several analysts raised their 
recommendations ahead of Enron's reporting its third quarter 
earnings on 16 October.
    On the day of the earnings announcement, one analyst raised 
their recommendation, pushing the consensus to a remarkable 
1.2. But as the Enron story began to unravel over the next few 
days, the recommendation downgrades exploded, plus six of the 
17 analysts dropped coverage.
    In these kinds of situations, it is easy to point a finger 
at the analysts for mistakes made. In my prior testimony, and 
in other forums, I have taken the analysts to task for not 
performing to an acceptable standard in certain situations. 
While the analysts are certainly not without blame on Enron, 
they are not the real culprits in this situation.
    I am not an expert in doing the actual accounting at a 
company, or in auditing a company's accounting, but having been 
an analyst for 22 years, as well as closely observing analysts' 
behavior at First Call for the last 10, I can say without 
reservation that this was a situation where either the company 
or its auditors or both were at fault in not providing 
investors, especially including the analysts, with the tools 
necessary to understand Enron's business.
    Whether the letter of the accounting rules were met or not, 
it is patently obvious that the spirit of the rules were 
violated in that Enron's financial statements did not fairly 
convey enough information for investors to reasonably analyze 
the company's operations.
    In that climate, it is hard to be too critical of the 
analysts' optimism. Enron had a long history of showing 
consistent and substantive earnings growth. If it had been up 
to me, if I was in that situation, I would have dropped 
coverage long before October 2001. The financial reports and 
details of operations had become more and more inscrutable well 
before then. But, as I mentioned earlier, most, if not all, 
analysts did not have that option. All things considered, they 
probably did as well as could be expected until October 2001, 
although in hindsight it is easy to say that they could have at 
least tempered their bullish recommendations to some degree.
    However, once the issues of the off balance sheet items 
became an unexplained issue on the 16 October 2001 conference 
call on third quarter results, it does seem that the analysts 
could have moved quicker to either suspend their recommendation 
or dramatically drop the level of their recommendation. The 
unexplained $1.2 billion balance sheet writedown was not a 
caution flag, it was a red flag.
    But Enron is not the situation on which to challenge 
analysts' performance. There are far more significant 
situations where analysts' conflicts and performance are at 
issue.
    The lessons to be learned here is how to ensure that 
companies and their auditors can be relied on to openly provide 
the necessary tools for investors to meaningfully analyze the 
company's business.
    Thank you.
    [The prepared statement of Charles L. Hill can be found on 
page 125 in the appendix.]
    Chairman Baker. Thank you very much, Mr. Hill.
    Our final participant is Mr. Richard Trumka, Secretary-
Treasurer, AFL-CIO.
    Welcome, sir.

  STATEMENT OF RICHARD L. TRUMKA, SECRETARY-TREASURER, AFL-CIO

    Mr. Trumka. Thank you, Mr. Chairman.
    Good afternoon, Chairman Baker and Chairwoman Kelly and 
Ranking Members of the committee and subcommittees. My name is 
Richard Trumka and I am Secretary-Treasurer of the AFL-CIO.
    On behalf of the AFL-CIO and our 13 million members, I 
would like to commend these subcommittees, and Chairman Baker 
in particular, for his leadership in calling this hearing and 
his foresight in looking at the issue of analyst independence 
last summer.
    I am here today first and foremost to make clear who the 
victims were in the Enron catastrophe. Let us start with those 
hurt worst by the conduct of the board and officers at Enron. 
More than 12,000 Enron employees participated in Enron's 401K 
plan. On October 17th, the same day that the SEC announced it 
was investigating Enron, the company implemented a plan to 
switch 401K administrators, knowing that their decision would 
freeze employees' accounts and that freezing took three times 
longer than is normal in these situations.
    Meanwhile, Enron executives continued to sell their stock, 
continuing a pattern of inside sales that netted a handful of 
executives over a billion dollars.
    Now, 5,000 of these same employees have been laid off and 
Enron has tried to extract waivers of liability from these laid 
off workers in exchange for their severance. Many of the 1,000 
members of the International Brotherhood of Electrical Workers 
at Enron's subsidiary, Portland Gas and Electric, suffered 
catastrophic losses. Members like Roy Rinard, who watched 
helplessly, his accounts frozen, as 22 years of retirement 
savings dwindled from $472,000 to less then $3,500. Or Tim 
Ramsey, a 33-year veteran, who lost $995,000 from his 
retirement account.
    Most pension funds and institutional investors held some 
Enron stocks or bonds. The AFL-CIO's pension fund held Enron 
bonds and watched them lose 75 percent of their value.
