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



 
                 H.R. 3763--THE CORPORATE AND AUDITING
                   ACCOUNTABILITY, RESPONSIBILITY AND
                        TRANSPARENCY ACT OF 2002
=======================================================================

                                HEARINGS

                               BEFORE THE

                              COMMITTEE ON
                           FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                      MARCH 13, 20; APRIL 9, 2002
                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 107-60







                       U. S. GOVERNMENT PRINTING OFFICE
78-501                          WASHINGTON : 2002
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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 FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
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







                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 13, 2002...............................................     1
    March 20, 2002...............................................    66
    April 9, 2002................................................   125
Appendix:
    March 13, 2002...............................................   175
    March 20, 2002...............................................   295
    April 9, 2002................................................   417

                               WITNESSES
                       Wednesday, March 13, 2002

Glassman, James K., Resident Fellow, American Enterprise 
  Institute......................................................    12
Hills, Hon. Roderick M., Former Chairman, Securities and Exchange 
  Commission.....................................................    47
Lackritz, Marc E., President, Securities Industry Association....     8
Melancon, Barry, President and CEO, American Institute of 
  Certified Public Accountants...................................    10
Roper, Barbara, Director of Investor Protection, Comsumer 
  Federation of America..........................................    49
Turner, Lynn, Director, Center for Quality Financial Reporting...    50
White, Ted, Director, Corporate Governance, California Public 
  Employees' Retirement System...................................    14

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................   176
    Gillmor, Hon. Paul E.........................................   182
    Carson, Hon. Julia...........................................   178
    Jones, Hon. Stephanie........................................   180
    Royce, Hon. Ed...............................................   183
    Glassman, James K............................................   210
    Hills, Hon. Roderick M.......................................   254
    Lackritz, Marc E.............................................   184
    Melancon, Barry..............................................   199
    Roper, Barbara...............................................   266
    Turner, Lynn.................................................   274
    White, Ted (with attachment).................................   226

                               WITNESSES
                       Wednesday, March 20, 2002

Clapman, Peter C., Senior Vice President and Chief Counsel, 
  Corporate 
  Governance, TIAA-CREF..........................................   107
DelRaso, Joseph V., Esq., Partner, Pepper Hamilton, LLP..........   101
Jasinowski, Jerry J., President, National Association of 
  Manufacturers..................................................   106
Livingston, Philip B., President and CEO, Financial Executives 
  International..................................................   104
McCall, Hon. H. Carl, Comptroller, State of New York, Office of 
  the State 
  Comptroller....................................................    96
Pitt, Hon. Harvey L., Chairman, U.S. Securities and Exchange 
  Commission.....................................................    69
Raines, Franklin D., Chairman and CEO, Fannie Mae; Chairman, 
  Corporate Governance Task Force of the Business Roundtable.....    98

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................   296
    Gillmor, Hon. Paul E.........................................   298
    Jones, Hon. Stephanie T......................................   299
    Royce, Hon. Ed...............................................   301
    Clapman, Peter C.............................................   397
    DelRaso, Joseph V............................................   360
    Jasinowski, Jerry J..........................................   388
    Livingston, Philip B. (with attachment)......................   365
    McCall, Hon. H. Carl.........................................   316
    Pitt, Hon. Harvey L..........................................   302
    Raines, Franklin D. (with attachments).......................   320

              Additional Material Submitted for the Record

Maloney, Hon. Carolyn:
    Hon. Eugene A. Ludwig, former Comptroller of the Currency, 
      speech, February 15, 2002..................................   413
Raines, Franklin D.:
    The Business Roundtable statement on the Corporate and 
      Auditing Accountability, Responsibility and Transparency 
      Act of 2002................................................   351
Department of the Treasury's Peter R. Fisher, Under Secretary for 
  Domestic Finance, prepared statement...........................   409

                               WITNESSES
                        Wednesday, April 9, 2002

Breeden, Hon. Richard C., former Chairman, Securities and 
  Exchange Commission, Richard C. Breeden & Company..............   137
Langevoort, Prof. Donald C., Georgetown University Law Center....   140
Silvers, Damon A., Associate General Counsel, AFL-CIO............   141
Walker, Hon. David M., Comptroller General of the United States, 
  U.S. General Accounting Office.................................   135

                                APPENDIX

Prepared statements:
    Gillmor, Hon. Paul E.........................................   418
    Jones, Hon. Stephanie T......................................   419
    Breeden, Hon. Richard C......................................   454
    Langevoort, Prof. Donald C...................................   482
    Silvers, Damon A.............................................   492
    Walker, Hon. David M.........................................   422








                 H.R. 3763--THE CORPORATE AND AUDITING
                   ACCOUNTABILITY, RESPONSIBILITY AND
                        TRANSPARENCY ACT OF 2002

                              ----------                              


                       WEDNESDAY, MARCH 13, 2002

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:00 a.m. in room 
2128, Rayburn House Office Building, Hon. Michael G. Oxley, 
[chairman of the committee], presiding.
    Present: Chairman Oxley; Representatives Roukema, Bereuter, 
Baker, Lucas, Ney, Kelly, Weldon, Biggert, Shays, Cantor, 
Grucci, Hart, Capito, Rogers, Tiberi, Royce, Gillmor, Ose, 
Green, LaFalce, Waters, Sanders, C. Maloney of New York, Watt, 
Sherman, Lee, Inslee, Jones of Ohio, Kanjorski, Moloney of 
Connecticut, Lucas of Kentucky, Clay, Israel, and Roso.
    Chairman Oxley. Good morning and welcome to the committee's 
first legislative hearing on the Corporate and Auditing 
Accountability, Responsibility and Transparency Act of 2002 or 
CARTA. This legislation makes important changes in the 
accounting profession, in the way public companies report their 
financial results, and the manner in which investors access 
their information. These issues are among the most serious in 
our jurisdiction. They have percolated for some time. Now, the 
bankruptcies of Enron, Global Crossing, and others have pushed 
them to the forefront.
    Hearings held in this committee over the past few months 
have demonstrated yet again the need for modernizing our 
financial reporting and disclosure system. Also, it is clear 
that we must have strong oversight of the accounting 
profession. There should be no question that the Federal 
securities laws need to be updated to ensure that investors 
have access to transparent, and meaningful information 
concerning public companies. Enhancing the public's faith in 
financial statements is absolutely critical. They serve as the 
bedrock of our capital markets.
    Our legislation, CARTA, addresses these fundamental issues 
by strengthening our markets in a very careful way. We avoided 
the temptation some apparently feel to blanket market 
participants in a sea of red tape. This legislation creates an 
entirely new oversight regime for public accountants, requiring 
accountants to be rigorously reviewed to ensure that they meet 
the highest standards of competence, independence, and ethical 
conduct.
    CARTA also recognizes the need for corporate leaders to act 
responsibly and holds them accountable if they fail to do so. 
The legislation makes important improvements in the area of 
corporate transparency, requiring that company's disclose to 
investors important company news on a real time basis. It also 
directs the SEC to require companies to disclose the use of 
off-balance sheet transactions.
    CARTA's provisions are designed to increase public 
confidence in the U.S. capital markets. It is important that 
they remain the world's most efficient means of promoting 
economic growth and providing retirement security.
    President Bush recently announced the 10 Point Plan to 
improve corporate responsibility and protect America's 
shareholders. I am pleased that the plan's core principles, 
providing better information to investors, making corporate 
officers more accountable, and developing a stronger more 
independent audit system are embodied in our legislation.
    I look forward to continuing our close collaboration with 
the Administration on this vital capital markets issue.
    I also would like to mention Fed Chairman Alan Greenspan's 
recent testimony before this committee. Discussing the 
implications of the Enron collapse, Chairman Greenspan noted 
that it has already sparked a very significant shift toward 
more corporate transparency and more responsible corporate 
governance practices. While it does not in my view obviate the 
need for Government action, the market's self-correcting 
mechanism certainly does underscore the danger of overreacting 
to the Enron matter.
    I am pleased that CARTA reflects Chairman Greenspan's 
support for more transparent financial reporting and for 
strengthening the independence of the audit.
    I want to thank all the Members of this committee for 
working so diligently on this important legislation. Let me 
also thank all of our witnesses in advance for their important 
participation here this morning.
    I turn now to Ranking Member LaFalce for his opening 
statement.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 176 in the appendix.]
    Mr. LaFalce. Thank you very much, Mr. Chairman. I ask 
unanimous consent that the entirety of my opening statement be 
included in the record.
    Chairman Oxley. Without objection, all the Members opening 
statements will be made part of the record.
    Mr. LaFalce. I thank you. Our committee assumed 
jurisdiction over securities and insurance for the first time 
in January of 2001. And the Chairman has indicated that he is 
concerned that we not overreact to the problem. Well, I think 
that that is a reasonable concern. But I think that it is also 
true that we under reacted to the problem historically and that 
was a much greater concern. At the beginning of 2001, I began 
talking about the problem of earnings manipulation. That is 
when we assumed jurisdiction. The SEC, as you know, was 
tripling the number of mandated restatements, which was at 
least some indication that something might well be wrong.
    And there was too much of an incentive it seemed to me 
within corporate America, particularly because of the 
compensation mechanisms that have evolved over the years, for 
earnings manipulation, for revenue recognition when it should 
not be recognized, for channel stuffing, cookie jar reserves, 
and so forth, and so forth. Very often, unchecked by the board 
of directors for one reason or another, because of a policy 
passivity that may have existed at too many boards, because of 
the same stock options to a lesser extent to be sure that 
corporate officers, their chief desire is not a better product 
or a better service, but market capitalization, to drive 
capitalization.
    And then enter the accounting profession that was 
responsible to the public as a public fiduciary for auditing 
these companies and making sure that the books by the CFO and 
the CEO, and so forth, and the audit committees were done 
right. And there was a difficulty there. They too had evolved 
over the years so that in a good many respects they would make 
more money through consulting than through auditing. But also 
independent of that they just had obviously a vested interest 
in being retained and then staying retained by the firm because 
it was an employer/employee relationship and you want to make 
the client happy so you have this tension.
    And then enter Wall Street. Wall Street got into an 
attitude of stock hype, there is actually no question about it. 
Certainly the number of recommendations went down precipitously 
from what it previously had been. And then too we witnesses a 
number of blatant conflicts that existed.
    Now nobody was paying attention in this committee when we 
were considering the SEC fee reduction bill, I said what we 
should be considering in the first instance is not a 2 or 3 
percent increase in the SEC budget, but a 200 or 300 percent 
increase in the SEC budget, because of what is going on. And I 
made the same argument before the Rules Committee, and I made 
the same argument on the floor of the House. But nobody was 
paying attention until Enron. And then when Enron happened, 
people started paying attention.
    Now, the Chairman is correct, we ought not to overreact, 
but we ought to act. And we have to find that balance, what is 
the right way. We ought to keep that pendulum. But we want good 
action, strong action.
    To restore confidence in the integrity of our markets, I 
think we have to do at least the following. Enact legislation 
that will address the serious deficiencies in our current 
system. Now, I have recently introduced a bill, the Chairman 
had called a hearing on his bill, but there is at least one 
other bill. There are many other bills actually. And there are 
good ideas in all of them. We have to sort through them and try 
to come to some consensus. I hope we can do that. If we don't, 
we will just vote them up or vote them down, not bill by bill, 
but issue by issue.
    We should at least consider these particular proposals. The 
appropriate separate of audit and consulting functions; the 
concept of auditor rotation; and other proposals that address 
the relationship of the auditor to its audit client. We must 
also provide for meaningful oversight of the audit profession. 
And that means a strong and credible regulator. And you have to 
have individuals who are on this board, whatever it is going to 
be, that will instill some confidence in the investing public 
and restore the concept of integrity to the accounting 
profession that is so richly deserved over the years. We must 
reform the functioning of audit committees and the boards of 
directors of public companies to ensure that independent 
directors are truly independent and that auditors are working 
for the shareholders, not for the management. And I think we 
need to reconsider liability issues. Did we go a bit too far in 
1995 and 1998? I think we need to reopen that issue, not in 
toto, but at least in part.
    I said early last year, and Lynn Turner, the Chief 
Accountant of the SEC at that time, said that what we have 
witnessed so far was just the tip of the iceberg. I am afraid 
that what we witnessed so far too is still the tip of the 
iceberg, that there is a lot more out there. Now I know that 
corporate officers and board of directors and accountants are 
much more zealous today than they were in October and November 
and earlier, but I think that having good legislation will 
enhance that.
    Second, and this is something that I think we can now agree 
on, and I will finish up, I called for the 200 to 300 percent 
increase in the SEC budget. I certainly called for pay parity, 
and the Chairman and I are going to team up I am sure with Mr. 
Baker and Mr. Kanjorski and push the Administration and the 
Congress to give the SEC the resources that it so desperately 
needs to do the job that all America wants it to do.
    I thank the Chairman.
    Chairman Oxley. The gentleman's time has expired. The Chair 
now recognizes the Chairman of the Capital Market Subcommittee, 
the gentleman from Louisiana, Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman. I want to commend you 
for the hearing and start by putting what I believe is our 
mutual perspective about this problem on the record. By and 
large, day to day, most professionals engaged in the business 
of running corporations, auditing corporations, analyzing 
corporations, and reporting on corporations are doing the best 
job in the most professional capacity they know how to achieve 
those ends for the benefit of all stockholders, including 
shareholders.
    And the problems we are addressing today, I do not believe 
are systemic or a condemnation of the business free-enterprise 
system in the United States. I do believe that the rules now 
written some 60-70 years ago, are inadequate in light of the 
technological change and the speed with which business is 
conducted, but it is apparent to me that most individuals who 
are here today to testify are coming with helpful suggestions 
in how they believe we can improve the legislation before us. 
But generally, everyone agrees we are on track. We have not 
missed it. It is time to act. Every stakeholder wants these 
issues resolved. We want to ensure investor and public 
confidence in the credibility of our markets. And it is in our 
mutual economic interest to see that occurs as quickly as 
possible.
    To that end, I want to point out, Mr. Chairman, that you 
took decisive action with regard to suggestions for treatment 
of analyst conduct, together with the regulators and members of 
the profession, and announced mandatory, not voluntary, changes 
that should be implemented which is now subject to public 
comment. And they were sweeping in their effects. Research 
departments may not be subject to supervision or control of the 
investment banking department. The subject company may not 
approve prior reports prior to distribution. The firm may not 
tie compensation to specific investment banking practices. A 
firm must disclose if the analysts receive compensation based 
upon the firm's investment banking revenues and establish 
certain quiet periods. No analyst may purchase or receive an 
issuer's securities prior to an initial public offering. No 
analyst may trade securities issued by the company the analyst 
follows for a period beginning 30 calendar days. And it goes 
on. A firm must disclose in research reports and an analyst 
must disclose in public appearances if they have a financial 
interest in the securities of the company. A firm must disclose 
in research reports and in public appearances whether or not 
the firm or its affiliates beneficially own 1 percent of any 
class of common equity securities of the subject company. And 
it goes on.
    The point being that these are mandatory changes in analyst 
conduct subject to penalties up to and including disbarment 
from practice, which will, I believe, significantly alter the 
method and manner in which analyst reports are issued and the 
public can view the information contained therein.
    The legislation before us here today is similar in its 
effect. I had suggested that we analyze the consequences of 
having exchange-based engagement of audits. There has been any 
number of suggestions to radically alter the relationships 
between audits and their corporations. And on reflection and 
consultation with the SEC and many others who have expert 
opinion, I believe the bill before us, with perhaps slight 
modification here or there, is an excellent vehicle for 
appropriate reform in light of the circumstance we face.
    Just examine the GAO's own report. I think they make two 
excellent statements that are worth repeating this morning. One 
is go carefully. We are engaged in discussions that affect the 
entire capital markets of this Nation and consequently 
internationally have some significant potential for 
repercussions if we get it wrong.
    And, second, that we need to make it clear that the 
financial statement belongs to the shareholder. I was somewhat 
taken aback when the CEO of Andersen Consulting said in 
response to a question before our hearing, ``To whom does the 
financial statement belong?'' He said, ``To management and the 
shareholder.'' Management 101, the financial statement should 
reflect accurate financial condition of the corporation based 
upon management's performance for the shareholder. Once we 
return to that, and we ensure that there is independence in the 
preparation of that audit statement, and that we enable a good 
auditor to do good work despite what management might choose 
for them to report, the consequences for our capital markets, 
the auditor, the shareholder, and everyone will be greatly 
enhanced.
    I think you have got it right, Mr. Chairman. I think this 
is an excellent start. Perhaps there is a change to be made 
here or there, but in the overall picture and the risk we would 
take by going further faster, I think it is not warranted in 
light of the circumstances we face, and I commend you for 
calling this hearing.
    Chairman Oxley. The gentleman's time has expired. We now 
turn to our distinguished panel. And let me introduce them. Mr. 
Marc E. Lackritz.
    Mr. Sanders. Mr. Chairman, will others be allowed to make 
opening statements?
    Chairman Oxley. Just the Ranking Member and the 
subcommittee.
    Mr. Sanders. We were told otherwise.
    Mr. Sherman. That is not what we were told by staff by the 
way.
    Chairman Oxley. Staff informs me that you are correct. The 
gentleman from Vermont, Mr. Sanders.
    Mr. Sanders. Thank you very much, Mr. Chairman. And thank 
you and Mr. LaFalce for holding this important hearing. I find 
myself in agreement with the Chairman and Mr. LaFalce and Mr. 
Baker, but I would go further than they, because I think we 
have a very, very serious problem, which the United States 
Congress has got to address.
    Let me just for a moment do a Dave Letterman Top 10, if I 
might, in terms of failed audits. This suggests that while 
Enron has gotten all of the publicity, the problem is a lot 
deeper than Enron.
    One: Arthur Andersen and Enron. We all know that.
    Number two: KPMG failed in its audit of Rite-Aid causing a 
$800 million loss in stock value after recalculation of 
profits.
    Number three: Arthur Andersen failed in its audit of 
Sunbeam, causing a $1.2 billion loss in stock value after the 
recalculation of profits.
    Four: PriceWaterhouseCoopers failed in its audit of Micro 
Strategy, resulting in a $10.4 billion loss in stock value 
after their recalculation of profits.
    Five: Arthur Andersen failed in its audit of Waste 
Management, resulting in a loss of $900 million in stock value 
after their recalculation of profits.
    Six: Arthur Andersen failed in its audit of McKessen HBOC, 
resulting in a $7.9 billion loss in stock value.
    Seven: Ernst & Young failed in its audit of Cendant, 
resulting in a loss of $11.3 billion in stock value.
    Eight: KPMG failed in its audit of Greentree, resulting in 
a loss of $1.1 billion in stock value.
    Nine: while Global Crossing executives cashed in on some 
$1.3 billion in Global Crossing stock, Arthur Andersen's failed 
audit of this company has caused many of their employees to 
lose their entire life savings.
    Ten: Arthur Andersen failed in its audit of the Baptist 
Foundation of Arizona.
    The point is, Mr. Chairman, we have a serious problem. And 
I think, Mr. Chairman, we need a serious solution. Mr. LaFalce 
touched on the inherent conflict of interest between those who 
consult for the company, and that is kind of obvious and I 
would hope that most of us would want to end that practice 
immediately. Mr. LaFalce also touched upon the employer-
employee relationship. If you are working for a company and you 
are getting paid well by that company, are you going to go up 
to that company and say: ``By the way, you are cooking the 
books and you are ripping off the stockowners of your 
company.'' Apparently, many of the large auditing firms are not 
prepared to do that.
    So it seems to me that at the very least we need to 
significantly beef up the SEC, but, in fact, we may want to go 
a lot further than that. When people invest in the stock 
market, when people who represent pension funds, who are 
representing the retirement savings of millions of American 
workers are investing in a company, they have the right to know 
that the books are being honestly kept. And, unfortunately, 
that has not been in many cases the record up to today.
    So I think we are going to need some very bold solutions to 
this very serious problem.
    Thank you, Mr. Chairman.
    Chairman Oxley. The gentleman's time has expired. There are 
other opening statements. The gentleman from California, Mr. 
Sherman, is recognized for 3 minutes.
    Mr. Sherman. Thank you, Mr. Chairman. We need not only to 
be concerned with the culture of the business world, which I 
don't think we can change, but rather design strong rules and 
clear rules rather than simply rely on adding more ethics 
courses to business school curricula.
    We ought to look at the scope of service that auditing 
firms provide. But keep in mind, if Arthur Andersen had just 
been an auditing firm, they would have collected only $25 
million from Enron, not $50 or $52. But they would have been a 
firm of half the size. And if our concern is the size of the 
fee having an effect on the auditor and the auditor's judgment, 
we ought to perhaps limit the total fee for all services 
provided to 150 percent of the audit fee so that some 
incidental services could be provided.
    We ought to look at the structure of accounting firms to 
ensure that the technical review department always makes the 
final decision. That is not what happened with Arthur Andersen, 
which unlike the other Big Five firms, decided to have the 
decisions made in Houston in effect by the sales partner.
    We need to have minimum capitalization requirements so that 
if you sue an accounting firm, you don't collect absolutely 
nothing. You can't drive in most States without liability 
insurance, but you can practice accounting and be responsible 
for trillions of dollars in market reliance without adequate 
malpractice insurance or adequate capitalization.
    If we are going to rotate auditors, perhaps we also ought 
to give them tenure as well. Because if you are in the first 
year of what is a maximum of 5 or 10 years of auditing a firm, 
you are subject to pressure from the client, loosen your 
accounting interpretations or you may lose your last 9 years of 
a contract. If instead these were 6 or 10-year contracts, 
auditors would be free without financial pressure to be able to 
make the judgment decisions.
    The SEC should have been here asking us to quadruple their 
budget or double their budget. Instead the SEC was not even 
reading Enron's financial statements. If tiny companies, going 
public for the first time, get a review of their filings by the 
SEC and have to answer questions and make their documents clear 
and complete, certainly we should require the same kind of 
scrutiny of the thousand largest firms in America.
    We ought to have the FASB come before us, Mr. Chairman, to 
talk about how the accounting standards were so loose that 
people at Arthur Andersen and Enron could convince themselves 
that they were even close to compliance. And we ought to hear 
more from institutional investors, who frankly I think have 
under investigated in their Washington presence. When it comes 
to reducing capital gains, we have thousands of lobbyists. When 
it comes to other things that would help investors, we tend not 
to hear from them nearly as loudly.
    I yield back.
    Chairman Oxley. The gentleman's time has expired. Are there 
further opening statements?
    Now, I turn to our distinguished panel. The gentleman, Mr. 
Marc Lackritz, president of the Securities Industry 
Association; Mr. Barry C. Melancon, president and CEO, American 
Institute of Certified Public Accountants; Mr. James Glassman, 
resident fellow of the American Enterprise Institute; and Mr. 
Ted White, director of Corporate Governance, California Public 
Employees' Retirement System.
    Gentlemen, welcome to all of you. And Mr. Lackritz, we will 
begin with you.

 STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY 
                          ASSOCIATION;

    Mr. Lackritz. Thank you, Mr. Chairman.
    Mr. Chairman, Congressman LaFalce, and Members of the 
committee, I am pleased to testify before you today on H.R. 
3763. We commend you, Mr. Chairman, and Members of the 
committee for your ongoing efforts to ensure that investors 
will continue to be well served and well protected.
    SIA is deeply concerned about the implosion of Enron and 
the corrosive effect this event is having on the public's trust 
and confidence in our country's corporations and financial 
markets. Public trust and confidence is the bedrock of our 
financial system, the core asset underlying why our financial 
markets are the envy of the world.
    Although Enron's collapse appears to be a massive failure 
in the accuracy of information that flowed into the 
marketplace, the securities industry's regulatory structure 
remains fundamentally strong. Although we are still learning 
the full story behind Enron's collapse, we strongly support 
responsible reforms that will ensure that financial 
information, the lifeblood of our markets, is honest, accurate, 
and easily accessible.
    SIA welcomes the reforms in pension laws announced by the 
Administration in February. We support, for example, 
prohibiting insiders from selling their securities during a 
blackout period, requiring prior notice of blackout periods, 
and the concept of permitting participants to sell company 
stock in their 401K plan after a reasonable period.
    We also encourage the Senate to follow the House's lead in 
passing legislation to allow retirement plan administrators to 
provide individual financial advice to employee participants. 
Giving investors greater access to information will help them 
make more informed decisions about their retirement accounts.
    SIA also supports full funding of pay parity for the 
Securities and Exchange Commission's professional staff. The 
SEC has been a tough, effective cop on the beat. We have been 
profoundly troubled by the huge turnover in experienced staff 
that the SEC has suffered in recent years. Congress should fund 
pay parity and increase the agency's funding to ensure that the 
SEC has the staff and resources it needs to be an effective 
regulator.
    SIA believes that H.R. 3763 includes a number of important 
improvements to the current regulatory system. The bill sets up 
a strong statutory framework for public oversight of the 
independent audit function. It is a sensible, appropriate 
reaction to the shadow the Enron debacle has cast on the 
current performance of outside auditors.
    We also support giving the SEC authority to prosecute 
senior executives of a public company that willfully mislead an 
independent auditor. Although the SEC already has strong 
authority in this area, the committee should consider President 
Bush's proposal to grant the SEC the statutory authority to 
require senior executives to disgorge bonuses and other 
incentive-based forms of compensation in cases of accounting 
restatements resulting from misconduct.
    Although SIA generally supports H.R. 3763's provisions for 
more timely and better disclosure of corporate information, we 
note that the SEC has already announced its intention to act in 
this area, we believe that the best action here is to provide 
the SEC with the flexibility to make the necessary judgments 
about the timing and content of required disclosures.
    Similarly, the bill's provisions to improve transparency in 
financial statements generally overlap with the recent SEC 
statement to issuers regarding certain disclosures. Since those 
disclosures have just been mandated, we believe it is premature 
to legislate at this time in this area.
    Our written statement includes additional recommendations, 
Mr. Chairman, for improving corporate disclosures. Further, 
special purpose entities play a critical role in a number of 
important financial markets, especially in the case of 
securitization programs. Regulatory or legislative actions 
should be considered carefully in light of the significant 
adverse impact upon financial markets that might result from 
inappropriate restrictions on SPEs.
    Finally, SIA supports the provisions directing the SEC to 
conduct a study of any final SRO rules regarding conflicts of 
interest by equity analysts. SIA developed a set of best 
practices for research a year ago that we believe have been 
very useful and constructive. The NASD and the New York Stock 
Exchange have recently proposed regulations in this area. And 
while we have some serious issues with some aspects of these 
proposals, we support their overall goal.
    SIA believes our system of securities regulation and 
corporate disclosure is second to none. Our financial markets 
are envied worldwide for their efficiency and integrity, and we 
now have the opportunity to develop sensible, responsible 
reforms that will improve the markets for everyone.
    Certainly Enron has brought us a new set of challenges to 
address. We look forward, Mr. Chairman, to working with you, 
the SEC, and the Administration to develop a reasonable 
measured response to those challenges.
    Thank you very much.
    [The prepared statement of Marc E. Lackritz can be found on 
page 184 in the appendix.]
    Chairman Oxley. Thank you, Mr. Lackritz.
    Mr. Melancon.

  STATEMENT OF BARRY C. MELANCON, PRESIDENT AND CEO, AMERICAN 
           INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

    Mr. Melancon. Thank you, Mr. Chairman. Chairman Oxley, 
Ranking Member LaFalce, and Members of the committee, I am 
Barry Melancon, a CPA and president and CEO of the American 
Institute of Certified Public Accountants. I am here today on 
behalf of the 350,000 members of the AICPA and for the almost 
1,000 firms that perform audits for public registrants and 
45,000 firms that service small business throughout America.
    CPAs across this country and the Members of this committee 
share a common goal, to restore faith in the financial 
reporting system and reassure investors that they have access 
to the most up-to-date, relevant, and accurate financial 
information.
    Our profession has a long history of dedication of 
maintaining and improving the quality of financial disclosures. 
We require it, investors demand it, and the strength of our 
financial markets depends upon it. We take that responsibility 
very serious, and we have zero tolerance for those who break 
the rules.
    I would like to be clear: We support meaningful change, 
because thoughtful improvements are needed. But we all should 
be wary of proposals that can lead to unintended consequences. 
We ask that this committee and Congress evaluate legislative 
proposals with an eye to a straightforward public interest 
test, a test that asks four important questions:
    Will it help investors make informed investment decisions?
    Will it enhance audit quality and the quality of financial 
reporting?
    Will it increase confidence in the capital markets, our 
financial reporting system, and the accounting profession?
    Will it be good for America's financial markets and 
economic growth?
    We support a robust private-sector regulatory body for 
auditors of public companies dominated by members who are not 
accountants, with SEC oversight, and a clear charter to 
undertake professional discipline and quality review. A highly 
effective disciplinary and quality review body will alleviate 
the need for individual prescriptive proposals.
    Audit quality is another issue that I would like to discuss 
today. New and more complicated financial instruments and the 
speed and complex nature of business transactions has 
significantly increased the challenges facing auditors. The 
competency and experience needed to conduct today's audit are 
vastly broader than they were just even a few years ago. And 
those requirements will be ever more far-reaching in years to 
come.
    I would like to take a moment here to discuss the very real 
risk that broad proposals that restrict services provided to 
audit clients, whether intended or not, could lead to a 
profession comprised of firms that provide narrowly defined 
audit services and little else. This will have unfortunate, 
unintended consequences. The ripple effect of such action could 
hurt businesses of all sizes and all communities. Such 
statutory restrictions will substitute informed and reasoned 
decisionmaking by companies in their audit committees with 
Government fiat.
    Next, the issue of corporate governance. We should all 
recognize that the financial reporting process is a complex 
system of checks and balances that begins with the creation of 
the financial statement by the company. To enhance this first 
step in the process, the audit committee should also have the 
sole authority to approve the company's financial statements 
and require business disclosures in the annual report and other 
public documents. And the audit committee should be responsible 
for the hiring and firing of the company's auditor. Equally 
important, it should be composed of outside directors with 
auditing, accounting, or financial experience.
    We hope that policymakers recognize that it would be 
harmful to cast a dark cloud over all services outside the 
statutory audit by establishing a negative presumption that an 
auditor cannot be independent if any such services are provided 
to an audit client even if that presumption could be overridden 
by an audit committee's affirmative action.
    Mandatory rotation of audit firms has been proven to 
increase the potential for fraud. The COSA study of financial 
statement fraud shows that client fraud is three times more 
likely in the first 2 years of a client-auditor relationship. 
Safeguards are already in place. All firms that conduct audits 
for publicly traded companies are currently required to take 
the lead engagement partner off engagements after 7 years for a 
period of at least 2 years. Finally, I must mention that at one 
time Canada, Greece, Spain, and Italy all required mandatory 
audit firm rotation in one form or another. Three of those four 
countries subsequently dropped the requirement. In short, given 
the known risk, why follow these failed experiments.
    On another note, it is ludicrous to suggest that 
accountants are off the liability hook. One simply has to read 
the newspaper today to see that the opposite is true. The past 
few years have seen record numbers of lawsuits and record 
settlements from accounting firms.
    And now to the reforms that the AICPA has advocated for 
many years.
    Chairman Oxley. Can you sum up, Mr. Melancon.
    Mr. Melancon. Yes, sir. Reforms in our 70 year old 
financial system. The current system is no longer adequate in 
the information age. Efforts to modernize business reporting 
must be accelerated.
    On behalf of the CPAs around the country, I thank you for 
the opportunity to present our views today and commend the 
committee for what we trust will be a thoughtful approach to 
these important and complex issues.
    [The prepared statement of Barry C. Melancon can be found 
on page 199 in the appendix.]

   STATEMENT OF JAMES K. GLASSMAN, RESIDENT FELLOW, AMERICAN 
                      ENTERPRISE INSTITUTE

    Mr. Glassman. you, Mr. Chairman. Mr. Chairman and Members 
of the committee, thank you for inviting me to testify today. 
My name is James K. Glassman. I am a Resident Fellow with the 
American Enterprise Institute and host of 
techcentralstation.com. Since 1993, I have been writing 
regularly on investing for a broad audience. I am a financial 
columnist for The Washington Post. My second book, ``The Secret 
Code of the Superior Investor,'' was published in January.
    I believe that my usefulness to this committee lies in my 
understanding of what makes small investors tick and of the 
consequences of financial policies on the economy and markets. 
In the current over-heated atmosphere, H.R. 3763 is admirably 
level-headed, especially in comparison with the Comprehensive 
Investor Protection Act. Still, some of the bill's provisions 
are troubling. Rather than protecting investors, these 
provisions may harm them.
    First, understand that investors do a remarkable job 
protecting themselves. Investors reward good corporate citizens 
with higher stock prices and they punish miscreants with lower. 
Recent academic research confirms this fact, as I show in my 
written statement. Investors have their own unwritten set of 
rules and when companies violate them, the retribution is 
swift. Investors do not tolerate lying. In Enron's case, as 
soon as it became clear that the firm had deceived them, 
investors entered a verdict of guilty and applied ``capital'' 
punishment. They didn't wait for a trial. They didn't wait for 
an SEC investigation. Similarly, clients of Arthur Andersen, 
Enron's accounting firm, did not wait for an indictment or a 
Government report. Delta Airlines, Merck & Company, Freddie 
Mac, among others, fired Andersen as their auditor. In 
addition, of course, Enron and Andersen executives face 
possible criminal penalties.
    In the face of such a ferocious reaction, why is Congress 
considering at least 30 pieces of legislation in the Enron 
matter? Congress has played an important role in exposing the 
details of the scandal to the public and in calling the 
participants to account publicly. This committee deserves 
particular praise. But much of the legislation itself is 
unproductive at best.
    Let me comment briefly. Auditor independence: H.R. 3763 
would bar accounting firms from providing clients with both 
external audit services and financial information services or 
internal audit services. The CIPA goes further. Both approaches 
are harmful to investors.
    First, Zoe Palmrose and Ralph Saul show in an extensive 
article in the winter issue of Regulation, which I would like 
to enter into the record, the issue of auditor independence has 
been extensively studied with almost no empirical evidence of 
abuse. The theory put forth by advocates of independence rules 
is that companies use the high fees involved in contracts for 
non-audit services in order to bribe accounting firms to 
produce deceptive audits that favor the company. But Enron 
actually paid low non-audit fees relative to its audit fees. 
And why should forbidding non-audit work solve the problem? 
After all it is just as easy to bribe accountants, if you 
believe this theory, directly. Just pump up the fees for audit 
work.
    While evildoers lurk in the corporate world as well as 
outside it, the main reason that respected companies use the 
same firms for audit and non-audit is not that this combination 
provides some kind of nefarious leverage, but that it makes 
sense economically in an age of high technology. Forcing this 
highly artificial separation will add expenses, lower profits, 
and inevitably lower stock prices, and that hurts investors. It 
does not help them.
    Increasing the complexity of accounting rules: You should 
understand that the complex nature of American corporations 
means that every loophole cannot be plugged, every possible 
deception and distortion cannot be remedied with a new rule. 
The answer is not more numbers and legalese, but more leeway 
for auditors and corporate executives to explain the truth 
health of a company, along with strict accountability from 
companies and auditors.
    So what should be done? Well, I strongly agree with Section 
4 of H.R. 3763, which requires officers and directors to 
disclose sales of company stock to the SEC within two days 
after the transaction. I would go further and say that this 
information should be contemporaneous. I also concur with 
blackout provisions and with stricter laws against companies 
interfering with audits.
    Another remedy, which is beyond the scope of this 
committee, is this: Cash dividends are the clearest, most 
transparent evidence of corporate profits. An investor who sees 
dividends increasing every year can properly have confidence in 
a company. But dividends are taxed twice and mainly as a result 
fewer public companies now pay dividends ever in history. 
Ending double taxation of dividends would increase pay-outs and 
vastly increase investor confidence.
    Repealing litigation reform: Congress, in 1995, overrode 
President Clinton's veto of the Private Securities Litigation 
Reform Act, a bill that scaled back the excesses involved in 
often frivolous securities fraud cases brought by a small group 
of politically generous plaintiffs' lawyers. Now some in 
Congress have decided that these moderate reforms were 
responsible for the Enron excesses. In fact, the law does not 
prevent such lawsuits. Cendant, for example, settled the class 
action lawsuit after the new law for $2.8 billion. And its 
former auditor, Ernst & Young, settled another suit for $335 
million. Attorneys could have sued Enron earlier and they are 
certainly suing Enron and its auditor, Arthur Andersen, today.
    Repealing this reform would not protect shareholders. It 
would hurt them by forcing their companies to make payments of 
tribute and distracting executives who should be focusing on 
managing their firm. Indeed, in my opinion, the bar should be 
raised higher to deter more frivolous suits.
    After the Enron scandal entered full public consciousness 
in December, the media carried stories claiming that as a 
result investors were losing faith in the stock market in 
general. Instead, while investors have certainly become much 
more vigilant, to their credit they have not responded by 
dumping shares across the board. In fact, in January 2002, 
according to the Investment Company Institute, investors added 
$20 billion more to equity mutual funds than they took out, the 
largest such net gain in many months.
    Chairman Oxley. If you could sum up.
    Mr. Glassman. Yes, sir. I do have to mention something. I 
was not aware that CalPERS was going to be testifying today, 
but let me say this. For this discipline that I have talked 
about, the discipline involved with investors enacting 
retribution against Enron and other firms, for it to work, 
investors must act responsibly. Unfortunately, that is not 
always the case. The New York Times reported on February 5th 
that while the large California Public Pension Fund, CalPERS, 
was alerted to the abuses at Enron, in December 2000, 9 months 
before the company started to announce to write-offs, was 
alerted to these abuses, executives ``did not confront Enron's 
board,'' or ``publicize its concerns.'' Instead it continued to 
profit from dubious partnerships like Jedi.
    Instead of concocting new laws, this committee should use 
its bully pulpit to exhort accountants, corporations, and 
pension funds to act responsibly. Finally, in times of scandal, 
emotions run high. And the urge to rush in with legislative 
remedies is understandable, but it should be resisted. Parts of 
H.R. 3763 are admirable, but market discipline and current 
criminal and civil laws provide powerful remedies and 
protections against another Enron already.
    Thank you, Mr. Chairman and Members of the committee.
    [The prepared statement of James K. Glassman can be found 
on page 183 in the appendix.]
    Chairman Oxley. Thank you, Mr. Glassman.
    Mr. White.