    Much of this money was going to fund pension benefits for 
working families, for the public employees we are counting on 
to protect us during this period of national crisis, for the 
pensions of the ironworkers, for instance, now clearing the 
rubble at Ground Zero.
    All of us who have S&P 500 index funds in our 401Ks or 
mutual fund portfolios lost money in Enron, probably about one-
half a percent of the total assets in those type of funds.
    Much of what happened at Enron, as has been stated earlier, 
remains murky, but from what we know, this is a story first and 
foremost about conflicts of interest, about a long list of 
people and institutions that were supposed to look out for 
workers' retirement savings and instead looked out for 
themselves.
    Now, what do I mean by a conflict of interest?
    Let us begin with the first line of defense, when 
management goes sour. That is the board of directors. At Enron, 
most of the board was independent of the company, according to 
the SEC filings. But look another layer deeper and you find 
some of these ``independent'' directors were actually investing 
in Enron-sponsored limited partnerships.
    Then there were the auditors. Arthur Andersen, who 
testified earlier, was the company's long-time auditor, but 
management was funneling lucrative consulting contracts to 
Andersen, as was stated, $59 million in fees.
    Then we come to the Wall Street analysts. Practically every 
Wall Street firm and post-Glass-Steagall commercial bank had an 
interest in courting Enron. Out of the 13 Wall Street analysts 
that covered Enron in October, according to Forbes Magazine, 11 
were bullish, while the majority of independent investment 
newsletters were bearish.
    Finally, there were money managers. Alliance Capital, a 
major money manager for pension funds, shared a director with 
Enron. Alliance kept buying Enron shares this summer and this 
fall, so many shares that Alliance ended up as Enron's largest 
holder. Enron was a company that talked about a future of 
transparent markets, but whose CFO openly bragged that, and I 
quote: ``We don't want anyone to know what's on those books. We 
don't want to tell anyone where we're making money.''
    Enron's mantra was deregulation and privatization and now 
Enron itself is a demonstration of why workers need both 
defined benefit pension plans and a Social Security system safe 
from the conflicts of interest that appear rampant in the 
capital markets.
    In response to these causes of the Enron fiasco, the AFL-
CIO is today submitting two rulemaking petitions to the SEC. 
These proposals have the support of the Council of 
Institutional Investors whose members have nearly $2 trillion 
in assets. We ask in these petitions that the Commission act to 
ensure independent directors are really independent.
    In the accounting area, our proposals are aimed to keep 
auditors independent and include a prohibition on accountants 
reviewing transaction they themselves structured, direct audit 
committee approval of any audit consulting arrangement, as well 
as the audit engagement itself.
    These proposals follow efforts in early November by the 
AFL-CIO and the Amalgamated Bank, a large index manager of 
union pension fund assets, to reach out to Enron's outside 
directors.
    Mr. Chairman, we did that immediately upon the announcement 
of their losses. We wrote to those independent directors and 
cc'd all the boards of directors.
    We asked for more independent directors and more extensive 
disclosure immediately, but we never received a substantive 
reply. In fact, the independent directors never wrote back. The 
company itself wrote back saying thanks for your letter.
    In the wake of the Enron bankruptcy, the Amalgamated Bank 
took the last step remaining open to investors, bringing suit 
last week in Federal court on behalf of Enron shareholders.
    Our funds will fight as hard as we can to get our money 
back, but the truth is, only strong Government action, led by 
the SEC and the Department of Labor, and the support of these 
subcommittees, and Congress can ensure that investors are not 
victimized again in this way.
    Mr. Chairman, I and the AFL-CIO look forward to working 
with you and these subcommittees in the coming days on these 
very, very important tasks.
    Thank you very much.
    [The prepared statement of Richard L. Trumka can be found 
on page 135 in the appendix.]
    Chairman Baker. Thank you, sir, for your good testimony.
    I just want to make a brief comment before asking my first 
question and that is I can assure all of you that every Member 
of the subcommittees, regardless of the philosophic 
perspective, finds no comfort in the fact that thousands of 
people are unemployed, their retirement benefits gone, their 
401Ks vanished. Regardless of the circumstance and how it came 
to be, this is a most unfortunate event over which there is no 
happiness anywhere.
    From here forward is the issue. How do we preclude it from 
reoccurring? In order to do that, we must understand how this 
came to be.
    I happen to believe that within the capital markets most 
people, as in politics, get up every morning and try to do the 
best they can to do the job they are assigned to do. It appears 
to me without knowing all the facts yet today that there were a 
few individuals engaged at very high levels within the 
corporate structure that did not provide the disclosures that 
are required perhaps by law, but certainly by good moral 
judgment, either to the accountants, to the analyst community, 
to the journalists or to anybody else and that it appears from 
the disposition of assets over the time preceding the 
bankruptcy filing that their profiteering coincided with the 
lockout of the employees' access to their own funds. If these 
facts turn out to be the case, this is a travesty.
    Now, could a change in our structural law have precluded 
it?
    I do not know, but that is what we are about.
    To that end, Mr. Hill, you were making the comment that 
some analysts, because of enthusiasm and the pressure of 
prominence, take an LTCM, they were making hand over fist great 
sums of money, very bright people, never had a back-to-back 
trading loss, banks were throwing money at them, investors were 
throwing money at them. It was almost as if you had a question 
about their methodology, there must be something wrong with 
you, because you did not understand the business model.
    It would seem from what I know now that to a great extent 
the Enron story is not too dissimilar. The principal 
difference, however, is that in the closing days of LTCM the 
principals believed in their own philosophy, they were putting 
money in. In this case, the principals were taking money out. 
That is a tremendous difference of great public policy 
consequence which troubles me greatly.
    But to your point about the independence of the analysts, 
as of 2:40 today, December 12th, checking by Yahoo! finance 
page, we have 13 analysts listed covering Enron, we have two 
``strong buys,'' we have one ``buy,'' we have eight ``holds,'' 
one ``sell'' and one ``strong sell.''
    How do you respond to that today? Is there something of 
value that these subcommittees are missing? How could anybody 
look at these events and come to the conclusion that this is a 
``strong buy'' opportunity?
    Mr. Hill. I have a problem with the ``strong buys.'' Again, 
if you have your decoder, you know that the holds are really 
meaning sell, so the majority of them are saying sell now to 
those that--as we said last time----
    Chairman Baker. But given these circumstances and the 
public discussion and the pending investigations and all the 
other matters that are out there, why not for the first time 
break the code and say, for goodness sakes, to the American 
public, ``sell this stuff''?
    Mr. Hill. I agree.
    Chairman Baker. If you can.
    Mr. Hill. I agree. But this is not new, you know, this 
whole thing. I mean, you brought up Long-Term Capital 
Management, and I have in my notes here that when we got into 
the questions to mention it, so you beat me to it on that one.
    Not long after I got in the business, there was a company 
that I was covering called Memorex. It was selling back then at 
over 100 times earnings. I do not remember the exact date, but 
it was some time in the early 1970s. Larry Spitters, the 
Chairman of Memorex, came to Boston to explain to the financial 
community their lease accounting and we have talked this 
morning about the similarities between off-balance lease 
accounting and off-balance derivatives, but same idea, there 
was no transparency. Part way through the presentation--he was 
using flip charts in those days--he got to the point where he 
threw up his hands and said, ``I can't explain it, I can't 
answer your questions.''
    I think a lot of us either dropped coverage or went to 
``sell'' on Memorex.
    Chairman Baker. And let me ask on that point, what is the 
significance in the market if someone drops coverage? What is 
the decoding of that activity?
    Mr. Hill. Well, assuming it is not because an analyst is 
leaving or whatever, it is interpreted as there is a problem 
here.
    Chairman Baker. So what we also need----
    Mr. Hill. And to me, that was the easy out, would be at 
that point certainly once that restatement----
    Chairman Baker. Well, are all these actions, the drop 
coverage, the hold comment, is this the prominence problem? Is 
that we do not want to downgrade someone because of the 
consequences of that to the firm?
    Mr. Hill. Absolutely. And the conflicts are threefold. 
First is the obvious one that most everyone is aware of, is the 
investment banking problem. And until we change the 
compensation situation for the analyst, which means we have got 
to find some way to go back, for the firms to get paid for 
research.
    When I was an analyst, my bonus was incentivized to do good 
fundamental research, but that was when the commissions were 
high enough that the firm was getting paid for research.
    Chairman Baker. Well, let me interrupt you, if I may. I 
want to get one question in to Mr. Berardino. My time is 
expiring. If we have a chance for a second round, I really want 
to come back.
    Mr. Berardino, I think what troubles me, I am standing on 
the presumption that the in-the-field auditor has no direct 
benefit from a lucrative contract with the larger firm and that 
in my view of the operative auditor function, he has a 
contractual relationship with the company, certainly he wants 
the company to be profitable. But, in the case of Arthur 
Andersen, whose gross income per year is in the millions and 
millions and millions of dollars, the relationship with Enron I 
do not view as being a significant factor in the judgment of an 
in-the-field auditor looking at the books.
    What troubles me, I believe, is in this case it appears 
that individuals who were responsible for disclosing the books 
or the activities to the in-the-field personnel in most cases 
may have not been providing you with the appropriate 
information or insight.
    If that is the case, what do we do about changing the 
system to correct for that problem? How do you know the data 
that the auditor is looking at is the real set of books?