   STATEMENT OF TED WHITE, DIRECTOR OF CORPORATE GOVERNANCE, 
         CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM

    Mr. White. Thank you. Chairman Oxley, Ranking Member 
LaFalce, and distinguished Members of the committee, I am Ted 
White. I am the Director of Corporate Governance for the 
California Public Employees' Retirement System or CalPERS. On 
behalf of the CalPERS' board and myself, I would like to thank 
you for the opportunity to testify today regarding issues that 
are of such importance to our capital markets.
    CalPERS is the largest public pension system in the world, 
with approximately $155 billion in assets. We represent over 
1.2 million members. Over $67 billion of our assets are 
invested in the U.S. stock market alone.
    CalPERS has long been a vocal, leading advocate for 
effective corporate governance. We strongly believe that as 
owners of the companies we invest in, shareholders have a right 
and a duty to attempt to hold management and boards of 
directors accountable for their performance. The concepts of 
accountability and transparency have long been recognized as 
the cornerstones of a successful corporate governance model. 
Unfortunately, the events of the last few months have 
demonstrated all too clearly that basic ethics, something that 
we may have all taken for granted, must also be a concern for 
today's investors.
    With this background, I would like to focus on two key 
legislative issues, auditor independence and audit industry 
oversight and several regulatory matters.
    CalPERS was pleased to see both Chairman Oxley's bill and 
Ranking Member LaFalce's bill include provisions on these 
important topics. Thank you both for recognizing the need for 
Congress to address these issues.
    On the issue of auditor independence, CalPERS believes 
there is currently a crisis of confidence with the accounting 
industry. The independence of the auditor must be beyond 
reproach. Investors must be able to trust when an auditor says 
the books are accurate, then they are accurate. The Enron/
Andersen situation, as well as many others, have prompted this 
erosion in investor confidence due in large part to the very 
obvious conflicts that exist when an auditor is simultaneously 
receiving fees for non-audit work. How can investors trust the 
discretion that is inherent in audit work while the auditor may 
be influenced by the desire to keep a well-paying client happy.
    We understand that there is much debate over when to draw 
the line between audit and non-audit services. As one investor, 
CalPERS believes that there should be a bright line ban on 
external auditors providing consulting work or internal audit 
services to audit clients. A firm should be an auditor or a 
consultant, but never the same for the same client.
    CalPERS is also advocating a system of mandatory auditor 
rotation of company external auditors. We have suggested a 5 to 
7-year limit. Although we recognize there is a cost inherent in 
this proposal, we believe the cost is far outweighed by the 
benefits, benefits that can bring a fresh perspective and 
renewed investor confidence in the industry.
    I would note for your reference that CalPERS is mandatorily 
required to rotate its auditor every 5 years. And while this is 
not easy for a financial institution of our size and 
complexity, we do it nonetheless.
    Turning to the oversight of the accounting industry, we 
again applaud the efforts of this committee, SEC Chairman Pitt, 
and President Bush for identifying the need to strengthen the 
oversight of auditors and accountants. We believe it is time to 
update the oversight of this industry.
    To achieve a goal of rebuilding the market's confidence, we 
must create an effective oversight body. To be effective, we 
believe that the oversight body should be created with the 
following principles in mind. It must represent the interests 
of end-users. The governing body should be dominated by 
independent public members. It should have a stable and 
independent funding source. It should have the power to 
effectively oversee the industry, which means conduct 
investigations and discipline. And it must have standard 
setting capability. We also believe that while the SEC should 
oversee this new entity, the creation, its charter, and its 
scope of authority at a minimum must be established by 
Congress.
    We recognize that the current forms of the Oxley bill, as 
well as the LaFalce bill, contains several elements that are 
consistent with CalPERS existing reform package and we 
appreciate that you are addressing these issues. For example, 
requirements on auditor independence, mandatory auditor 
rotation, revolving door provisions, requirements that the 
auditor be hired by the auditor committee, provisions related 
to director independence, and the creation of the oversight 
body with a secure funding service, investigative and 
disciplinary power, and the ability to set standards.
    Finally, CalPERS would like to express our strong desire 
that pay parity for the SEC staff be fully funded by Congress 
this year.
    In conclusion, CalPERS is pleased that the Members of this 
committee are taking such a thoughtful and constructive 
approach to addressing the financial reporting issues stemming 
from the Enron collapse. We believe Congress must play an 
important role in helping restore investor confidence by 
improving auditor independence, enhancing accounting industry 
oversight, providing regulators with the power and resources to 
effectively regulate the industries, and encourage interested 
market participants to assist them when practical.
    Thank you. And I would be pleased to answer any questions.
    [The prepared statement of Ted White can be found on page 
226 in the appendix.]
    Chairman Oxley. Thank you, Mr. White and thanks to all of 
our panel.
    Let me begin by asking Mr. Lackritz, and this was also 
mentioned by Mr. Glassman, there have been media reports and 
sources from the trial bar that the Securities Litigation 
Reform Act of 1995 has reduced the number of shareholders' 
suits or the average settlement amount. Would you care to 
comment on the numbers as they are reflected today after 
passage of that Act?
    Mr. Lackritz. Yes, I would be happy to, Mr. Chairman. In 
fact, the number of lawsuits that have been filed in the 4 
years since the Act became effective have actually gone up, and 
gone up proportionately, to the number of suits that were filed 
actually before the Act was passed. And in addition the average 
settlement amount has actually gone up, so that indicates that 
the quality of the lawsuits that have been filed have probably 
improved significantly. And the purpose of the Act, which is to 
deter abusive practices by lawyers that didn't have any 
clients, is being served quite well. And I think that the 
examples that Jim Glassman cited are further evidence that the 
law is actually working very much as it was intended to work.
    Chairman Oxley. Thank you. Mr. Glassman, you had indicated 
even that you would have perhaps gone further in the pursuit of 
limiting those frivolous lawsuits. Is that correct?
    Mr. Glassman. Yes, sir. I think that when you talk to 
people in Silicon Valley today, these lawsuits, the threat of 
these lawsuits is hanging over their heads. The notion that 
just because the stock price has declined, somebody did 
something wrong, which by the way is the wrong signal always to 
send to investors, they have to understand that stock prices do 
decline and they need to protect themselves against that, I 
think in part has put a chill on that industry and distracted 
many of its executives. And it is not a good thing. But 
certainly when companies like Cendant do the things that 
Cendant has done, they ought to be punished for it in the 
courts and perhaps in criminal activities.
    Chairman Oxley. I thought your comments were most 
appropriate. And I am speaking now to Mr. Glassman, 
particularly in view of Chairman Greenspan's comments that the 
markets have a remarkable way of making corrections, punishing 
wrongdoers and the like. One of the biggest fears that I have 
frankly, and it was expressed by you and Mr. Melancon, at least 
obliquely, is what would be worst, doing nothing, that is the 
Congress, or overreacting and passing overly restrictive 
legislation? I obviously know your answer, Mr. Glassman. Let me 
ask Mr. Melancon what his perception of that is?
    Mr. Melancon. Mr. Chairman, I would certainly agree with 
you that in effect Congress has done something through its 
bully pulpit, through these hearings, and a whole host of 
others that have caused changes to occur, due diligence to 
occur, a greater awareness by everybody involved in the 
process. And that is a positive thing and that is an 
indication, as Mr. Glassman has said, of the marketplace's 
unique capabilities in our economy to be responsive.
    With that as a basis, if you are asking me specifically on 
would it be better to have far-reaching unintended consequences 
through legislation or no legislation, I think our economy 
would be better served because it has responded to your 
activities and others with the more restrained approach because 
the unintended consequences could be extraordinarily negative.
    Chairman Oxley. One of the things you learn after being 
around here awhile is that sometimes laws are forever, or at 
least seemingly so. It took us 70 years to repeal Glass-Steagle 
and some of us have the wounds to prove it. That is, when the 
Congress enacts even bad legislation, it tends to take us a 
long time for it to correct. And clearly the intent of our 
legislation was to provide a broad framework for corrective 
action, but essentially to allow the regulators and to allow 
the market to work this out.
    Mr. Greenspan even indicated that he thought, even at this 
early going, that 50 percent of the problems inherent with the 
Enron debacle have already been dealt with. And in my 
discussions with CEOs from various industries, it also leads me 
to think that that is happening. Clearly, the actions taken by 
a number of boards recently regarding Andersen, by Andersen 
hiring Paul Volcker, by Volcker's announcement just recently, 
all would indicate that there is a heightened awareness of 
corporate responsibility. There is heightened awareness of 
auditor independence and their need to provide an accurate and 
fair audit.
    And there is indeed, obviously, the need with the changes 
taking place in technology for virtually instantaneous 
information to be placed before the investing public. Mr. 
Glassman, for example, thought 2 days was perhaps too slow, 
that it ought to be instantaneous, maybe we ought to look at 
that. Maybe there are some other issues that can be brought up. 
But, I have to say the more I discuss these issues with people 
in the private sector, the more I am convinced that we have to 
tread very carefully in this arena.
    I thank you, and my time is just about up. Let me recognize 
my good friend from New York, Mr. LaFalce.
    Mr. LaFalce. Thank you, Mr. Chairman. And of course we must 
always act deliberately and carefully, but we must act. And we 
must not act with timidity. And we must act in the public 
interest as opposed to listening primarily to the voices of the 
private special interests. Discerning the difference between 
the two is often difficult.
    I am struck by a number of comments that have been made. 
Mr. Lackritz praised the 1995, 1998 legislation, saying that 
number one, lawsuits have gone up. Number two, settlement 
dollar amounts have gone up. Number three, the quality of the 
lawsuit has gone up. And that the intention of the Congress has 
worked. I didn't know that the intention of the Congress was to 
increase the number of lawsuits, increase the settlements. Some 
people said it was indeed to the contrary. Some people who 
authored the legislation of 1995, 1998 may actually have wanted 
to see the number of lawsuits gone down, may have actually 
wanted to see the settlement figures go down. But that is I 
supposed historical perspective.
    There has also been quite a bit of talk too about the 
markets will punish the wrongdoers. The markets will make 
corrections. Well, there is a certain amount of truth in that. 
But to what extent will the markets, number one, obtain redress 
for the victims of wrongdoing. And, number two, to what extent 
will the working of the marketplace in and of itself prevent 
future difficulties, future earnings manipulations?
    That is where I think that you do need--in order to make 
the market work, you do need a good system of laws and a good 
system of regulation. That is the whole concept of law and 
regulation, to make the market work. We have a good public 
capital market, the public can invest on it. But I don't think 
we can rely on the concept of buyer beware, which is if I were 
to summarize Mr. Glassman's testimony in two words, which would 
be very unfair, Mr. Glassman, because you were thousands of 
times more nuanced than that, but basically it sounds to me as 
if you are saying, ``Let the buyer beware.'' And we have to go 
beyond that. Now how far beyond that, we need to discuss and 
debate.
    Clearly, the accounting industry has come in with its own 
proposals. Clearly, there have been countless recommendations 
from corporate America for corporate governance changes. 
Clearly, the securities industry, the regulator, the NASD, has 
come in with some changes. They are good as far as they go. 
Other major securities firms have gone even further, and maybe 
that is the best practice and maybe we should codify the best 
practice. This is what we certainly need to debate.
    But I don't think it is good to just put our head in the 
sand and say the marketplace is going to take care of it and to 
warn us all about overreacting. I have not seen too many 
individuals so far who have been overreacting. And I don't 
think when the comptroller for the State of New York, for 
example, calls for mandatory rotation, when the former 
controller of the city of New York calls for mandatory 
rotation, when one of the former chairmen, at least one, of the 
SEC calls for that concept, that is something that should be 
considered seriously. When the Chairman of the Capital Markets 
Subcommittee does not call for mandatory rotation, but calls 
for at least a consideration of the concept of the exchanges 
being responsible for the determination of the auditors, that 
is something that merits very, very serious consideration.
    And I look forward to working with the Chairman, maybe his 
idea is better. It ought to be on the table. When CalPERS can 
rotate its auditors every 5 years, that shows it can be done. 
When companies fire one auditor and hire another, as they have 
been doing the past several weeks, it shows it can be done. And 
it is done hopefully to improve things. It is done for a whole 
slew of reasons even though they may have been satisfied with 
the auditing, they think it is necessary to restore investor 
confidence, which is a good value in and of itself too that 
should be weighed along with whatever learning difficulties 
there might be. So if we have problems, learning difficulties, 
whether it is a new Congressman, whether it is a new chief of 
staff, and so forth, that goes with the territory, but it 
should not create a paralysis on our part.
    I thank the Chair.
    Chairman Oxley. The gentleman's time has expired.
    The gentleman from Louisiana, Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman.
    Mr. White, in reviewing your testimony, I found it very 
helpful in this sense, that you obviously manage a system that 
is financially significant, with a significant responsibility 
for a large number of people's retirement futures. In your 
remarks you talk about the adequacy of the audit committee 
construction and point out that having only one member possess 
financial literacy skills is not sufficient. I agree with you 
and think that the provision in the underlying legislation that 
allows for public members to be part of the regulatory body is 
an advisable thing, but only if we can assure that the 
appointment of these individuals to this incredibly important 
responsibility have financial literacy as an asset. I think it 
goes beyond the ability just to read the financial statement 
itself. I think it creates an environment where there is much 
more likely to be independence in making judgments because you 
then understand what the facts are saying.
    And that really gets to one of the principal concerns I 
have about whatever system we adopt, to what extent is there 
assurance that when the auditor is within the structure, doing 
the work that is required at the direction of the audit 
committee, the audit team has to engage with management to 
understand what is going on almost always. Based on Mr. 
Melancon's comment that fraud is most likely to occur when an 
auditor is new to the business structure.
    At the same time, I don't know on how many occasions that 
the audit team is asked by the audit committee has management 
asked you to modify, alter, change, in any way indicate that 
the financial report you are presenting to us was inaccurate 
and have a responsibility for that auditor to disclose what 
relationships may have occurred with management beyond the 
normal due diligence required to prepare the financials?
    Is that a customary practice in your view?
    Mr. White. That is a good question. First, your opening 
comments about the applicability of how we feel about the role 
of the audit committee and the expertise there and the 
expertise needed on the oversight body I think are excellent 
points. What we would stress on the oversight body is that the 
independence of those members is of extreme importance, along 
side with their expertise and that they will obviously hire 
audit staff that would carry out the reviews and you would need 
a greater level of expertise at that level.
    Your question about the role of the audit committee, it 
would be our strong desire that chairmen of audit committees 
and audit committee members would hold the audit firm's feet to 
the fire on exactly those issues. I have no statistics to 
represent to you how often that happens. In my conversations 
with audit committees and audit committee chairmen, I think it 
is a mixed bag of how well they fill that role. One of the 
things that we have learned out of this is we are going to put 
additional pressure on audit committees to do exactly the types 
of things that you mentioned right there. It is one of the 
reasons that we want the audit committee to have the absolute 
responsibility to hire and fire the auditors and to approve any 
non-audit services, whether there be a ban or come from another 
angle.
    Mr. Baker. Thank you. Mr. Glassman, I always respect your 
defense of free enterprise and generally are right there with 
you on most of these observations. One point that I think needs 
to be made in the current environment though is that short-term 
earnings pressures on corporate management are enormous. And if 
you don't beat the street numbers by a little, something is 
wrong. And if you invest for the long-term profitability of a 
corporation's life at the expense of the short-term quarterly 
report, you enter that category called fired.
    I think we need to incentivize in some method a way for 
management to look to the long term, not to the short-term 
quarterly report. One of the ideas was to indicate where a no-
cost option is exercised by an executive and through 
manipulations of reports helps to bump the stock price up, 
either by whisper numbers or whatever is out there that can be 
done accordingly. And subsequent, in some time period, 3, 4, 5, 
6 months, there is a restatement of earnings. Today, the 
individual profits greatly while the shareholders take the hit 
for that write-down of value.
    Is there any kind of scenario, if it is a no-cost option, 
give back of profits in that environment, is there anything we 
can do to lock down and incentivize executives to return to the 
old fashioned way of making product?
    Mr. Glassman. I agree that that is a big problem. And I 
know that Chairman Greenspan said the same thing. I believe, 
and I say this in my written testimony, that one step that can 
be taken is, in fact, to expense options immediately, the 
majority of options. I know that is a controversial issue. I 
know that there are especially technology companies that say 
this would be terrible for them. I don't believe that. I 
understand their concerns. But I think that would go a long way 
toward addressing exactly what you are talking about. In other 
words, there is no reason why there should not be a level 
playing field between options and cash compensation so that 
companies are making economic decisions about how compensation 
should be awarded to executives. And I think that that is a 
step that I would take.
    Chairman Oxley. The gentleman's time has expired.
    The gentleman from Vermont, Mr. Sanders.
    Mr. Sanders. Thank you, Mr. Chairman. The issue that we are 
discussing is really not very complicated. And the issue is if 
somebody invests in the stock market or Mr. White helps invest 
billions and billions of dollars representing workers in the 
stock market, do they have a right to know that the financial 
reports that they are reading, talking about the conditions of 
the company are accurate and who is going to help us determine 
that. That is the issue.
    I think the evidence is pretty clear that we cannot simply 
trust the industry or the accountants under the present 
scenario to provide us with that information.
    I would like to ask Mr. Melancon a question. Mr. Melancon, 
while the AICPA has the power to discipline auditing firms and 
their employees for ethical and legal infractions, my 
understanding or my observation is that it does not seem to be 
doing that job. Now I read a little while ago 10 instances of 
where the top five auditing firms screwed up. Can you tell me 
the kind of punishment that your organization levied on any of 
them? You said in your report, as I understand it, we have zero 
tolerance for those who break the rules. Now tell the American 
people exactly how you have sanctioned Arthur Andersen and the 
other companies for repeated violations of the rules, and, in 
fact, in situations where they were sued for huge sums of money 
and, in fact, even fined by the SEC. Now tell us what the self-
governing regulatory body did in terms of sanctions to those 
companies?
    Mr. Melancon. Congressman, we discipline hundreds of CPAs 
each year. In addition to that, I think as you talk about 
moving to different types of bodies, there are obviously issues 
of individual due process rights that come into play. And 
clearly we have supported an enhancement to the disciplinary 
process that has been talked about because there are some 
weaknesses in private sector bodies being able to discipline 
primarily concerns in the liability areas, and so forth.
    However----
    Mr. Sanders. Excuse me, Mr. Melancon, may I ask you this. 
In the last 25 years, has your public oversight board once 
sanctioned a major accounting firm, one time in the last 25 
years?
    Mr. Melancon. The public oversight board oversees peer 
reviews. There have been firms in the top 20 firms in this 
country that have gotten modified reports, yes.
    Mr. Sanders. In the top five?
    Mr. Melancon. The firms in the top five have had----
    Mr. Sanders. Who account for a huge amount of the volume.
    Mr. Melancon. There have been individuals that have been 
sanctioned in the Big Five, yes, sir.
    Mr. Sanders. In the last 25 years?
    Mr. Melancon. Yes, sir.
    Mr. Sanders. Can you tell me who they are?
    Mr. Melancon. I cannot tell you who they are right now. We 
will be glad to provide you that information.
    Mr. Sanders. My understanding, and I stand to be corrected, 
is that, in fact, in the last 25 years of existence your 
supposed regulatory board has never once sanctioned a major 
accounting firm.
    Mr. Melancon. There has been disciplinary action against 
members of the Big Five absolutely in that 25-year period. And 
in addition to that, Congressman, we have a system that----
    Mr. Sanders. Can you describe what--my understanding of 
that may mean retraining of auditors. Fines? How much have they 
been fined?
    Mr. Melancon. We do not have the power to fine, 
Congressman.
    Mr. Sanders. You don't have the power. What do you do, do 
you re-train? Do you slap them on the wrist? Do you give them a 
talking to? What do you do?
    Mr. Melancon. We publicly, in an egregious situation, they 
are publicly dismissed from the AICPA, which would----
    Mr. Sanders. Any of the Big Five publicly dismissed from 
the AICPA?
    Mr. Melancon. Individual members have been, yes, sir.
    Mr. Sanders. Top members? Mr. Chairman, I would say----
    Mr. Melancon. Partners have, yes.
    Mr. Sanders. Mr. Chairman, I would say that here is a 
situation, some people talk let the industry regulate itself. 
You don't need Government to play a role to protect investors 
or pension funds. I would give an example, I would just simply 
say that the record is fairly clear that the self-established 
regulatory group, the AICPA, has not done the job that is 
necessary. And in fact, whether we like it or not, the 
Government is going to have to play a much stronger role to 
protect American investors.
    I yield back, Mr. Chairman.
    Chairman Oxley. The gentleman yields back.
    The gentlelady from New Jersey, Mrs. Roukema.
    Mrs. Roukema. Thank you, Mr. Chairman. I, unfortunately, 
did not hear all your testimony, but I have reviewed some of 
it. And I do have a question for Mr. Lackritz. If I understand 
his testimony, I believe he said, ``We believe that as part of 
the effort to improve disclosure, it would be beneficial to 
look at the earnings estimates that firms release.''
    Could you elaborate a little bit more and with more 
specificity with respect to how this proposed legislation would 
deal with that issue?
    Mr. Lackritz. Sure, I would be happy to. The issue here is 
how to improve the quality of the information in the 
marketplace. And while the legislation for example would 
accelerate reporting requirements that are necessary under SEC 
regulation, the really relevant and important reporting comes 
with the earnings releases that happen about 21 days after the 
end of the quarter, not statements to regulators. What we were 
suggesting was that there might be a means of suggesting a best 
practices for releasing earnings estimates into the marketplace 
that would provide a common set of practices for firms to 
follow in addition to the regulatory requirements.
    Mrs. Roukema. Well, does this legislation adequately deal 
with that subject or how would you suggest that we would refine 
it and close any potential loophole there?
    Mr. Lackritz. We were suggesting that it might go further 
than it did and that is why the suggestion was in there.
    Mrs. Roukema. Well, if you have anything more that you 
would contribute with a specific proposal as to how we would do 
that, I would be more than happy to accommodate you and work 
with you.
    Mr. Lackritz. Great.
    Mrs. Roukema. In defining that. And I must say that I do 
look to the SEC for leadership here.
    I thank the Chairman.
    Chairman Oxley. The gentlelady's time has expired.
    The gentleman from Washington, Mr. Inslee.
    Mr. Inslee. Thank you, Mr. Chair. From my neck of the 
woods, the CPAs are people of integrity and the people I know 
have acted very professional. And yet since the Enron collapse, 
when I have been thinking about how the accounting industry is 
structured, where you essentially have one team paying the 
referee and the referee being able to go to work for one of the 
teams afterwards at a good salary, and the referee being sort 
of working in tandem with just one team like the Harlem 
Globetrotters for 30 years, it is really amazing to me that we 
have done as well as we can. So this has been a real eye-opener 
for me in the Enron situation.
    And one thing I think that many of us are considering are 
how to gain the independence that we need from auditors while 
not having unnecessary dysfunctions in their services, and that 
is what I think all of us are looking for.
    Mr. Melancon, I was really struck by your testimony. I read 
your testimony. I don't know if you said this verbally, but you 
had something that really caught my eye. You said that, ``Lower 
paid, less skilled accountants may staff audit-only firms, 
harming the ability of lead audit partners to go toe to toe 
with the modern corporate financial executive.''
    And the reason it struck me is that what I think you 
posited there is that we need auditors who can go toe to toe 
with their clients, if you will, which is a difficult thing to 
do when the client is paying you to go toe to toe with the 
client. But we need, because we are unwilling to have the 
market pay for the auditing services, we are all sort of agreed 
that we are going to continue the situation where the client 
pays the service, and that has obvious huge problems for an 
auditor to go toe to toe with the guy who is paying him. And it 
seems to me we need to look for ways to reduce the 
disinclination to go toe to toe like that.
    Now in your testimony you told us that some auditing firms 
now have rules about rotation of lead auditors internally, that 
that is a rule. And I assume if you rotate a lead auditor, you 
would have the same difficulty of getting up the knowledge bank 
as you would if we imposed this rotational requirement. I just 
wondered should we look at those differently somehow, if 
internally companies impose the rotational requirement for 
their lead auditors, it is a much greater problem to have a 
rotational requirement for the firm itself. And don't exactly 
the same reasons to impose a rotational requirement for lead 
auditor, shouldn't those same reasons exist for a firm in 
itself?
    Mr. Melancon. Congressman, the requirement for rotating a 
lead auditor is a profession-wide requirement. It is not a 
company requirement. It is, in fact, a requirement that we have 
put on the profession.
    And on your sort of dilemma issue that you raised, that is 
why the audit committee is particularly important in the 
process, because the audit committee is the buffer if you will 
in that environment that you described in the pay.
    When you look at an audit engagement, there is a team of 
people, these are multi-national companies in large part today, 
there are literally hundreds and hundreds of people involved in 
learning curves and understanding the business complexities. To 
rotate that whole team of people actually creates a greater 
risk from an audit quality perspective. The fact of the matter 
is is that by changing the lead partner, which is a requirement 
again as I said of the firm, of the profession, we are trying 
to have, and through standard setting in the past, have tried 
to set up a system that approaches the appropriate balance. And 
that is really--and you sort of described it and captured that 
very well, it is the appropriate balance in all of these 
issues. And so the system that we have in place is we try to 
extract the best of knowledge of the enterprise, knowledge of 
the details, so that the quality of auditing is good, with 
requirements to take some different look from a lead audit 
perspective.
    We also have a series of requirements if, in fact, someone 
goes to work for an engagement that requires the audit--for a 
client that the auditor take certain steps.
    So it really is all about balance, Congressman.
    Mr. Inslee. So what do you think of this analogy of the 
referee situation. I think it would be unhealthy if NBA 
referees had the possibility of going to work for management of 
one of the teams they are refereeing in, it seems to me that 
that is an unhealthy situation. But that is the situation we 
have now for auditors.
    And I understand part of your testimony that that decreases 
the attraction of the profession a little bit, to think that 
you now are less able if you do the auditing function to go to 
work with management. But how can we tell our constituents that 
we have got this increased level of trust in the profession if 
we continue to allow the referees to go to work for the people 
they are refereeing the next Monday morning after they finish 
the audit? Isn't that a major issue here in trust?
    Mr. Melancon. Congressman, there are series of issues 
associated with that. There are requirements to discuss that 
issue with the audit committee. There are requirements where a 
person would go to work for an audit client, if it is during 
the audit engagement, that the work that that person did to be 
re-done by someone else. There is a requirement that if, in 
fact, a person goes to work in an important position in the 
client, that someone not associated previously with that audit 
team review the work of that person and review that work to 
make sure that there is a completely different look and so that 
there is no, the concerns that you are articulating or the 
closeness issues that are taken care of from that perspective.
    And in addition to that, if a person is a member of an 
audit team and is even offered employment from--not even if he 
takes it, but if he is offered employment from a client, he is 
required to be removed from that audit team.
    Chairman Oxley. The gentleman's time has expired.
    Mr. Inslee. Just one more comment, if I may. I want to 
thank a lot of your members for helping us. I have been talking 
to a lot of your members and they have been very good in 
helping us understand these issues. I just want to pass that on 
to you.
    Thank you.
    Mr. Melancon. Thank you, Congressman.
    Chairman Oxley. The gentle lady from New York, Ms. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman.
    Mr. Melancon, could you please tell me--and give me the 
correct pronunciation of your name?
    Mr. Melancon. It is Melancon. Congressman Baker had it 
right because we both have those Louisiana ties.
    Mrs. Kelly. Thank you very much, Mr. Melancon. I would like 
to ask you a question. In your testimony, you talk about your 
opposition to a cooling off period. We in Congress have one 
here as do a lot of the Hill staffers. I am curious about why 
you don't see any conflict of interest for businesses wrongly 
influencing audits by offering better jobs with the company. 
You seem to be opposed to that cooling off period. I wonder if 
you would talk about that a bit.
    Mr. Melancon. Interestingly, Congressman, in the past we 
have articulated concerns in that particular area as a 
profession. The Independent Standards Board, which was made up 
of people, 50 percent who were not associated with the 
profession at all, spent a lot of time just in the last couple 
of years focusing on this particular issue. And the conclusion 
that was reached was that a series of safeguards was the best 
way to balance that particular environment, some of the 
safeguards that I just articulated that require discussions 
with audit committees, that require work that that person was 
involved with being reviewed by someone else in the firm that 
didn't have anything to do with that particular person and the 
audit team to ensure that the work is being done correctly. And 
the conclusion was reached through a very deliberative process, 
with public exposure and a tremendous amount of non-profession 
involvement in the issue that the right answer was, in fact, a 
series of safeguards to produce the appropriate balance.
    The other thing that I just might mention on this 
particular issue is that the movement of individuals into 
corporate America, if we look at that history over the last 40 
or 50 years, has had a tremendous positive influence on the 
quality of financial reporting. If we compare corporate 
America's internal capabilities today versus decades ago, we 
have a much better situation in this country because of 
movement that is supported in that area.
    But the safeguards are very, very important. And 
Congressman Baker's questions about audit committees, I think 
there is an audit committee role when that particular situation 
does occur to ensure the protection from the shareholder 
perspective.
    Mrs. Kelly. Thank you. I still find it curious that we are 
held to such strong restrictions here on Capital Hill and the 
business community doesn't feel any compunction--well, even 
though you are talking about your safeguards, you feel that you 
can get around that. I hope it works better than the Chinese 
Walls that are written into some areas.
    I would like to talk to Mr. Glassman a minute. You talked 
about the fact that you agreed with parts of H.R. 3763, but you 
think it is too regulatory and it sends the wrong message to 
the investors. What do you see as the wrong message here? Do 
you think it is going to hurt the investment for small 
investors?
    Mr. Glassman. First of all, I think there are two points 
where small investors are concerned. Number one, as I said 
earlier, I think it adds unnecessary costs when you essentially 
tell really some of the best corporations in America--there are 
8,000, I think that is the most recent number, listed companies 
on the three major exchanges, certainly there have been abuses 
by some of them. But the vast majority of excellent companies, 
companies like IBM, McDonald's, Exxon-Mobil use the same 
company for audit work and non-audit work, and there is a 
reason for that. It is the most efficient way to do it. These 
companies are very well run. They are looking toward 
efficiency. So you add in cost.
    The second thing, and I think this is maybe more important, 
the signal that Congress has frequently sent to investors, not 
just in this area, but in some hearings about analysts is that 
look, if stock prices go down, somebody is at fault. Somebody, 
some crook is taking your money away. That is not the way the 
stock market works. In 22 years out of the last 76, the stock 
market has declined. It goes up. It goes down. What investors 
need to be told is the market is extremely risky in the short 
term. You need to hold diversified portfolios. You need to hold 
them for the long term. And to have them feel that Congress is 
going to take care of everything, that there is going to be a 
law that is going to be passed so that this stock is not going 
to go down anymore, that is just the wrong signal. While, as 
you said, I do agree that there are some steps that ought to be 
taken, and I think there are parts of this bill that I admire.
    Chairman Oxley. The gentlelady's time has expired.
    The gentleman from North Carolina, Mr. Watt.
    Mr. Watt. Thank you, Mr. Chairman. I appreciate your 
calling this hearing. It has been enlightening and informative. 
I just had a couple of comments and maybe one or two questions.
    I guess we are all kind of seeking a framework to evaluate 
what has happened, and we all do that from our individual 
backgrounds and experiences. In my experience of 22 years of 
practicing law before I came here and working in the trenches 
beside accountants, representing small businesses, and seeing 
them do consulting and/or auditing and accounting more than 
perhaps auditing for those businesses is that there has been a 
very strong sense of professionalism among both lawyers and 
accountants. So I have been kind of wrestling on where I come 
down on this, whether we should be heavy-handed and 
overreacting or whether we should be letting the market take 
some of this into account.
    It seemed to me that auditors over the years and 
accountants over the years have had an even greater 
responsibility to be independent of the people, the companies 
for which they are doing work even than lawyers. Yet there has 
always been a very, very strict conflicts of interest set of 
standards that apply to lawyers in their relationships with 
clients and others.
    I am wondering, Mr. Melancon, I blow it even worse--I think 
it is spelled wrong on our sheets is the problem.
    [Laughter.]
    Mr. Melancon. It is just pronounced wrong.
    Mr. Watt. Well, maybe it is pronounced wrong. Well, I 
certainly just pronounced it wrong.
    Do you think that the existing conflicts of interest and/or 
other rules in place in your profession are strong enough, the 
existing set that are out there, strong enough to allow 
consulting and accounting and auditing to peacefully co-exist 
without any kind of further regulation or do you think there is 
something that needs to be done to adjust that?
    Mr. Melancon. First off, Congressman, thank you for the 
kind comments about the members of our profession that you have 
worked with over the years, and I would agree with your 
assessment from that standpoint. There are 350,000 members of 
our profession, men and women doing the right thing in small 
businesses and large businesses every day.
    Mr. Watt. Don't take too much of my time to brag about 
them. I gave them as much of my time to do that----
    Mr. Melancon. Thank you, Congressman.
    Mr. Watt. As I wanted to.
    Mr. Melancon. I will move to the answer to your question.
    The fact of the matter is that there are significant rules 
in place to protect that environment. We only need to look at 
the existing situation to understand that if, in fact, a CPA 
treads on their reputation, that the horrendous results that 
can occur. And the thing that they have to protect is their 
reputation. And so there is a more----
    Mr. Watt. You know I kind of expected you to say that. I 
think the thing that I am having trouble reconciling, and I 
think Mr. Glassman probably pointed it out more than anything 
else, it is hard for me to be saying that we should let the 
market control accounting practices at the same time we seem to 
be ratcheting up our oversight and rules and laws related to 
the legal profession. And so this whole--I mean, it seems to me 
that what Mr. Glassman is saying is--and I mean this in the 
kindest way, not in a negative way--almost duplicitous. That we 
should be ratcheting up the standards that are at play in the 
legal profession, but we should be letting the market kind of 
control what is happening in the accounting profession.
    And so if he could just respond to that.
    Mr. Glassman. Well, in the first place, I am not aware of 
any PRO that governs the legal profession. I do think however 
that conflict of interest is a serious problem. There is no 
doubt about that. The set-up with CPAs and corporations 
presents a conflict of interest. The question is how do you 
constrain it? I think it is very well constrained by the 
marketplace where investors say if you guys are fooling around, 
we are not going to invest in this company.
    And let me just give you an analogy, because it is a 
business that I know about and that is journalism. In 1992, 
according to a survey by The Freedom Foundation, 89 percent of 
journalists who were the chiefs of their bureaus in Washington 
voted for Bill Clinton for president, 9 percent voted for 
George Bush. But I can tell you that 100 percent of those 
journalists will tell you that they are unbiased, that they put 
that particular interest aside in their professional lives. And 
I would say for the majority of them that is true. And they are 
constrained by the public. That if their bias shows, people are 
not going to read their newspapers. People are not going to 
believe them.
    Mr. Watt. In drawing a parallel between voting for some 
Member of Congress or the President and the responsibilities, 
the professional responsibilities that accountants have to 
shareholders and businesses, I think that is----
    Mr. Glassman. I am saying that professionals in all walks 
of life are torn by conflicts, as are you. I am sure you have 
personal interests, but you have also obligations to your 
constituents. And you are constrained by what your constituents 
see of your behavior here. Same thing with investors. I don't 
think we necessarily need rules on rotation. For example, 
CalPERS can tell companies, ``We are not going to invest in you 
unless you rotate your auditors.'' So those are the kinds of--I 
think those are much more effective constraints.
    Chairman Oxley. The gentleman's time has expired.
    The gentlelady from Illinois, Ms. Biggert.
    Ms. Biggert. Thank you, Mr. Chairman. I am sorry to have 
missed the testimony, but I still have a couple of questions 
that I would like to ask.
    One of the issues that came up in one of the hearings 
recently was the fact--there was a discussion of whether audits 
now always have to be unqualified or whether an auditing firm 
can give a qualified opinion. I know that in the past they 
could. But it was stated, I think on the other side of the 
aisle. I don't know whoever can answer that, I would appreciate 
it.
    Mr. Melancon. Certainly there can be qualifications to an 
audit report today. I think that comment was probably related 
to where there is a qualified opinion, there is any gradation 
of a qualified opinion. And so I think that was where it is. 
But there are qualifications available.
    Mr. Glassman. Could I just comment on that briefly?
    Ms. Biggert. Yes.
    Mr. Glassman. This is what I was trying to drive at in part 
of my testimony. I really think that audit firms should be 
freer to tell people, tell investors in clear English what is 
going on with a company. For example, I think Andersen could 
have said, if it believed that these books were sound, that 
everything here is on the up and up. However, investors should 
be aware that there are hundreds of special purpose entities 
out there, that here are the liabilities. That is the 
obligation of accountants. And I think frankly that they have 
failed in that obligation. But part of the reason they fail is 
the structure, the incredibly complicated structure of the GAAP 
system. In fact, if it were loosened and more judgment were 
involved, but also more accountability, the system would work 
better.
    Ms. Biggert. And I think that that is what I was driving at 
in asking that question. And it seems that there is--they want 
to make it appear the best and even if it is qualified, there 
still isn't any statements on that. So I would agree with you.
    The other question I have is talking about real time 
disclosures. And it is my understanding that when officers now 
sell stock or purchase--particularly selling their stock, but 
purchasing, that the newspapers do carry that. And I guess I 
would ask this of Mr. Glassman.
    Mr. Glassman. Yes, the way that the current system works is 
that smart CEOs who want to conceal their sales can time it in 
such a way that it doesn't appear for 40 days. And I think 
there is no reason on earth for that. I think that sales and 
purchases of stock by insiders are an important market signal 
that investors should know about. And they should know about it 
the instant that it occurs. And I think the technology is there 
for that happen. And it should happen.
    Ms. Biggert. In the paper, but certainly there has never 
been any education to the public or to anyone that this is an 
important item that maybe as an investor they should be 
watching for.
    Mr. Glassman. Well, there are services that provide this 
information. It can be overrated as an item. There are hundreds 
or thousands of little items that go into making decisions 
about investments. And I think that is one of them. It is not 
dispositive. It doesn't mean that because someone has sold 
stock as an insider that there is something terrible going on 
with the company. But that is a piece of information that 
people should be able to take into account. Right now, frankly, 
they can't.
    Ms. Biggert. So you would agree with the bill then, that it 
should be immediate disclosure?
    Mr. Glassman. Right, what I say in my testimony is actually 
that the disclosure should be faster. The bill allows 
essentially 2 days for the information to get to the public, I 
think it should be 2 minutes.
    Ms. Biggert. And then as far as the restrictions on selling 
stock, the selling in the blackout period for officers should 
be the same as the employees, the restrictions?
    Mr. Glassman. I agree with the blackout period in the 
interest of fairness, even though I understand that there is a 
difference between assets held in the 401K plan and assets held 
outside the plan by executives. But I think this is a hardship, 
if you want to call it that, that executives of corporations 
should endure in the interest of fairness. So, yes, I think 
there should be a blackout period for them too.
    Ms. Biggert. OK, thank you. Thank you, Madam Chairwoman.
    Mrs. Roukema. I thank you. Now, Mr. Kanjorski.
    Mr. Kanjorski. We seem to be talking around the issue in 
terms of what transparency and accountability will do.
    First and foremost, I will tell you what I am disturbed 
about. If you look at the Enron situation, it seems that 
because of the accounting system that was established, there 
was not a clear disclosure of all of these risky transactions 
that were happening. Then, we see that the pension fund was 
heavily invested in its own stock. 401Ks particularly were 
heavily invested by the employees. But also, when you look 
across the country, we have the pension funds, throughout the 
States, the public pension funds and the private pension funds, 
that were heavily directed to one stock. So the loss factors, 
it seemed as a result of the Enron collapse, fell upon people 
who were not in control of their investments. Their investments 
were basically being made by investment companies on Wall 
Street. These companies were deriving profits from the 
transactions on commission basis as opposed to having anything 
at risk. They had nothing to lose, and they could only gain by 
the transactions.
    As we move toward democratic capitalism, and that is what 
we are talking about, we have to recognize, I think, a couple 
of factors. One, a lot of these people do not directly control 
their investments. They are controlled by ``specialists'' who 
reside on Wall Street. Second, they are not the best informed 
investors in the world. Now, unless we develop a system that 
guarantees that we are either going to educate our investors, 
and that is a large mass of new investors, and we are going to 
give them some capacity to directly control their investments, 
they are at risk of these people that did not exercise 
diligence. These people were the 14 out of 15 analysts that 
were calling for purchasing Enron's stock up to a week before 
the collapse. It is ridiculous. All of us are shocked.
    Now, it seems to me that the accounting profession and the 
accounting firm clearly did not follow principles and rules of 
accounting to account for all these risky transactions on the 
book. If they did, they wrote it in such a way, in such 
language, that not even the best Wall Street analyst could 
penetrate the language to understand the risk. So clearly, if 
we do not do something there, this is going to continue in the 
future.
    On the other hand, we run the risk of passing legislation 
very quickly, and then getting the unintended response. I 
understand we are hell-bent on getting this legislation passed 
by Memorial Day, which is shocking to me, because I do not 
think we know the extent of the problem here.
    So maybe any one of the four of you can tell us what you 
think, or tell me what you think this problem really is at this 
point and whether or not the Congress of the United States is 
so able, that it should be able to act in 2 or 3 weeks to solve 
the problem?
    Mr. Glassman. Let me respond quickly. I agree with you that 
this Congress should not be hellbent on finding a solution, 
because we really do not even know all the facts in this case. 