    Mr. Berardino. That is a very complicated question and a 
very fundamental question, Mr. Chairman.
    As you probably know, Enron was an extremely complex 
company. They had over 20,000 employees. In fact, I recently 
found out they had 600 CPAs. So they spent a lot of time trying 
to keep their books. They had 3,000 subsidiaries all over the 
world.
    And as auditors, you know, we do not live there. We do test 
checks, we do statistical samples to inspect the transactions 
as the company presents us the information. And the company 
does have a legal obligation to present us information that we 
require.
    Chairman Baker. Let me do this, because I do not want to 
run inordinately time since I am trying to keep other folks on 
the clock.
    To put a simple point to it, must we make the consequences 
of failing to properly disclose, to provide transparency so 
severe that it ain't worth the risk?
    Mr. Berardino. I think that would be very helpful. It will 
add, though, and I made this comment in my testimony, it is an 
illegal act to withhold information from an auditor.
    Chairman Baker. Well, I understand that and, believe me, in 
my experience in Louisiana political life, having something be 
illegal is not necessarily a prohibition. I think we need to 
have something a little more strenuous than just the fact that 
you get written up in the books. And I do not know what that is 
in this case, but it ought to be pretty significant.
    Mr. Berardino. Well, that is worth investigating, sir.
    Chairman Baker. Mr. Kanjorski.
    Mr. Kanjorski. Yes. I was just thinking to myself as we 
heard the dialogue between yourself and the Chairman, if this 
were 1942, Nazi Germany, and people were talking about the 
death camps, it seems like a tremendous establishment of 
plausible deniability. If you do not know, you do not have to 
answer and you are all home free, other than Mr. Trumka.
    I do not quite sense----
    I will give you a chance, Mr. Hill, are you not outraged? 
Are you not outraged? Do you two gentlemen just not think this 
is horrendous, what happened to the shareholders, what happened 
to the investors, what happened to the employees?
    I mean, do we not have to say something to the system?
    If this system is so broken that the seventh largest 
corporation in the United States can play these silly games and 
everybody comes and just says, ``Well, I did not know,'' or 
``we did not understand,'' or ``we have these complications,'' 
are we any different than any other nations in the world that 
are having problems with transparency?
    Mr. Hill. I think when you get into this derivatives issue, 
we are in a whole new world and I do not know what the answer 
is. I do not know whether we need another class of security or 
whatever for people whose business is essentially driven by 
derivatives. I do not know what the answer is, but I agree with 
you, that we have to have some kind of different system because 
the normal fundamental analysis really does not apply to these 
kind of companies. I just do not know how you could really do 
it.
    Mr. Kanjorski. Let me ask something. You know, I thought 
corporate statements were required to give an understanding of 
what is going on and these special purpose entities, I have to 
confess, I know very little about them as to how they operate 
or derivatives. We have had hearings on it, everybody has come 
in here and said they are so important, they balance and hedge 
the market and do not worry about it and they get into the 
trillions and trillions, it is all OK. But why not just 
disclose it?
    If there is a special purpose entity, why should it not be 
disclosed? Unless it is constructed, and I think you gave an 
indication to me yesterday when we talked about this, it is 
particularly constructed so that it does not hurt the 
disclosure in the company?
    So here you are.
    Mr. Berardino. Well, Congressman, you are obviously getting 
right to the heart of the matter, which I appreciate. There is 
no great answer to your question right now. These special 
purpose entities have been in business for years.
    Mr. Kanjorski. And I understand that. But, by God, did not 
the accounting profession say, hey, by having these things, we 
are not really giving transparency here and disclosure?
    Mr. Berardino. Well, you know, there have been great 
debates and there is a great irony, unfortunately, in all of 
this. There is been a great debate within the accounting 
profession as to what goes on off balance sheet and there are 
two schools of thought, if I could just do a little accounting 
101, maybe.
    One school of thought is if you lose control, if you are an 
Enron and somebody else has control over these SPEs, 
simplistically defined as more than a 51 percent vote, these 
transactions go off your balance sheet, assuming these other 
tests, 3 percent, and so forth, are passed.
    Mr. Kanjorski. In spite of the fact that by doing that you 
lose transparency of what is really occurring in the company?
    Mr. Berardino. If you will just bear with me for a second, 
Congressman.
    The second school of thought, which is the school of 
thought Andersen has always been in, is that one ought to look 
at risks and rewards. So even though these transactions went 
off balance sheet, Enron could maintain 97 percent of the risks 
and rewards.
    Mr. Kanjorski. And we are arguing that in the accounting.
    Mr. Berardino. We lost that debate within the accounting 
profession.
    Mr. Kanjorski. And it has been going on for years?