They are just not out yet.
    But I just want to comment very quickly on one of the 
things you said that I completely agree with, and I am glad 
that you brought it up, Congressman, and that is this issue of 
investor education, which I have devoted a good deal of my 
professional life to. The fact is that 50 percent of Americans 
now own stock. It is going to be 60, 70, 80 percent within a 
few years. And that is good. That is good. However, many of 
them really do not understand the basics of investing. And I 
really think that if there is a role, a major role for Congress 
here is in making sure that investors do have that base in 
education. Now in most cases they are going to have to trust 
professionals to make these decisions, these investing 
decisions for them. And most of the time professionals do a 
good job, but they do need that base of education.
    And that to me is one of the most important factors that 
has come out of this Enron case, how little people still 
understand about the basics, such as diversification. That is 
the way to protect yourself against an Enron.
    Mr. Kanjorski. Yes?
    Mr. Lackritz. Mr. Kanjorski, I would like to respond to 
your question too. I think that it is very important to get 
this right rather than necessarily getting it fast. That being 
said, I think there are a number of provisions in this 
legislation that obviously are going to help to improve the 
quality of information in the marketplace, and the real issue 
here is how to improve that quality of information, because 
that is what everything else stems from.
    And then to go on with the other point that Jim Glassman 
raised with respect to investor education, I think that is 
something that both the private sector and our association is 
engaged in in a big way. We are launching an investor education 
website next month that will draw together the best of class 
investment advice, objective investment advice, because there 
is nothing that is being sold on this site. It is going to be 
made available throughout the country.
    And so I think that along those lines, I think some of the 
responses we are making go to that question that you have 
raised as well.
    Mr. White. From our organization, I would be the first to 
say that we do not want to see overreaction either. We are one 
of the groups with significant assets at risk in the financial 
markets. We care more about how they work than any other group. 
But what I would submit to you is that the issues that are on 
the table and all the current forms of legislation and SEC 
Chairman Pitt's proposal and President Bush are not at all 
overreaction. These issues are not brand new. They have been on 
the table for years. The issue of auditor oversight and the 
issue of auditor independence are things that have been fully 
debated in the public.
    We are an end-user of this, and we are completely convinced 
that the measures that are being debated are absolutely 
essential to the capital markets and to our protection as an 
investor.
    Mr. Kanjorski. I am not sure I understand. You think we 
should adopt immediately, before Memorial Day, the Bush 
solutions and then go home?
    Mr. White. No, I am not saying that that should be a 
deadline. But what I am saying is that the issue of 
overreaction is one that we just simply do not agree with. 
These issues are all real. And, yes, let's take the time to 
debate them and discuss them, but I think the comments toward 
overreaction are more geared toward slowing down the process so 
real reform does not take place.
    Mr. Kanjorski. Do you really think that the Congress----
    Mrs. Roukema. Excuse me, excuse me. The 5 minutes are up, 
but will you let the last panelist respond to your first 
question. I do not think you have time for another question.
    Mr. Melancon. Thank you, ma'am. Just a couple of quick 
points. I think, Congressman, the overreaction or the 
unintended consequences is something you should be concerned 
about, because it has a dire concern to us in the financial 
market system. As to the education of people, this Congress 
enacted a tax-free benefit to educating employees on investment 
advice, which was a good first step in this education activity. 
And if you had to focus on one thing that was important to 
changing this whole environment, that is a financial reporting 
model that is not rooted in the 1930s, but is commensurate with 
the world that exists today.
    Mrs. Roukema. I thank you.
    Congressman Shays.
    Mr. Shays. Thank you, Madam Chairwoman. I would like to ask 
Mr. White some questions and preface my statement by the fact 
that in our previous hearings and going over the Powers Report, 
Enron clearly is a story of a tremendous amount of greed. And 
no profession looks good. The accountants do not look good. The 
lawyers do not look good. The analysts do not look good. The 
bankers do not look good. And the investors do not look good 
either, particularly even your organization frankly.
    And I want to ask you about the special purpose entities 
and why you invested in them?
    Mr. White. First off, I am not the best person at CalPERS 
to answer those questions. I will gladly answer what I can and 
if you want further detail, I will be more than happy to 
respond in writing at a later date.
    The two private equity deals that CalPERS did with Enron 
were fundamentally different in their nature than the 
partnerships that got Enron ultimately into trouble. And I 
would note to you that CalPERS declined to invest in those 
relationships after the fundamentals of the investment proposal 
changed. Why there is criticism----
    Mr. Shays. Well, you invested in Jedi One and you invested 
in Jedi Two. And Jedi Two was basically determined to be 
somewhat illegal, wasn't it?
    Mr. White. I do not believe that is accurate, no.
    Mr. Shays. Do you have any expertise to be able to respond 
to us on these issues? What expertise are you bringing here?
    Mr. White. My role is--I am the Director of Corporate 
Governance. The private equity unit in CalPERS is an asset 
class that is headed by a senior investment officer. And those 
questions----
    Mr. Shays. The reason why I thought you were here was that 
basically you were a major player with Enron. Isn't that true? 
Didn't you invest almost $300 million in the first one. And 
almost $500 million in the second?
    Mr. White. Correct.
    Mr. Shays. And what brought Enron down was the fact that 
these special purpose entities were basically hiding their 
liabilities and over-inflating their income. Isn't that true?
    Mr. White. Well, the two partnerships that CalPERS invested 
in, number one, did not have the conflicts of interest that the 
later partnerships, which CalPERS did not invest in had. There 
is a fundamental difference in that. Our organization was not 
interested in participating in those, because we did not like--
--
    Mr. Shays. Were you an investor in the company besides 
having these special purpose entities?
    Mr. White. Correct. We hold common stock in Enron as well 
as----
    Mr. Shays. So you had common stock and yet you were part of 
an operation, all these special purpose entities basically 
enabled the company to get into the fix they were in. And when 
they had to disclose Jedi Two, they basically were disclosing a 
tremendous amount of liabilities that nobody knew. That is what 
basically brought the company down. And that was your 
investment.
    Mr. Glassman, do you have any comment on this?
    Mr. Glassman. Yes, because I think actually the worst thing 
that CalPERS did, which the New York Times revealed on February 
5th, and I mentioned in my oral statement, is that when it was 
alerted about the nature of another one of these special 
purpose entities by its advisors in December 2000, it declined 
to invest in it. As Mr. White said, it did decline. But then it 
did not live up to what I think is its moral and public 
responsibility to bring the matter before the board of Enron. 
And more important I think what I would have done at CalPERS, I 
would have brought it to the attention of the American 
investing public.
    Mr. Shays. Let me ask why----
    Mr. Glassman. And if that had been done, we may have 
learned about this whole Enron situation at least 9 months 
before we ended up learning about it.
    Mr. Shays. Why wasn't that done, Mr. White?
    Mr. White. Again, personally I was not even on staff at the 
time that that happened. But while it is true CalPERS is a 
leading governance organization, and we pride ourselves on 
being an active, involved owner, we cannot read the tea leaves. 
We do not have a crystal ball. While there may have been a 
conflict at Enron, it was impossible for anybody to forecast 
that those conflicts would mushroom into the types of 
relationships and become what is apparently fraud at Enron.
    Mr. Shays. See, I have a different theory and 
unfortunately, you are not--you are saying you are not capable 
of answering. My theory is that basically you were making such 
a great return on the first 22 percent and then you were making 
62 percent on an annualized basis, that you all basically were 
part of the problem like everyone else. You were part of the 
whole thing on greed. It would seem to me that anyone who is 
making 62 percent says, ``Hey, why is this happening?'' And 
when they start to ask the questions, they learn. In your case, 
you learned and then your organization remained silent.
    Mr. White. No, sir, our organization did not invest. The 
types of returns that we made on the partnerships----
    Mr. Shays. Did you invest in Jedi two?
    Mr. White. Correct.
    Mr. Shays. Isn't it true that you had an annualized gain 
through June of 2001 of 62 percent?
    Mr. White. I believe that is accurate.
    Mr. Shays. OK. I mean, when you are getting that kind of 
return, it should tell you a lot of things. And one of the 
things it tells you is maybe this is not happening in a way 
that is credible.
    Mr. White. Well, if I may respond? If your theory about our 
decisions were driven only by greed were correct, then those 
returns would have led us to invest in the next partnerships, 
yet we did not.
    Mr. Shays. No, I think by then people were aware of what 
was going on. I think by then people knew that this was a house 
of cards that was about to collapse.
    Mr. White. I think to the contrary, Enron was only 
beginning to form all of the partnerships that had the terrible 
conflicts of interest that led to the problems, at that point 
in time. You remember this 1996, 1997 era. So at that point in 
time, Enron was not even forming those partnerships.
    Mr. Shays. My time is up.
    Mrs. Roukema. All right, thank you.
    Mr. Sherman.
    Mr. Sherman. Thank you, Madam Chairwoman. I am glad we are 
doing something, hopefully not by Easter, but by the Fourth of 
July. And what we should do is not mere window dressing. We 
cannot just use the bully pulpit of this committee to urge Wall 
Street to all join hands and sing Kumbayah or community values 
are better than greed. Nor can we scream, ``Caveat Emptor'' at 
the investing public.
    I hope very much that we do not introduce ``judgment'' into 
Generally Accepted Accounting Principles to the point where two 
identical companies will be issuing wildly different financial 
statements based on the different styles of the auditors that 
they select, nor can we analogize the conflicts of interest 
faced by an auditor, by that faced by a journalist who might 
happen to vote for Al Gore. The difference between the local 
journalist on the one hand and David Duncan of Arthur Andersen 
on the other is $52 million. Now if there was any journalist 
getting $52 million for himself or his publication, then 
perhaps that would be an equivalent conflict of interest.
    I hope that if we rotate, we will also look at providing 
tenure to auditors. Otherwise if you have a chance of being the 
auditor for 8 years, but you can get fired after 1, then 
perhaps Ken Lay will be able to convince you to go a little 
easy on which special purpose entities you consolidate.
    Mr. Melancon.
    Mr. Melancon. Melancon.
    Mr. Sherman. Melancon. On the wall of my office is the 
AICPA certificate. I hope our colleagues recognize that you are 
a voluntary organization like the ABA. Many CPAs choose not to 
pay you dues. The worst you could do to a CPA is throw him out 
and then he saves the dues. Really the worst you can do though 
is publish rules that if we violate, some lawyer can sue us. 
And it is your rulemaking, not your ability to discipline 
members who after all do not really want to pay your dues 
anyway that is key.
    I think you are wise to bring up the fact that we need not 
only untainted judgment, which is the focus of these hearings, 
but smart investigators. And those two are in conflict. A smart 
investigator would love to be involved in the internal auditing 
because he would learn more about the company or the 
accountants would learn more about the company. But then they 
would get a fee which might taint their judgment. Likewise, 
rotation may reduce the tainted judgment, but might prevent the 
audit from being as effective as it would be because you are in 
a learning curve the first year of an audit. So I would hope 
that we would make sure that auditors remain good investigators 
as well as do everything we can to prevent them from having 
tainted judgment.
    I would like to focus on one area where I think the AICPA--
--
    Mrs. Roukema. Excuse me, Mr. Sherman. I do not know that 
you realize that a vote has been called. So do you want to 
continue this or do you want to recess--do the two votes on the 
floor and then return because your time is almost out?
    Mr. Sherman. Why don't I continue and then we can go vote.
    Mrs. Roukema. Go ahead.
    Mr. Sherman. The one area where I think the AICPA screwed 
up is in allowing Arthur Andersen to adopt a structure where 
the technical review department did not have final authority 
over whether Arthur Andersen signed the financial statements. 
And that is like having a situation where the life insurance 
agent decides whether to insure me for $10 million despite a 
little heart flutter rather than the underwriter back at the 
home office. What we I would hope, and I would like to know if 
you are planning to do this soon, adopt an ethics rule that 
every member of the AICPA must vote within their firm to demand 
that it is the technical review department that makes the 
decision as to whether to sign the audited financial statement. 
Otherwise we are going to be in a situation where the guy whose 
chief job is to go golfing with Ken Lay is the guy that makes 
all the decisions as to whether Arthur Andersen's name appears 
at the bottom of the audit report.
    I would like you to respond.
    Mr. Melancon. Congressman, first off, I appreciate the fact 
that you have the AICPA certificate. And I understand your 
point on that control issue. And I think it is one that is very 
important for us to take a look at. It would be in the issue of 
quality control. It would be in the standards in the SEC PS 
just from a technical standpoint. And I am sure that we will, 
in fact, take a look at that.
    Mr. Sherman. Well, I am sure you are going to look at it. I 
hope that you will call me a month from today and tell me that 
you have decided to change what is a glaring hole in the ethics 
rules that you have control over.
    Mr. Melancon. Thank you, Congressman. I would also say, I 
would agree with you on the issue of discipline and that is why 
we have supported, as I think you have, the notion of an 
enhanced capability of discipline that actually is beyond the 
way you described it from that standpoint.
    Mrs. Roukema. I think we are going to have to recess now 
because the bells have rung. I would just ask the Members to 
please return promptly so that we can continue and conclude 
with this panel.
    Pardon me?
    Mrs. Maloney. Can you tell me who the next questioner is, 
please?
    Mrs. Roukema. Dr. Weldon on our side and you will follow 
that.
    Mrs. Maloney. Very good, I will rush.
    Mrs. Roukema. You are the second one after the recess. All 
right, we will be back shortly.
    [Recess.]
    Chairman Oxley. [Presiding] Come to order. And the Chair 
would recognize the gentleman from New York, Mr. Grucci.
    Mr. Grucci. Thank you, Mr. Chairman. At the risk of 
destroying your name once more, would it be OK if I called you 
Barry?
    Mr. Melancon. That would be great, Congressman.
    Mr. Grucci. Thank you for that. You had in your testimony 
earlier talked about the ability of industry to self-police 
itself. And I concur that industry can do a good job of doing 
that. And you talked about some of the issues that took place, 
some notices in files and people being expelled, and so forth. 
If I was a business and I wanted to know about an accounting 
firm that I was thinking about putting on to give me the types 
of information and look over my books, and contacted your 
operation, if indeed there was a sanction against them, would I 
be able to access that information?
    Mr. Melancon. You would be able to access the results of 
their peer review report and discipline is typically on an 
individual basis, however, Congressman.
    But it is important to make one point on this that I didn't 
get to make on the other, and it is along the lines of your 
questioning. One of the advantages that we have--and we support 
enhanced discipline and an enhanced regulatory body for 
discipline. So we are not opposed to that. But one of the 
advantages that we have is that if a auditor, a partner, a 
public company auditor is alleged to have done something wrong, 
we do not have to--by rule we do not wait until the culmination 
of the investigation. We can require the firm, and we do today, 
require the firm to take that person off of audits. They have a 
choice. They can take the person off audits. They can fire the 
person. Or they can build an infrastructure around the person 
to protect the public in effect without going through the whole 
due process system that would be in a normal Government 
environment. That is a public protection point. It is an 
advantage that we have. Now we have some disadvantages as well.
    Mr. Grucci. But, I guess what I am trying to get to is that 
I would be able to determine as a business owner that a firm 
that I was thinking about hiring indeed had some issues that 
were being addressed by a peer review board of some sort. What 
kind of an effect do you think that that would have?
    Mr. Melancon. You could get their peer review report and 
something called their letter of comments, which is sort of 
like management suggestions and you could have dialogue with 
the firm as to what are they doing to fix those letter of 
comments, if they have any, and you could reach a conclusion 
from that standpoint. All 45,000 firms in the country go 
through a peer review.
    Mr. Grucci. And I would suspect that they don't look 
forward to those types of peer reviews because it could have a 
chilling effect on their business?
    Mr. Melancon. Congressman, firms, first off, invest 
millions and millions and millions of dollars in their systems 
of quality control to avoid failing that process, which is a 
part of the constant improving process that is in place in our 
profession, because failing that process is like putting a gun 
to your head.
    Mr. Grucci. Thank you. I would like to move to Mr. White if 
I may. You represented a pension fund that has $150 billion, 
and I don't know how much of it was invested in any single 
company. I do not wish to drag up the Enron issue. But what I 
do wish to ask you is when you are about to invest parts of 
your pension fund in either a company or in a construction 
project or whatever you may be investing in for the purposes of 
getting a return back for the retirees. What process do you go 
through to make that determination? When I make an investment, 
basically because it is such a small investment on my part, it 
is a gut hunch. Do I think that investment is going to do well 
or not? I would think that you would do more than just a gut 
hunch when you put millions upon millions of dollars of 
retirees' pensions at risk. Could you bring me through the 
process that leads you to your investment decisions?
    Mr. White. Certainly. The bulk of our assets, approximately 
two-thirds, are invested through what we call an index 
strategy, it is a passive strategy. You will find that many 
large institutions use that because it is a cost-effective way 
for us to get equity exposure to the market. We also invest 
through active strategies through both internal programs and 
through external programs. We also have private equity 
partnerships. We also have a real estate program. You will see 
a huge distinction between how institutional investors put 
money out on an index strategy versus an active strategy. For 
the index, if companies are included in the index, by and large 
we are going to hold them.
    Mr. Grucci. Let me try asking this another way, because I 
am not sure I made myself clear to you. When you invest the 
money, is there a criteria that you go through? Is there a 
checklist that you go down? Is there some kind of thought 
process other than, yes, I know that project, it sounds like a 
good one. I think I will put some money in building a shopping 
center or building offices or investing into a corporation. 
What do you do to ensure in your own minds that you have made 
the right decision in investing in that product?
    Mr. White. OK, let me just get to the distinction quicker 
then. Through our active strategies, we do a high level of due 
diligence, that includes the real estate program. It includes 
the private equity program. And it includes the active 
investments on the public market side. Our external managers 
that operate on our behalf, as well as our internal managers, 
do due diligence on company specific. This is fundamental 
research on the things that you are asking about, whether or 
not we feel that a company is under valued or overvalued.
    On the index strategy, again which is the bulk of our 
assets, we are buying the market index. It is an efficient way 
to get exposure to the markets. But what it does is it gives us 
companies in our portfolios that you may not pick through an 
active strategy, companies that are weak. It is one of the 
reasons that CalPERS has such an active corporate governance 
program, is because our size necessitates that we have broad 
equity exposure. We simply could not in a cost-effective way 
make active decisions for a portfolio of our size.
    Mr. Grucci. Thank you and I assume my time has expired. 
Thank you, Mr. Chairman.
    Chairman Oxley. Thank you, Mr. Grucci.
    Mrs. Jones.
    Mrs. Jones. Thank you, Mr. Chairman. When you are doing, 
Mr. White, your active strategy, what do you use--let me be 
just real straight. You rely on an audit to make your decision 
about a company, whether you are going to invest in them, don't 
you, sir?
    Mr. White. Yes, ma'am, we do.
    Mrs. Jones. Thank you. Let me turn to Mr. Glassman. Mr. 
Glassman, tell me what is the American Enterprise Institute, 
sir?
    Mr. Glassman. The American Enterprise Institute is a think-
tank started about 50 or 60 years ago. They have 150 people who 
work there. A think-tank is----
    Mrs. Jones. I know what a think-tank is.
    Mr. Glassman. OK.
    Mrs. Jones. Thanks. Mr. Glassman, what is your area of 
specialty at the Enterprise Institute?
    Mr. Glassman. Economics, finance, markets, although I have 
wide-ranging interests, including education and health care as 
well.
    Mrs. Jones. OK, but you are here based on your economics 
and finance background today, is that correct?
    Mr. Glassman. I think I am mainly here because I have for 
many years written a column about investing that is syndicated, 
it is in The Washington Post.
    Mrs. Jones. Simple answer, Mr. Glassman, you are here 
because of your background or experience in this area. I only 
have 5 minutes. I can't give you a chance to do all you would 
like to do.
    Mr. Glassman. Yes, yes.
    Mrs. Jones. OK, now, would you say that as a result of the 
regulations of the SEC that accountants have a place in the 
process of investment that few other professionals have?
    Mr. Glassman. Yes.
    Mrs. Jones. And as result of that, that puts a greater 
burden upon auditors to be highly ethical in their conduct and 
forthcoming in the work that they do on behalf of companies. Is 
that a fair statement?
    Mr. Glassman. I think it puts a great burden on them, 
greater than corporate executives.
    Mrs. Jones. Well, let me finish. Greater than any other 
profession that is not required by the SEC?
    Mr. Glassman. Quite frankly, I think corporate executive 
boards of directors have enormous responsibility.
    Mrs. Jones. I was not talking--listen to my question.
    Mr. Glassman. Probably greater than accountants.
    Mrs. Jones. Mr. Glassman, listen, my question was with 
regard to accountant----
    Mr. Glassman. Right.
    Mrs. Jones. Professionals dealing with companies, they have 
an unusual placement by the SEC, greater than any other 
professional, I mean a lawyer, I am not talking about the 
people in the business. I am talking about professionals that 
are hired by the company. You don't have to have----
    Mr. Glassman. I don't necessarily agree with that, but 
there certainly is a great burden.
    Mrs. Jones. Well, let me ask you this question. You don't 
have to have a lawyer to allow people to invest in your 
company, do you, sir?
    Mr. Glassman. I think it would be a good--I can't imagine--
--
    Mrs. Jones. I didn't say whether it is a good idea, but you 
are not required by the SEC to have a lawyer?
    Mr. Glassman. I guess not.
    Mrs. Jones. And you are not required to have a doctor?
    Mr. Glassman. No.
    Mrs. Jones. And you are not required to have a 
psychologist?
    Mr. Glassman. Right.
    Mrs. Jones. But you are required to have an accountant who 
is to do the audit. Is that a fair statement?
    Mr. Glassman. Correct.
    Mrs. Jones. I say that to get to the point that you are 
saying that we ought to allow the industry to regulate--the 
market regulation to require--to do compliance in this area, is 
that a fair statement?
    Mr. Glassman. No, it is not a fair statement. I think that 
investors apply--you can call it the market if you want to 
think about it as----
    Mrs. Jones. I got that word from you. I wrote a quote, but 
if you----
    Mr. Glassman. The investors and the market apply a 
tremendous discipline to corporations to behave correctly.
    Mrs. Jones. Who applies the discipline to the auditors?
    Mr. Glassman. To the auditors? Well, let's put it this way. 
Arthur Andersen has just been accused of doing some terrible 
things regarding Enron. It has been fired by some of the 
biggest corporations in America.
    Mrs. Jones. But what does that do for--since you all are 
beating up on CalPERS, claiming they made so much money, what 
does that do for the other smaller public employment retirement 
systems that lost money as a result of the reports or audits 
done by Arthur Andersen that were not factual?
    Mr. Glassman. There is no doubt that among the 8,000 listed 
companies in America some of them misbehave. Now actually Mr. 
White just said something important about indexing. Enron----
    Mrs. Jones. My question is, what does that do for the poor 
people who lost their money as a result of the 
misrepresentation of Arthur Andersen?
    Mr. Glassman. Well, I have to say that the nature of the 
stock market is that you sometimes lose money. And you 
sometimes make money. Dell Computer was up by 7,800 percent.
    Mrs. Jones. OK, that is enough.
    Mr. Glassman. You don't have to turn that money back.
    Mrs. Jones. Let me go back to this. That maybe the nature 
of the stock market that you sometimes lose money and sometimes 
make money.
    Mr. Glassman. Correct.
    Mrs. Jones. But when you invest in the stock market, you 
invest knowing the financial situation of the company, whether 
you win or lose, and you chose to win or lose based on that 
knowledge.
    And I will be done, Mr. Chairman.
    Mr. Glassman. Oh, can I respond? Absolutely.
    Mrs. Jones. Oh, I want you to respond, sir.
    Mr. Glassman. Absolutely, Congresswoman. I think that that 
is true. You either make money or lose money. In the case of 
Enron----
    Mrs. Jones. You said you make money or lose money. My 
statement is you make money or lose money and you invest based 
on the knowledge you have on the financial condition of the 
company. Is that fair?
    Mr. Glassman. There is no doubt about that and that is why 
we are here today. Enron misrepresented its financial 
statements. It is dead as a company. Capital punishment has 
been inflicted on it before it was ever indicted, before 
Congress did anything, before anybody did anything. And that is 
probably true as well----
    Mrs. Jones. But what we are trying to do here today----
    Mr. Glassman. Because of Arthur Andersen.
    Mrs. Jones. Is figure out how we never find ourselves in 
that situation again.
    Mr. Glassman. I realize that.
    Mrs. Jones. And the position that I am trying to get is 
that you have auditors who have a position better than anybody 
else in the investment world and therefore there has to be a 
greater obligation on them to represent the truth.
    And I yield the balance of my time. Thank you.
    Chairman Oxley. Thank you, Ms. Jones.
    Mr. Cantor.
    Mr. Cantor. Thank you, Mr. Chairman. I would like to ask 
Mr. Glassman, in your testimony I think it is fair to say, and 
if not, please correct me, that while you agree with parts of 
the bill, H.R. 3763, you contend it might be too regulatory in 
its approach and sends the wrong message to investors. Can you 
respond to that assertion and perhaps offer some suggestions if 
that is your position?
    Mr. Glassman. Well, it is my position. I think there are 
certain things that should be done that I outlined in my oral 
testimony and my written testimony. I think there should be a 
blackout period. I think there should be stricter 
accountability. I think there should be contemporaneous 
reporting by executives when they buy or sell stocks. But I 
worry about for example the notion that Congress should decide 
the functions that auditors perform within a company. There is 
a good reason why corporations, the biggest and best 
corporations in America, corporations completely beyond 
reproach, and I mentioned some of them earlier, companies like 
Exxon-Mobil and IBM and McDonald's, and I don't want to leave 
anybody out, there is a reason that they pay more in 
proportional sense for non-audit services than audit services 
because they think they are getting good value. And when you 
come in and decide that this not the way that they should be 
doing business, it causes them to incur extra costs, reduces 
their efficiency, and diminishes their profits and therefore 
their value to shareholders. So I think that is a big problem.
    And the second problem is something I alluded to earlier, 
which is that we are telling--in hearings like this sometimes 
people get the wrong message, investors get the wrong message. 
And the message is that the reason that stock prices go down is 
there are all these crooks around who are out to make money and 
do things in nefarious ways and that is why you, the poor 
shareholder, is losing money. That is not why people lose money 
in the stock market in most cases. The reason they lose money 
is because stocks do not go straight up. They never have. About 
one out of every 3 or 4 years, the market as a whole goes down. 
And I think it is very important that investors, that Americans 
understand that and structure their portfolios accordingly. So 
that is basically my point.
    Mr. Cantor. Can you talk about and address the issue of 
repealing litigation reform and say that it would not help 
shareholders. Can you try and address that as well?
    Mr. Glassman. Well, I just, you know, despite litigation 
reform, there have been many, many cases filed, actions taken, 
I cited in my testimony the Cendant case in which Cendant paid 
$2.8 billion to settle a shareholder's suit. The accounting 
firm that was involved paid $330 million. Lots of money has 
been spent to settle suits since this law was passed. And some 
in Congress are pointing to this law as a reason for the Enron 
scandal itself, and I am just saying that it is not and I don't 
think that law needs to be revised. And I think if anything, 
the bar ought to be raised, because the law still makes it so 
easy to sue companies that really are not doing anything wrong 
in many cases. In some cases they are, and I think it is good 
that they are sued and they ought to pay for it. However, it 
does distract executives and causes money that shareholders--
shareholder assets get paid out in these lawsuits. It hurts 
shareholders.
    Mr. Cantor. Thank you, Mr. Chairman. I yield back.
    Chairman Oxley. Ms. Waters.
    Ms. Waters. Thank you very much.
    Mr. White from CalPERS, how much did we lose with our Enron 
investments in California?
    Mr. White. At CalPERS, I can speak for CalPERS, we still 
have assets at risk. As it stands right now, we have total 
losses based on the book value of approximately $9 million. But 
we still have private equity assets that are what I would say 
at risk. We do not know how much of that we will be able to 
recover.
    Ms. Waters. Thank you very much. I have a million questions 
I could ask, but I chose to use this time to distinguish 
between the thinking of American Enterprise Institute as 
represented here by Mr. Glassman and the more conservative 
thought in America politically. I am a Democrat. I am a liberal 
Democrat. I believe in the body of law that we have developed 
in this Nation to protect consumers. I do not take the position 
that they ought to know better. They ought to be smart enough. 
We have consumer law that is developed in so many ways. For 
example, maybe people should know the difference between bad 
meat and good meat. But we do not leave it to them. We have 
meat inspections. Maybe people should know how to protect 
themselves against dirty water. But we have laws to ensure that 
we have clean water. Maybe people should know the difference 
between big banks and financial institutions that do predatory 
lending and all of that and insurance companies, but we do not 
just leave it to them. We believe that Government has a role in 
helping to protect the least of these or the average consumer. 
And perhaps we should not have any building and safety laws, 
because people ought to know when they contract with someone to 
build a building, that they are just going to do the right 
thing.
    That is where you and I differ. That is the difference 
between your conservative thought and my more liberal thought. 
We believe that Government must play an important role in 
protecting consumers. And when we find that Government is 
intruding unnecessarily, we should stand up for that also.
    To assume that somehow because Enron has been caught and it 
is going to have to pay a price that the market is working fine 
and we should not worry about having to come up with new law by 
which to deal with the problems that have surfaced. However, 
how many people have to be hurt? You talk about the biggest and 
the best corporations in America. Enron was considered the 
biggest and the best. It even got an award for being the best. 
Enron enjoyed close relationships with the President of the 
United States and Members of Congress and they gave out lots of 
money. They were all at the best parties. They said the right 
things. It was considered one of the biggest and the best.
    If you are saying do not get involved in creating new law 
or getting overly involved in this because it is all right now, 
they are going to be punished, what do you say to the 
pensioners who had their life savings in that 401K that was 
managed by Enron that helped to make them feel comfortable in 
putting their funds into the company stock? What do you say to 
the person who had no more than $300,000 or $400,000 to live 
with for the rest of their lives once they retired? Don't 
worry. Don't worry. If another company does something bad, we 
will catch them. The marketplace will work.
    No, the political difference and the philosophy that is so 
different here is that some of us no matter what you say about 
the fact that they will have to pay a price, we come at this 
differently and we say we should not allow people to get harmed 
time and time again, because eventually the thieves will get 
caught and the big corporations may come down. Just do not 
bother with trying to create a body of law that will prevent 
it.
    Well, I want you to know we disagree with you, Mr. 
Glassman. And we do not think for one minute that the fact that 
Enron is going to have to pay a price that that is enough. We 
think that we should use the power that the people have given 
us to legislate, to prevent this kind of catastrophe from ever 
happening again.
    And so instead of asking you a question, I just want to 
help people to understand the difference in your thinking and 
someone like me, my thinking. And probably conservatives versus 
so-called liberals. We are people who believe that Government 
must play a role in protecting folks. If you say don't they 
know they should diversify, don't they know that the stock 
market is cyclical and that it changes and they should be aware 
of that, no, we do not take it for granted that they know. And 
that is why we are going to protect social security from being 
privatized and leaving retirees out there at the mercy of the 
suede shoe boys who would take their money and do whatever at 
the time they can do with it and leave them penniless.
    So without having any questions to you, I hope that the 
students around the country are listening to this so that we 
can help them to understand the difference between the 
conservative thought that comes out of the American Enterprise 
Institute and the thought of us liberals about consumerism and 
how we use our role in Congress to protect folks who some 
people think ought to know better, but maybe they don't.
    Thank you very much.
    Chairman Oxley. The gentlelady's time has expired. And I 
would like to start a short second round, and say to a great 
extent there are elements of Ms. Waters' comments with which I 
agree. Just because a corporation is large, just because it has 
been successful, just because it is well regarded does not 
necessarily mean that it is not subject to failure nor 
criticism nor that regulatory changes are in order. I would 
welcome her participation with regard to the GSEs in that 
regard.
    I would also say that----
    Ms. Waters. You got it.
    Chairman Oxley. I would also say that despite the fact we 
suffered great loss on 9-11 and that we have suffered another 
great loss with the demise of a Fortune 50 corporation, that 
the markets have remained extraordinarily responsive and 
appropriately balanced to these difficult times. Investors, 
although guardedly, are still investing their money in the 
greatest capitalist system in the world and our profiting from 
it.
    Now should we prohibit the blue suede shoe guys from 
getting involved in the pension funds of social security is 
another issue. Should we relegate the American taxpayer to a 
2.3 percent rate of return simply because we do not want to 
allow them inside the corporate boardroom? I don't think so. 
There is balance here to be obtained. I think the balance is 
appropriate oversight to catch the wrongdoers and create an 
environment in which there are penalties for inappropriate, 
unprofessional, irresponsible behavior. And I also agree that 
the rules of 1930 do not fit 2002 and they need to be 
revisited, rewritten, and made appropriately responsive for the 
environment in which we find ourselves.
    I do not however think it is advisable to have the Unite 
States postal system making corporate decisions for the rest of 
the world. And that the role for Government, from a 
conservative perspective, is to get out of the way and let free 
markets make appropriate decisions to provide for a competitive 
environment where you have the most number of products provided 
at the cheapest price so that consumers can make the best 
choice for their families and not be told by the Government 
they are too stupid to make their own investments.
    Somewhere between the chasm that has been created by Ms. 
Waters and myself there is an appropriate balance that I hope 
this committee will reach. And for all those students who are 
listening here today, I hope they take a well-advised approach 
in looking at both the alternatives presented in the committee 
today.
    Thank you very much.
    Mr. LaFalce.
    Mr. LaFalce. Mr. Chairman, may I just point out between the 
extreme that you pose and the extreme that Ms. Waters pose is 
my middle ground bill.
    [Laughter.]
    And I am glad in trying to reach common ground you have now 
endorsed it. At least that is one spin that I could put at it.
    Just a few comments, because I do want to get on to the 
second panel and when I am Chairman we will only have one panel 
per day for a hearing so they don't have to stick around 
forever and lose all the members. I don't know when that day is 
going to come, but if it does.
    Let me just make a few points. Mr. Lackritz, and we go back 
a long time, and I have the highest regard for you and your 
profession. But if I were to single out anybody where we need 
to focus, it is the securities analysts. And I do not mean that 
in a punitive sense at all. But we have got to improve the 
quality of analysis. And you have got to work on some 
mechanisms to compensate analysts based upon the quality of 
their research. And there has got to be much better peer review 
and we have got to withstand the pressure to get on a bandwagon 
and hype stocks. And you and your organization and the NASD are 
better equipped to do that than the Congress, but that is a 
heavy, heavy responsibility and you have to be really zealous 
in going after it. And we will try to watch over your shoulder 
and assist you in that effort, OK. Sure.
    Mr. Lackritz. Mr. LaFalce, I think we agree with what you 
said and I think given the hearings that Congressman Baker 
initiated last year and the process that he initiated----
    Mr. LaFalce. Yes, his hearings were terrific.
    Mr. Lackritz. We have made a lot of strides.
    Mr. LaFalce. And you have made strides. You have made 
strides. We cannot undo the damage, but we can try to prevent 
future damage.
    And speaking of undoing the damage, Mr. Glassman, you point 
out the settlements. The difficulty is most of those 
settlements have been for pennies on the dollars that have been 
lost because of the wrongdoing. And I am not talking about 
honest--I am talking about the wrongdoing. And so the 
individuals who have aggrieved have not been made whole even 
when there has been a successful lawsuit and a so-called 
settlement. And we want to prevent that, especially given the 
evolution of people's financial habits and corporate habits. 
What do I mean? Well, 20 or 30 years or so ago, if you were 
fortunate enough to have a pension plan, you had two-thirds 
probability of having a defined benefit plan. Today, a smaller 
percentage of Americans have pension plans and of those who do, 
two-thirds are in defined contributions. And a corollary of 
that and an outgrowth of that in part has been the fact that 
only a small handful of Americans invested in their publicly 
traded securities decades ago, today a good preponderance do. 
So an awful lot more people have an awful lot more of their 
wealth in the markets, and we need to be more zealous and our 
laws have to be better, our regulation and our oversight needs 
to be better.
    It is going to be difficult to make the people whole. They 
have been injured. I don't know that we can, but we have to try 
to prevent other people from being injured in the future.
    And Mr. Melancon.
    Mr. Melancon. Melancon.
    Mr. LaFalce. Melancon. I am very concerned about a number 
of things. I do not want the accounting profession to take an 
unfair wrap, but clearly there have been some inappropriate 
actions, negligence, recklessness, and you have to see this in 
perspective. There are an awful lot of accounting firms. There 
is a Big Five right now and then thousands of others that are 
much smaller and they range from $1 billion dollar to $100,000 
accounting firms in revenues. And I know you are responsible 
for them all. I don't want to see an Arthur Andersen go under. 
They have got 85,000 employees. I spent money with the chairman 
of the board of Eastman Kodak, which has so many employees in 
my district, well, Eastman Kodak is far smaller than Arthur 
Andersen. That is how big Arthur Andersen is. And I don't want 
to see a Big Five go to a big four because I don't think the 
country would be well-served. I like when we had a big eight. I 
don't think we are going to be able to revisit those days. But 
I am very worried, if you only have four or five that could do 
the major corporations in any event, those that are global in 
nature, and increasingly even small companies are global in 
nature, you have some real problems in the marketplace because 
you don't have the type of competition that you do need.
    And so we need to do something, with all due deference to 
the 99 percent of accountants who are always doing the very, 
very best they can, that small percentage can wreak havoc with 
the marketplace. And while the marketplace may correct, the 
damage done by that 1 percent is not self-corrective and it 
does not prevent future abuses. So we need to work together. 
And I just don't think will ever be able to rely on accountants 
watching accountants again. I just don't think that is going to 
sell to either Democrats or Republicans. I could be mistaken.
    I think we need a stronger oversight board. We can argue 
about who should be on that oversight board. My preference is 
to have representatives of investors and institutional 
investors such as private employees pension funds, public 
employee pension funds, Council of Institutional Investors 
because I think they are more likely to be zealous in 
overseeing it. And that is probably the most, single most 
important provision within my bill or maybe anybody's bill I 
think to restore confidence and integrity in the markets.
    With respect to each of the other provisions, we will 
dialogue on them. I thank you.
    Chairman Oxley. Thank you, Mr. LaFalce. I would like to 
express appreciation to the panelists for their participation 
and helpful remarks today, particularly you, Mr. Melancon, for 
the many names that you were called during the course of the 
day. But as I have explained your good humor to other Members, 
guys from Louisiana are accustomed to being called a lot of 
things.
    To all of the panelists, our appreciation. I would like to 
have the second panel.
    I am sorry, I did not know you had an interest.
    Mrs. Tubbs Jones.
    Mrs. Jones. Thank you, Mr. Chairman. I have a couple of 
questions. Well, I am going to ask a question and then make a 
quick statement.
    Mr. Lackritz, what is your position with regard to the 
provision that would limit--put a 4-year limitation on the use 
of an auditor for purposes of preparing an audit?
    Mr. Lackritz. You mean the term limits?
    Mrs. Jones. Yes.
    Mr. Lackritz. On auditors?
    Mrs. Jones. Yes, like the people running for public office, 
yes.
    Mr. Lackritz. We have not taken a specific position on that 
provision. What we are concerned about primarily is improving 
the quality of the information and so we don't have a specific 
position on that.
    Mrs. Jones. Mr. Glassman, what is your position?
    Mr. Glassman. I am against term limits in all their forms, 
including for Members of Congress.
    Mrs. Jones. What do you that think term limits will do in 
terms of the support or the ability of an auditor to do his or 
her job?
    Mr. Glassman. I think it will add to confusion if there is 
a term limit. I just do not see the necessity for it. I think 
companies can do a very good job on their own deciding how long 
the tenure of their accounting firm ought to be.
    Mrs. Jones. Knowing the public's discomfort with auditors 
right now, let me put this question to Mr. Melancon, even if 
you do not support the term limits, sir, what do you do to 
increase the public's confidence in your profession?
    Mr. Melancon. Well, first off, public confidence is 
critically important and I would agree with your focus in that 
area. We have supported a board that has greater capabilities 
in enforcement and in quality control areas so we would support 
that. We think that that would be a very positive step.
    The problem with rotation, ma'am, is that as Mr. LaFalce 
just pointed out, there are huge capacity issues and there are 
going to be disruption issues. And if you are looking at 17,000 
public companies on an annual basis, 3,400 or so would be 
changing auditors, there would be a tremendous inefficiency to 
mandate that.
    CalPERS has a situation where they voluntarily do that. 
They want to do that. That is part of their corporate 
governance. That is part of the free market system. And we 
think that audit committees ought to review that relationship. 
And the other thing that I would say is that we have supported 
is that the audit committee, representing the shareholders, 
ought to be the one that hires and fires the auditor.
    Mrs. Jones. Let me close with this, Mr. Chairman. I had an 
opportunity about 2 weeks ago to speak to a class at the 
Wutherhead School of Management at Case Western Reserve 
University. These were first year students working on their 
Master's degrees and they were just full of questioning about 
what is Congress going to do about Enron and so forth and so 
on. I went through some of the things that were being 
presented. But what I tried to weigh upon each and every one of 
those students, and I call upon each of you when you give 
testimony, is to help young people in every profession to 
understand the importance of character and good worth and 
loyalty and all the things that I don't care how much 
regulation we do in any of our professions we are not going to 
take care of.
    I feel obligated as Member of Congress sent here by the 
people of the City of Cleveland and the surrounding communities 
to put forth some legislation that will deal with some of the 
issues that Enron brought forward. But I am constantly trying 
to say, and I come from having been a judge, an elected 
prosecutor, I serve on the Ethics Committee, I have done a lot 
of things like that, to say we have got to teach young people 
what it means to have character and honor. And if you don't do 
it, I don't know who else will. Those of you sitting in the 
profession.
    I yield the balance of my time, Mr. Chairman. And I thank 
each of you for coming here this afternoon.
    Chairman Oxley. Again, I thank you gentlemen and appreciate 
your participation. The record will remain open if other 
Members have additional questions as a follow-up.
    Thank you very much.
    And we do appreciate your patience in participating in this 
important hearing. We have the Honorable Roderick M. Hills, 
former Chairman of the Securities and Exchange Commission; Ms. 
Barbara Roper, Director of Investor Protection, Consumer 
Federation of America; and Mr. Lynn Turner, Director, Center 
for Quality for Financial Reporting.
    Welcome. Please proceed. Your statements will be 
incorporated as part of the record. Feel free to summarize.
    And, Mr. Hills, we are glad to have you with us today, sir.