    Mr. Berardino. Things go off balance sheet, it has been 
going on for years, people know about it.
    Mr. Kanjorski. Ten years, I think you told me yesterday. 
And as a result of that not coming to some conclusion, we are 
now faced with somebody lost $80 billion, I think a hell of a 
lot of somebodies who Mr. Trumka was talking about that are 
important, and innocent investors and a lot of bad guys who 
were inside traders made billions while this thing was going to 
hell in a basket.
    And now you are putting Congress as representatives of the 
people in the position that if we have had enough and we are 
fed up, you are telling us the Government better come in and 
regulate your profession, the corporations, disclosure, the 
business interests of this country seem to me to make the most 
compelling case in the world of we need heavy regulation.
    And that sort of offends me, because I felt that we could 
rely on the decency, the honesty and the professionalism that 
the professions aiding these corporations and the corporate 
executives would be using the highest moral and ethical 
standards and I just--somebody was in the hen-house. And I 
think it is up to you guys to tell us who that was. And then 
let us find out--are we going to slap them on the wrist with a 
$1,000 fine and put them in jail for a year so they can take 
their billion dollars in jail and speculate and make two or 
three billion? Or maybe set up some more special purpose 
entities out there?
    Mr. Berardino. Congressman, I am here voluntarily because I 
want to be part of the solution. The points you raise are 
valid. I understand them. I do not feel good about where we all 
are. But I think the Chairman set the right tone here by saying 
we have to learn from this. We are prepared to shed whatever 
facts we can on the accounting and auditing side of this 
because I think we can get it better.
    Mr. Kanjorski. And I appreciate that and I want to tell you 
I appreciate you having the--I am trying to use the right word 
here--nerve to be here today. I think my patience at this point 
is fully tested. I applaud the petitions for regulations filed 
by the AFL-CIO. I think America is going to go back to a lot of 
instances of re-regulation where it will be counterproductive 
to the market if we do that, but it is going to happen because 
people are not going to take it, $80 billion, what that means 
to America, where we could go with it, and to allow----
    I do not know whether this is a Ponzi scheme or what the 
hell it is, but when the best analysts from the best investment 
banking in the country are, at a time when everything is gone, 
still recommending heavily that people buy and put their 
pensions, their savings--I think we have to do something and I 
think that is very unfortunate, that the business community 
here is forcing the Congress on behalf of representing the 
people to get involved with the accounting profession on 
conflicts of interest, with the analysts and the way they get 
paid. That should not even be an issue, as you indicated.
    We have so many compromises out there it is amazing that 
anything is working in this system.
    I know I have had my time. Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Kanjorski.
    Mrs. Kelly.
    Mrs. Kelly. Thanks, Mr. Chairman.
    First of all, I want to say thank you, Mr. Trumka, because 
you represent a lot of people, not only in AFL-CIO, but by your 
words today you represent a lot of other people out there in 
the United States who also got involved, not because they were 
in the union, but because they trusted. And I think it is 
important that your testimony was heard.
    I want to turn to you, Mr. Berardino. I want to follow up 
on the mark-to-market situation.
    Do you think that the mark-to-market accounting system has 
yielded a situation where we have misleading information being 
provided to investors?
    I was not real happy with what I heard this morning. I 
would like to hear it from your standpoint.
    Mr. Berardino. I think it is an extremely important issue 
and I will hide behind theory to start and then I will get real 
life for you, if you do not mind.
    Theoretically, it is a very appropriate way to account for 
transactions. You get a more current valuation. I think what 
you heard this morning is some of the difficulties in the 
methodologies that go into evaluating something. It is easy to 
evaluate something that might be due tomorrow than something 
due 30 years from now.
    We share your concern, and by ``we'' I mean the accounting 
profession. We issued a statement, the five CEOs of the major 
firms, just 1 week ago, where we called to the SEC and said we 
need more disclosure so people know what is going on this mark-
to-market stuff. It is hard, it is complex and there are 
different interpretations as to how to get there.
    We think it is a real issue, we think it is an important 
issue. It is on the agenda. We have put it on the SEC's agenda 
and we are fully prepared as a profession to try to get some 
guidance out before this year end as companies are ending their 
years December 31 so that there will be more clarity this year 
than there might have been last year.
    Mrs. Kelly. Well, bear with me for a minute. How would you 
really do that?
    What are we talking about? How can you get a type of 
transparency in that type of transaction so that people 
understand why decisions were made to do the projections that 
they have done and that they can evaluate the sensibility of 
those projections?
    Mr. Berardino. This is very difficult, very difficult, 
because these are highly sophisticated transactions that 
require a number of estimates and in some cases where there are 
not active markets day to day that one can refer to. So it is 
not going to be easy. But I do think it is an area worth 
exploring and we are fully prepared to help in real time to 
come up with some more clarity.
    Mrs. Kelly. Did you ever ask the SEC for guidance on the 
Enron audits?
    Mr. Berardino. I do not remember.
    Mrs. Kelly. Would there be somebody here who could advise 
you about that?
    Mr. Berardino. I was not directly involved. Perhaps. If you 
do not mind, let me just check with my friends here.
    Mrs. Kelly. Feel free.
    Mr. Berardino. Thank you.
    [Pause.]
    Mr. Berardino. The answer is yes. On mark-to-market, we 
were heavily involved with Enron back in the early 1990s and 
working through with the SEC how they might do mark-to-market 
on their portfolio. Very open conversations to try to get to 
the best answer. And there have been consultations on many 
different items, not just mark-to-market, since then.
    Mrs. Kelly. Did you find them forthcoming? Maybe you want 
to consult on that one, too.
    Mr. Berardino. Did I find who forthcoming?
    Mrs. Kelly. The SEC. Were they helpful? Did they have 
guidelines? Were they able to give you what you needed in order 
to do something that is complicated and bringing the mark-to-
market----
    Mr. Berardino. Oh, again, these are hard issues that you 
need a lot of smart people in a room to try to figure out what 
is right, and in the early 1990s this was new, and the SEC was 
very helpful in that conversation.
    Mrs. Kelly. Do you think the kind of environment exists at 
the SEC to encourage public companies to seek their advice?
    Mr. Berardino. Well, I think that that has varied over the 
years, quite frankly, and in the past, there has been 
unfortunately more of an adversarial relationship and less of a 
let us work this all out together relationship, which I think 
the current chairman is trying to change and which, frankly, we 
welcome because it is--you know, many people think accounting 
is a science, where one number, namely earnings per share, is 
the number and it is such a precise number that it could not be 
two pennies higher or two pennies lower.
    And I come from the school that says it really is much of 
an art, that a company like Enron, $500 million transactions 
going through Enron online, highly complex organizations where 
there is no one number, and one of the challenges we have and 
one of the reasons I think we have the opportunity for reform 
here is the accounting model has traditionally been historic. 
You know, we told you what happened 90 days ago or a year ago. 
Most analysts, most investors are really interested in 
predicting the future. And we do not have an ability in our 
present financial reporting model, mark-to-market is an attempt 
to get there, to give investors more current information on a 
more timely, real time basis.
    I think this is a time for change and I think some of the 
stresses in the system we have seen at Enron, not to understate 
them, will provoke all of us to be thinking outside the box. So 
I think your questions are incredible. And I will tell you we 
are prepared to be part of the solution.
    Mrs. Kelly. Thank you very much. I appreciate your being 
here.
    Chairman Baker. Thank you, Mrs. Kelly.
    Mr. LaFalce.
    Mr. LaFalce. Thank you very much, Mr. Chairman. And I thank 
all the panelists for coming here, especially you, Mr. 
Berardino, for stepping up to the plate. It is not an easy task 
to be the number one person at the accounting firm that is 
being looked at right now, but I commend you for the integrity 
of your comments and the approach you are taking.
    Let me just ask a few questions. First of all, any of you, 
what percentage of the CEOs, CFOs, and members of audit 
committees have their compensation in large part based upon the 
market valuation of their stock?
    Mr. Berardino. Quite a few.
    Mr. LaFalce. A very high percentage?
    Mr. Berardino. Yes, sir.
    Mr. LaFalce. I would think that that creates a tremendous 
incentive on their part, both the officers and the directors, 
especially the audit committee, to have a good market valuation 
and therefore to report good earnings. Is that correct?
    Mr. Berardino. Well, Congressman, this is a paradox, is it 
not? The shareholders----
    Mr. LaFalce. Well, it is a fact, I think.
    Mr. Berardino. Well, but----
    Mr. LaFalce. There may be a subsequent paradox that is 
coming, but----
    Mr. Berardino. Well, it is a fact to some, but to others as 
shareholders, do you not want your CEO to help the stock price 
go up? I hope you do not want him to have it go down.
    Mr. LaFalce. So long as it is real rather than imaginary.
    Mr. Berardino. Of course.
    Mr. LaFalce. And that is the difficulty. So my point is 
simply that there really is a need, it seems to me, for 
improvement in the system and you have called for improvements. 
The question is where do we start?
    And it seems to me we have to start first with the issue of 
corporate governance. And what do we--independence?
    I do not think you could bring it into the management 
itself, but what do we do to bring independence into the audit 
committee of the board? Or can there be some audit committee 
outside of the board? But some committee that does not have a 
vested interest in doctoring earnings because of the market 
valuation that will determine what their compensation is.