     STATEMENT OF HON. RODERICK M. HILLS, FORMER CHAIRMAN, 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Hills. Thank you, Mr. Chairman and Mr. LaFalce.
    It should be clear that the accounting embarrassments of 
Waste Management, Enron, Global Crossing, to name a few, means 
that we have serious weaknesses in our accounting profession 
and in our regulatory system. We have had them before. In the 
middle 1970s, the Securities and Exchange Commission compelled 
400-plus companies to disclose that they had bribed foreign 
officials or made questionable payments to them. At that time, 
the SEC stimulated the New York Stock Exchange to require 
outside audit committees as a condition of listing. We 
strengthened the responsibilities of auditors and we required 
internal controls for the first time. As we deal with the 
weaknesses in the system, I would hope that we could build upon 
the foundation laid back then.
    What are the weaknesses?
    First, the overall system, as many have said, is very old, 
it is almost 70 years old. Almost anything 70 years old gets a 
little creaky. It needs a major overhaul.
    Second, it has become increasingly clear that some audit 
partners are not going to be able to consistently resist the 
management pressures to allow questionable accounting policies 
or incomplete financial statements.
    And, finally, the audit committees of far too many boards 
are just not exercising the authority that has been given them.
    H.R. 3763 has the prospect of making significant 
improvements in all three areas.
    Criticism of the regulatory system really has two aspects. 
The audit has become a commodity. The CEO sees no value added. 
The accountants compete on the basis of price, not on quality. 
Auditors are not chosen for their judgment. They have become 
rule checkers and we have too many rules. They have allowed the 
implication that if something is not prohibited, it is 
therefore permitted.
    The traditional auditor statement says: ``In our opinion, 
the financial statements prepared by management fairly present 
in all material respects the financial position of the 
company.'' That suggests judgment. That is not what they mean. 
What they mean is we have found no material violation of the 
laws.
    Section 6 of the bill would cause both management and 
auditors to use considerable judgment in deciding what the key 
accounting principles are that affect the financial position of 
the company, whether for good or for bad.
    Let me turn briefly to FASB, the Financial Accounting 
Standards Board.
    Paul Brown of the accounting department of NYU summed up 
the role of FASB pretty well. He said, ``It is an old adage of 
a FASB rule. It takes 4 years to write it. It takes 4 minutes 
for an astute investment banker to get around it.'' The 
proposed bill does not deal specifically with FASB, and I would 
suggest the committee may wish to put in Section 9 that 
somebody review it.
    Turning to the profession. In addition to its other 
problems, the accounting profession is not able to get the 
talent that it needs. Twenty years ago, some 25 percent more 
people were entering the profession. Twenty years ago the 
leading business schools, Stanford, Wharton, Michigan, sent a 
substantial percentage of their graduates to the accounting 
profession. They do not go there anymore. And yet today, the 
Big Five are hiring far more people than they hired before.
    This difficulty of finding top-notch personnel, the 
difficulty of finding a precise rule to deal with an ingenious 
corporate structure designed by Wall Street, and perhaps above 
all, the pressing financial need to keep a client. Too often, 
as I said before, it allows a questionable accounting policy to 
slip by.
    Section 3 of the bill will provide some deterrent to 
zealous management people to try to influence the auditors. But 
auditors will not have the freedom unless the freedom is given 
to them, the independence is given to them by the audit 
committees.
    Section 2 of the bill restricts the ability of auditors to 
provide some services to their audit clients. To the extent 
that it deals with financial system design, I think it is 
constructive. I do believe however that an absolute prohibition 
against the internal audit is both unwise and unpractical. I 
have set forth in my written statement some reasons for that.
    The SEC rules now permit an external auditor to do 40 
percent of the internal audit. As long as there is a strong 
independent audit function, it seems to me that the SEC rule is 
better than an absolute ban.
    The audit committee. The primary responsibility of the 
audit committee is to protect the auditor. Unfortunately, CEOs 
too often appoint the members to the board and therefore decide 
who is going to be on the audit committee and selects the chair 
of the audit committee. The audit committee members seldom ask 
the auditors if there is a better way to make the financial 
presentation that has been designed by the company. In other 
words, is there a better way to do it?
    The audit committee seldom plays any role of significance 
in the selection either of the auditors or the selection of the 
audit partner. In short, they seldom establish themselves as 
the party in charge of the audit, and they do not establish 
themselves as the party in charge of retaining the auditor.
    Section 9 of the bill asked the President's working group 
to decide whether or not the Commission should establish the 
duties of the audit committee. I think that is appropriate. But 
I suggest that the committee may wish to be a bit more specific 
about what the responsibilities of the audit committee should 
be.
    After 25 years, I think the audit committee deserves a 
legal status. It has been ambiguous. I suggest first of all 
that the SEC by a simple speech could say that the failure to 
have a competent, independent audit committee constitutes a 
material weakness in the internal controls of the company. That 
status would be obtained if the SEC would say it.
    The SEC could also make clear, as could this committee, 
that the failure to have an independent nominating committee is 
absolutely necessary to having an independent audit committee. 
Who is going to put the members on the committee? Who is going 
to select the chair? Who is going to evaluate their 
performance?
    And, finally, the SEC can make it clear and this committee 
can make it clear that the audit committee's single most 
important task is to make the auditor believe that its 
retention depends solely upon the discretion of the audit 
committee.
    In conclusion, Mr. Chairman, the Enron debacle is 
emblematic of weaknesses in the regulatory system. Andersen is 
in the headlines, but they all have the same problem. Andersen 
and the other firms are not blameless, but they are not 
entirely to blame. The profession has real problems because of 
a system that they cannot change by themselves.
    Thank you very much.
    [The prepared statement of Hon. Roderick M. Hills can be 
found on page 210 in the appendix.]
    Mr. Baker. [Presiding] Thank you, Mr. Hills.
    At this time I would like to recognize Ms. Barbara Roper, 
Director of Investor Protection, Consumer Federation of 
America. Welcome.

 STATEMENT OF BARBARA ROPER, DIRECTOR OF INVESTOR PROTECTION, 
                 CONSUMER FEDERATION OF AMERICA

    Ms. Roper. Thank you. I would like to thank the committee 
for inviting me to testify today. I am testifying on behalf of 
both Consumer Federation of America and Consumer's Union.
    Because of the central importance of the outside audit in 
keeping company managers honest, our organizations believe the 
two most important things Congress can and must do to restore 
investor confidence in the reliability of corporate disclosures 
is to first and foremost restore real independence to the 
independent audit and second to provide effective oversight of 
auditors.
    This legislation tackles both of those issues and for that 
reason we congratulate you. However, because it fails to deal 
adequately with the central issue of auditor independence and 
because it does not do enough to guarantee the effectiveness 
and independence of the regulatory body it creates, H.R. 3763 
does not provide the comprehensive strong reforms that we 
believe the current crisis demands.
    Because of time limits I am going to focus exclusively on 
these two aspects of the bill in my oral testimony. My written 
testimony discusses the broader provisions of the legislation.
    Unless the auditor is independent, unless he or she is free 
of bias, brings an appropriate level of professional skepticism 
to the task and feels free to challenge management decisions, 
the audit has no more value than if the company were allowed to 
certify its own books. Unfortunately, in recent years auditors 
have been unwilling to adopt the total independence that this 
essential watchdog function demands.
    To increase auditor independence, this legislation directs 
the SEC to adopt a rule prohibiting auditors from providing 
internal audit and financial information system design and 
implementation to their audit clients. In doing so, it simply 
codifies steps that the major accounting firms have said they 
plan to adopt voluntarily. While there is certainly a benefit 
to having these restrictions written into the rule book to 
prevent backsliding once attention has turned elsewhere, we 
believe more is needed. Specifically, we support a broad ban on 
the provision of non-audit services to audit clients. Certain 
services could be exempt on a case by case basis, but only if 
they benefit investors and only if they are directly and 
separately approved by the audit committee of the board.
    Furthermore, we believe Congress must look beyond the issue 
of consulting services in dealing with auditor independence. 
After all the lack of independence starts with the fact that 
auditors are hired, paid, and fired by the audit client. This 
gives them considerable potential influence over the audit. We 
believe one way to limit that influence is to require mandatory 
periodic rotation of auditors. The basic reasoning behind this 
approach is that it is far easier for an auditor to challenge 
management and risk losing an audit client if they know the 
audit engagement is only temporary.
    Another problem that in our view clearly needs to be 
addressed is the revolving door that all too often exists 
between auditors and their audit clients. And that is why we 
also support a cooling off period for auditors before they 
could seek or accept employment at an audit client.
    While Congressman LaFalce's bill, H.R. 3818, does not ban 
all non-audit services, it contains most of what we believe is 
necessary to restore a reasonable level of independence to the 
independent audit.
    H.R. 3763 is, in our view, stronger on the issue of auditor 
oversight than it is on auditor independence. At its heart is a 
requirement that all accountants who audit publicly traded 
companies belong to a newly created professional regulatory 
body with oversight and investigatory powers. We believe that 
an independent regulator subject to SEC oversight could 
significantly improve the regulation of the accounting 
industry. To do so however it must be completely independent of 
the accounting industry, be adequately funded, have extensive 
rulemaking and standard setting authority and be endowed with 
strong investigative and enforcement powers.
    The bill takes important steps in this direction. 
Unfortunately, much of the language in H.R. 3763 is simply too 
vague to ensure that these essential standards for effective 
oversight will be met.
    The Enron collapse has understandably shaken investor 
confidence in the safeguards our financial system provides to 
keep company management honest. Only a comprehensive package of 
reforms with strong auditor independence and oversight at its 
heart will restore that confidence. If it were strengthened in 
these key areas, H.R. 3763 could provide the framework for 
meaningful reform. Without these changes, many of which can be 
found in H.R. 3818, fundamental problems will persist and 
investor distrust of corporate disclosures will remain.
    Once again, I want to thank you for inviting me to appear 
today.
    [The prepared statement of Barbara Roper can be found on 
page 266 in the appendix.]
    Mr. Baker. Thank you.
    The Chair now recognizes Mr. Lynn Turner, Director of the 
Center for Quality Financial Reporting. Welcome.

    STATEMENT OF LYNN TURNER, DIRECTOR, CENTER FOR QUALITY 
                      FINANCIAL REPORTING

    Mr. Turner. I would like to thank Chairman Oxley and 
Congressman LaFalce and Members of the committee, including the 
one remaining Member of the committee, for inviting me here to 
speak today. My comments today do draw upon my past experience 
as an auditor, a business executive, a regulator and an 
educator.
    I commend Chairman Oxley, Ranking Member LaFalce, and 
Congressmen Baker and Kanjorski for their respective efforts in 
raising red flags with respect to leaks in our system before 
Enron struck the iceberg. But now that we have a sunken ship, 
we need to ensure adequate reforms are made in a timely fashion 
to protect investors. After tens if not hundreds of billions in 
losses, we must stop the damage to capital markets and 
investors.
    As described in further detail in my written statement, 
reforms set forth in the proposed legislation and the following 
testimony will be even more critical if the Big Five turn into 
the Final Four. It is in the best interest of both the business 
community and the profession if Andersen continues as a 
separate firm. If we end up with just four firms and there is 
another disaster, our current system of public audits will 
quite frankly no longer be a viable system. American investors 
will then rightly ask Congress why was it not fixed after 
Enron?
    The independent and oversight committee of Andersen chaired 
by former Federal Reserve Chairman Paul Volcker has said the 
problems facing accountants today are profession wide and not 
just an Andersen issue. I agree with their conclusion. Those 
changes made by Andersen and/or the oversight board should 
receive serious consideration by the committee.
    H.R. 3763 does encompass some of the changes that will 
enhance the current financial disclosure system. But as I will 
describe later, there are additional reforms required that are 
addressed in Congressman LaFalce's bill, H.R. 3818, that need 
to be enacted. While I may quibble with certain sections or 
have minor quibbles with certain sections, I think it--that 
bill has my wholehearted support and I think it will move 
things along a long way.
    Key elements of H.R. 3763 include:
    The establishment of a public regulatory oversight board 
for the accounting profession under the oversight of the SEC, 
making it unlawful for company executives or directors to 
willfully and improperly influence, coerce, manipulate or 
mislead the auditor; requiring more timely disclosure of 
financial information provided all investors receive such 
information consistent with the current requirements of 
Regulation FD; and real time electronic disclosure of insider 
transactions.
    Certain improvements to H.R. 3763, many of which are set 
forth in Congressman LaFalce's bill, would provide greater 
protection for the investing public. These improvements 
include:
    Providing the PRO with greater authority and powers along 
the lines of what are outlined in my written testimony, 
including a public board, as Congressman LaFalce earlier 
described, made up of members from the public; enhancing 
auditors' independence by including all the original provisions 
of the SEC's rule proposal rather than just those the 
accounting firms have already quite frankly agreed to. There 
should be both mandatory retention and mandatory rotation of 
auditors.
    Modifying the bill to require the SEC--or modifying the 
bill to require the SEC to modify its rules in the event that 
FASB does not complete the task in a timely manner. I strongly 
oppose congressional influence over and legislation of 
accounting standards. It has directly contributed to less 
transparency in accounting for stock options and some of the 
problems we have today.
    Adding a statutory requirement that CEOs and CFOs provide a 
statement to their shareholders vouching for the full and fair 
disclosure of a company's public disclosures and consistent 
with legislation previously enacted by this committee, Section 
36 of the Federal Deposit Insurance Corporation Improvement Act 
of 1991 include a report on management's responsibility for 
internal controls and laws and regulations and the 
effectiveness of those controls accompanied by an independent 
accountant's report provide the necessary appropriations for 
the SEC, including a provision for adequate staffing and 
technology resources to undertake the mandated review 
requirements. In that regard, I strongly support the funding 
and risk rating system proposed in H.R. 3818, enhancing the 
independence and oversight of corporate boards.
    In general, I believe the PRO proposed in H.R. 3763, while 
a step in the right direction, does not advance the ball 
sufficiently down the court to score. As my dad always taught 
me, if something is worth doing, it is worth doing right the 
first time.
    Let me close by noting that many of the issues being 
debated today are not new. They were raised again and again 
during congressional hearings in the 1970s and in the 1980s.
    [The prepared statement of Lynn Turner can be found on page 
274 in the appendix.]
    Mr. Baker. Thank you, Mr. Turner.
    Mr. Hills, I would like to address the first question to 
you. In view of your extensive experience not only as Chairman 
of the SEC, but your extensive board experience, can you tell 
the committee a little bit about what you view the role of the 
audit committee should be in specificity? What makes a good 
audit committee and what should they be doing?
    Mr. Hills. They should initially take charge of the audit 
and that is a simple thing to do. If the auditors know that you 
are in charge, they will know it. The audit committee should be 
in charge of the fee negotiations. In my experience of seeing 
any audit committee for the first time and hearing of other 
audit committees, they often think their highest role is to 
reduce the audit fee by 5 percent. They seldom ask what could 
you do if we gave you $100,000 more?
    Let me just speak quickly about the subject of 
independence. We all talk about objective independence. That is 
one dimension. But the auditor independence has three 
dimensions. Objective independence means how many times do you 
play golf with the CEO? And that is easy to determine. The 
second dimension is the audit committee has to understand for 
itself what it needs to know about the company. You cannot just 
sit there passively and hear what is told you. You need to go 
out. Whether you call it financial expertise or commonsense, 
you need to figure out what you need to understand that 
company. And that takes a second dimension.
    And, third, you have got to confer that independence upon 
the auditor. They have to know that you are in charge of their 
fee. They have to know that you will be there to mediate the 
disputes. They need to know that they have to come to you 
first.
    Let me give you an example. At Waste Management we wrote 
off $3.5 billion in 6 months. The audit committee had not seen 
a management letter in 5 years, and yet the auditors had given 
the management a treaty of 12 items, 12 significant items, you 
have got to change those things. Nobody told the audit 
committee. Well, who do you blame? I think you cannot 
understand fully the fragility of the auditor, who is about 55 
years of age. If he loses that account, he is out of there. And 
so the most important thing for the audit committee is to 
confer that independence upon the auditor.
    Mr. Baker. Ms. Roper, I would like to ask you to turn again 
to this issue of auditor independence, and I think that we are 
in agreement that Congress should not politicize and legislate 
accounting standards. But when you get to talking about 
standards of independence, I believe that you have suggested 
that Congress get involved in that area beyond what even the 
SEC has recommended. And so can you explain to the committee, 
this difference in your opinion on these two issues?
    Ms. Roper. The only reason to have an audit and to impose 
that expense on companies is if it is independent. If it is not 
independent, it does not serve its mandated function to provide 
outside expertise. And we believe that people respond to 
financial incentives. And in the area of audits right now we 
have the worst possible combination. We have financial 
incentives that at least up to a point favor doing the wrong 
thing. The money is in consulting. The glamor is in consultant. 
If you are too tough on the audit, you could lose the 
consulting contract. If you are too tough on the audit, you 
could lose the audit fee and not this year's audit fee but, 
because of the low turnover, an endless stream of future audit 
fees.
    And so we have, as I say, financial incentives that benefit 
the firm if they do the wrong thing, and we have no real 
regulatory oversight to punish them in those instances. We 
think regulation only works effectively when the financial 
incentives are not stacked too strongly against it. But if you 
have a system of regulation that is imposed on a system where 
the financial incentives work the other way, that regulators 
are always swimming upstream, always cleaning up messes after 
they have been made.
    And our view on auditor independence derives from the 
Supreme Court's statement that the public watchdog function 
that auditors perform demands total independence. And so if we 
are going to have a law that mandates that the audit be 
conducted, and if its only value is independence, then I think 
it is absolutely appropriate for the laws to specify what it 
takes to be independent. And I think it is necessary because 
the necessary has not accepted that responsibility that goes 
with performing that function.
    In the area of writing accounting rules, we have decided, 
rightly or wrongly, to delegate that to a provide standard-
setting body. And we believe that more needs to be done to 
enhance the independence of that body as well, because our 
experience has taught us in following some of the rules that 
they put forward that if they contemplate a rule that will be 
opposed by big business and will also be opposed by the 
accounting firms, they know they have years of opposition in 
front of them and that those constituents will go to Members of 
Congress and that they will in turn face threats to their role 
as a private standard-setting body.
    And so we do believe that that process should be 
politicized, not that Members of Congress don't have an 
absolutely appropriate way to play in commenting on rules if 
they have a direct interest in them, but that a group cannot 
maintain its independence if it feels that its very existence 
as a standards-setting body will be threatened if it does 
anything controversial. And I think you have to look at one of 
the reasons we do not have comprehensive rules on special 
purpose entities is that FASB knew that if they tackled that 
issue, that they would be running into even more opposition 
than they have run into on their rules on hedging practices or 
stock options disclosures.
    So if we are concerned that we do not have adequate rules 
in this area, I think we have to look at some of the reasons 
why we don't have those adequate rules. And I think the lack of 
a guaranteed independence for FASB is one of the reasons.
    Mr. Baker. Thank you, Ms. Roper.
    Now, Ranking Member LaFalce.
    Mr. LaFalce. Thank you, Mr. Chairman.
    Mr. Baker. It is nice to be a Chairman after just a year.
    Mr. LaFalce. Again, let me apologize to the three of you. 
Mr. Turner, you came from Colorado. Ms. Roper, Colorado also?
    Ms. Roper. Also Colorado.
    Mr. LaFalce. And, Mr. Hills, where are you?
    Mr. Hills. Just up the street.
    Mr. LaFalce. Just up the street, OK. You came a long 
distance and spent a lot of time to testify. It is regrettable 
that we have almost no Members here, and so they won't hear the 
benefit of your comments, because each of the three of you, I 
think, had some really terrific comments to make about the 
issues. That is why, again, I would exhort at our future 
hearings we have one panel. What happened here today was not 
only predictable, but virtually certain, that is you would have 
an empty House. And we won't correct that. We need some 
structural changes too in the way we do business and one of 
them is just one panel per day.
    Having said that, I hope the Chair will give me a little 
latitude since we have so few Members here.
    Mr. Baker. Latitude granted.
    Mr. LaFalce. OK, thanks. Let's try to take the issues one 
at a time. Let's first go to the corporate officers themselves. 
And then from the corporate officers, let's go to the board of 
directors and the audit committee in particular and then let's 
go to the auditing firm. And if you want to, we can go to the 
credit rating agencies. But I am just not sure what we should 
or shouldn't do there. I certainly want to focus on the 
securities analysts and see what we should do.
    How do we get to the corporate officers to make sure that 
they do not engage in earnings manipulation in order to 
increase market capitalization in order to make big bucks on 
their stock options?
    Mr. Hills. I will be a broken record, Mr. LaFalce. The only 
way you deal with that, first of all, you have to have the 
capacity to punish them, and I certainly support the notion 
that the SEC should have an effective way to ``disbar'' them. I 
thought the existing law was sufficient, but Chairman Pitt 
thinks he would like some more help, and I think he should get 
it.
    If you don't have somebody speaking up for the auditors and 
speaking up for the financial statements, the chairman will run 
the company, the chairman of the company.
    Mr. LaFalce. My experience, which is extremely limited, has 
been the chairman or the CEO runs everything. They pick members 
for the board who are already friendly to them or who will be 
friendly to them. They pick auditors who are or will be. And 
then they nurture that relationship so that it almost becomes 
like a familial relationship where you can't tell on a family 
member.
    Mr. Hills. Well, it is not quite as bad as it used to be or 
I wouldn't have been on the last eight boards. It is better. It 
really is better. But, again, it is to me an oxymoron, you 
cannot have an independent audit committee unless you have an 
independent nominating committee. And that happens more and 
more. Now it happens that Enron did have an independent 
nominating committee.
    Mr. LaFalce. We don't have to legislate that. That is 
something that is within the power of the SEC to promulgate by 
rule, correct?
    Mr. Hills. You bet. You bet.
    Mr. LaFalce. OK, good. Is this something you have discussed 
with Harvey?
    Mr. Hills. You bet.
    Mr. LaFalce. Please continue.
    Mr. Hills. Well, it is that function, it is that capacity 
to have--it is the capacity of an independent board. Are there 
seven to nine people coming to hear the chairman as a panel or 
have they coalesced into a body that has the capacity to make 
decisions.
    Mr. LaFalce. They almost need a staff of their own then 
too, because in my experience on boards, you come and you do 
not even know what the agenda is before until the night before 
maybe you get something in the mail and then you probably don't 
have time to read it by the time you get it. And then the CEO 
or the chairman, whoever it is, goes over the agenda and sort 
of tells you. You pretty much rely on the chairman of each of 
the committees within the board to tell you what is going on 
within their committee. And then you find out that their 
committee didn't even meet, that they did everything by phone. 
And so the members of that particular committee who are 
supposed to be responsive to the full board usually don't even 
know what went on within their own committee.
    Mr. Hills. There is a staff available. The chairman of the 
audit committee, all he has to do is have one lunch a year with 
the CEO of the audit firm, the audit partner and spend a day or 
an afternoon. I have been chairman of nine audit committees, 
and that is how you start out. You sit down and go away to 
their place, spend the day with them and make sure he 
understands you are in charge. There is your staff.
    Mr. Turner. Congressman LaFalce, I think it takes a number 
of things to drive at the question that you are asking about. 
For starters, I think President Bush's and Secretary O'Neill's 
notion of dealing with the executives, forcing them to write a 
statement to their shareholders acknowledging their 
responsibility for those financial statements and ensuring that 
they are thoroughly presented I think is an excellent idea. I 
certainly support that notion along with----
    Mr. LaFalce. But, I don't think that Mr. Lay or Schilling 
would have had any qualms about writing such a letter or 
statement. So I don't know whether that is adequate.
    Mr. Turner. In and of itself, no, I think you not only have 
to deal with the executives, you have to deal with the board 
and audit committee so I come at it from a number of angles. I 
think that is a very good thing, and I strongly support what 
they have done there. I strongly support that some of the 
things that former Chairman Hills has stated. I would 
definitely make it a requirement that the audit committee hire, 
fire, and really oversee directly the audit. Right now in 
practice the bottom line is the auditors are dealing directly 
with management. I have been there myself as an audit partner 
in one of these firms.
    Mr. LaFalce. What about banning auditors from working for 
the corporate employer for a certain period of time, a year or 
two, because it seems to me that very frequently an auditor 
will be encouraged by his firm, maybe take an early retirement, 
go to work for the company and that will just deepen the 
relationship between the auditing firm and the company. And of 
course if an auditor is contemplating future employment as an 
individual with the firm, the less zealous that auditor is 
likely to be about the public fiduciary responsibilities. So I 
have got a 2-year ban on employment if you have audited a firm. 
What do you think about that?
    Mr. Turner. I will actually speak from personal experience. 
I was a partner at Coopers, certainly one of the big six at the 
time and actually went to work for my audit client. Obviously, 
it was permitted, but it was not a good situation. And I think 
some of the things that you highlight, if I go back and look at 
it. First of all, the company had other very fine qualified 
CFOs that were in the search that they could have picked from. 
You have always got in the back of you mind the point you just 
made about would you cut them a deal or not if you had a 
difficult issue, because you know if you are getting into a 
fight with them, they are not likely to hire you.
    But at the same time when you get across on the other side 
and you get down to the audit time and here are all these 
people that you have known for many, many years and now you are 
in charge, if you will, as the CFO, it just leaves you with a 
queasy thing. It would be like when I was at the Commission, if 
I had been involved with an investigation of a situation like 
Enron and then walked out the door and then right the next day 
I was back in trying to influence the SEC about the outcome. 
The Government has put in prohibitions against that. And having 
gone through that process, and had some of those concerns in 
the back of my mind, I strongly think the 2-year cooling off 
period is very good.
    And a number of years ago, it was either the chairman of 
the Big Five firms, the Big Six at that time, or the board of 
directors of the AICPA recommended a 2-year cooling-off period 
too. So I think it is an excellent idea.
    Mr. LaFalce. They recommended it?
    Mr. Turner. Yes, they recommended----
    Mr. LaFalce. What happened to the recommendation?
    Mr. Turner. It never went anyplace.
    Mr. LaFalce. That is the difficulty when something is 
volitional.
    Mr. Turner. It is still a recommendation.
    Mr. LaFalce. It was a recommendation to themselves, 
correct?
    Mr. Turner. Yes.
    Mr. LaFalce. Yes, OK.
    Chairman Oxley. The gentleman's time has expired. The 
gentleman from Louisiana, Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman. I wanted to compliment 
you, Ms. Roper, on the content of the Federation's analysis of 
the legislation. Obviously, there are points where you feel 
that modification is warranted, but on balance the approach 
seems to be one which has merit. And I think that is very 
helpful in the discussion we are having. At the request of the 
Chairman, we are going to have a number of hearings in the 
subcommittee over the coming weeks to receive suggestive 
criticisms and potential modifications to the bill before we 
would go to a full committee mark up. But I think it is 
appropriate to say based on all we have heard today, that we 
have got it pretty close and we are on the right track. And 
there are elements that need to be addressed, but we are 
certainly acting appropriately given the circumstances we face.
    And to any who choose to respond, I think to a great extent 
many are looking at the problem as if we only have bad audit 
and bad audit individuals within a company where we have 
perhaps questionable management or maybe OK management. What 
troubles me, and I don't have a good sense of how we resolve 
this, is if you have a good auditor who is in a company where 
you have clearly badly motivated management. And where does 
that auditor go short of resigning from service to get 
assistance in balancing the act within the influence of 
management. If you have an independent audit team, that goes 
away. If you don't have good management, you are not likely to 
have an independent audit team.
    If there were disputes as to the construction, oh let's say 
of an SPE, and whether it would be beneficial to shareholders 
or not. And the audit team said we think this ought to be 
disclosed, because it is not in the shareholder interest. And 
there was a dispute. How does that resolve today? Mr. Hills, is 
there a SEC phone number you call and say ``I've got a problem, 
come help me''?
    Mr. Hills. Well, if you believe as I do that the failure to 
have a strong independent audit committee is a material 
weakness to the internal controls, the auditors have no right 
to take the assignment unless they first determine that there 
is such an independent audit committee. I think that is the 
law, but I cannot get anybody to say it.
    Mr. Baker. But assuming for the moment that that is the law 
and it is not an independent situation after you arrive on the 
scene, ought there not be a place where you could go and get an 
advisory opinion privately, not on the record, so that if later 
you were dismissed or if the management chooses not to abide by 
your recommendation that there is a methodology for protection 
of that audit team?
    Mr. Hills. Yes, I said in my written statement that the PRO 
that the bill provides for is an ideal place for the auditor to 
go and say, ``I have this account, but I don't have an 
independent audit committee. Would you look into it?''
    We try to do that once in a while with the New York Stock 
Exchange and they are willing, but they do not have the 
capacity to do that. So the ability to go to something like the 
PRO that is proposed in the bill to say, ``I have got a problem 
here,'' is a tremendous assistance and I very strongly support 
that.
    Mr. Baker. And then with regard to corporate governance, 
one of the concerns I have is manipulation of revenue or the 
hiding of debt intentionally by management in the face of a 
non-cost option being exercised to drive up share price, 
retirement is in sight, and then 6, 7, 10 months later there is 
a restatement of earnings and the shareholder takes it and the 
individual who benefited from the precipitous increase in value 
does not have to give the money back. What about the 
advisability of some time period during which there is a 
disgorgement required and the difficulty is markets are 
volatile. You could have good management making good judgments, 
exercises the option in good faith as part of the employment 
contract and have these same circumstances develop.
    Where are the equities in that argument, Mr. Hills?
    Mr. Hills. Well, the law is pretty clear if we can find 
people that are capable of enforcing it. And this again is a 
function of corporate governance. I can give you the example of 
Waste Management where many things like that happened, there is 
the right of the company to sue the former officers that did 
it. There is a shareholder derivative cases. The law is there.
    Mr. Baker. But, in that case we are talking evidentiary 
process, a court determination, the fellow is gone, the money 
is tied up with his lawyers. If there were an automatic clock, 
and then it would be maybe a hearing process, my thought was 
let the executive come in and make his case.
    Mr. Hills. Well, you have something called the bill of 
attainder and that is difficult. We have a legal system--I 
think you could spruce it up. I think it would not be wrong to 
have a specific procedure for the independent committee to 
decide that he is subject to it. That would give a road map for 
a lawsuit. You could make the lawsuit easier. I would be very 
reluctant to give up the notion that somebody could take 
substantial sums of money away from somebody without due 
process. You could make the due process faster or specific, but 
I think it is--and you could give the SEC the capacity to make 
the first decision as long as it was a subject of judicial 
review.
    Mr. Baker. I don't dispute that. The problem is that with 
the speed with which transactions are closed and the volume of 
dollars involved and the ability for individuals who chose to 
do so to move assets out of the reach of even the Government's 
control. I think we have a problem that is not appropriately 
responsive when given a judicial remedy.
    Mr. Hills. It is hard, but give the SEC a little more 
capacity. They have a judicial system. They have an 
administrative body. The SEC could have the right to come in 
and declare, you could have an automatic injunction relief that 
would be subject to judicial review. There are a lot of things 
you can do with the system you have.
    Mr. Baker. Thank you. My time has expired.
    Chairman Oxley. The gentleman's time has expired. Thank 
you.
    Let me conclude, and I apologize for being out of the room, 
but I did want to first welcome all of you and we certainly 
appreciate your concern. It is always difficult on the second 
panel. But your testimony has been excellent and we have 
appreciated your being here.
    I want to, first of all, probe generally where--given what 
we are faced with now in light of Enron and Global Crossing and 
other accounting issues that are in front of us in the 
legislation that we have, as well as the proposed regulations, 
where each one of you see the accounting, the Big Five/Four 
maybe accounting firms over the next 10 years, given your best 
judgment as to where you see these large companies going, where 
they resemble anything like they are today. What is your best 
guess, Mr. Hills, on where that might go?
    Mr. Hills. I think the most serious problem facing the 
country is the failure or the fact that we could lose our 
accounting profession as we know it. It is deteriorating. It 
has deteriorated as I said earlier. The caliber of people going 
into it no where near match what they were 20 years ago. We 
have a real responsibility to get them back into the 
profession. So it is a danger. As I said before, partly it is 
because the whole audit process has become a commodity. There 
is no quality involved in the securing of an audit assignment. 
So we have a basic responsibility to put judgment back into it, 
to bring people into it, to get the MBAs from the better 
business schools, among others, to come into the profession. I 
would say the accounting profession is in danger.
    Chairman Oxley. And where are those MBAs going now if they 
are not going into accounting?
    Mr. Hills. Well, they go to consulting firms. They go to 
investment banking. They even go to law school sometimes, 
unfortunately. They have other places to go and they are not 
being pulled in. Russ Palmer, some of you know, was the great 
dean of the Wharton School. He had long before that been the 
chairman of Touche Ross. Twenty-three percent of his graduates 
were going to the accounting profession when he was the dean. 
In the last 2 or 3 years, not one went.
    Chairman Oxley. Ms. Roper, do you think it is important 
that we have a strong public accounting firm, say five or 
whatever number large, multi-faceted accounting firms in 
existence, or do you think it ought to be shrunk considerably?
    Ms. Roper. We generally do not think concentration in 
industries benefits consumers, although it is not clear in this 
area that they compete on the basis of benefits to investors. 
But we do not look to shrink the accounting industry. And since 
the first place that shrinkage would likely occur would be with 
Arthur Andersen, I have to say there is the potential with the 
Volcker Commission for Andersen to emerge from this if it can 
survive as something of a model company. And we do not want to 
see Andersen destroyed by the current situation.
    I do not claim any particular talent for predicting the 
future. And it seems to me that there are too many factors in 
question right now to be able to look into the future with any 
accuracy. We do not know what you will decide to do about 
auditor independence. And we do not know what you will decide 
to do about auditor oversight, although as we have said we see 
real progress being made here.
    I think it is absolutely essential that we have strong 
independent accounting firms performing public audits. One of 
the things that has changed--we have had scandals in the past, 
one of the things that has changed since the 1970s and 1980s, 
when we had previous major accounting scandals is that most 
people did not invest then, and today most households do. And 
they invest primarily to save for retirement.
    And there was a statement earlier that seemed to imply that 
this bill was designed to send the message to investors that it 
is Congress' job to protect them from stocks going down. It 
seems to me that this bill is designed, and Congressman 
LaFalce's bill, are designed to ensure that investors get 
accurate information so they can determine for themselves 
whether the stocks should go up or down and that they should 
not--it is not enough that Enron is now being punished when for 
years its stock was artificially elevated based on 
misinformation. And so we believe that if you take the steps 
toward really enhancing auditor independence, enhancing auditor 
oversight, doing a broad range of other things that we did not 
talk about today to improve the quality of disclosure, that you 
will significantly improve the ability of investors to make 
informed decisions based on accurate information instead of 
hype.
    Chairman Oxley. Mr. Turner, are you good at predicting the 
future?
    Mr. Turner. Oh, I am right up there with you.
    Chairman Oxley. I will look at your brackets for the NCAA 
if you are.
    Mr. Turner. I do believe the markets will drive where the 
firms go to some degree. And I think the markets are already 
reacting to that. In fact, there is evidence that the firms are 
already reacting to it. And just 2 years ago, we had a unique 
bonding arrangement with the firms when I was at the SEC over 
the auditor independence rules and they were not willing to 
give up a few things that they are now. Now that the markets 
have turned around and said we do not want you doing certain 
things, they are moving more in that direction. And I think, in 
fact, that what we will see in the future is the firms to some 
degree, not because of themselves, because I do not think they 
would ever do it on their own, but because the markets and the 
fact that now we have one out of ever two million American 
investors in the market, 60 percent higher than just 10 years 
ago, the investors are raising up after Enron, Global Crossing, 
and all the others and saying we want some independent 
auditors, I think it is going to drive them there.
    Financially, that may actually leave them even stronger in 
some respects than what they have been for the last 10 years. 
Probably make them stronger, it takes them back about 30 years 
ago when 70 percent of the fees were just audit, they were 
principally audit and tax. In fact, if you go back to the mid-
1970s, there was only probably 5 to 10 percent in each of the 
firms that were in consulting, and financially they did very, 
very well at the time.
    When you look at the gross margins, and as my resume says, 
I have run one of these business units, the gross margin on the 
audit practice, and this came out in our public hearings as 
well, is actually higher than the margin that you make on the 
consultant. It has just been that consulting has grown at a 
much more rapid rate than the auditing, but that was because 
the economy was good. As the economy turns down now, the 
consulting won't be as important to them, the auditing will. 
Given that financial side of it plus what I think the market is 
demanding, as we have seen, and seen from the audit committees, 
I think they are going to step back from being consulting firms 
to becoming much more of an audit firm than they have been in 
the past, market driven. And certainly I would encourage the 
committee to take more steps in that direction to protect the 
franchise.
    Chairman Oxley. Thank you. My time has expired.
    The gentleman from New York had a couple of extra questions 
before we close.
    Mr. LaFalce. Yes, first, just a brief comment. We focus an 
awful lot on accounting firms and the audit, but most investors 
do not have the vaguest idea of what that audit was, would not 
be able to read it if it was put in front of them, and could 
not interpret it, and that is why it is so important that we 
not lose sight of the securities analyst because so often the 
investor, and the less sophisticated the more this is true, 
relies primarily on the recommendations of the Wall Street 
analysts, and they have got to do a much better job. They have 
just missed too much for one reason or another, to the point 
where you could say some of their analysis has been grossly 
negligent or reckless with disregard for reality.
    But I believe, Ms. Roper and Mr. Turner, you are familiar 
with both Chairman Oxley's bill and my bill. Mr. Hills, I am 
not sure if you are familiar with my bill.
    Mr. Hills. I am not.
    Mr. LaFalce. Pardon?
    Mr. Hills. I am not. I have been in Singapore all week.
    Mr. LaFalce. OK, well, to the extent that any of you are 
familiar there are similarities and then there are some clear 
differences too. And we are going to be airing those 
differences I am sure during the course of mark-up, which we 
anticipate will be after Easter.
    Ms. Roper and Mr. Turner, since you are familiar with both, 
what do you think are some of the salient differences and why 
do you favor with respect to each of those differences one 
version over another?
    Ms. Roper. OK, on the issue of auditor independence, as I 
said, we believe that we need a broad ban on consulting 
services. And while your legislation does not go quite as far 
as perhaps we would, its provisions to go back to the original 
SEC rule proposal language on the whole range of non-audit 
services we think is very important, because although at the 
time the attention was focused primarily on the questions of 
internal audit and financial system design, all of those areas 
were weakened in the final rule. We think it is very important 
that once you define a list, once you have decided that you are 
going to take the approach of defining a list of services that 
are prohibited, that that list not be set in stone. And so we 
favor the idea that the SEC would have ongoing responsibility 
to review services that are provided to determine whether they 
create independence problems for the auditors and to do that 
according to the set of principles that were included in the 
SEC rule proposal.
    We also believe very strongly that the auditor should be 
hired directly by the audit committee and that if we are going 
to allow any non-audit services to be provided, that they 
should be directly and specifically approved by the audit 
committee in keeping with the idea that we need the board 
rather than the management to be controlling these decisions.
    And in addition we believe that mandatory periodic rotation 
of auditors helps to reduce the inherent conflict of interest 
that exists when the auditor is hired and fired by the audit 
company and that an auditor who is looking at the--because of 
the low turnover in the firm, an auditor is looking at a 20, 
30, 50 year engagement with that audit client has way more to 
lose than one who risks losing 2 years of audit fees because 
they are near the end of the term of their rotation.
    I mean, we are not married to a single idea of how long 
that term would be. You have to balance the cost of the 
learning curve at the start of the audit with the benefit that 
we think it provides independence, but we do think that that is 
an approach that deserves attention. We are willing to look at 
other options as well to deal with that issue, but we think 
that is a credible solution to that problem.
    And, on auditor independence, if you look at the constant 
flow of personnel from Andersen to Enron, or from Andersen to 
Waste Management, where you had at Waste Management, since 
1971, no chief financial officer or chief accounting officer 
who did not come from the auditor, I think that creates a 
climate in which the outside auditors are viewed as just 
another part of the corporate community, and that that kind of 
intimacy is not conducive to true independence. And so we also 
strongly support the cooling off period for auditors.
    Mr. LaFalce. Mr. Turner, and also could you include any 
comments you might have about litigation reform efforts and 
where at least my bill would address that?
    Mr. Turner. I would be happy to. As far as the PRO goes, 
which both of them have, which is actually excellent, I think 
in your bill it is a much stronger SRO in that just in terms of 
the ability to compel testimony and document production, which 
is I think very important. It is probably more public--not only 
in public in terms of what it can do as it comes out of a 
disciplinary action, but also in terms of the board makeup 
itself.
    In the area of auditor independence, I would echo what has 
just been said by Ms. Roper. Going further I think is needed at 
this point in time than what has just been mandated there, 
especially in light of what we have seen in a number of cases 
that have come out since we did our rulemaking. We have got 
Waste Management behind us now. We have got Enron behind us. 
Global Crossing. I think those all beg out for a much stronger 
independence standard.
    On mandatory rotation, I certainly, having been an auditor, 
understand the concerns of the profession. But if you do a 
mandatory rotation, for example, once every 7 years, the 
additional cost is not going to be great. If you say the 
average audit for the 10,000 to 12,000 public companies is 
about 2,000 hours, real cost is going to be in the first year. 
On average, you provide about a third additional hour in the 
first year. So over a 7-year time period, you would go from 
about 14,000 hours up to about 14,600, 14,700 hours. And in 
light of the losses that investors have incurred, that is a 
drop in the bucket.
    And the issues with first year audits, there are also 
indications with the top 10 list that Congressman Sanders 
pointed out, there is probably much greater losses and exposure 
there in the continuing relationship the market has shown and 
the losses have shown, much greater damage and much greater 
exposure to problems if you don't have the mandatory rotation 
provision billed in. And they talked about Greece and Italy and 
some of the other countries, I don't know if I would use them 
as a model.
    On the litigation issue, I certainly would urge the 
committee not to go back and undo the PSLRA. I have served as 
an expert witness, in fact, for some of the accounting firms 
and being a partner myself, there was too much ambulance 
chasing quite frankly, and so I would not go back and roll that 
out.
    But I think there is a reasoned approach to dealing with 
that today. These are not all frivolous litigation. In fact, 
most of the cases have got some validity to them that are being 
brought. I think that is one of the benefits that we have got 
out at the PSLRA, the fact that there has been an increase in 
litigation, just the increase itself does not mean anything 
unless you turn around and look at it. There has not been as 
much increase against the accounting firms, if you actually go 
in and dig into the numbers. But what the surveys do show is 
that, in fact, the incidence of financial misstatement 
wrongdoing has increased significantly. Given that, I would 
expect that there would be an increase in the amount of 
litigation. I think the PSLRA has avoided frivolous litigation, 
but perhaps swung--you heard the accounting firms talk about 
``unintended consequences,'' maybe one of the unintended 
consequences of that bill was it swung way too far to one side. 
And I think we need to bring it back into the middle and 
perhaps the best way to do that would be to undo the Central 
Bank case and bring back aiding and abetting.
    Mr. Hills. May I make one comment, Mr. LaFalce? As an 
alternative to mandatory rotation, the notion that every 3 
years the audit committee has the specific responsibility with 
independent consultants to analyze the performance of the 
auditors and must affirmatively decide it is in the best 
interest of the company to retain them, that keeps authority 
and responsibility in the audit committee. The mandatory 
rotation for all practical purposes takes total responsibility 
away from the audit committee. They no longer have any role to 
play.
    Mr. LaFalce. I understand where you are coming from Mr. 
Hills, but the difficulty with that is I remember my days in 
the Army when you had to be rated, if you were not rated in the 
top 1 or 2 percentile, you were really doing terribly. And I am 
afraid that it might become automatic.
    Mr. Hills, I have no idea where you stand on the issue of 
overturning the Central case and once again permitting lawsuits 
based upon aiding and abetting liability. Do you have a 
judgment on that? It seems to me that the accounting profession 
is likely, if they only have proportional liability rather than 
joint and several, and most especially if they are not subject 
to private litigation from an aggrieved party for aiding and 
abetting, they are much more likely to be lax in their 
standards. What are your thoughts on that? And I shouldn't ask 
the question unless I know the answer and here I don't know the 
answer so I am proceeding at my own peril.
    Mr. Hills. If you look at the 16 committees I have served 
on, a whole lot of those audit firms paid a whole lot of money 
to settle the claims that we brought. And I would say to you 
that the punishment of the courts is really quite severe. In 
the Waste Management case, in the Enron case, the monies 
offered by, you cannot hardly think they could offer much more 
money.
    So something works. What works is conferring independence. 
What works is a good independent audit committee. I say bolster 
them. Give them the authority to do their job and you will have 
a much better climate.
    Mr. LaFalce. Thank you.
    Chairman Oxley. The gentleman's time has expired.
    Let me just close if I can, Mr. Hills. What role does 
Congress play in this? That is, there was some concern 
expressed in the first panel with trying to many I guess put a 
one-size-fits-all solution to auditor independence and so I am 
wondering exactly what we need to do? I am concerned that if we 
do so, that we step in, we almost federalize the auditing 
profession and I have some real concerns about that. Do you 
share those concerns? And if you do, shouldn't the auditing 
committees, as you indicated, and the SEC step in and deal with 
these issues?
    Mr. Hills. I think your Section 9 is an extraordinarily 
good way to go about this. The SEC will respond very strongly 
to that kind of request. The SEC can do most of the things you 
want. They can require for example that the audit committee 
affirmatively decide whether to retain the auditors. They can 
decide whether or not there must be an independent nominating 
committee. They can decide those things if you push them to do 
it or you can legislate. I do believe that we have gone a long 
time in a limbo. The audit committee reached a certain 
pinnacle, maybe 10, 15, 20 years ago and it stayed there, and 
we have not pushed them over to that last part. I think this 
committee can do it. I think the Senate Banking Committee can 
do it because the Commission will be responsive. It may take a 
little bit of legislation, but I think a little bit of 
legislation will provoke a wonderful response.
    Two things the SEC has done since September. One they said 
the auditors must propel the directors to understand the 
alternative ways to understand the financial papers. That is a 
big change.
    The second thing happened just 3 weeks ago when the chief 
enforcement officer or the chief accounting officer of the 
enforcement division, said, ``By the way, the fact that you 
satisfy all the rules does not mean that you are not violating 
the laws if it is not overall fair.'' Those are huge 
differences.
    Now, when I was a kid, I thought those were the laws. But 
they said it again and this committee can tell them well done 
and make sure he does mean it.
    Mr. LaFalce. Anything wrong with that 30 year old case that 
has been rediscovered and codifying that into law?
    Mr. Hills. I think that is a good idea.
    Mr. LaFalce. Thanks.
    Mr. Hills. I mean. I think there is a place for a push, a 
barb, if you will.
    Mr. LaFalce. Yes.
    Chairman Oxley. We thank you so much for your patience and 
excellent testimony and response to a myriad of questions from 
the committee.
    And with that the hearing stands adjourned.
    [Whereupon, at 2:10 p.m., the hearing was adjourned.]