    I mean, it is an outrageous conflict. And then my first 
question is how do we deal with it?
    Let me ask you to come back to that, but I do think that is 
a very threshold question.
    The second question or point is you made the statement, Mr. 
Berardino, that it is a violation of the law to withhold 
information from the accountant auditor, correct?
    Mr. Berardino. Yes.
    Mr. LaFalce. Is that a criminal or a civil violation?
    Mr. Berardino. I am not sure. Probably criminal.
    Mr. LaFalce. Well, in your prepared testimony, you said 
with respect to the one SPE, the one that accounted for 
approximately 80 percent, the one with the far larger impact, 
our audit team was not provided critical information.
    Now, applying the logic and syllogisms that I learned in my 
Jesuit days, it would seem to me that you are therefore saying 
and that therefore Enron violated the law in their relationship 
with you.
    Mr. Berardino. Congressman, I also have a Jesuit education.
    Mr. LaFalce. That is why I am referring to it.
    Mr. Berardino. I am also taught to believe that we need to 
have all the facts. And if I could shed some----
    Mr. LaFalce. But you did say it would appear.
    Mr. Berardino. Yes. I mean, to shed some color commentary, 
what had happened was that the requirement for 3 percent equity 
from an outsider was met in one end of the Enron house and in a 
completely distinct other part of the house a compensating 
balance was offered to that same investor and when you look at 
the two together it flunks the test.
    Now, we do not know if that was willful or not, but once we 
had all the facts and the company had all the facts, we had to 
restate the financial statements.
    Mr. LaFalce. OK. Mr. Hill, because my time is about to 
expire, most companies who are doing an analysis of stocks, the 
strong buy, buy, hold, accumulate, sell or what have you, it is 
my understanding that in the year 2000, only 1 percent of all 
the recommendations made by all the research firms were sell 
recommendations and that if you go back a half-a-dozen years or 
so, it was more like 6 percent. That is a considerable decline.
    I have recommended to the SEC and others that every 
recommendation be accompanied with at least one thing and that 
is the number of recommendations a firm makes, if they make 
200, and a statement, ``we are recommending a strong buy'' and 
150 of our recommendations are ``strong buys,'' 25 are 
``buys,'' 20 are ``hold,'' and 5 are ``sells,'' or whatever it 
might be.
    I think that would be a good idea. I would like to know 
your thoughts on that.
    Second, it took Mr. Baker two seconds to go to Yahoo! 
finance and tell you that there are approximately 20 firms 
analyzing the stock right now, of which two are ``strong 
buys,'' and one is a ``buy'' or what-have-you.
    What about if we required that any written recommendation 
of an analyst's firm give you the number of firms covering it, 
at least as of close of business yesterday, according to some 
criteria, whether it is an SEC or First Call or what have you, 
and if they are issuing a strong buy, it would be interesting 
to know that there are 12 others that are recommending sells 
and we would like to know who they are.
    What are your thoughts on that?
    Chairman Baker. Mr. LaFalce, let me suggest this, if I may. 
I am trying to help Members get on the record on this issue, 
particularly Mr. Bentsen and Ms. Jackson-Lee, before the 
recess.
    We have six votes and I am afraid we are going to be on the 
floor for about an hour and I feel very badly about having kept 
our witnesses here all morning and then keeping them here 
another hour into the evening. And I understand perhaps one has 
another appearance which cannot be missed anyway at 4:00.
    With the subcommittees' understanding, Mr. Shays has waived 
his time.
    Mr. Shays. Well, just one quick question.
    Chairman Baker. Yes, Mr. Shays.
    Mr. Shays. I want to thank our witnesses. I understand that 
we are going to have more hearings, so it makes sense to close 
this hearing, but I just want to say to you, Mr. Trumka, that I 
believe that you are going to take your retirement funds and 
not invest them all in Treasury bills, thank God, and I just 
have to say I hope with Social Security funds that we also do 
the same.
    Chairman Baker. Thank you, Mr. Shays.
    I would like to suggest to the subcommittees 2 minutes to 
Mr. Bentsen, 2 minutes to Ms. Jackson-Lee, call the meeting to 
a conclusion and let our witnesses go, but with this caveat, we 
have to have participation in future hearings. This matter is 
too complex to have covered it even in a day. This has been 
just a very light introduction to the subject.
    Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman. I appreciate the 
panel being here and I have comments with Mr. Hill and Mr. 
Trumka, but I am going to have to do those another time.
    Mr. Berardino, in your testimony, there are two things that 
stick out. One, when you talk about the SPEs and particularly 
the Jedi and Chewco SPE, you talk about no prohibition against 
company employees being involved as investors.