 H.R. 3763--THE CORPORATE AND AUDITING ACCOUNTABILITY, RESPONSIBILITY 
                      AND TRANSPARENCY ACT OF 2002

                              ----------                              


                       WEDNESDAY, MARCH 20, 2002

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:00 a.m., in room 
2128, Rayburn House Office Building, Hon. Michael G. Oxley, 
[chairman of the committee], presiding.
    Present: Chairman Oxley; Representatives Roukema, Baker, 
Royce, Ney, Kelly, Gillmor, Weldon, Ryun, Ose, Shays, Cantor, 
Hart, Ferguson, Rogers, Tiberi, LaFalce, Kanjorski, C. Maloney 
of New York, Bentsen, J. Maloney of Connecticut, Hooley, 
Carson, Sherman, Meeks, Inslee, Schakowsky, Moore, Capuano, 
Ford, K. Lucas of Kentucky, Crowley, and Israel.
    Chairman Oxley. The hearing will come to order. Good 
morning and welcome to the committee's second legislative 
hearing on the Corporate and Auditing Accountability 
Responsibility and Transparency Act of 2002, or CARTA.
    Last week, the committee held its first hearing on CARTA. 
We heard from a diverse panel of witnesses, including former 
SEC officials and representatives from the securities industry, 
a leading consumer organization and the accounting profession. 
The testimony was very instructive. Our witnesses represented a 
broad spectrum of views about the securities markets and the 
role of Government in protecting investors. Some of the 
witnesses said that CARTA regulates too much. Others said not 
enough. Clearly we must be on to something that is reasonable.
    CARTA was carefully crafted to strengthen the oversight of 
the accountants who audit public companies without federalizing 
the accounting profession. The legislation requires companies 
to give investors accurate and immediate access to important 
company information without drowning issues in red tape, and 
the bill would make it a crime for company officials to mislead 
auditors, ensuring both that corporate officers act responsibly 
and that auditors can do their jobs effectively.
    CARTA encourages business leadership by prompting 
executives to act in the best interests of shareholders. It 
requires greater transparency and prevents insiders from 
benefiting when their employees cannot.
    Today's witnesses will further eliminate the important 
issues that face the committee as we seek to reassure investors 
in the strength of America's capital markets. Already the 
committee has held extensive hearings in the wake of the Enron 
bankruptcy. Going as far back as December of last year, the 
Financial Services Committee has held hearings on the Enron 
collapse to ensure we fulfill our obligation to protect 
investors. Our hearings have revealed that while some bad 
actors may seek to take advantage of investors, ultimately the 
laws in the marketplace will catch up with them.
    No one should doubt that America remains the best place to 
invest not only for the ability of our workers and the 
ingenuity of our entrepreneurs, but also because America does 
not tolerate cheats. CARTA represents our further efforts to 
strengthen America's capital markets so that they may remain 
healthy and vital, and I look forward to the testimony of our 
witnesses.
    I now recognize the Ranking Member, Mr. LaFalce, for an 
opening statement.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 296 in the appendix.]
    Mr. LaFalce. Thank you very much, Mr. Chairman. As we 
continue our consideration of legislation to address the 
serious systemic weaknesses that have undermined confidence in 
financial reporting and in our capital markets, I think it is 
useful to reflect on some of the testimony we have heard thus 
far.
    One witness warned last week that we should not overreact 
to the failure of Enron. If Enron were an isolated instance it 
would be one thing. But unfortunately, it is not. The use of 
deceptive accounting practices to paint a false picture of a 
company's financial health has become much too common at some 
of our largest companies.
    Enron is no longer even the most recent major failure 
linked to accounting concerns. SEC and Justice investigations 
into the failure of Global Crossing have again raised the 
specter of another major United States company using accounting 
practices to hide its true condition.
    The safeguards intended to protect investors have been 
overwhelmed by the temptations for companies to either cheat or 
overstate or obscure financial disclosure, largely to improve 
short-term results and meet analyst or investor expectations 
and therefore enhance market capitalization.
    Virtually all of our witnesses last week spoke of the need 
for auditors to be willing to stand up to management and for 
audit committees to take real responsibilities for audits and 
auditors. To do this, I believe that we must fundamentally 
alter the relationship of the auditor to its client and we must 
strengthen the functioning of audit committees and we must 
provide meaningful and ongoing oversight of the auditing 
profession. Auditors and audit committees should be the first 
line of defense in protecting investors, and our task in these 
hearings is to determine how we can best restore the vitality 
of these critical investor safeguards.
    Equally important, we must ensure that the restoration is 
permanent and not merely evolutional and therefore most likely 
a temporary response to the headlines of the day. We should not 
delude ourselves into believing that the market will provide a 
lasting solution to the issues we have identified.
    Now I have introduced legislation that seeks to do exactly 
that, the Comprehensive Investor Protection Act, CIPA. The 
measures included in CIPA on auditor independent, corporate 
governance and oversight of the audit profession have been 
strongly endorsed by both consumer and institutional investor 
groups. The auditor independence requirements of my bill are 
comparable to auditing standards adopted by the General 
Accounting Office and proposed by New York State Comptroller 
Carl McCall, who will be testifying before us this morning. 
They were crafted after the very closest consultation with many 
outstanding individuals, including, amongst others, the former 
chief accountant of the SEC, Lynn Turner.
    I look forward to working with Chairman Oxley, Members of 
this committee and you, Chairman Pitt, as we seek to find a 
legislative response that will help to restore confidence in 
the financial reporting system on which our markets rely.
    Chairman Oxley. Gentleman's time has expired.
    The gentleman from Louisiana, Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman. I commend you for 
calling this hearing with regard to the important reforms 
contained in CARTA. I certainly want to point out the work that 
has already been done with regard to the reform of endless 
conduct with Chairman Pitt and the exchanges under Chairman 
Oxley's leadership, and I do believe that the provisions 
contained in the underlying bill with regard to audit reform 
are significant, important and I think timely for the committee 
to pursue.
    My focus today will be more toward the issue of corporate 
governance and how we can incentivize those who are in 
managerial responsibility to manage for the long term. It 
appears that the events of Enron would indicate there was 
manipulation of corporate assets for the benefit of enhancing 
executive compensation, and it is not a unique, but very 
troublesome problem in the business world today that management 
is under extraordinary pressure to beat short-term quarterly 
earnings estimates in order to maintain their positions in the 
particular corporation they manage, all to the disadvantage of 
the long-term shareholder interest and corporate growth. I 
think we should explore with all diligence any remedies that 
would incentivize management to work for the long haul and not 
to manipulate the stock price, for example, that would enable 
them to exercise no cost options that then results perhaps in a 
few weeks later a restatement of earnings all to the 
shareholders' detriment with no downside risk for the 
executive. I think we should at least explore disgorgement as a 
result of these events or any other mechanism that would make 
it clear to management that short-term manipulation of values 
to enhance one's own compensation is unacceptable behavior in 
today's world.
    Given the complexity of very large corporations and the 
difficulty that the common investor has in understanding the 
true financial condition, the executives find themselves in a 
very advantageous position with no liabilities for this 
performance.
    I commend you, Mr. Chairman, for your work and I look 
forward to engaging the witnesses today in pursuit of remedies 
for the public interest and for the working families. Thank 
you.
    Chairman Oxley. The gentleman's time has expired.
    The Chair would observe that we have a vote on the floor, 
and I would like to recognize the gentleman from California for 
a brief opening statement, and the Chair would recess the 
committee for two votes on the House floor and return 
immediately. Gentleman from California.
    Mr. Sherman. Mr. Chairman, we have got a lot to do. There 
is a lot of talk about how the fees for non-audit services are 
significant. We ought to be looking at the amount of those fees 
rather than the particular services rendered. Even tax services 
can pose a conflict of interest as you plan to set up 100 
Cayman Island corporations and then accrue a tax liability to 
determine whether those corporations are going to succeed in 
avoiding Federal income tax.
    We need clear accounting principles. We need a structure of 
our auditing firms so the technical review department makes the 
final decision with all the information, not the engagement 
partner whose chief job it is to go golfing with Ken Lay.
    Finally at the SEC, I wish that you had read the Enron 
financial statements and those of the top thousand corporations 
in America with the same care that you read the little $15 
million and $10 million IPOs that I was involved in long ago 
where you made sure that the filings for those small offerings 
were clear and complete, but the Enron financial statements 
clearly did not meet that standard.
    Thank you very much.
    Chairman Oxley. Gentleman's time has expired.
    The Chair would now declare a recess for a vote, and then 
we will be pleased to hear from the Chairman of the SEC.
    [Recess.]
    Chairman Oxley. The hearing will come to order. We are 
pleased to welcome back once again to the committee the 
distinguished Chairman of the Securities and Exchange 
Commission, Harvey Pitt. Mr. Pitt, it is good to have you back 
again and it has been a real pleasure to work with you through 
some very difficult issues over the last several months, and I 
want you to know that the Chair, and I am sure I speak for all 
the Members, appreciate your diligence and hard work and 
positive attitude as we work through some very difficult 
issues. So welcome and good to have you back.