    That seems to me to be pretty closely related parties and 
if the law does not address that now, it sure as hell ought to 
address that in the future.
    And, second of all, it would appear to me on the issue of 
the international financial institution that--and you may not 
want to answer this--that looks a lot like a pretty contrived 
deal to create an off balance sheet financing vehicle that 
really was not one. And if they did not disclose that you as 
their auditor, then I think they have some real problems on 
their hands and I think that may be a crux. And you may not 
want to address that.
    The other thing which I think is a serious issue is on page 
6, where you talk about some people say we should have required 
the company to make more disclosures about contingencies such 
as accelerated debt payments, which did in part bring the 
company down, associated with the possible decline in the value 
of Enron's stock or changes in the company's credit rating. 
They ran some very high octane structured deals that were--and 
the credit consideration, the credit covenants were critical to 
that company going because they were extremely highly 
leveraged.
    How that could not be a material item for disclosure, I do 
not know and, again, you may not want to answer it. I assume 
this issue will come up in other forums, but----
    Mr. Berardino. Well, I will partially answer it and then 
there is some disclosure. I will not say it is in neon lights, 
but there is some disclosure in the derivatives area about the 
fact that this company relied on the confidence of its trading 
parties and, frankly, one of the issues was what happens when 
your trading parties do not want to trade with you? Do you have 
a business?
    And there is no requirement to anticipate every possible 
contingency in terms of where a company's stock price might go 
and we obviously understand your point. I think it is one worth 
further exploration.
    Mr. Bentsen. Well, my time is up, but let me say this. 
Stock is a pretty volatile instrument and to not treat it as 
such in disclosure, disclosure is only as good as in the eye of 
the beholder and so I would hope that the industry would look 
at that.
    Thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Bentsen.
    Ms. Jackson-Lee.
    Ms. Jackson-Lee. Mr. Chairman, I cannot thank you and the 
Ranking Members and the Full Committee chairs and Ranking 
Member enough for your extreme courtesies to me and to the 
colleagues on this committee for their extreme courtesy. Very 
briefly, because we all are learning and I mentioned earlier 
that the eyes of the Nation are on us, and Houston, and 
particularly the pain and anguish that is experienced by those 
in Houston.
    Mr. Berardino, thank you for your presence. Very quickly, I 
just want to know as it relates to the information that you 
thought you got incorrectly or made a mistake on the SPEs, what 
could have been done differently? Why did you probe further 
when you thought you had the information or are you just 
finding out you had incorrect information in your testimony?
    Mr. Berardino. Well, thank you for your question. These are 
not easy issues. On the 80 percent where we did not have all 
the facts, this is a very complex company. They do lots of 
these deals. It is not like there is one a year that everyone 
looks at. There are, you know, scores and scores of them. And 
unfortunately, we just did not have the information. And once 
we and the company, the accounting department, had all the 
information, we all knew what the right answer was and 
unfortunately it resulted in a restatement.
    On the other issue, where we made a mistake in judgment, at 
the time, our team made a very good faith, reasonable decision 
in terms of looking at these transactions and in hindsight they 
made an error in judgment. And let me be clear, you know, in no 
way do we think that this caused the collapse, but it is 
unfortunate that with the thousands and thousands of hours of 
work----
    Chairman Baker. Twenty seconds, Ms. Lee, because we are 
running out of time to make the floor vote.
    Ms. Jackson-Lee. Thank you very much.
    Let me just say, Mr. Trumka, I thank you very much for 
being here. One quick word. How catastrophic is this to working 
people?
    Mr. Trumka. We do not know the entire answer, but we can 
tell you that as far as Taft-Hartleys are concerned, the Taft-
Hartley pension funds have probably lost a minimum of $250 
million in stock and another $250 million in bonds. When you 
put all of the pension funds together, we are talking about 
tens of billions of dollars. When you look at individuals, many 
individuals have had their entire 401K retirement benefit wiped 
out. They are penniless.
    Ms. Jackson-Lee. Thank you, Mr. Chairman. We just have a 
lot of work to do.
    Thank you so very much.
    Chairman Baker. Thank you. We will return after the 
Christmas recess to this topic, the analyst topic, transparency 
questions, a long litany of issues.
    I wish to keep the hearing record open an unusually long 
period, 30 days, for all Members not only to formulate further 
questions, but for interested parties to make comment. I do 
appreciate your courtesies in being here and your longstanding 
patience throughout the day. We have to run. We have less than 
2 minutes to make this vote.
    Thank you.
    [Whereupon, at 3:20 p.m., the hearing was adjourned.]
                            A P P E N D I X


                           December 12, 2001
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