 STATEMENT OF HON. HARVEY L. PITT, CHAIRMAN, U.S. 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Pitt. Thank you, Mr. Chairman, and it is a pleasure to 
be back. Mr. Chairman, Congressman LaFalce, Chairman Baker, 
Members of the committee, I am pleased to be here to discuss 
H.R. 3763, the Corporate and Auditing Accountability 
Responsibility and Transparency Act of 2002. As you will 
recall, on February 4 of this year, I testified before Chairman 
Baker, Congressman Kanjorski, and Members of the Subcommittee 
on Capital Markets about possible solutions to problems arising 
in the wake of the Enron implosion. The leadership and Members 
of this committee have worked diligently since then to explore 
the substantive issues at stake and to develop well thought out 
reform proposals intended to help restore confidence in the 
integrity of our financial markets.
    Mr. Chairman, I would like to commend the leadership you 
have shown, and I would like to commend the efforts of Ranking 
Member LaFalce as well as Chairman Baker and Congressman 
Kanjorski and all the Members of the committee. These are 
difficult issues. These are difficult times, and your 
leadership has been remarkable. We appreciate the opportunity 
to work with you and your staffs on many ideas in your 
legislative proposals, and we look forward to our continuing 
cooperation. Whether by legislation, regulation or some 
combination of legislation and regulation, we will work with 
you to make our Nation's Federal securities laws more 
responsive to the current day needs of investors.
    I also want to say how very much the entire Commission and 
its staff appreciate your support for funding pay parity and 
for your concern for our agency's resources at this especially 
critical time.
    The past several months have tested the mettle and 
resiliency of our markets and the investing public's 
confidence. With the events of September 11, Enron's bankruptcy 
and last week's indictment of Arthur Andersen, we have all 
witnessed how critical our capital markets are to the country's 
strength, security and spirit.
    In the aftermath of Enron's meltdown, our staff is 
investigating whether violations of Federal securities laws 
occurred and, if so, who perpetrated them. Until that 
investigation is completed, we cannot address the specific 
conduct of Enron and those involved with it or the activities 
under investigation. The public can be confident, however, that 
our Enforcement Division is conducting a thorough investigation 
and that we will address any and all wrongdoing and wrongdoers 
swiftly and completely.
    Even prior to Enron, we were working to make disclosures 
and financial reports more meaningful and intelligible to 
average investors. Investors are entitled to the best 
regulatory system possible. To reassure investors and restore 
their confidence, we must address flaws in our current 
disclosure and accounting systems that languished unaddressed 
for many years.
    The Commission intends to reexamine our rules and 
regulations in light of Enron. There are fundamental 
longstanding flaws in our system. Now they are on the table. No 
one yet knows what the final answers are or should be. But, at 
the end of this process, we will have taken the best system of 
corporate disclosure, regulation of the accounting profession 
and fidelity to fiduciary duties by corporate managers and 
directors, and made that system even better.
    In the President's State of the Union address, he 
appropriately demanded ``stricter accounting standards and 
tougher disclosure requirements'' to hold corporate America 
more accountable to employees and shareholders and to hold them 
to the highest standard of conduct. We share and embrace these 
principles and are firmly committed to achieving them.
    We can achieve needed improvements by improving standards 
and our regulations in three principal areas. First, disclosure 
by public companies must be truly informative and timely. 
Second, oversight of accountants and the accounting profession 
must be strengthened, and accounting principles that underlie 
financial disclosure must be made more relevant and timely. 
Third, corporate governance must strengthen the resolve of 
honest managers and directors who oversee management's actions 
and make them more responsive to the public's expectations and 
interests.
    The Commission already has statutory authority to adopt 
rules to implement virtually all of the President's program as 
well as other improvements necessary to address systemic 
problems brought to light by Enron's collapse. We will work 
closely with you to ensure that the regulatory framework we 
ultimately propose accommodates your views of what is 
appropriate and in the public interest.
    We have endeavored to move forward as quickly as we 
responsibly can on these issues. First, in cautionary advice on 
December 4 of last year, we gave guidance on the appropriate 
use of, and limits on, pro forma financials. In further 
cautionary guidance on December 12, we set forth initial 
requirements and guidance on the obligations of public 
companies to disclose critical accounting principles.
    On December 21, we announced our Division of Corporation 
Finance would monitor annual reports submitted by all Fortune 
500 companies in 2002. This initiative significantly refocuses 
and improves our review program for financial and non-financial 
disclosures made by public companies.
    On January 17, we announced our preliminary concept of a 
new private sector regulatory body to oversee the accounting 
profession. On January 22, we identified issues in Management's 
Discussion and Analysis to be addressed in 2001 fiscal year end 
reports regarding off balance sheet financing arrangements.
    On February 4, the securities industry and its self-
regulators, acting under the leadership of Chairmen Oxley and 
Baker as well as Ranking Members LaFalce and Kanjorski, 
announced proposed rules to create more transparency for 
analyst recommendations.
    On February 13, we announced proposals to address aspects 
of corporate disclosure meeting improvements. On the same day, 
we called upon the New York Stock Exchange and Nasdaq to look 
at specific components of corporate governance. And just this 
past Monday, in response to the Andersen indictment, we 
released orders and temporary rules to assure a continuing and 
orderly flow of information to investors and the U.S. capital 
markets.
    In addition, over the past several months, we have been 
seeking input broadly, from all concerned on both corporate 
disclosure and auditor regulation. To that end, we held 
roundtables on March 4th in New York and March 6th in 
Washington, with distinguished business executives, lawyers, 
accountants, academics, regulators, and public interest 
representatives. We have scheduled our next roundtable for 
April 4th in Chicago, and plan to hold additional roundtables 
in the next 2 months. This May, we will hold our first ever 
``investor summit'' to solicit additional investor input.
    Congress, however, must make the final judgment whether 
legislation is necessary or appropriate. We intend to continue 
working with Members in both Houses and on both sides of the 
aisle regarding legislation. We will continue these efforts and 
will commit to implementing any legislative changes Congress 
ultimately believes are necessary.
    Last month, Chairman Oxley and subcommittee Chairman Baker 
introduced H.R. 3763. This proposed legislation addresses many 
of the key issues facing our capital markets today, most 
notably, creating a statutory public regulatory organization to 
oversee the public accounting profession. In my formal 
testimony, I have addressed some of the key aspects of this 
proposed legislation and I do ask that my formal testimony be 
included in the record in its entirety.
    Chairman Oxley. Without objection.
    Mr. Pitt. Thank you. For present purposes let me offer a 
brief overview on my comments on this legislation.
    First, given our existing authority, combined with Section 
12 of the bill, we believe that this legislation would give us 
ample authority to enforce the bill's directives, if enacted.
    Second, the proposed public regulatory organization the 
bill mandates and our proposals for a public accountability 
board share many common attributes and characteristics.
    Third, if legislation is enacted, the key is giving us both 
the authority and flexibility to ensure comprehensive and 
effective regulation of accountants and accounting.
    Fourth, the Commission shares the bill's underlying 
philosophy of holding auditors to the highest standards of 
independence, competence and ethics. We think it unwise to cast 
solutions to issues of auditor independence in legislative 
stone, but we do agree with the bill's fundamental precept that 
auditor independence is a critical issue which requires 
constant attention.
    Fifth, the Commission embraces the bill's core concept that 
financial disclosures must be timelier, more comprehensive, 
more relevant and provide greater transparency.
    Sixth, we agree with the bill's concept that the 
Commission, through its staff, must significantly expand its 
review of financial and non-financial disclosures. We must also 
try to use our resources more effectively by targeting our 
reviews at the most important areas of disclosure at any given 
point in time.
    Seventh, the bill requires us to perform or participate in 
several studies that we believe would shed light on possible 
additional reforms. We support each of these initiatives, and 
yesterday the Commission voted to commence a formal inquiry of 
rating agencies and their regulation.
    Finally, a companion bill increases our authorized funding. 
We have identified current needs and have worked with OMB to 
reach common ground. OMB supports our additional request for 
100 additional personnel. It does not as yet support 
appropriating funds for pay parity in fiscal 2003. We hope to 
persuade OMB to fulfill the implicit promise of pay parity once 
the legislation authorizing pay parity was enacted into law.
    Mr. Chairman, Congressman LaFalce, Chairman Baker, Members 
of the committee, I thank you for the opportunity to testify 
today, and I am pleased to try to respond to any questions the 
committee may have.
    [The prepared statement of Hon. Harvey L. Pitt can be found 
on page 302 in the appendix.]
    Chairman Oxley. Thank you, Mr. Chairman, and let me first 
indicate we will help you on a bipartisan basis on your issue 
on pay parity with OMB. This Congress spoke very clearly on the 
pay parity issue along with the SEC fees legislation that were 
contained therein, and we want to be equal partners with you on 
convincing our friends at OMB and the Administration that pay 
parity is the law of the land and that we have a firm 
commitment to that ideal and we are going to continue on that 
best effort.
    And let me also congratulate you on a number of initiatives 
within the SEC and working with our committee. It is 
frustrating somewhat, I am sure it is to you, that many of 
these initiatives go relatively unnoticed in the popular press 
while high profile hearings get most of the attention, but I 
have to tell you I think I share that with the other Members of 
the committee. We understand the hard work it takes to 
undertake these initiatives. And clearly the news conference we 
had with you along with Mr. LaFalce and Mr. Kanjorski and Mr. 
Baker on the analyst issue was a good example, I think, of what 
we can do when we work together, and I want to thank you for 
all of your help in that area and many others.
    Let me begin the questioning, Mr. Chairman, with a question 
that was raised last week. One of our witnesses testified that 
the market incentives for responsible corporate governance and 
accurate accounting are incredibly powerful. How would you 
characterize the practices of post-Enron America from your 
viewpoint?
    Mr. Pitt. My belief is that the response in the post-Enron 
era has been all that one could hope for in terms of 
articulation of commitments to fiduciary obligations and 
companies reexamining the qualities of their disclosure. We 
have had an upsurge of companies coming to us asking for advice 
and assistance on a number of these issues. That doesn't, in my 
view, obviate the need either for legislation like yours and 
Mr. Baker's or further regulatory work. But I do believe that 
the market has now created very powerful incentives for people 
to do the right thing, and, with the proper legal framework, we 
can ensure everyone that that fidelity won't be short lived.
    Chairman Oxley. That is an excellent point, and it is the 
goal of our legislation, as you know, to provide for more 
timely disclosure, more transparency, not necessarily more 
difficult rules and regulations, but indeed to allow the great 
forces of the marketplace to work effectively based on those 
concepts of early disclosure and transparency, and we thank you 
for your support in that regard.
    Let me ask you, what is the relationship, if any, between 
the Private Securities Litigation Reform Act of 1995 and the 
ability of investors to recover for actual fraud?
    Mr. Pitt. In my view, the Private Securities Litigation 
Reform Act, which was a bipartisan effort, reflected sound 
approaches to the problems it was designed to deal with. We 
have taken a look at the statistics since the adoption of the 
Act in 1995. In fact, there has been no diminution in the 
number of class actions that have been brought on average in 
the 7 years since it was enacted, and the average value of 
settlements has increased. In point of fact, by encouraging 
large institutions to take more of a role to ferret out the 
frivolous from the meaningful, I think we are seeing a better 
use of the class action mechanism, and in my view those who 
suggest that the Private Securities Litigation Reform Act is 
somehow responsible for any aspect of what we see in Enron, or 
any of the other high profile matters, are very much mistaken.
    Chairman Oxley. We have had some witnesses and other 
commentators to say that there is a real danger if Congress 
tries to create audit only firms. What kind of ideas do you 
have in that regard?
    Mr. Pitt. This is a subject that I think is very critical, 
and you are correct to hone in on the significance of that. In 
my view, there is no direct correlation between consulting work 
and auditing failures, but there is a problem with respect to 
the independence of auditors. Independence is the bedrock on 
which the accounting profession was founded and all steps have 
to be taken to strengthen it.
    My concern is that, if we go to the absolute separation 
that some people are proposing, over the next 5 years the 
quality of audits will diminish, not improve. It stands to 
reason that if accounting firms doing audits only engage in 
auditing, they don't become more independent, they become more 
dependent on their audit work. To me the problem is twofold. On 
the first hand, and the most important aspect, are those on the 
immediate firing line: the engagement partners and all of those 
who do the audit work. Those people must scrupulously adhere to 
independence notions. In my view, cross selling compensation to 
those people, that is, enabling them to sell other services, is 
absolutely inconsistent with the notion of independence.
    On the other hand, you have the firms as a whole. Most 
people have tried to deal with this issue as if it were a firm 
wide issue and not as if it were the engagement partner and 
engagement team's problems. For the firm, the issue is to 
provide appropriate incentives and sanctions if the firms do 
not properly supervise those people who are on the engagement 
front line.
    So, it is a twofold problem, but most people have looked 
away from the individual audit partners and have looked at it 
as if it were a firm wide problem.
    In addition, one other point--and I apologize for going on, 
but this is a very critical subject. If we take away much of 
the expertise that auditing firms have developed, for example, 
in the tax area, they will not be competent to perform audits. 
Getting into the issues of tax work enables auditors to have a 
clear sense of where the company is and how the issues can be 
handled.
    Chairman Oxley. The Chair's time has expired.
    The gentleman from New York, Mr. LaFalce.
    Mr. LaFalce. Thank you very much. Since you were just 
discussing the separation of the auditing and the consulting 
function and you mentioned taxation in particular, in my bill I 
call for a separation, but not a complete separation, same way 
as people can advocate a separation between church and state, 
but we have never had a complete separation within the United 
States. And I specifically would exempt the tax function.
    Now, Chairman Levitt did articulate a rule, and I supported 
it at the time although many others in the Congress generally 
opposed it. What is the status of that rule right now and where 
do you agree or disagree with the former Chairman of the SEC, 
Mr. Levitt.
    Mr. Pitt. I appreciate that question, because again I think 
it goes to the heart of this issue. Eighteen months ago, the 
Commission adopted its independence rule, and at that point 
Chairman Levitt said, and I am quoting this from memory, but I 
have the exact quotes: ``the rule we put in place today is 
better than an absolute ban.'' I happen to agree with him. I 
don't think 18 months has been a sufficient time for us to 
allow the rule to take effect.
    Mr. LaFalce. How did that rule compare with his original 
proposal, which was not an absolute ban?
    Mr. Pitt. Exactly. He did not have an absolute ban. My view 
is that----
    Mr. LaFalce. My question is how did the rule that was 
promulgated 18 months ago compare with his original rule? Was 
it watered down significantly, somewhat, not at all?
    Mr. Pitt. No. What I am saying is I have read some people 
say that the rules were watered down. Chairman Levitt's 
comment, with which I fully agree, was not that the rules were 
watered down, but that they were better than the absolute ban.
    Mr. LaFalce. No. You originally said that he said they were 
better than an absolute ban. You did not originally say that he 
said that they weren't watered down. And so are you now saying 
that he also said that the rules that were promulgated were not 
watered down from his original proposal?
    Mr. Pitt. I will tell you this. I have looked at, I think, 
every statement I can get through computerized research and at 
no time did I hear Chairman Levitt suggest, because I don't 
think he believed it nor do I believe he should have, that the 
rules were watered down. There was a process of discussion and 
analysis with accounting firms, but eventually the rule that he 
enacted he thought was much better than what he had originally 
proposed, which was an absolute ban.
    Mr. LaFalce. One of your predecessors other than Mr. 
Levitt, Mr. Hill, argued last week before this committee, and 
you were his General Counsel when he was Chairman, that we 
should confer on audit committees a more formal legal status. 
He argued that the SEC should make it clear the failure to 
maintain an independent auditing committee constitutes a 
material weakness in a company's internal controls.
    My first question is do you agree with that?
    He also recommended that independent directors should be 
nominated by an independent nominating company rather than by 
the CEO or chairman of a company and that this was in the 
program of the SEC. Do you agree with that? Two specific 
recommendations of your former Chairman, and do you agree or 
disagree?
    Mr. Pitt. It would be hard for me to question former 
Chairman Hill's judgment since you are right, I did serve as 
General Counsel during his tenure. But my view is that, if you 
do not have a validly constructed and operating audit 
committee, that that is a material weakness. I believe that 
former Chairman Hill----
    Mr. LaFalce. Well, is it necessary for you to promulgate a 
rule to that effect to make that operative?
    Mr. Pitt. No. I don't believe----
    Mr. LaFalce. He suggested that it was.
    Mr. Pitt. I think what I read him to say and certainly what 
he has said in private discussions and communications with me 
is that the Commission should make that point loud and clear. I 
think I have just done that.
    Mr. LaFalce. Could you explain that more explicitly in some 
writing somewhere because the response to my question is one 
thing. But something a bit more formal in writing would carry a 
bit more weight, I believe. So I would be anxious to see that.
    And now to the second question regarding his recommendation 
for an independent nominating committee or the board of 
directors as opposed to taking the recommendations of the 
Chairman or President or CEO.
    Mr. Pitt. I believe that those suggestions are quite 
constructive. And as you may be aware and as I indicated in my 
opening statement, we have asked both the New York Stock 
Exchange and Nasdaq to come forward with corporate governance 
standards.
    Mr. LaFalce. Which they can do or which you can do, 
correct?
    Mr. Pitt. I believe they can do that, yes.
    Mr. LaFalce. And you can also too, can you not?
    Mr. Pitt. I believe we can do that. I believe it raises 
some significant questions, and indeed there is an opinion in 
the DC. Circuit, the Business Roundtable rule, that suggests 
that the Commission has some limitations on its authority.
    Mr. LaFalce. I would suspect you disagree with that, do you 
not?
    Mr. Pitt. I don't agree with the decision.
    Mr. LaFalce. I thought so. You think you have the plenary 
authority. I thought you would.
    Chairman Oxley. Gentleman's time has expired.
    The gentleman from Louisiana, Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman.
    Chairman Pitt, when CEO Berardino appeared before the 
committee he responded to a question from me as to the 
ownership issue of the financial statement in that it belonged 
jointly to management and shareholders. I was a bit taken aback 
by that view. Recently the GAO has issued a significant report 
in which one of the recommendations of that report is to 
statutorily define that the financial statement should reflect 
the financial condition of the corporation for the 
shareholders' evaluation and not be the subject of managerial 
influence or control. Would it be of help to the Commission if 
there was a provision of law that made it clear that the 
financial statements should be prepared to reflect accurate 
financial condition of the corporation for the benefit of 
shareholders?
    Mr. Pitt. The law already provides that, and I would be 
concerned such a provision actually would create an implication 
that the law does not require that.
    Mr. Baker. Terrific.
    With regard to incentives, it appears that there are 
significant conflicts, whether it is an audit firm which is 
consulting and is paid $50 million in the aggregate or whether 
it is simply a $50 million dollar audit. There are 50 million 
reasons in both cases to be influenced. Likewise, for 
management to manipulate earnings, revenue streams, obfuscate 
debt, the consequence of which is to increase stock values. It 
is all too often the case that part of the employment contract 
incorporates no cost options which are obviously intended. If 
you do well and manage the company properly, those options 
become more valuable, you exercise them. But then subsequently 
if there is a restatement of earnings within some short-term 
period, the shareholder takes the consequences of that loss 
while the executive is able to retain those proceeds. I don't 
know the appropriate remedy, but in both cases are there 
incentives that could be considered by this committee for 
inclusion in the mark, which would cause one to invest for the 
long term, not for the benefit of the quarterly report, and are 
there further incentives that might be provided for the audit 
side of the function, for example, a cooling off period, where 
if you are the principal audit firm engaged by a corporation, 
that you could not be employed by that corporation in an 
executive capacity for some period of time after you conduct 
the audit, traditionally known as a cooling off period? With 
regard to either of those, do you have recommendations or could 
you make those at some future point to us?
    Mr. Pitt. I do. With respect to incentives, I could not 
agree more with you that there is a need to make sure that 
management's incentives align with shareholders' interests. 
Just last week, we brought a case that is a bit unusual for the 
Commission in which we have sought to have a former CEO of a 
public company disgorge his compensation in stock options and 
bonuses because the appearance of profitability was an 
illusion. I believe that the Commission has to be much more 
aggressive in targeting misconduct. And where serious 
misconduct has occurred, I think one incentive or sanction has 
to be removing any benefits and making certain that benefits 
are seen as a long-term proposition and not as a short-term.
    The other thing, and this is a place where we do need 
legislation, is that I believe that the Commission should be 
given administrative authority to bar officers and directors of 
public companies who commit violations of the Federal 
securities laws from serving as officers and directors. We can 
do that in the securities industry. The banking agencies can do 
it with banks. I believe we should be able to do it with public 
corporations, obviously subject to review.
    Mr. Baker. Let me jump in with one quick statement. 
Finally, with regard to our whole accounting system, although 
we are taking important steps with the bill, as to the overall 
system we have today, which tends to be historic in nature, 
reporting activities 90 days old, we need to look more 
thoroughly over the long term toward real-time forward 
disclosure as opposed to the regular FD approach, which appears 
in retrospect not to have worked very well at all. If reg FD 
was intended to provide the investing public with a thorough 
understanding of the markets, it would appear given recent 
circumstance that it has been a failure at best and we have a 
long-term project ahead of us to reconstruct our whole 
accounting methodology to give investors real-time information 
that is helpful to the forward direction of the company. My 
time has expired.
    Mr. Pitt. One of the propositions in the bill I support 
that you and Chairman Oxley have authored is the notion of 
moving to more current disclosure. My concern about regulation 
FD, which I share in terms of the remarks you made, is that you 
can satisfy the rule by saying nothing to anyone. We are 
proposing affirmative disclosure requirements, and I think that 
solves the concerns that the former Chairman had about 
selective disclosure, but does so in a way about informing the 
market rather than keep information away from the market.
    Chairman Oxley. The gentleman's time has expired.
    The gentleman from California.
    Mr. Sherman. Thank you. Let me first suggest something that 
I think you could probably do next week and might not be 
terribly controversial, and that is to require that every audit 
report filed with the SEC be signed by the head of the 
technical review department within the accounting firm after 
seeing all the information and that we not have a circumstance 
where the final decisionmaker as to whether Arthur Andersen's 
signature appears at the bottom of a report is made by the 
billing partner, the engaging partner, the golfing partner, but 
is instead made by someone whose loyalty is to the firm as a 
whole and who is selected on the basis of the technical 
expertise. Can you do that next week?
    Mr. Pitt. I don't know if we can do it next week. But I 
will say this, we are very much in favor of the concept you are 
articulating, which is that in order to make sure that firms 
apply their supervisory responsibilities, the national 
technical office be assigned to every audit and not leave the 
final decision in the hands of the engagement partner. We think 
that would produce even better audits than we presently have, 
and most firms I think are doing that.
    Mr. Sherman. There was one Big Five firm that wasn't.
    Mr. Pitt. You are right.
    Mr. Sherman. The SEC under the Chairman's bill will be 
reviewing, I believe, the top 500 firms when they file their 
accounting statements with you, reviewing them I hope as you 
review initial public offerings by small firms. I hope I have 
that right. But can you provide us with how much money you will 
need to do an outstanding job of reviewing either the 500 most 
important financial statements or the Fortune 1,000 or the top 
5,000 and would it be necessary to increase your budget by 50 
percent or 100 percent so that we get the same kind of review 
process there as I commented earlier I was used to with smaller 
companies? Obviously you can't plan your budget on the back of 
that envelope in front of you, but if you could submit that for 
the record so that we know? And can you also comment now, do 
you have the independence as the head of an independent agency 
to come to Congress and say I need my budget doubled or are you 
under the thumb of OMB and under the thumb of those looking at 
the macro-budget situation from the Administration?
    Mr. Pitt. I would like to assure you that, with the 
exception of my four children and my wife, I am under the thumb 
of no one. I will say this, that we have had a very positive 
and constructive working relationship with OMB. We have 
differences of view and at my confirmation hearing I stated 
under oath that I will always come back to Congress and inform 
you whenever there were differences of view if Congress wanted 
to know what we had asked for.
    Our major difference with OMB only relates to funding pay 
parity for 2003. And, because I believe we have a good 
relationship with them, I believe that we will ultimately 
prevail, although I am an optimist by nature.
    Mr. Sherman. You may disagree on that one point, and that 
is how much your existing people get paid. You seem to comment 
favorably on the idea of the SEC at least reading and demanding 
clarification of the financial statements filed with you. That 
is a lot of additional work. The President doesn't have a penny 
in his budget to allow you to do that work. I assume that all 
your people are working hard now and that they don't have free 
time. So I would hope that you would submit to us something 
that I guess would be your second potential difference with the 
Administration, and that is how much you would need to carry 
out either the kind of review that I believe the Chairman's 
bill calls for and I am asking you also to expand that, not 
from 500 firms, but to 1,000 and then 5,000.
    Mr. Pitt. May I just say this. When we testified before the 
Senate Commerce Committee on March 7, I had indicated that in 
order to deal with the incredible vigor with which we are 
approaching financial fraud cases and to deal with our review 
of Fortune 500 filings we need 100 additional people. OMB 
supported that, and indeed, after our testimony, my 
understanding is that they asked whether, rather than waiting 
until 2003, we would prefer to have it immediately, which, of 
course, we would. I do want you to understand what the 
relationship is.
    I also believe that the Commission is not a separate 
government. I believe the SEC has to be part of an overall 
government and it is my view that we are under an obligation to 
respect the fact that there are a lot of budget priorities.
    With regard to the point you make about how many more 
people we would need, I do think one point is critical to 
stress. My hope had been that I would have taken the first 
couple of months in office and done a thorough assessment of 
how many people I thought we needed, whether there were 
efficiencies. A funny thing happened to me on the way to the 
Commission. And we are now dealing with our third crisis, and 
so I haven't had the time. This week we will be announcing, 
however, a 4-month in-depth internal review of our deployment 
of resources and with an effort to figuring out before 2004 
budget time what our actual needs are, and we are devoting 
substantial attention to that. But you should be aware, and 
this is the one concern I have, there is not enough money and 
there aren't enough people to give you the kind of guarantee 
that I think we all would like to have. And so there are always 
tradeoffs.
    But, one thing we did the minute Enron hit was to redeploy 
our assets in the Corporation Finance Division to review 
Fortune 500 filings. And one of the things that we want to do 
with the additional 100 people is to hire risk management 
specialists who will direct us to look for places where the 
greatest likelihood is that problems will arise. I think that 
will help us strategically.
    Chairman Oxley. The gentleman's time has expired.
    The gentleman from Ohio, Mr. Ney.
    Mr. Ney. Mr. Pitt, can you give your view on how accounting 
firms maintain their independence of their auditors when 
members of their firm work for years with the same company? And 
what I am trying to get at, the question I had asked in the 
earlier hearing a few weeks ago, I raised the issue about how 
Andersen employees were intertwined with Enron and were 
actually mistaken for Enron employees. They even went as far as 
to wear Enron golf shirts and went on Enron retreats and some 
of the people thought they were Enron employees.
    Could you tell us, in your opinion, if the reforms proposed 
in H.R. 3763, whether the reforms you suggest will ensure 
independence of future auditors, not just with golf shirts, 
but----
    Mr. Pitt. I believe they will, because both H.R. 3763 and 
the proposition that the Commission has put forth are designed 
to create a board that exclusively deals with the ethics, the 
quality control and the independence of public accounting 
firms. One concern I have is that we not write something in 
stone, because if we put it in stone today we may discover 
tomorrow that it creates a different problem, and that I would 
like to avoid. But I believe both the legislation and our 
proposal would respond to that concern of yours, which I think 
is a legitimate concern.
    Mr. Ney. And still have flexibility.
    Mr. Pitt. Yes, we would have flexibility.
    Mr. Ney. The other thing, Mr. Chairman, is it possible for 
a company to meet the GAAP standards and still provide a full, 
fair and complete picture of a company's financial condition? 
If so, would the bill improve the standards to solve that 
problem?
    Mr. Pitt. I believe that it is possible and it has happened 
that companies may comply literally with GAAP and still have 
financial statements that may prove misleading. About 40 years 
ago--actually less than that, but almost 40 years ago, Judge 
Friendly in the Second Circuit in the U.S. Against Simon case 
rejected as a defense the notion that financial statements were 
done in accordance with GAAP and therefore the accountants 
could not be held criminally liable. He held just the opposite.
    Judge Stanley Sporkin in the Lincoln Savings case held the 
same thing, that you can still create a misleading impression. 
Notwithstanding that, we think there is a strong need to change 
the way accounting principles are adopted and the way 
accountants look at those principles. The current set of 
principles facilitate a check the box mentality. That is 
something that we believe has got to be changed.
    We want professionals as well as management to ask 
themselves, if I were an investor, does this disclosure tell me 
everything that I would want to know. And the fact that it may 
comply with GAAP is only one issue. If it still creates a 
misleading impression, it should not be satisfactory to anyone.
    Mr. Ney. Does it tell you everything you need to know and 
also in a timely manner, also information gets there obviously 
as quick as it can?
    Mr. Pitt. Absolutely.
    Mr. Ney. One other thing, if updating the accounting 
standards has been lengthy and arduous, which I think we all 
agree in recent years that task has been tough, do you think 
the reforms that we are discussing today can change that?
    Mr. Pitt. I am sorry, can they change----
    Mr. Ney. It has been a lengthy process to update accounting 
standards. Do you think that the reforms we are discussing 
today will change that process, open it up, or is it still 
going to be a lengthy and arduous task and possibly should be?
    Mr. Pitt. I believe that, both under our proposal and this 
legislation, we could improve the way accounting standards are 
articulated. The FASB, which presents a full-time reflection on 
accounting principles, is a wonderful concept. Its 
implementation however, is troublesome. First, its funding is 
not truly independent, because it is voluntary, and we believe 
it needs to be mandatory. Second, we think that the Commission 
in the past has been lax in overseeing what the FASB has been 
doing, how quickly they do it and what matters they attend to.
    One of the most important subjects in accounting is revenue 
recognition. For 27 years, there has not been a statement of 
principle on revenue recognition. So I believe the Commission 
has to have clear authority to direct the FASB to respond to 
questions.
    And finally, I believe accounting principles have to be 
principled and not Tax Code formulated. They have to be 
designed to make use of professional experience and knowledge 
without giving people such a detailed approach that all they do 
is check the boxes. At the same time, they have to be 
promulgated rapidly. The notion of taking 5 or 10 years or, as 
I said, 27 years, with respect to revenue recognition just 
doesn't cut it, and it has been allowed to go on way too long.
    Chairman Oxley. Gentleman's time has expired.
    Gentleman from Massachusetts, Mr. Capuano.
    Mr. Capuano. Thank you, Mr. Chairman.
    Thank you, Mr. Pitt. Before I ask you questions, I just 
want to make sure you note that the budget that is on the floor 
today, in the Budget Committee, an amendment to fund pay parity 
this year was voted down. Mr. Moore made the motion and it was 
voted down along party lines, just as a little footnote. So 
your difference is not just with OMB, but with Members of 
Congress as well.
    I guess I need to go back about a month or so ago, and this 
is the first time you have appeared before this committee. Mr. 
Berardino testified at the same table. And during my 
questioning he made a comment that I found a little shocking, 
because I suggested every auditor has an opportunity, if they 
differ with what a client wants to do, to either add a comment 
to the audit report or qualify that audit report, which is a 
kiss of death on many levels. And his reaction was something 
along the lines, well, we can't do that under GAAP, which I 
found a bit shocking. And at some point if you could clarify my 
understanding of that, because I am still under the impression 
that any auditor can either add a comment at the least or 
qualify that audit report any time they find a client kind of 
crossing the line or not doing something within the four square 
of what they need to do.
    Mr. Pitt. Let me say that the concept that you articulate 
is one that I embrace, which is I believe that auditors have to 
have the responsibility as well as the backbone to question and 
take issue with management's selection of auditing principles 
or their application. Whether or not current law permits a 
qualified opinion, which is generally given under certain 
circumstances, may be a more technical question, but as your 
question suggests, we shouldn't be interested in 
technicalities. That is one of the reasons why we have proposed 
and will be implementing the rule which requires companies to 
identify their critical accounting policies, explain what would 
have happened if they had chosen different policies and also 
discuss what assumptions they made and what would have happened 
if they had operated under different assumptions. We believe 
that is going to get us to the place that you want to be and, 
as I say, I support the notion that we have to have accountants 
reflect independent judgment on the financials they review.
    Mr. Capuano. And the other thing I suggested to him is in 
the final analysis even if you feel hamstrung you can always 
walk away from the client, which in this particular case I 
think in the final analysis is going to be proven to have been 
less expensive walking away from a $100 million client than 
what is going to end up happening. But we will let history be 
the judge of that.
    And that leads me to the next question and some of my 
concerns on both the bills that are filed before us is on 
proper influence. Arthur Andersen was my auditor when I was the 
mayor of my city, and one of the ways they kept me from doing 
some things I wanted to do to make the city look good on the 
books is if you do that we are going to have a qualified 
report. If you do that, OK, fine. My job was to make the city 
look as best it could in front of investors, as is the job of 
anybody else.
    So my concern in some of the language that is used in this 
improper influence, what is the line that I can't cross. My job 
is to push. The auditor's job is to say that is enough, you 
can't cross this line. And my concern with some of these 
languages, improper influence, what does that mean? I 
understand if I say I got a picture of you and your girlfriend, 
that is improper influence. But for me to say I want to go 
here, I want to report this in this manner and don't you think 
you should count this revenue, under some of this language I am 
a little concerned that could be considered improper influence. 
And as we go through these bills, I would like you and your 
people to kind of keep that in mind, because I don't want this 
committee doing something that I don't think we really want to 
do.
    Mr. Pitt. Let me again say I share with you the underlying 
principles that your question implicitly raises. Both the bill 
and the Commission's proposal would set up an independent body 
that would be reviewing the quality of audits, not just 
providing discipline when something has gone wrong, but 
reviewing every major accounting firm on a yearly basis. 
Unfortunately, the present mechanism, the public oversight 
board which had been in effect for 25 years, was dramatically 
flawed. It wasn't given the powers and authority it needed. 
Under the proposal that we have raised and under the bill, you 
have a body that would effectively go through quality review 
and have the power to strip an audit firm of a client if it 
found that the audits were not of the highest quality. We 
believe that will create exactly the kind of incentive that you 
want to see occur.
    Mr. Capuano. Though my time is out, I would like to add a 
footnote. If and when that is the way we end up, I would hope 
that such action on your behalf would be somehow publicly 
notified. If it is a private thing in the back of a room and 
nobody knows you did it, it really won't accomplish much.
    Mr. Pitt. Let me say that discipline in secret does not 
achieve its purpose. When we take disciplinary action, when the 
stock exchanges and the NASD take disciplinary action, we 
publicize it. The public has a right to know if people have not 
lived up to appropriate standards.
    Mr. Capuano. Thank you, Mr. Chairman.
    Chairman Oxley. The gentleman from Connecticut, Mr. Shays.
    Mr. Shays. Thank you, Mr. Chairman.
    Mr. Pitt, thank you for being here. I have a number of 
questions. Let me begin by saying, by asking this question. 
Some have told this committee that there is a danger in 
creating audit-only firms. Do you agree or disagree?
    Mr. Pitt. I agree completely with that. I think it is a 
simplistic solution to a complicated problem. And it will 
produce worse audits than we presently have. I believe that, as 
I have said earlier in response to I think a question from 
Chairman Oxley, that the problem is a twofold problem. One is 
with the engagement team, where they must have absolute 
scrupulous impartiality and independence, and then at the firm 
level, there has to be incentivization to make sure that the 
firm enforces the right supervisory techniques.
    Unfortunately, this issue with a total separation would 
only deal with the firm-wide question and not deal with the 
real problems here.
    Mr. Shays. Let me get to another question. A witness on our 
next panel has taken the position he supports mandatory audit 
firm rotation, and what is your position on that?
    Mr. Pitt. My view is that mandatory audit rotation would 
write in stone a process that could prove detrimental. I 
believe that when an audit firm is not living up to the highest 
standards, then a disciplinary body should require mandatory 
rotation of that client. But I don't believe that setting in 
stone a rote process of a new auditor every 7 years is 
beneficial. There are a number of reasons for that.
    Mr. Shays. Let me get to that later in the 5 minutes that I 
have. In the Oxley-Baker bill, which I am a cosponsor of, is 
there any new authority that you would like to see in the bill 
that is not in the bill now?
    Mr. Pitt. The principal authority that we would like to see 
included is our ability administratively to bar someone from 
serving as an officer or director of a company if we find that 
they have engaged in egregious misconduct.
    Mr. Shays. Is that the primary addition?
    Mr. Pitt. That is the principal one.
    Mr. Shays. Would you send that to this committee, suggested 
powers that you want that aren't in the bill? Let us know what 
they are.
    Mr. Pitt. Well, there are----
    Mr. Shays. In writing.
    Mr. Pitt. Yes, I would be happy to do that.
    Mr. Shays. In 1992, the SEC, the Treasury and the Federal 
Reserve in a joint report recommended legislation to repeal the 
GSE's exemption from the Federal securities law. As you know, 
Fannie Mae and Freddie Mac are the only two publicly traded 
firms that aren't. Does the SEC still adhere to the 
Commission's 1992 report?
    Mr. Pitt. We have not changed our general position, but we 
have focused on it again. I will say that in this day and age I 
believe transparency has to be the order of the day. To the 
extent that the exemptions permit anything less than 
transparency, which I believe is the case, I believe at least 
that portion has to be removed. Frankly, I could care less 
whether the GSEs pay registration fees or things of that 
nature. But I do believe that disclosure is critical for the 
GSEs as well as for other public companies.
    Mr. Shays. You say it fairly strongly. But in your 
statement where you say comprehensive information is the 
lifeblood of strong and vibrant markets, our system and the 
global markets supporting that system require accurate, 
complete and timely disclosure of financial and other 
information. The current system of Federal securities 
regulation is premised on a full and fair disclosure of this 
information. Companies choosing to access the public capital 
markets must provide material information about their financial 
results and conditions, businesses, securities and risks 
associated with investments in those securities. Could I use 
this as a strong support in some cases of such disclosure?
    Mr. Pitt. Yes.
    Mr. Shays. Thank you. I yield back, Mr. Chairman.
    Chairman Oxley. The gentleman yields back.
    The gentleman from Texas, Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Chairman Pitt, I have a few questions for you. I want to 
talk for a second about the audit firms. Under the MSRB, isn't 
there a rule for auditing firms that audit the books of issuers 
of debt of public entities, cities, states, whatever, that 
during that period of time those firms can't conduct other 
services for that issuer? And you may not know off the top of 
your head, but I just wonder if we already have some 
experience.
    I understand your concern about complete separations and 
bans, but what I don't know, is there something wrong if we are 
already doing it, is there something wrong with saying if you 
are going to audit one firm, you can't consult with them, but 
you can consult with everybody else? If you have 17,000 public 
companies, there is plenty of business to go around.
    Mr. Pitt. Let me say that neither the MSRB nor anyone else, 
to my knowledge, has thus far taken the position that a firm 
may only do audits as a way of business. What a firm can or 
should be allowed to do for an individual client is a very real 
issue. And there can be conflicts, for example, where the other 
services would involve the auditor in reviewing its own work. 
That would be a situation clearly where auditors shouldn't be 
allowed to undertake those particular functions for a client. 
What I was addressing, and what I continue to urge upon this 
committee, is the notion that stripping down accounting firms 
so that the only thing they do is audits will produce worse 
audits in the future than we presently have.
    Mr. Bentsen. I agree with that. I guess what I am saying is 
just on a client-by-client basis, you know, the number one can 
do the audit, the number two can do the other consulting 
business. Whether or not there is merit in that, in saying you 
just can't do both when one is say a public issuer.
    Mr. Pitt. The problem with any generalization is that 
somebody will always find circumstances to create problems, and 
the tax area is a good one. If accounting firms provide tax 
services to audit clients, they will be far more familiar with 
the company they are auditing and they will be developing the 
kind of expertise that is critical to do a qualified audit. So 
my view is that if a particular function creates the 
possibility of a lack of independence, it should not be 
allowed. But I don't think we should have an absolute ban.
    Mr. Bentsen. Let me go to the public regulatory 
organization because I am curious about that. I think it is 
generally--I think it is a good idea. I am curious about 
exactly how you would envision it working and the ideas of 
setting principles or guidelines for auditing firms to meet 
which the Commission would have oversight over both the 
drafting of those principles and the enforcement of those 
principles, if I understand your testimony correctly. Are we 
heading down a path where basically the Commission would be 
overseeing the quality of audits and in effect you would have 
to be giving an opinion just like you give a qualified tax 
opinion for an issuance of debt or securities, that you would 
be giving a qualified opinion that the audit meets the 
standards as established by the PRO? And that may be where we 
want to go. I just don't know. What do you envision how this 
ultimately will come out?
    Mr. Pitt. I think what we have in mind is somewhat 
different from that. What we have in mind is having a vigorous 
body that both can discipline individual accountants as well as 
whole accounting firms or offices of accounting firms, that can 
do quality control review to make sure that, even if there 
hasn't been a violation, the standards are the highest, a body 
that can enforce ethical requirements and that can enforce 
existing auditing standards.
    With respect to accounting principles, my view is that I 
would leave that in the FASB. But in both cases, what I think 
is critical is that the Commission has to provide meaningful 
oversight. And I think over the last several years the 
Commission has not provided meaningful oversight to those 
functions, and that is something that we are pledged to change.
    Mr. Bentsen. So this would be a form of registration for--
any auditing firm of a public company that is going to have a 
registered issuance would then have to meet the principles and 
would be subject to greater oversight than what is under 
existing law or rule by the Commission?
    Mr. Pitt. Any firm that wanted to be an auditor of public 
statements by public companies would have to belong to the PAB, 
as we call it, or the PRO, as the Oxley-Baker bill refers to 
it. And they would have to adhere to all of the standards, and 
they would have to be subject to discipline, and they would 
have to be subject to all of the rules and requirements of that 
organization. That is what we believe is a necessary approach 
to restore public confidence in the accounting profession.
    Chairman Oxley. The gentleman's time has expired.
    The gentleman from California, Mr. Royce.
    Mr. Royce. Thank you, Mr. Chairman.
    Thank you, Chairman Pitt. Let me ask you if you envision 
any practical way of ensuring that the board of directors for 
public traded companies are held accountable in their duty of 
directing management with a view toward optimizing company 
performance and increasing shareholder wealth. One of the 
things you talked about was specifically giving the SEC the 
ability to bar anyone who was engaged in egregious conduct. I 
agree with that. But looking at it from the incentive side for 
a minute, are there any changes that the Federal Government can 
make to its best practices recommendations in regard to board 
member selection and in regard to remuneration that would 
incentivize members to pursue the interests of the stockholders 
themselves rather than the interests of management?
    Mr. Pitt. I think you will hear about that on the next 
panel, among others from Mr. Livingston, who is with Financial 
Executives International. At our request FEI reviewed its 
existing code of ethics, which I thought was excellent when it 
was promulgated, to see whether there ought to be some changes, 
and indeed they have recommended a change in that. And, in 
addition, they have taken a position on 12 critical issues 
relating to this entire aftermath of Enron.
    I believe that corporate officers and directors have to be 
held to much higher standards. The question is how those 
standards are articulated. If they can be articulated even 
through the stock exchanges' listing standards, or through such 
codes of ethics as the FEI has proposed to me, that is a very 
sensible way of getting to the right result. And I think that 
it would provide a real incentive, particularly if we have the 
power to effectively sanction people who don't live up to those 
highest standards.
    Mr. Royce. We talked about incentives. Let's talk about 
deterrence then. Short of having those involved in egregious 
conduct simply barred, which is a good idea, what are some of 
the other tools that the SEC would use or how would you 
envision other sanctions on those corporate leaders who do not 
act responsibly?
    Mr. Pitt. Well, one of the things that we have discussed 
here, but I think is worth mentioning again in response to your 
question is the notion that whatever incentives corporate 
officers and directors receive for performance should be 
honestly earned. So, if officers and directors have been 
compensated either by stock options or salaries or bonuses for 
producing results that turn out to be shams, they should have 
to give back every penny that they took from the shareholders. 
That is another thing that we are proposing, and, as I said, 
last week we filed a case in which we have sought that against 
a former CEO of a public company.
    Mr. Royce. Do you feel at this point in this legislation 
are you crafting language that would give the SEC that ability?
    Mr. Pitt. Well, on the removal of unearned incentives, I 
believe that all the authority that is needed exists. When we 
go into court, we can ask the courts to provide that relief. 
Obviously if the courts don't agree with our case or for 
whatever reason they think it is not an appropriate remedy, we 
are not going to get it. But that system has worked quite well.
    Mr. Royce. We would certainly with legislative intent in 
this bill amplify that and state that it is Congress' desire 
that you do have these powers, which you are now exercising or 
attempting to exercise in the Enron case, but just to clarify 
those powers to further assist in your court proceedings. I 
think that would be a wise policy.
    Mr. Pitt. I think that would be helpful.
    Mr. Royce. I will be happy to follow up with you on that 
language if you could assist me in developing the language that 
you think would be most effective toward that end. And I thank 
you very much. I thank the Chairman of the committee.
    Chairman Oxley. The gentleman's time has expired.
    The Chair now recognizes the gentleman from New York, Mr. 
Meeks.
    Mr. Meeks. Thank you, Mr. Chairman.
    Chairman Pitt, let me ask, the regulatory structure that 
you advocate for the auditing profession would move quality 
review and discipline to an organization controlled by public 
members rather than accountants. And it leaves the standards 
that the auditors must meet subject to the rules of the 
industry control organizations. Wouldn't it make more sense to 
have the same entities set standards and enforce those 
standards, you know, at one body as opposed to having two 
separate?
    Mr. Pitt. I think that is a suggestion that is worthy of 
consideration. My own view is the difficulty isn't with the 
ethical standards that have been promulgated. The difficulty is 
with the adherence to those standards and the enforcement of 
those standards. If we had reason to believe that the ethical 
standards were lacking in some way, then I think your point 
would be very well taken. At the present time it seems to me to 
be a problem of enforcement, not of standard-setting.
    Mr. Meeks. Let me ask this question, then. I believe in 
your testimony earlier you said that the--it was too early to 
tell if the auditor independent rules that were in place in the 
year 2000 needed to be amended. As a result of the additional 
corporate disclosure required under those rules, we have 
already learned that some companies are paying the auditors as 
much as 30 times more in fees for non-auditing services as they 
do for auditing services. Auditing services have been turned 
into a loss lender to enable firms to get contracts for non-
offered services. Do you think that it is appropriate for them 
to make so much more consulting?
    Mr. Pitt. I don't really feel that the question should 
focus on whether that is appropriate or not. The question that 
I think those facts suggest is whether or not that situation 
could give rise to a lack of independence. That is what is 
implicit in the question. I have to say it is always possible 
that at some level, fees could create problems. But I think 
that there are ways to deal with that issue. I don't think, for 
example, that you and I sitting down together--I know you and I 
could reach agreement--but I don't think that, if you and I sat 
down together and said, fine, you can only make 50 percent of 
your revenues from consulting, that that would necessarily 
produce better audits.
    In fact, I think if you look at the history of some of the 
failures in the 1960s and 1970s, long before consulting was a 
factor, you will find that we had some enormous audit failures. 
And they had nothing to do with the consulting fees.
    My concern is that we should be sensitive to the problem of 
where the fees are coming from, how much auditors are earning. 
But I don't feel that there is a right number or amount of 
fees. What I think is there is a right way to conduct an audit 
and there is a right way to discipline auditors who don't meet 
the highest standards. That is what is critical.
    Mr. Meeks. Finally, it caught my attention also you 
mentioned your concerns about the time period to roll out FASB 
standards and what they should be based on. Do you believe the 
adoption of standards based on a simple majority would be 
better than what is now instituted, the super majority, 
especially when you consider there are only seven members on 
the board?
    Mr. Pitt. My answer is unequivocally ``yes.'' And the 
reason is that we simply can't afford to wait. There is very 
little unanimity on anything, any issue of the day. What we 
need are principles that are sound, that are overseen by the 
SEC to make sure that they are in the interest of shareholders 
and that they promote full disclosure. But a reduction of the 
size of FASB, which has been proposed to five, and then having 
principles adopted by a 3-to-2 vote seems to me to be perfectly 
sufficient. This body operates by standard majority. It is the 
way the Senate operates. And I think it is appropriate for the 
FASB as well.
    Mr. Meeks. Thank you, Mr. Chairman.
    Chairman Oxley. The gentleman's time has expired. If I 
could just follow up briefly. Is it your understanding that the 
Commission, the SEC, could overturn any decision made by FASB?
    Mr. Pitt. Absolutely.
    Chairman Oxley. Thank you.
    The gentleman from Virginia.
    Mr. Cantor. Thank you, Mr. Chairman.
    Mr. Chairman, I just have a question concerning the Private 
Security Litigation Reform Act of 1995, and there has been 
some, I guess, renewed vigor around discussing sort of the 
impact of that Act and opposed to the Enron situation that we 
are in. I was just curious about your thoughts on the 
relationship between the Act and the ability of investors to 
receive any kind of results for actual fraud under the Act and 
then if you think there was or is a relationship with the Act 
and the Enron collapse.
    Mr. Pitt. Let me say first that, if I thought that the Act 
in any way created the possibility that we might have more 
failures, I would be back here urging you to reconsider aspects 
of that legislation. As I have said repeatedly, I don't think 
any issue can be off the table. We have checked with a number 
of entities, independent entities, that keep statistics, 
including one run by Professor Grundfest at Stanford. The 
statistics that have been reported to us show that the number 
of class action suits has remained constant, may even be a 
little bit larger, but that the amount of awards has increased 
significantly. If anything, I believe that the legislation on 
private securities litigation has actually strengthened bona 
fide cases while weeding out those cases that are frivolous and 
that simply seek to take advantage of a downturn in the market.
    In my view, there is absolutely no connection that has been 
shown between the collapse of Enron and the Private Security 
Litigation Reform Act. Absolutely none.
    Mr. Cantor. Thank you very much. Yield back, Mr. Chairman.
    Chairman Oxley. The gentleman yields back.
    The Chair now recognizes the gentlelady from New York, Mrs. 
Maloney.
    Mrs. Maloney. Welcome, Mr. Pitt. And I commend you and some 
of the initial steps that the accounting and security 
industries have take in recent weeks to eliminate conflicts of 
interest. And I represent many employees in the accounting 
business, and for the most part the vast majority of these 
professionals are hard working and honest people. Yet I very 
much support the Oxley bill and the LaFalce bill and really the 
statement of the accounting firms themselves that we should 
separate accounting and consulting and create a strong public 
regulator for accounting. And many of our members have stated 
that you could do consulting for other firms, but at least 
separate it, as former Chairman Levitt advocated so strongly, 
to put a firewall between auditing and consulting, and I think 
this should be the first step. Even the consulting firms and 
auditing firms themselves have called for this and say they are 
doing it voluntarily. So we should put the statutory strength 
behind it.
    You mentioned that there is a difficulty in enforcement and 
a number of professionals have come forward with an idea to 
ensure that accounting firms do their jobs correctly without 
heavy Government interference. And what do you think of the 
proposal that the SEC could require that all publicly traded 
companies hire a second auditing company to review its books 
every 3 years? That would be built-in oversight without heavy 
governmental interference.
    Mr. Pitt. The difficulty with that suggestion, which I 
believe is well motivated, is that there are only five major 
accounting firms. And my concern is that would create a 
taxation on investors effectively that wouldn't produce the 
results you want. I think the goal is right.
    Mrs. Maloney. A taxation on investors and accounting firms?
    Mr. Pitt. Because both accounting firms would charge fees. 
If you just take the Enron situation for example, it has been 
reported that Andersen received $25 million for its audit. So 
if you brought in a second firm, we have now upped it to $50 
million. Somebody is going to have to pay that.
    Mrs. Maloney. We are talking about rotating every 3 years.
    Mr. Pitt. You are talking about rotation. I apologize. I 
misunderstood. I am in favor of rotation where it has been 
shown that an accounting firm has not lived up to the highest 
standards of auditing professionalism.
    Mrs. Maloney. But, it is difficult to see if you are living 
up to the highest standards of auditing professionalism. Enron 
was believed to be a model of a well run company up to months 
before it failed. And I find it tremendously troubling that 
Enron's techniques that duped the public were blessed by one of 
the world's most prominent accounting firms. And it is equally 
troubling that Enron is not an isolated case. It is by far the 
largest and most spectacular of several failures and near 
failures over the past several years, but they all had the same 
elements.
    So in many ways I see the Enron scandal, debacle, as the 9/
11 for the financial industry that we need to do something 
about it. They were condoning what has been alleged to be 
fraudulent accounting practices by one of our top accounting 
terms. So if you rotated it, it wouldn't cost more money and it 
would build in competition and build in oversight without 
increasing bureaucracy which----
    Mr. Pitt. My concern on that is there have been studies, 
the Cohen Commission, the Treadway Commission and others, which 
have shown that a large percentage of financial frauds occur in 
the first 2 years of an audit-client relationship. I believe 
that any per se mandatory rule removes flexibility from our 
society, and what it might produce are worse audits rather than 
better audits. You would have audit firms that weren't as 
familiar with the companies they were auditing and would be 
more susceptible to not catching fraud than they would 
otherwise.
    My view is that, if we establish a public accountability 
board, as we have proposed, which would do quality control 
review, not just where there has been a breakdown, but would do 
quality control review every year for the major firms, we would 
hopefully make certain that firms were providing the best 
quality services. And, if they failed to do that, they would 
lose their clients. The client would be automatically removed.
    Mrs. Maloney. But we have a case before us and other 
similar cases that took a tremendous toll on middle and lower 
income company employees that were left impoverished while 
politically connected insiders at the top walked away with 
millions. And the practice was condoned by one of our best 
accounting firms, or was considered to be one of our best 
accounting firms. So I feel that we need to do something and 
the Oxley and LaFalce bill certainly get us going in the right 
direction.
    Chairman Oxley. The gentlelady's time has expired.
    Mrs. Maloney. May I please respond to his study and request 
permission to place into the record another study that was 
cited in Business Week recently that showed that companies that 
use their auditors as consultants tend to manage earnings, 
including moving debt of the books into partnerships, the MIT, 
Michigan State and Stanford study that demonstrates that this 
practice is widespread and cites that steps need to be taken 
statutorily.
    Chairman Oxley. Without objection. The gentlelady's time 
has expired.
    [The following information was subsequently furnished by 
Hon. Carolyn B. Maloney for the hearing record.
    The gentlelady from New Jersey, Mrs. Roukema.
    Mrs. Roukema. I am sorry, Mr. Pitt, that I was not here for 
your testimony and I unfortunately could not be here for all 
the questioning, because I was in a markup in another 
committee. But I read with great interest the Business Week 
article which features an article called ``The Reluctant 
Reformer,'' and they identified Harvey Pitt. Do you know him as 
the rereluctant reformer? It did raise some questions in my 
mind, and I wonder whether you have already responded to these 
in one form or another. But, for example, where you were asked 
a few questions and gave an answer, I have a question mark 
beside a number of them, particularly, and I think this will 
bear repeating even if you have gone over it, because I think 
it is essential and the core of the issue before us. And the 
question was posed to you do you still oppose a rule that bans 
a firm from doing audits and consulting work for the same 
company?
    I know previously you had opposed any such rule. Your 
answer here is not quite explicit. Could you give us a precise 
answer as to your recommendations about audits and consulting 
firms from the same company. Because I believe they have to be 
separated. And I think our legislation indicates that requires 
that.
    Mr. Pitt. Let me----
    Mrs. Roukema. Or should, anyway.
    Mr. Pitt. Two things. First of all, those who know me know 
that I am seldom right, but never in doubt. There is nothing 
reluctant about me so ever.
    Mrs. Roukema. You sound like quite a few people I know in 
Government.
    Mr. Pitt. And secondly, reform is something I pledged to do 
when I came in. With respect to your question, do I believe 
that there are certain combinations of certain consulting 
activities that can create a conflict for accounting firms? 
Yes, and those should not be permitted. What I don't believe is 
prudent is an absolute separation of accounting from 
consulting, that is to provide that a firm may only do auditing 
work. That, I believe, would be a mistake.
    Mrs. Roukema. Can you explain that? Because it sounds to me 
as though you are endorsing the great potential for conflict of 
interest here.
    Mr. Pitt. Not at all. And, if I thought there were any 
potential for that, I would move swiftly to prevent it. My view 
is this: That restricting firms solely to audit work will 
deprive those firms of the ability to produce more revenues 
that will help them do better training of their auditors; 
second, it will deprive them of critical knowledge that would 
be useful for auditors to have when performing an audit; and 
third, it will create----
    Mrs. Roukema. Excuse me. That was your answer here. But it 
does not address the question of the conflicts of interest. How 
do you protect again the conflict of interest potential?
    Mr. Pitt. I have said that there are certain types of 
consulting work that inherently create the potential for 
conflicts, such as an auditor reviewing his or her own work, 
and auditors effectively acting in a management or a managerial 
capacity. Those things have to be wholly prohibited.
    I have also said that the SEC 18 months ago, under my 
predecessor, adopted a series of rules to define what could be 
done and what could not be done. And I believe that those rules 
should be given a fair chance to see whether they solve the 
problem or not.
    What I am opposed to are the proposals that have been made 
by some that a firm that does auditing cannot do anything else 
for anyone. That is something I am totally opposed to at this 
point.
    Mrs. Roukema. Thank you very much.
    Chairman Oxley. The gentlelady's time has expired. Let me 
point out to the committee we have two votes on the floor. I 
would like to get through the Members who are here for 
questioning. And let's begin with the gentlelady from Oregon, 
Ms. Hooley.
    Ms. Hooley. Thank you very much. Mr. Pitt, thank you for 
coming today. I want to make sure that we are all on the same 
wave length, and as we look at all of these issues that we are 
all here to protect the investors. Is that a common goal?
    Mr. Pitt. It absolutely is.
    Ms. Hooley. OK. To something that one of the other Members, 
Mr. Sherman, talked about, do you pay enough money to your 
auditors to be able to hire well qualified auditors in your 
department?
    Mr. Pitt. I am sorry?
    Ms. Hooley. Are the salaries of your auditors enough to 
hire well qualified auditors?
    Mr. Pitt. I think at the present time the salaries are not 
enough, and I think that there is a need for improvement. If 
you are talking about the private sector, my own view is that--
--
    Ms. Hooley. I am talking about within the SEC.
    Mr. Pitt. We have steadfastly urged the passage of pay 
parity, and funding for it. Since we don't have that funding 
for 2003, I believe that our people do not make enough money.
    Ms. Hooley. Let me just give you an example of a friend of 
mine who has worked for a couple of different CPA firms, large 
ones. One of the things that--comments she made to me recently 
was, you know, in all of these large companies they pay--this 
is the starting point for everyone. This is their training. 
This is where they put their newest, most lowest paid employees 
is out on auditing to sort of earn their way. What are we 
doing--a company can do that. They can do whatever they want. 
But what are we doing to make sure that we hold those companies 
to some standard so in fact they are not putting their least 
experienced out on the auditing road?
    Mr. Pitt. Well, that to me is one of the gaps in the 
existing set of regulations, including the Public Oversight 
Board. In my view, it is absolutely critical that people be 
appropriately trained as well as sensitized to both legal 
requirements and ethical requirements in the accounting firms, 
and then that there be diligent review by an independent body 
to make sure that firms live up to those standards.
    At the present time I don't believe that that is happening. 
That is why we have proposed a public accountability board, and 
Chairman Oxley and Chairman Baker have proposed a public 
regulatory organization.
    Ms. Hooley. Let me mention one other comment that another 
person made, and she was doing some temporary work at a company 
who I won't name. And she said half the people that worked in 
that financial department had all come from the auditing firm. 
And she said I can guarantee you when the auditing firm they 
came in, they knew one another and they said they were never 
going to get a very tough audit. And she said, and they knew 
all the people working for this company got paid more than they 
got paid as the auditors because they were the lowest paid. Do 
you ever hear any comments about that? Is that common or----
    Mr. Pitt. I do.
    M. Hooley. Again, how does that protect the investor?
    Mr. Pitt. I am concerned about the so-called private sector 
revolving door problem. I think it is a legitimate issue, and 
one that requires some attention. My big concern is that, for 
middle and smaller size companies, it may not be possible for 
them to attract from a wider pool of talent. And my only 
concern is making certain that before we adopt any 
restrictions--and I think there is a need for some guidance 
here, and some guidelines--but, before we adopt an absolute 
restriction, we make sure that smaller firms are not somehow 
being disadvantaged. But the issue is a fair one.
    Chairman Oxley. The gentlelady's time has expired.
    The gentleman from Pennsylvania, Mr. Kanjorski.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Mr. Pitt, am I to assume that you are opposed to term 
limits? I mean, it seems to me limiting an auditor's ability to 
stay with a corporation to a certain number of years is very 
analogous to term limits of Members of Congress. I think that 
was a very popular, easy solution in the early 1990s that has 
since faded. I expect that you favor or are opposed to term 
limits in that regard, as you are for the auditors. Is that 
correct?
    Mr. Pitt. Well, let me say that I don't think that there is 
a direct correlation between term limits on politicians and 
term limits on auditors.
    Mr. Kanjorski. So you would like us to have term limits, 
but not the auditors?
    Mr. Pitt. I haven't said that. I just said that the--I 
think the issues----
    Mr. Kanjorski. I am opposed to term limits. I was using the 
analogy to say it seems to me the problem is the electorate. 
The electorate, in this case, is the shareholders in the 
corporation. They are the ones that elect the board. The board 
is to proceed using due diligence to protect their interests. 
They are allowed to make mistakes, I guess. They are allowed to 
hire foolish or fraudulent auditors, as members of the 
electorate are able to elect foolish or fraudulent Members of 
Congress.
    Mr. Pitt. Although that hasn't happened yet, to my 
knowledge.
    Mr. Kanjorski. No, that never happens, right?
    I am a little worried about this rush to decision and 
structuring a lot of rules to accomplish what appears to be a 
lot of good purposes, but in the end, could result in great 
damage to the system. So, when people come up with these 
definite rules, it concerns me. What is the next thing? Well, 
are we going to term-limit lawyers? Can we have a law firm 
representing a corporation for only 4 years? That is 
ridiculous. They are hiring professionals. The relationship is 
of such a nature that you do not want to have someone telling 
you that you can not hire your auditor or lawyer. Those are the 
people you have the most trust in. They in turn have the 
professional responsibility to perform to the highest 
standards.
    In between there, we have a board of directors, or 
governors, to oversee and be sure that these professionals 
protect the interest of the shareholders. If the shareholders 
find they do not do that, they can kick them out. The only 
problem is, it ends up Enron occurs before there is any value 
in the shareholders having a meeting.
    The one area that I----
    Mr. Pitt. I share your concern about destroying what is 
good about our system. That is a very real concern.
    Mr. Kanjorski. I will hope that you will constantly remind 
us up here to not be overly rambunctious in what we do, but try 
to act deliberately and deliberatively, and hopefully take our 
time on this.
    It seems to me--of course, I am just a simple lawyer from 
Pennsylvania--but it is awfully complicated stuff. I do not 
know how many of our graduate professors up here are fully 
aware of what the ramifications may be consistent with the 
speed by which we seem to be moving.
    But, there is something you said earlier in your testimony 
that I just wanted to correct. We have an opportunity here to 
assert that the New York Times made a fatal error when they 
reported on February 3, 2002, you are reported here as saying: 
``Now some in the group''--and this is referring to the people 
that supported the change of the law in 1995, like Senator 
Dodd--``have been having second thoughts about their opposition 
to the tougher accounting rules. Others, like Harvey L. Pitt, 
the Chairman of the Securities and Exchange Commission, say 
they are beginning to rethink the wisdom of some provisions of 
the 1995 law.''
    You were obviously misquoted in that article.
    Mr. Pitt. No, I believe the reporter who wrote that is very 
careful, and quoted me accurately, at least on that 
proposition. I think nothing is off the table. I believe that 
people have legitimately raised an issue about the PSLRA and 
therefore I thought it was appropriate to start collecting 
statistics and look at the issue. What I have found thus far 
leads me to believe that the Act has actually served its 
purposes and is not responsible for Enron. But I believe that 
we have to be open to changes in any aspect of our system in 
light of what we have seen in Enron.
    Chairman Oxley. The gentleman's time has expired.
    The gentleman from Tennessee, to wrap things up.
    Mr. Ford. Briefly. Thank you, Chairman Pitt. I know we are 
fresh out of time here. When we had Mr. Barandino before the 
committee, we talked a little bit about his announcement, I 
guess, and some of the other accounting firms--and forgive me 
of not going through all the pleasantries, you are great, I am 
glad to see you here and all those things. We will do that 
another time--but that they would no longer offer financial 
information systems designed for implementation to their audit 
clients. My friend Chairman Oxley's bill would prohibit 
auditors from offering these services to audit clients as well 
as internal audit services. This is probably a good start. But 
there a whole range of business consulting and other services 
that can and do create the possibility, at least the 
appearance, of conflict of interest.
    How significant are financial information systems 
consulting and internal audit services to the non-auditing 
revenue collected by accounting firms? And, two, what other 
areas of consulting business do you believe could pose these 
conflicts of interest? And in interest of time, that we have 
two bills up here, Mr. LaFalce and Mr. Oxley, and I hope we 
work everything out, but in Mr. LaFalce's version he has a 
provision that would require accountants to preserve records 
and documents relating to audits for 7 years after the audit is 
completed. I am not going to be facetious and say do you think 
that could have helped to at least expose some of the 
challenges and problems involved with Enron. Obviously probably 
it would have. But shouldn't we have a clear standard for 
recordkeeping, I guess, is the larger and broader question that 
is obvious to this committee and Congress will soon address. I 
know we have a vote. I wanted to talk a little faster than my 
part of the country expects me to. So if you could answer that, 
I would appreciate it.
    Mr. Pitt. A broader standard as to what might constitute a 
conflict?
    Mr. Ford. I was speaking to the 7-year mandate for 
recordkeeping, number one, and do we need a clear standard. 
And, yes, could you extrapolate clear standard even on 
conflicts of interest. I didn't ask it that way, but that may 
be a better way of framing it.
    Mr. Pitt. Let me make a few observations on that, if I 
might. First, before Enron reared its head, I had given a 
speech in which I said that the Commission would not tolerate 
people who come in and lie to us in investigations, people who 
obstruct investigations or destroy documents.
    Without commenting on the particular Enron situation, 
destruction of documents cannot be condoned, because once 
somebody gets away with it, everybody will try to get away with 
it and the system falls apart. So I have very, very strong 
views on document destruction and obstructing an investigation.
    As to how long records ought to be kept, in my view, some 
rational period may be useful. And with computers, now there is 
an ability to store information electronically that may enable 
them to be archived so that we have access to it even after 7 
years. But I believe that auditors should, and I believe they 
generally do try to, maintain records that reflect what audit 
practices they went through in conducting a particular audit 
for 5, 7 or 10 years after the audit is completed. Not 
everything that gets generated in the course of an audit needs 
to be retained.
    Chairman Oxley. The gentleman's time has expired. I thank 
you for the time. The Chair would note that Under Secretary 
Peter Fisher has submitted written testimony for this hearing. 
I would like to thank the Treasury Department. Without 
objection, Secretary Fisher's testimony will be entered into 
the record.
    Mr. Pitt, thank you, Mr. Chairman, for your appearance 
today. And the committee will reconvene at 1:00.
    [The information can be found on page 409 in the appendix.]
    [Recess.]
    Chairman Oxley. The hearing will reconvene. Here comes the 
Ranking Member.
    Let me introduce the panel. Let me introduce our 
distinguished panel: Mr. Franklin D. Raines, Chairman and CEO 
of Fannie Mae, on behalf of the Business Roundtable; Mr. H. 
Carl McCall, Comptroller, State of New York, Office of State 
Comptroller; Mr. Joseph V. DelRaso, Partner, Pepper Hamilton, 
LLP; Mr. Philip B. Livingston, President and CEO of Financial 
Executives International; Mr. Jerry Jasinowski, President of 
National Association of Manufacturers; and Mr. Peter C. 
Clapman, Senior Vice President and Chief Counsel of Corporate 
Governance TIAA-CREF. Gentlemen, thank you all for appearing 
and your willingness to appear here today. Let me yield to the 
gentleman from New York.
    Mr. LaFalce. I too would like to welcome every member of 
the panel. And so many of you I know so well: Mr. Raines with 
whom I have had a long working relationship before his days at 
Fannie Mae and the Administration; Mr. DelRaso with whom I have 
worked over the years through the auspices of the National 
Italian American Foundation; Mr. Jasinowski, going back 20, 30 
years now; but most of all, I want to welcome Mr. Carl McCall, 
the Comptroller of the State of New York. Again, Carl has been 
one of the most outstanding public servants it has been my 
pleasure to know, whether it was a State senator, whether it 
was as a United States Ambassador, whether it was as a 
Commissioner, whether it was in the private sector as a leading 
vice president of one of the major financial institutions in 
the world, and he has been elected to statewide office in the 
State of New York by overwhelming margins on two separate 
occasions. And one of his distinctions, among many, he is also 
a member of the board of directors of the New York Stock 
Exchange.
    So, not to slight the other members of the panel, but I 
just don't know you quite as well. Thank you, Mr. Chairman.
    Chairman Oxley. Thank you. All you New Yorkers stick 
together, I notice that. I understand Mr. McCall has some 
issues and has to get back to New York, and I appreciate that.
    Let us begin with Mr. McCall.

 STATEMENT OF H. CARL McCALL, COMPTROLLER, STATE OF NEW YORK, 
                OFFICE OF THE STATE COMPTROLLER

    Mr. McCall. Thank you, Mr. Oxley. As I said in my prepared 
remarks, I had a note here that I am to start off by saying 
good morning. I guess that is not now appropriate, but thank 
you for this opportunity. And, unfortunately, I do have to go 
back to New York, but I hope I can stay for some of the 
questions.
    Chairman Oxley. Mr. Raines is shaking his head because he 
has been on several second panels. So good afternoon.
    Mr. McCall. I want to thank the Ranking Member, Congressman 
LaFalce, for all he has done, and I appreciate the long 
relationship I have had with him and to all the Members of the 
committee.
    I want to thank you for giving me this opportunity to 
address issues of corporate accountability and investor 
confidence. In the past few months, Americans have learned that 
the integrity of the financial markets and, in fact, the 
economic well-being of our country depend on these issues.
    I commend this committee for holding a hearing. It is 
essential that we have a national discussion on these issues. I 
assure you our future depends on it. We need action at the 
Federal level to prevent another Enron in the future.
    I applaud my good friend, Congressman LaFalce, for his 
leadership in introducing the Comprehensive Investor Protection 
Act of 2002. As comptroller of the State of New York, I serve 
as the sole trustee of the State's $112 billion Common 
Retirement Fund, the pension fund for nearly 1 million New York 
State and local government employees and retirees. The fund 
owned nearly 4 million shares of Enron through its index 
portfolio and active managers prior to the company's 
catastrophic downfall. Our losses are expected to exceed $58 
million.
    While our fund is strong enough to absorb the financial 
blow inflicted by this corporate collapse, we are deeply shaken 
by the lack of diligent oversight by the independent auditors, 
board of directors, rating agencies and analysts on whom 
investors rely.
    And we are not alone. In fact, I believe that the loss of 
investor confidence is the most devastating effect of the 
corporate collapse experience over the last several months. And 
if we don't restore that confidence quickly and completely, the 
consequences will be immeasurable.
    The bill before the committee today, the Corporate and 
Auditing Accountability Responsibility and Transparency Act of 
2002, offers measures for enhanced auditor oversight. However, 
this is no time for small steps. I believe additional standards 
are necessary to ensure the restoration of investors' 
confidence in auditors and their findings.
    The Comprehensive Investor Protection Act that Congressman 
LaFalce introduced goes much further toward that goal. I urge 
the committee to consider a legislative compromise that 
includes some form of the provisions included in the 
Comprehensive Investor Protection Act that would correct what 
is currently a failed regulatory structure. I am speaking in 
particular of provisions that align with recommendations I have 
made as New York State comptroller.
    Let me explain. First we need standards to make auditors 
more independent from the companies they audit. I submitted 
proposals to the Securities and Exchange Commission and to the 
Big Five auditing firms and called on companies to take three 
steps:
    One, prohibit auditors from providing non-audit services to 
audit clients except under limited circumstances.
    Two, limit audit relationships to a maximum of 7 years.
    Three, restrict auditors from accepting employment with 
clients for 2 years following work on an audit.
    In short, auditor independence is critical to long-term 
shareholder value and confidence. That is why I supported the 
SEC's proposed revision of auditor independence requirements in 
2000. And that is why I submitted these proposals, and that is 
why I pushed for change in my various roles as a public 
official.
    I have introduced legislation that would require all New 
York State agencies to adopt these standards in their 
relationships with auditing firms. In addition, I issued an 
executive order to implement these standards in the Office of 
the State Comptroller. I believe these are important steps 
toward achieving meaningful auditor independence.
    But we can't achieve comprehensive reform on a State-by-
State basis. We also need a national effort. For this reason, 
the provisions in the Comprehensive Investor Protection Act 
that promote auditor independence are extremely important. As a 
shareholder, I have adopted a proxy voting policy to oppose the 
appointment of any auditor that also performs non-audit 
services to the company. I also sent a letter to the Common 
Retirement Fund's 50 largest portfolio companies, explaining 
our proposed standards and requesting information about how 
long companies have retained their current auditor.
    As comptroller, I can take these steps at the Common 
Retirement Fund, and I can encourage my counterparts around the 
country to do likewise, but it is essential that we hear from 
Washington on these matters. It is essential to know that our 
legislators share our commitment to investor protection.
    The work of this committee sends a vital signal to all 
investors. To ensure that I continue to develop appropriate 
proposals to increase investor protection, I have also created 
a panel of advisors who will focus specifically on measures 
that enhance board independence and corporate accountability 
and minimize conflicts of interest in the marketplace. As a 
last resort, I have also taken legal action against Enron. I 
have filed a notice of joinder in United States District Court 
for the Southern District of Texas in support of a legal 
application to freeze the assets of directors and executives 
who may have benefited from stock sales based on information 
that was not available to other shareholders.
    I applaud this committee for seeking input from a variety 
of sources, especially from the private sector. As a member of 
the board of the New York Stock Exchange, I serve as co-
chairman of a recently created Committee on Corporate 
Accountability and Listing Standards. The committee will review 
corporate governance and shareholder accountability issues such 
as the composition of corporate boards and committees, 
disclosure requirements and the role of independent audit 
committees. The committee will also consider new listing 
standards that will have a profound impact on the marketplace.
    In closing, I would like to say that I am acutely aware of 
my fiduciary responsibility to the retirees and hard-working 
people of New York State. Their ability to enjoy an 
economically secure retirement depends on the faithful and 
prudent investments of the Common Retirement Fund. In 9 years 
as comptroller, I have never heard from as many members of the 
pension systems as I have in the past few months. They are 
nervous and frightened and beginning to question the 
rationality of equity markets generally. This is not an 
encouraging sign for the marketplace. We must restore their 
confidence, each of us, fiduciaries, legislators and 
regulators. We all have a role to play.
    I thank you for your reasoned and constructive approach to 
the important issues before us. I look forward to working 
together with you to restore investor confidence and ensure the 
long-term viability of the American marketplace.
    Again, I thank you, Chairman Oxley, Ranking Member LaFalce, 
and Members of the committee for allowing me to testify today.
    [The prepared statement of H. Carl McCall can be found on 
page 302 in the appendix.]
    Chairman Oxley. Thank you, Mr. McCall. And feel free to 
stay as long as you possibly can. Hopefully we can get to 
questions before you have to leave.
    Now I am pleased to go back to regular order and introduce 
the gentleman, Mr. Raines.

STATEMENT OF FRANKLIN D. RAINES, CHAIRMAN AND CEO, FANNIE MAE; 
    CHAIRMAN, CORPORATE GOVERNANCE TASK FORCE, THE BUSINESS 
                           ROUNDTABLE

    Mr. Raines. Thank you, Chairman Oxley, and thank you, 
Ranking Member LaFalce and Members of the committee. My name is 
Franklin Raines and I am Chairman and CEO of Fannie Mae. I am 
here today as Chairman of the Corporate Governance Task Force 
of the Business Roundtable, and I appreciate the opportunity to 
express the views of the Business Roundtable with respect to 
the topic of today's hearing.
    Before I do that, Mr. Chairman, let me take this 
opportunity to recognize the foresight and leadership of this 
committee in raising and addressing issues of financial 
institution safety, soundness, and transparency, well before 
the collapse of Enron brought these issues to national 
attention. Let me recognize your leadership and that of Ranking 
Member LaFalce, subcommittee Chairman Baker, and subcommittee 
Ranking Member Kanjorski, for your consistent and strong 
leadership over the years on issues of corporate 
responsibility, transparency and market discipline.
    The Business Roundtable is recognized as an authoritative 
voice on matters affecting America's business corporations and, 
as such, has a keen interest in corporate governance. Indeed, 
as leaders of some of our Nation's largest businesses, the 
Roundtable has the strongest interest in corporate governance 
practices that secure the confidence of shareholders, 
employers, policymakers, and other constituencies.
    The Roundtable has been involved in corporate governance 
issues since 1978. In 1997, we published our statement on 
corporate governance, which suggests best practices regarding 
matters including the functions of the board of directors, 
board structure and operations, and shareholders' meetings. We 
are pleased with the number of large corporations that have 
adopted these practices.
    In light of recent events, the Roundtable is reviewing its 
1997 statement regarding corporate governance, and we expect to 
issue a new statement on this subject later this spring. The 
Business Roundtable has prepared a detailed analysis of H.R. 
3763, and with your permission I would like to submit that 
analysis for the record.
    [The following information was subsequently furnished by 
Franklin D. Raines for the hearing record.]
    Chairman Oxley. Without objection.
    Mr. Raines. This afternoon I would like to summarize what 
the Business Roundtable believes should be the guiding 
principles of corporate governance. The Business Roundtable has 
issued a public statement regarding the issues related to the 
bankruptcy of Enron, in which we expressed our view of Enron's 
collapse and a set of principles we believe should guide the 
discussion of proposed changes, practices, regulations and 
laws.
    With respect to Enron, the Business Roundtable believes 
that a number of the actions and behaviors revealed in the 
report of the special committee of the Enron Board of 
Directors, which contributed to the collapse of the company, 
are unacceptable. The Powers report describes a pervasive 
breakdown in the norms of ethical behavior, corporate 
governance, and corporate responsibility to internal and 
external stakeholders. The Enron situation appears at this 
point to derive fundamentally from a massive breach of trust.
    We understand why the American people are stunned and 
outraged by the failure of corporate leadership and governance 
at Enron. It is wholly irresponsible and unacceptable for 
corporate leaders to say they did not know, or suggest it was 
not their duty to know about the operations and activities of 
their company, particularly when it comes to risks that 
threaten the fundamental viability of their company.
    The success of the American free enterprise system follows 
from the merger of corporate responsibility with individual 
responsibility, and the Business Roundtable believes that 
responsibility starts at the top.
    The United States has the best corporate governance, 
financial reporting, and securities market systems in the 
world. These systems work because of the adoption of best 
practices by public companies within a framework of laws and 
regulations.
    The collapse of the Enron Corporation is a profound and 
troubling exception to the overall record of success. Other 
less dramatic exceptions may also exist among the thousands of 
United States public corporations, but there are exceptions in 
systems that have generally worked very well.
    In light of the public interest and issue drawing out of 
the Enron situation, we thought it would be useful to 
articulate a set of guiding principles of corporate governance:
    First, the paramount duty of the board of directors of a 
public corporation is to select and oversee competent and 
ethical management to run the company on a day-to-day basis.
    Second, it is the responsibility of management to operate 
the company in a competent and ethical manner. Senior 
management is expected to know how the company earns its income 
and what risks the company is undertaking in the course of 
carrying out its business. Management should never put personal 
interests ahead of or in conflict with the interest of the 
company.
    Third, it is the responsibility of management under the 
oversight of the board and its audit committee to produce 
financial statements that fairly present the financial 
condition of the company and to make sufficient disclosures to 
investors to permit them to assess the business and financial 
soundness of the company.
    Fourth, it is the responsibility of the board and its audit 
committee to engage an independent auditing firm to audit the 
financial statements prepared by management and to issue an 
opinion on these statements based on generally accepted 
accounting principles. The board, its audit committee, and 
management must be vigilant to ensure that the corporation or 
its employees do not take any actions that compromise the 
independence of the independent auditing firm.
    Fifth, it is the responsibility of the independent auditing 
firm to ensure it is in fact independent, is without conflict 
of interest, employs highly competent staff and carries out its 
work in accordance with generally accepted auditing standards. 
It is also the responsibility of the independent accounting 
firm to inform the board, through its audit committee, of any 
concerns it may have about the appropriateness and quality of 
significant accounting treatments, business transactions, and 
about any weaknesses in internal control systems. The firm 
should do so in a forthright manner and on a timely basis, 
whether or not management has communicated to the board or 
audit committee on the same matters.
    Six, the company has a responsibility to deal with its 
employees in a fair and equitable manner. Employee benefit 
plans, once established, should be operated in a manner that is 
fair and equitable to all employees. These responsibilities and 
others are critical to the functioning of the modern public 
corporation. No law or regulation alone can be a substitute for 
the voluntary adherence to these principles by corporate 
directors and management and by the accounting firms retained 
to serve American corporations.
    Several thoughtful proposals have been offered to create 
new regulations or laws to deal with what appear to be breaches 
of trust and failure of responsibility at Enron. Two weeks ago, 
the President announced his plan to improve corporate 
governance. The President's personal involvement in seeking 
reform is welcome and underscores just how fundamental ethical 
and responsible corporate governance is to the health of the 
American economy.
    Chairman Oxley, you and Mr. Baker have put forth a number 
of laudable proposals to improve corporate governance we are 
considering today, as has Mr. LaFalce and others. Some 
legislation and regulatory changes are necessary and advisable. 
The Business Roundtable worked closely with policymakers to 
help ensure that any necessary changes to laws and regulations 
are effective and efficient, taking care that our responses to 
the unusual circumstances presented by Enron do not inhibit 
U.S. Public corporations' ability to compete, create jobs, and 
generate economic growth.
    Mr. Chairman, that concludes my statement, and on behalf of 
the Business Roundtable and its member companies, thank you for 
the opportunity to participate in today's hearing.
    [The prepared statement of Franklin D. Raines can be found 
on page 320 in the appendix.]
    Chairman Oxley. Thank you Mr. Raines.
    And I now call on Mr. Joseph V. DelRaso.

 STATEMENT OF JOSEPH V. DelRASO, PARTNER, PEPPER HAMILTON, LLP

    Mr. DelRaso. Good afternoon, Chairman Oxley, Ranking Member 
LaFalce, and distinguished Members of the committee. Thank you 
for this opportunity to present my views on H.R. 3763, 
legislation which I believe will do much to restore the faith 
of investors in the way in which public companies report their 
financial results.
    I commend the committee for its level-headed and 
responsible approach, especially at a time when many pundits 
and commentators are generating more heat than light on these 
important issues.
    I am a partner in the law firm of Pepper Hamilton in 
Philadelphia. My practice focuses on corporate and securities 
matters, particularly on matters arising under the Investment 
Company Act of 1940 and the Investment Advisors Act of 1940. I 
served as an attorney advisor with the Securities and Exchange 
Commission in the 1980s, and I serve as a member of the board 
of directors of both public and private companies and non-
profit institutions.
    Having experience on the regulatory side as a lawyer in 
private practice and as a corporate board member, I believe I 
offer the committee an important perspective on the practical 
effect of key aspects of this legislation. Because this 
committee has already heard a wealth of testimony on auditor 
oversight provisions, I will focus my comments on other 
sections, particularly the transparency of corporate disclosure 
provisions of section 6, corporate governance provisions of 
section 9, and accredited rating agencies of section 11. Each 
of these sections, the committee should ensure that studies and 
activities undertaken do not attempt to fix things that are not 
broken.
    Federal Reserve Board Chairman Alan Greenspan in his 
earlier testimony to this committee noted a pronounced move 
toward more transparent reporting and improved corporate 
governance practices in the wake of the Enron collapse. As 
Chairman Oxley said at the committee's hearings last week, 
while Government may still need to take action, that action 
should not stifle the ability and initiative of the financial 
markets to self-correct.
    In my practice as a lawyer, the vast majority of boards of 
directors, especially those of publicly held companies that I 
represent, take their responsibilities very seriously. In the 
last few years in particular, I am sure even more so now in the 
post-Enron and post-Global Crossing world, independent 
directors have become increasingly aggressive in acting as 
watchdogs over their respective shareholders' interests.
    Audit committees have already been required to adopt 
charters governing their operations.
    But perhaps they even need more guidance in this area. And 
I concur with some of the remarks earlier today that the stock 
exchanges and the other self-regulatory organizations may look 
into other areas with regard to adopting rules to help guide 
audit companies in their role as the watchdogs on the financial 
side of the shop.
    Whether or not these policies and procedures are 
aggressively enforced, obviously, vary from company to company. 
On the one hand, given the proclivity of the plaintiffs' bar to 
act as a self-appointed protector of shareholder interests, 
even the most diligent board of directors is constantly 
checking itself to avoid costly unnecessary litigation. This 
serves as an important catalyst for directors instituting 
improved corporate governance policies and procedures.
    This also points to the need for appropriate government 
action to craft legislation and implement rules that are 
clearly understood and not easily manipulated.
    Appropriate implementation and enforcement is just as 
critical as the legislative effort. Again, while the actions of 
the plaintiffs' bar keep directors and officers focused and 
diligent, the appropriate deterrent is and always and will be 
government enforcement and prosecution. The spectre of criminal 
sanctions and incarceration for the most egregious behavior or 
civil fines and sanctions for other transgressions serves the 
public interest much more sensibly than allowing certain 
members of the bar to extract their self-imposed penalties from 
companies in the form of their sometimes very large contingency 
fees. A more direct distribution of funds to compensate victims 
of corporate malfeasance, or fines that are used to further 
bolster Government enforcement efforts might be preferable, and 
indeed are just plain common sense in some circumstances. Any 
effort to roll back securities litigation reform may make 
business only more expensive by increasing insurance costs and 
the like and still produce inferior results.
    Again, we heard studies undertaken by the SEC that point to 
the fact that the plaintiffs' bar is alive and well and still 
impacting the markets. On the other hand, prosecutorial 
judgment most times is a markedly more effective approach to 
handling some of these problems rather than ``strike suit'' 
targeting.
    Below the board level, the President's Working Group, 
referred to in section 9, should examine how the financial 
markets can deter managers and other employees from interfering 
or influencing third-party professionals, whether they be 
auditors, rating agencies, and other parties that are relied 
upon in one way or another to put their imprimatur on corporate 
actions.
    From a practical perspective, any additional Government 
overlay from either a statutory or regulatory standpoint might 
further dampen the enthusiasm of qualified people to serve as 
independent directors. On the other hand, appropriate sanctions 
for inappropriate behavior would be welcome. The overwhelming 
majority of independent directors has been and continue to be 
good corporate citizens, dedicated to discharging their duties 
to protect shareholder interests.
    Further initiatives, including personal liability expenses, 
except in the most egregious cases of willful and wanton 
misconduct, and other erroneous regulatory sanctions or 
requirements may merely serve to deter good individuals from 
accepting positions as independent directors.
    Finally, corporate governance ties in with the provisions 
in section 6 regarding the need for improved transparency of 
corporate disclosures. Boards should be able to discern from 
transparent reporting the correct state of affairs. There 
should be little excuse for a well-informed board of directors 
to fail or be victimized by obfuscation and financial high-
jinks constructed as off-balance-sheet transactions and other 
clever financial tricks. Uniform standards of financial 
reporting will not only sustain a level playing field, but will 
uphold the integrity of the process.
    I applaud the work of this committee in seeking improved 
transparency, for without it, the efficient functioning of our 
financial markets may be impeded. Financial investors expect to 
see, and will demand more than ever, quality of earnings that 
can be reported via clear and concise accounting standards 
consistently applied. This is especially true in dealing with 
non-exchange traded financial instruments and other instruments 
that are not readily tracked in public markets. This 
legislation, I believe, will put the ``fair'' back in fair-
value accounting.
    Finally, with regard to credit agencies, I believe many of 
the issues I noted regarding the corporate governance 
procedures also apply in this field, particularly the 
overwhelming need to avoid conflicts of interest. This again is 
essential to the efficient operation of our financial markets. 
Just as a ``seal of approval'' is expected by the auditor 
certification accompanying audited financial results, the grade 
awarded by rating agencies will only be worth the strength and 
integrity of the name behind it.
    Finally, Mr. Chairman Oxley and Ranking Member LaFalce, I 
would like to thank you again for this opportunity to testify 
today on this important piece of legislation. The dark cloud of 
Enron and Global Crossing, while obviously dire to investors, 
employees, and those most immediately affected, may have some 
element of a silver lining if, as I believe, it serves as a 
wake-up call to responsible independent directors and corporate 
officers and if it provides the Congress the impetus to enact 
some long-needed reforms to ensure responsible reporting of 
corporate financial results.
    [The prepared statement of Joseph V. DelRaso can be found 
on page 360 in the appendix.]
    Chairman Oxley. Thank you.
    And I recognize Mr. Livingston.

STATEMENT OF PHILIP B. LIVINGSTON, PRESIDENT AND CEO, FINANCIAL 
                    EXECUTIVES INTERNATIONAL

    Mr. Livingston. Thank you, Chairman Oxley and Ranking 
Member LaFalce. I am here today to represent FEI and its strong 
support for H.R. 3763 and the leadership of this committee. As 
Chairman Pitt kindly recognized this morning, the FEI released 
its own recommendations for improving financial management, 
financial reporting, and corporate governance. These 
recommendations dovetail nicely with H.R. 3763.
    Financial officers know that good corporate control 
requires broad frontline defense mechanisms to prevent 
problems. As a result, that is where our suggestions begin. Our 
most important recommendation is that all senior financial 
officers adhere to a special code of ethical conduct. We 
recommend that this bill include an additional provision 
calling upon the SEC to work with the stock exchanges to 
develop a requirement that senior financial officers of all 
public companies adhere to a code of ethical conduct similar to 
that in use by FEI members today. We believe adherence to such 
a code is a crucially important cornerstone of sound 
management, appropriate atonement at the top, and successful 
fiduciary stewardship.
    In order to reinforce management and board awareness in the 
maintenance of a strong ethical climate, we strongly recommend 
that all senior financial officers annually sign such a code 
and deliver it to their board. I will tell you that one of our 
leading CFOs has required all of his company's 3,000 financial 
professionals worldwide to sign such a code and deliver it back 
to their corporate headquarters.
    Unfortunately, the Enron case once again demonstrates the 
need to improve audit committees. Three years ago, the Blue 
Ribbon Panel on Audit Committee Effectiveness called for all 
audit committee members to be financially literate and for each 
committee to have at least one financial expert. Unfortunately, 
the criteria for meeting the standard was set so low that no 
real change or addition to audit committee personnel actually 
occurred in the time leading up to Enron's demise.
    We must get on with truly raising the bar and adding real 
expertise to audit committees. We need Congress and the stock 
exchanges and the SEC to act on this matter. The stock 
exchanges should be required to write tougher standards into 
their listing agreements. Explicit experience in financial 
reporting must be required of such experts.
    FEI is also proposing recommendations as to the issue of 
auditor independence. As recently as last year, I testified 
before the Senate Banking Committee in opposition to former 
Chairman Levin's proposal to split audit and non-audit services 
provided by accounting firms. I tell you, it is still my strong 
personal opinion that consulting services do not corrupt the 
integrity of independent audits. The truth, in my view, is 
exactly the opposite. Consulting projects enable the auditor to 
get out of the accounting department and learn about the 
intricacies of the business and, in the end, conduct a more 
effective audit.
    However, the accounting profession is suffering from a 
post-Enron crisis of confidence. Therefore, certain 
restrictions should now be imposed on non-audit services 
supplied by the independent audit. They should no longer 
provide clients with internal audit services or consulting on 
computer systems used for accounting. We strongly believe that 
tax services should be allowed, as well as acquisition due 
diligence, audits of employee benefit plans, and other 
statutory audits. We do strongly recommend that audit 
committees approve all large non-audit services provided by the 
auditor.
    I also want to address the controversial issue of stock 
option accounting. Unfortunately, the current crisis has 
encouraged some to attempt opportunistic initiatives to advance 
narrow and unconstructive agendas with little regard for the 
important matters in front of us. These very tactics were too 
often employed over the last 10 years and are at the core of 
many of our problems.
    Unusable accounting standards and dysfunctional financial 
statements result from processes and regulatory environments 
unable to recognize the real problems, yet set out to achieve 
narrow political-or governance-related objectives.
    Stock option accounting is such a case. This debate has a 
long and acrimonious history between shareholder activists, 
enraged by cases of excessive executive compensation, and the 
corporate preparers of financial statements that find 
employees' stock options as hard to accurately measure as an 
Enron energy contract or put agreement to sell broadband 
capacity. A charge to the income statement for stock options is 
the Trojan horse in the battle over governance controls of 
options and executive compensation.
    When recently asked about the ongoing accounting debate, 
Sarah Teslik, the CEO of the Council of Institutional 
Investors, was quoted as saying: ``If we can't get the vote on 
these things, then we have to punish them on the balance 
sheet.'' Her comments reflect the reality of the issue. It is 
about the practices and the quantities of option grants, not 
the quality of the income statement.
    A real reform would be for shareholders to approve all 
stock option plans and therefore control abusive levels of 
shareholder dilution in the few cases that it occurs. Because 
of the intense controversy around this subject, Congress can do 
a great service by mandating shareholder approval of employee 
stock option plans, and we urge you to act.
    Briefly, FEI would like to add its continuing support for 
the Private Securities Litigation Reform Act. The PSLRA is 
working today and there is no need to change or modify the 
current law. Enron's employees and shareholders will not be 
hindered by the PSLRA in seeking restitution of their losses. 
Now is the time for real reform, not opportunistic grabs of 
narrow agenda items.
    FEI also recommends that we increase the SEC's budget and 
that a significant portion of the additional funds be earmarked 
for attracting new high-caliber professional staff. Further, 
FEI supports the creation of a new regulatory organization for 
the auditing profession. We believe it is important to clarify 
that the two-thirds members specified as ``not members of the 
accounting profession'' be further defined as individuals who 
are not currently practicing CPAs, but do have extensive 
education and experience in financial management of public 
companies, auditing, or accounting.
    That concludes my remarks, and I would like to thank the 
Chairman and the Members of the committee for allowing FEI this 
opportunity.
    [The prepared statement of Philip B. Livingston can be 
found on page 365 in the appendix.]
    Chairman Oxley. Thank you.
    Our next witness is Mr. Jerry Jasinowski. I was so used to 
having you testify in the committee across the hall, and we are 
facing in different directions from the past, but I think this 
year you made an appearance before our committee. Welcome. And 
it is good to see you again and particularly under these 
circumstances.

     STATEMENT OF JERRY J. JASINOWSKI, PRESIDENT, NATIONAL 
                  ASSOCIATION OF MANUFACTURERS

    Mr. Jasinowski. Thank you very much, Chairman Oxley, for 
your leadership on this, and allowing us to testify before this 
committee.
    With 14,000 manufacturing companies, both large and small, 
we are a user of the auditing information and a producer of the 
auditing and financial information, and so have a particularly 
unique perspective on this and have thought very carefully 
about it. Although we have not concluded all of our decisions 
on it, we certainly feel that your bill 3763 is a good 
framework.
    I want to acknowledge, Congressman LaFalce, also our 
longstanding relationship, and we look forward to working with 
you in terms of the legislation you propose.
    In our press release, Mr. Chairman, we put the emphasis on 
best practices and enforcement, and suggest that we have a very 
good system in this country which has been badly damaged by 
Enron, Andersen, and other misjudgments which Frank Raines has 
articulated rather well, and I would associate myself with his 
remarks.
    Our 14,000 members are outraged by what appear to be 
certain transgressions on the part of both companies and 
auditors, and feel that the bulk of our membership are 
absolutely opposed to anything like that and strongly want to 
affirm the need for honest and complete information. In fact, 
as we indicate in the statement--which I would like included in 
the record--information is critical to our capital markets, and 
I think without it, we will not be able to have the growth and 
productivity that we so badly need.
    Let me make five points. And the first point is to stress 
your bill H.R. 3763, although we do not yet endorse it, we 
certainly feel it provides the framework for the kind of 
reform--thoughtful balanced reform, that we need.
    Disclosure beyond GAPP is important in getting better 
information, public regulatory oversight, as you suggest, is 
the kind of thing that we think is important in the legislative 
area.
    Having said that, we really put a lot of emphasis in our 
testimony on best practices and the need for the private sector 
to further improve the quality of the information that they 
have--and not just the auditor, but also the companies. We do 
have the best system in the world. But as Chairman Pitt said, 
we can make it a lot better. And I think there are many ways in 
which we can.
    At the heart of that, of course, is strengthening the audit 
committee and strengthening the oversight of the management, 
having a more independent board, focusing on such matters as 
the critical accounting policies and practices that have come 
out of the SEC, and other matters where we think a good system 
could be made much better if, in fact, it is fully employed. I 
think the tone of much of your bill puts the emphasis on that 
and we would want to associate ourselves with that.
    And we think we have an obligation, Mr. Chairman, to speak 
out to our own members and say look, we know most of you are 
doing a fine job, but not everybody is, and you can do better; 
and we will certainly encourage that within our own membership.
    As I said, I thought that Chairman Pitt was very helpful in 
terms of his proactive emphasis on enforcement, information and 
clarity. We think we ought to be very tough with wrongdoers. 
People make mistakes, they ought to pay. And it is important 
that society generally, the SEC, and the Congress assure that 
that happens.
    Having said that, there may be some opportunities for 
legislative reform, as you suggest, in your bill and beyond 
that. Certainly the public regulatory organization to oversee 
accounting standards, as you suggest, is something that we 
think merits careful consideration. Also, it might surprise 
some, but we think it is important to increase the funding for 
the SEC in order to have the kind of education, clear 
information, and enforcement that they need. We cannot expect 
to get this job done if we do not have adequate resources 
there, and we support that.
    I am sure there are other measures as these hearings 
continue, and in the market session we will support 
legislatively. But again let me repeat, we don't think there 
needs to be a whole set of new laws. There is an enormous set 
of good laws on the books that, with proper enforcement and 
good action on the part of the companies, will lead us to 
improve this system as it now stands.
    We think it is, finally, important not to take on some 
measures which will do real harm; that is, to produce a lot of 
new legislation, new liabilities, try to reinvent the wheel. 
This committee, your own leadership, Congressman LaFalce, and 
the SEC have been working on this for some time. The Enron-
Andersen affairs require us to redouble our efforts, to 
strengthen our laws in some cases, but let us not try to 
reinvent the wheel. Certainly we don't need new liability 
provisions for the most part, and we ought to avoid increases 
in costs.
    Having said that, again, I think it is important for us in 
the private sector to take responsibility to further improve 
our own management and implementation of the accounting 
provisions.
    Thank you, Mr. Chairman.
    [The prepared statement of Jerry Jasinowski can be found on 
page 388 in the appendix.]
    Chairman Oxley. Thank you, Mr. Jasinowski.
    Mr. Clapman.

STATEMENT OF PETER C. CLAPMAN, SENIOR VICE PRESIDENT AND CHIEF 
           COUNSEL, CORPORATE GOVERNANCE, TIAA-CREF.

    Mr. Clapman. Thank you. Thank you, Chairman Oxley, Ranking 
Member LaFalce, and Members of the committee. I am Peter 
Clapman. I am speaking from an investor and shareholder 
perspective on the issues of the day. I will be talking not 
only about the accounting regulation issues, but the board of 
corporate governance issues as well.
    TIAA-CREF has a fiduciary responsibility to over 2-1/2 
million members of our pension system, which is the largest 
pension system in the world. We have approximately $275 billion 
under management. I also chair the most prestigious global 
corporate governance organization in the world, and I must say 
that the Enron episode has had a real detrimental effect on the 
reputation of the United States and corporate governance.
    TIAA-CREF has been a leader in corporate governance. We are 
convinced that our initiatives to better corporate governance 
will produce better returns for our pension participants and 
shareholders. We also believe that it is our responsibility to 
monitor the managements of our portfolio companies and hold 
them accountable. Good corporate governance depends critically 
on the performance of the board of directors and, in 
particular, its most important board committees: compensation 
committee, auditing committee and nominating committee. If the 
board is not independent, if the directors lack the proper 
qualifications, and if the directors do not pay sufficient time 
and attention to fulfill this role, an Enron is not only 
possible, but it is also likely. Are there other Enrons out 
there? We can hope that there are not, but prudently cannot 
trust that will be the case without reforms.
    And I will now address some of the needed corporate 
governance reforms and how I suggest they best be accomplished. 
One area that must be addressed involves the conflicts within 
the key professions. Too often accountants and lawyers, 
ostensibly representing the company, in fact wind up 
representing only its senior management. Such conflicts were at 
the heart of the problems of Enron.
    The professional organizations themselves have a key role 
and must do a better job through education and discipline to 
minimize these abuses. The regulation of the accounting 
profession demands change, and already excellent proposals have 
been made.
    TIAA-CREF CEO John Biggs has urged, among other things, 
that companies assure the integrity of the auditing process by 
not giving the same audit firm that does its audits, consulting 
work. We are not advocating the split of auditing and 
consultant work for the organization, but that each company 
should be conscious of this potential issue of conflict and 
split its auditing and consulting work on that basis, and also 
by periodically rotating the auditing firm or at least 
considering such action.
    He also proposed that an independent board oversee the 
accounting profession, with its own funding source, and with 
the legal authority to enforce rules and impose sanctions for 
wrongdoing.
    But on a broader scope, a related corporate governance 
reform needed for more accurate financial reporting is on the 
subject of executive compensation, particularly affecting the 
use of stock options. The reforms needed are twofold: require 
that the cost of options be reflected in the financial 
statements; and, two, require shareholder approval for dilution 
of option plans, introducing greater accountability in this 
most important area of executive compensation. Stock options 
are overused and abused, with the accounting rules largely to 
blame for this problem. The true cost of fixed-price options 
escape the earnings statement, encouraging this overuse and 
abuse. This structural failure of corporate governance must be 
addressed.
    The National Stock Exchange as the New York Stock Exchange 
and Nasdaq must be an important engine for needed reform. The 
exchanges, however, have dual objective organizations. While 
they must regulate companies and brokers in the public 
interest, as businesses they also seek listings from the very 
companies they must regulate. To the credit of Chairman Harvey 
Pitt, the SEC has already requested that the exchanges evaluate 
which corporate governance reforms are necessary. The exchanges 
must respond by imposing stronger standards of director 
independence, requiring shareholder approval of all material, 
equity plans promoting education of directors, and implementing 
more stringent policies to ferret out conflicts of interest. If 
the exchanges fail to act, the SEC, using its regulatory powers 
and persuasive influence, should press for needed reforms.
    The education of directors is a major concern. Directors on 
audit committees only recently had to meet a standard of 
financial literacy; literally, to have the ability to 
understand a financial statement. Directors on compensation 
committees often do not take a proactive role on behalf of 
their company, because they lack an understanding of 
compensation issues and do not obtain independent consultants 
when needed. The abuse and overuse of stock options results 
from inadequate performance of many compensation committees and 
the board as a whole.
    What is the role for Congress? It is not clear to me how 
many new laws are needed. But as a minimum, your oversight role 
is critical. At some point, memories of Enron will fade as 
other issues take center stage, but the corporate governance 
problems that I have highlighted, and are highlighted by the 
Enron experience, should be fixed.
    I have outlined a number of corporate governance issues in 
which I believe reforms are both necessary and possible:
    One, dealing with the conflicts among the professionals.
    Two, better regulation of the accounting profession.
    Three, reforms in the area of executive compensation, 
particularly in the area of stock options, and to require 
shareholder approval.
    And in the role of the stock exchanges, to deal with issues 
in the public interest and recognize their responsibility 
there.
    And, finally, the education of directors.
    You may be sure TIAA-CREF is an organization that will 
continue to press for these reforms. We hope the current 
widespread public interest in such issues will provide focus 
and impetus for such reforms.
    Thank you very much.
    [The prepared statement of Peter C. Clapman can be found on 
page 397 in the appendix.]
    Chairman Oxley. Thank you Mr. Clapman.
    Let me begin by asking Mr. Raines, what role corporate 
management plays in assuring that audit firms are independent, 
and how is it similar or different to the role of the audit 
committee itself?
    Mr. Raines. As we stated in our principles, it is not only 
the obligation of the auditor to be independent, but it is also 
the obligation of both management and the board to not take any 
steps that would compromise its independence. And that means 
from the management standpoint, that management should not ask 
the auditors to undertake activities that may be inconsistent 
with their role as independent auditors, and must ensure that 
the practices with regard to the personnel of the auditors and 
to the provision of information needed for the auditors to do 
their work are consistent with the auditor's independence.
    Sometimes it is easiest, if you have a task and you have a 
professional firm working for you, to simply use the firm who 
is there and use a different department of that firm. But that 
easy path can lead to independence questions. If, for example, 
you used the consulting arm of an auditor to create your 
financial systems, and then the auditors then have to audit 
those systems, that can impinge on the independence of the 
auditors. So it is in part management's job to not even suggest 
to the auditors that they put themselves into positions that 
may create independence concerns.
    Chairman Oxley. Mr. DelRaso, you mentioned that Congress 
should be careful in trying to fix things that aren't broken. 
What proposals specifically are you concerned about?
    Mr. DelRaso. I think the CARTA legislation has done a 
pretty good job of addressing the problems without going too 
far. But I am still concerned about two areas in particular: 
one, the groundswell that may be developing in terms of rolling 
back the reforms made on securities litigation; and, number 
two, I think in the area of auditor independence, Congress 
should take a careful look at the real role of the modern-day 
accounting firm and the services they provide across the board, 
audit and consulting.
    We have seen the worst in these recent cases. I represent a 
number of companies that deal in the global markets, and I 
think a little more work may have to be done to take a look at 
the role of these firms in the non-audit areas, especially 
overseas. When global companies are setting up subsidiary 
operations and other types of international functions, the 
auditing firm is the law firm in that jurisdiction and it 
provides other areas of advice and, quite frankly, it is the 
best source of that advice in that particular market. And at 
the same time, that firm also has the institutional knowledge 
of a particular client.
    There are, I think, a number of functions that really 
aren't necessarily in as deep a conflict as we believe.
    Chairman Oxley. I don't know whether you were here for Mr. 
Pitt's testimony, Chairman Pitt, but I think you and he share 
the same concerns that perhaps I do as well; that is, we would 
be very careful about putting things in stone, as Chairman Pitt 
said, because it is much more difficult to extricate ourselves 
from a bad decision. Better it be left for the most part to the 
private sector, and indeed to regulators.
    Let me ask, Mr. Jasinowski, Chairman Greenspan testified a 
couple of weeks ago to this committee and, in response to a 
question, seemed to indicate that in many cases, the 
marketplace is the best way of disciplining unwanted behavior. 
What do you think your members would fear the most, Government 
reprisals or market reprisals?
    Mr. Jasinowski. I think the market reprisals are already 
taking place, Mr. Chairman, as you know, and I don't think 
there is a company in my membership which isn't reviewing all 
of its procedures to be absolutely sure they are not only 
sound, but they are made stronger. And I think the markets, the 
equity markets, have also reacted already. So we don't have any 
choice about the private markets except within running our own 
companies, where we do have a choice, and I think we are going 
to do a lot better there.
    I think the biggest concern is that people are going to try 
to create a whole new legislative, regulatory, liability system 
to go after some particular transgressions. And I think one of 
the reasons why your particular legislation is appealing is 
that you respond legislatively, you set up a framework to use 
the SEC, you try to involve the private sector, and at the same 
time, you have punitive actions if they are necessary.
    I think you have got to have a balance. You have got to 
have perspective. That is what all our members are really 
looking for, and we are concerned that Congress may overreact.
    Chairman Oxley. Mr. Livingston, while I may share your 
philosophical opinion regarding the division of labor between 
accounting and consulting, the fact is that several of the 
accounting firms have already indicated that it is their desire 
as the corporation or partnership to divide those. Some would 
say that we need to make sure that maintains, by passing a law 
that would forever divide those functions. What is your 
reaction to that?
    Mr. Livingston. I think it would be a great role for the 
new oversight body that we are talking about for the accounting 
profession. And the main reason it would be a great role for 
that body is because there are many, many nuances. And our 
group, while it feels strongly about continuing to get tax 
services from the auditor, because most of that work is 
compliance work, it is related to the tax return and ties into 
all the work they do on the audit, there are areas in tax 
preparation, tax advisory, that might be good for this 
oversight body to be concerned about; tax structurings and tax 
shelters that have been in the news, and where there are 
contingency fees and tax savings. And that just illustrates the 
kind of nuances that an oversight body could react much more 
quickly to in a more focused manner.
    Chairman Oxley. Thank you. My time has expired.
    The gentleman from New York, Mr. LaFalce.
    Mr. LaFalce. I think everybody agrees we need to have some 
type of oversight board, correct? So I guess the question is, 
what powers should it have and who should serve on it? Now, 
with respect to powers, does anybody doubt that they have 
should have their own independent investigatory powers, that 
they should have their own ability to subpoena, to promulgate 
standards, and see to its enforcement, adequate staff resources 
to do the job? Does anybody have any quarrel with any of those 
concepts?
    Mr. Jasinowski, do you have a quarrel with those concepts?
    Mr. Jasinowski. I do in the sense that it is not clear what 
the relationship is to the SEC in that whole articulation.
    Mr. LaFalce. It surely would be subject to the SEC.
    Mr. Jasinowski. I think as long as the SEC is the one who 
has the determination with respect to investigation.
    Mr. LaFalce. I assure you, anything coming out of this 
committee will absolutely ensure that the board is subject to 
the jurisdiction of the SEC, which is subject exclusively to 
the jurisdiction of this committee.
    Having said that, the question is, who is going to be on 
it? We know that Charlie Boucher resigned when he heard of the 
appointment of certain individuals to a new board created by 
Mr. Pitt. We know yesterday that Charlie Boucher said that the 
new board should consist exclusively of public members. And I 
don't know we have to go that far.
    Suppose we put in legislation that the SEC's appointive 
power of members of the board should be based upon 
recommendations made by certain institutional investors; that 
TIAA-CREF should make certain recommendations; that the Council 
of Institutional Investors should make certain recommendations; 
that private employees' pension plans and public employees' 
pension plans should make certain recommendations. A slate of 
candidates could then be decided upon by the SEC.
    How does that sound to you, Mr. Jasinowski, because it is 
important who is on it. Mr. Boucher would have rejected out of 
hand those individuals that Mr. Pitt wanted.
    Mr. Jasinowski. You have a lot of shareholders here, like 
you, Congressman LaFalce, and employers are some of those. 
Management, auditors, pension funds.
    Mr. LaFalce. We want to check the employers, because it is 
the employers that are the CEOs with the stock options, the 
CFOs with the stock options that are the first line of defense 
against earnings management or manipulation. Then it gets to 
the audit committee who very often also has the same stock 
options, perhaps not in the same quantity, and very often have 
a policy of passivity that permeates the board. And so we need 
to check that. And it is my judgment that the best check is to 
have at least a majority of members coming from individuals 
representative of these pension funds' institutional investor 
groups.
    It is not unreasonable in any event?
    Mr. Jasinowski. No.
    Mr. LaFalce. Thank you. Let us go to the next issue. Is 
there anybody here who thinks we should permit auditors to 
immediately leave the audit firm and become an employee of the 
firm that they were auditing? Don't you think we ought to have 
some ban on the time period? Wouldn't that be a good thing to 
put in the legislation?
    How about you, Mr. Raines?
    Mr. Raines. We believe there ought to be a period of time 
when someone who worked on the audit is not eligible for 
employment.
    Mr. LaFalce. OK, good. Anybody who disagrees with that 
concept? We can accept that.
    Mr. Livingston. That ought to be a company-driven thing, a 
policy adopted by the companies. And I don't think you should 
legislate.
    Mr. LaFalce. You can say it, and I would strongly disagree 
with it, because the problem is that 90 percent of the 
companies you don't have to worry about would adopt it, and the 
10 percent that you might have to worry about wouldn't adopt 
it. And that is why you have laws. Most people don't murder, 
but you have laws against murder. Publicly traded corporations, 
if we are talking about publicly traded corporations--and we 
are not talking about private corporations, Mr. Livingston--
publicly traded corporations subject to--invested by public at 
large.
    Let us go on to some other issues. Mr. Jasinowski, you were 
very worried about adopting new laws dealing with grievances in 
the securities markets. What about a return to old laws? Would 
you consider that? I mean, you are opposed to new laws. What 
about return to old laws?
    Mr. Jasinowski. We are not opposed to new laws.
    Mr. LaFalce. Let me focus in particular. What provisions in 
the 1995 Securities Litigation Act were so important that you 
think they are so wonderful that they shouldn't be changed? 
What was done in the 1995 legislation that reformed or changed 
securities litigation that was so important that you think it 
should not be revisited? Would you please explain that?
    Mr. Jasinowski. I think in general----
    Mr. LaFalce. Not in general, in specific.
    Mr. Jasinowski. I don't see any reason we ought to be 
changing that law.
    Mr. LaFalce. What did it do that it should not be changed? 
What did it do specifically that is so good that we shouldn't 
change it?
    Mr. Jasinowski. I am not in a position----
    Mr. LaFalce. All right. Thank you. OK, good. I know you 
came out strongly.
    Mr. Jasinowski. Again, it is not altogether new laws; I 
didn't say we ought to go back and change that particular law.
    Mr. LaFalce. That is the law you said should not be 
changed, but it was enacted in 1995. And I want to know what 
did it do that was so good that it ought not to be changed? And 
I have a non-response. But I understand that this is an 
institutional response as opposed to a specific response. Is 
there any problem with making sure that it is the audit 
committee that has the responsibility for the hiring and the 
firing of the auditor? Is that a good idea?
    Mr. Jasinowski. Congressman LaFalce, I particularly like 
that aspect of your legislation, and I think having an 
independent nominating committee making a decision about the 
audit committee and establishing in-house as independent an 
audit committee as you can have is a very good idea. Whether or 
not you need to codify it in legislation I don't know, but I 
think it's something we ought to be striving for.
    Mr. Clapman. You made the point that the audit committee 
should have the right to hire and fire the accountant. I think 
that is embedded currently in the law. Whether it is followed 
in practice is a different issue. But it does tie into----
    Mr. LaFalce. What if we make it a material breach if they 
do not?
    Mr. Clapman. I think it already is.
    Mr. LaFalce. Well, then, there is not an awful lot of 
material breaches, I would suggest, that have not been----
    Mr. Clapman. That is true. There is a tie-in to the 
consultant aspect of what the audit firm does and why we take 
the position that we do.
    Mr. LaFalce. Speaking of the consultant, we do not say that 
certain firms have to be auditors and can't be consultants. We 
say they can't be the auditor and consultant for the same 
employer. They could be a consultant for some other employers 
and still retain all that capacity. And, of course, I do think 
certain types of consulting such as tax should be allowed for 
the same employer.
    Mr. Clapman. But there is an aspect of that point that goes 
to the heart of your question, and that is that the consulting 
services typically will not be retained by the audit committee. 
Typically, the consulting services are obtained by the 
management of the company. And that is where the potential 
conflict comes about: How does that firm view their loyalties? 
Do they view their loyalties to the audit committee and the 
shareholders, or do they owe their loyalties to the senior 
management of the company? And that is the effect of having 
large-scale consulting services by the same firm that does the 
audit being hired by management, and how the audit firm then 
assesses where their bread is buttered.
    Mr. Baker. [Presiding.] We will come back for another 
round.
    Mr. Raines. If I could differ. My experience is different 
than that. Audit committees typically are, in fact, shown the 
entire workload by the audit firm, whether or not it is audit-
related or consulting, and it is the responsibility of the 
audit committee to supervise that entire relationship; and in 
the firms that I am aware, where best practices would include 
the audit committee supervising the entire relationship, 
regardless of the scope of services.
    But on the scope of services issue, I would urge the 
committee to make, as you are thinking about the legislation, 
to not fall into these definitions of audit, audit-related, and 
consulting, because they are in many ways very false 
distinctions. Some of the audit-related are in fact audits of 
the pension plan, and they are indistinguishable from audits of 
the financial statements. So I think most people would believe 
having the same auditor doing auditing is not a problem.
    On the other hand, there are some things that are called 
``consulting'' that look a lot like what you think an auditor 
should do, such as looking and verifying information that is 
going to be used for securities offerings. So, rather than 
using these broad definitions, I think it is far better to try 
to come up with something that says things that are consistent 
with the attestation role of an auditor, where they are not to 
do broad-gauge management consulting, but to provide assurance 
to third parties that something is accurate. And I think that 
is far better than these distinctions that are currently being 
used, because I think they really confuse what it is that the 
auditors are doing.
    Mr. LaFalce. I think if you look at Mr. Levitt's 
recommendations, they were about an inch or two thick. And 
clearly, it would be the job of the SEC to articulate 
regulations. We have separation between church and state, but 
very often there must, of necessity, be a merger of the two. It 
is absolutely impossible to have a complete separation.
    Mr. Baker. The gentleman's time has expired.
    Mr. Raines, I want to pursue this line you just initiated 
with regard to the manner in which the Congress should act. And 
I sense from a number of the other members of the panel that 
with regard to the Congress being able to circumscribe current 
business practice by certain definition and thereby preclude 
inappropriate conduct in years to come, all of you are very 
bright people who can construct a business model that would 
meet whatever rule Congress comes up with, and that we should 
address principles of governance and then empower the SEC to 
enforce those principles where they don't already have the 
authority to act--which I believe they do have authority to 
act.
    To that end, I think it was inappropriate for Enron 
officials to have exercised no-cost options when, at the same 
time, constrained employees may have been prohibited at 
different intervals from acting on the exercise of their own 
stock options. And if there had been a subsequent accounting, 
there certainly would have been a restatement brought about 
which would have caused shareholders, if they had been a viable 
corporation still standing, to take significant loss while the 
executives earned significant compensation during that same 
environment.
    Is it your understanding that participants generally in the 
Roundtable, as a matter of business ethics, have in place today 
some prohibition on those generalizations that I have 
described? Or how can we construct rules that encourage long-
term earnings growth versus short-term profit and the extreme 
pressures that I understand management faces?
    Mr. Raines. I think you outlined the core problem, and let 
me give you my perspective on that. For example, in our 
statement with regard to the treatment of employees and 
treating them fairly, I think it would be entirely appropriate 
for Congress to say that one of the tests of fair treatment 
under the pension laws is that the fair treatment would go to 
questions of when can individuals trade or not trade. That is a 
broad principle that doesn't go to the Enron case, that says in 
this particular instance, here is what the rules can be. And 
then the Labor Department, as necessary, can begin to elaborate 
on how that might apply.
    But we don't believe there should be special treatment for 
one set of employees of the corporation versus another as to 
when they have access to the market. And most companies have 
tried to hold any such periods to be very small. But I think it 
would not be unreasonable for that specification to be there, 
because it establishes a principle without establishing exactly 
how it should be done for all times; because, you know, 20 
years ago we didn't have 401Ks. And 20 years from now we may 
have something different that is in place.
    But, I think the broad principle that employees should be 
treated similarly in the implementation of these plans and 
should not be disadvantaged vis-a-vis other employees in the 
exercise of their rights to purchase or sell stock, I think is 
a broad principle that would make an enormous amount of sense.
    Mr. Baker. Do shareholders generally today, as members of 
the Roundtable, have the authority to approve or disapprove 
option plans?
    Mr. Raines. The vast majority of option plans are presented 
to the shareholders for approval; not all, but the vast 
majority of the plans are presented to shareholders for their 
approval, and they are not always approved. Indeed, a number of 
the shareholder activist groups have taken very strong 
positions with regard to the size of these plans, and many 
corporations go to great efforts to comply with the views of 
these shareholder activist groups when they put their plans 
together.
    Mr. Baker. I have suggested, as one incentive to preclude 
manipulation of stock value, exercising no-cost option with a 
subsequent restatement of earnings, to require disgorgement 
within a certain time period of the restatement occurring if 
there is a finding by the SEC of manipulation of stock price. 
And the reason for that mechanism as opposed to the litigation 
route is the SEC can act while there are still resources 
available to act upon, where if we rely on litigation under 
Section 10(b)(5), it could be years. What is your reaction to 
that general line of thought?
    Mr. Raines. Mine? With regard to disgorgement, the SEC does 
have authority now to undertake that. And in cases where there 
has been wrongdoing that leads to a misstatement of the 
information given to the public that has a material impact on 
the stock, I don't believe it is unreasonable at all for the 
SEC to pursue disgorgement among the senior management of the 
proceeds from options that would have occurred under those 
circumstances. I think you are going to have to define who was 
covered and what the circumstances will be. But as you 
described the situation, that would be a prime case in which 
the SEC should take action.
    Mr. Baker. As a general matter for the panel, does anyone 
dispute the observation that the financial statement should be 
an accurate reporting of corporate financial condition for the 
shareholder, and that it is not the property of the management? 
Does anyone dispute that particular view? Because we had the 
CEO of a significant accounting firm indicate it was a joint 
property of management and the shareholder, and I found that to 
be a bit distressing that that conflict would be publicly 
acknowledged by a CEO of an auditing corporation.
    Did you want to comment?
    Mr. Clapman. Yes, I did. I just wanted to add to the 
response of Mr. Raines to your question about whether 
shareholders have the right to approve stock options. I think 
the vast majority of the companies within the Business 
Roundtable do present their stock option plans for shareholder 
approval, but we have been tracking this and there are, 
increasingly, companies adopting plans without shareholder 
approval. So if you want to look at the direction, without some 
reforms in this area, the direction is toward more plans being 
put into effect without shareholder approval at the current 
time.
    Mr. Baker. I am sure we may come back to a second round, 
but Mr. LaFalce wanted to get 15 seconds.
    Mr. LaFalce. Mr. Chairman, pursuant to rule 11 of the Rules 
of the House and rule 3 of the rules of our committee, I would 
like to have an additional day of hearings on the matters 
related to comprehensive reforms and, most particularly, both 
Mr. Oxley's bill and my bill so we can see the best merits of 
each.
    Mr. Baker. I thank the gentleman.
    Mrs. Maloney.
    Mrs. Maloney. Thank you, Mr. Chairman, and welcome to all 
the panelists.
    I would like to ask Mr. Raines, we currently have five big 
accounting firms, and with the indictment of Andersen there is 
a possibility that we may soon be down to four; and doesn't the 
fact that only four auditors will be reviewing the financial 
statements of America's largest companies require that the 
industry regulator be a stronger public entity than those that 
have been proposed by the SEC? Could you comment on what the 
impact may be with only four firms?
    Mr. Raines. Well, I think that it is a bad thing that we 
might face the prospect of having only four major accounting 
firms in the United States. There are other accountings firms 
other than these current five. But I think the reduction in the 
number of accounting firms is not a good thing. I think 
competition in that market is a good thing. I think having 
multiple firms is a good thing. And that is a matter of 
concern, and I hope that is taken into account in future years 
as firms look to merge or otherwise reduce the number of 
competitors.
    With regard to an oversight body, I agree wholeheartedly 
that it needs to be a strong body and needs to be one with the 
power to actually investigate and the power to actually come to 
conclusions and to make determinations that might include 
penalties. And you ought to have on it those people who can 
both instill confidence in the public, but also those people 
who have some knowledge of the profession and the work to be 
able to come to decisions.
    But it should not be a body that is nearly honorific. It 
ought to have the ability to not only discipline, but also to 
look at the quality control procedures within accounting firms 
to ensure that they are working to become better and they are 
becoming better at what they do; because I believe the biggest 
impact they could have is not on the penalty side, but it is in 
quality control. It is ensuring they are hiring good people and 
they are training them and they have systems of conflict of 
interest in place; that they are enforcing their own internal 
rules, in fact, and actually going to look and review periodic 
audits and see if those audits meet standards. I think that 
kind of approach from an oversight body can have a tremendous 
effect on the quality of audits.
    Mrs. Maloney. There were two questions that have been asked 
by the prior panel by members of this company. One was rotating 
auditors, your feeling on that. And another of, say, every 3 
years having an auditor come in and look at the audit. And what 
is your response to those two proposals?
    Mr. Raines. In terms of the rotation of auditors, there are 
instances, and particularly in public bodies, that do require 
rotation. The concern that you have is that in the first year 
and last year of the audit, you may not have the same quality 
of the audit that you were looking for. I believe the SEC's 
evidence is that more frauds occur in the first year of a new 
audit relationship than in any other time. So I believe the 
members of the Roundtable would say it ought to be on a case-
by-case basis.
    In our company we have adopted the practice now of 
essentially requiring a de novo review of our auditor each year 
where we would have the same process we would have as though we 
were doing a new audit selection, where they have to present 
their credentials and identify their quality control and all 
the aspects to make a determination should they continue to be 
the auditor in the next year. And I think that practice can 
take the place of an automatic rotation, as a rule.
    Mrs. Maloney. With the proposal having, say every third 
year, another auditor review the work.
    Mr. Raines. Well, currently there is a process in the 
auditing profession of having another firm come and do a 
review. But this is a relatively private process in which the 
SEC is informed of the results, but it is a relatively private 
process. I personally believe that that is a process that 
should be overseen by the new oversight body, and that these 
reviews are used as a way to improve audits, not only to say 
how did this one firm do, but what did you learn in this case, 
in this type of a firm, or this type of an industry, and let 
other people know so that if they run into the same problems, 
they will know how to go about handling them.
    We don't have a good enough feedback loop so people are 
learning about what went right and what went wrong in audits. 
If you have someone come in every 3 years to review the entire 
audit, that is a massive undertaking for multinational 
companies that may be in 100 different countries, that to go 
replicate that audit would be a massive undertaking. I think it 
would be impractical. But I do believe having these periodic 
quality reviews, taking random audits and really thoroughly 
looking at them, could be a very important learning tool.
    Mrs. Maloney. Last week, former SEC Chairman Robert Hills 
suggested before this committee that audit committees should be 
given more formal legal status and that independent directors 
should be nominated by an independent nominating committee 
rather than by the CEO or chairman of a company. And what is 
your view of these suggestions?
    Mr. Raines. At least my experience since last fall is that 
audit committees have quite a status now within corporations. I 
think our general view would be that designating a particular 
committee as being independent of the board itself is not a 
good idea. Committees are just subsets of the boards. Audit 
committees should be populated by independent directors. And 
all committee assignments should be made, in our view, through 
a nominating committee, and that no one person----
    Mrs. Maloney. An independent nominating committee?
    Mr. Raines. Nominating committee of the board.
    Mrs. Maloney. But most board members are appointed by the 
CEO, so then you would have the CEO control.
    Mr. Raines. I don't believe the Chairman was really talking 
about a nominating committee that was independent of the board. 
I believe he meant an independent committee made up of 
independent board members. So it would be the nominating 
committee within the board that would be approving that. That 
is the practice of the corporations that I am familiar with 
personally in any event. Certainly the CEO is likely to have 
ideas, but I also know that very often that the CEO's ideas 
don't prevail in well-managed companies and that the nominating 
company ultimately has responsibility of picking both committee 
Members and members of the board.
    Mrs. Maloney. There has been some suggestion after the 
Enron debacle that there is a massive hole in our financial 
services regulatory system for entities like Enron, entities 
like Enron that act as financial services companies, but do not 
fit the current regulatory scheme. And do you believe that 
simply the reporting requirements for public companies to the 
SEC is regulation enough for these companies? In many cases, 
banks are very heavily regulated. And in many cases, these 
entities like Enron are larger than the banks in practicing 
formal banking practices. So either the bank shouldn't be 
regulated or possibly these entities should be regulated.
    Mr. Baker. That will be your last question, because your 
time has expired.
    Mr. Raines. I think you have raised an important issue. We 
have been talking here about the regulation of financial 
disclosures. But you are talking about as important, if not 
more important, safety and soundness regulation. Enron could 
have disclosed much of this and still have been unsound. And 
the rise of financial institutions who are not subject to 
safety and soundness regulation is a matter of concern, because 
just as surely as a large regulated financial company could 
cause concerns in the economy and concerns with other 
investors, you could have that same concern arise with a 
financial company that does not have a safety and soundness 
regulator.
    So I think it is important to keep in mind that we need to 
have appropriate disclosure, but also we need appropriate 
safety and soundness regulation to ensure that our financial 
institutions are contributing to a sound economy and not 
putting our economy in danger.
    Mrs. Maloney. With Enron, do you think there is a gaping 
hole for these type of entities? Should there be some type of 
regulation?
    Mr. Raines. I believe that that is an issue that ought to 
be given very careful regulation. Enron was becoming a 
financial company. It had no safety and soundness regulation or 
oversight of any kind. And where we see very large companies 
becoming financial institutions without safety and soundness 
regulations, I think that is a concern.
    Mr. Baker. Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman. I want to go back to 
a comment you had a few moments ago and this whole issue of 
whether or not you preclude an auditor from providing other 
services. And I agree that you don't want to get caught up in 
the minutia of saying, well, it can't be this or that, and I 
understand there is some synergy between tax return preparation 
and auditing.
    But you raise an interesting point which I was trying to 
raise earlier today with Mr. Pitt; and that is, there are 
certain things that auditors provide that are verification 
oriented for investors. And it would seem to me, and again I 
recall--you may recall from your prior experience--I seem to 
recall there was an MSRB rule or other rule that precluded 
auditors from providing other verification numbers in the same 
issuance that was being done.
    Now, I may be wrong about that, but it does seem to me that 
is really what we are trying to get at. And I would be curious 
and, Mr. Livingston, I would like your comments, because you 
talked a little bit about this in your testimony, whether or 
not if we proscribe something a little more broadly in the way 
that Mr. Raines discussed it, that that would be an acceptable 
form of separating out, saying if you are going to be providing 
auditing for public companies and even tax return preparation 
that you can't--at least in the same issuance of a registered 
issuance--provide other forms of verification. Because I think 
our concern is not just that there is perhaps padding of other 
accounts in order to get a more favorable audit, but I think 
our other concern in the case of Andersen was that they were 
providing qualified opinions and verification for off-balance-
sheet financing which, had they put all the pieces all 
together, they very likely would have said perhaps it wasn't 
being properly disclosed.
    Mr. Raines. I may not have been clear, but let me try to 
answer that. It has been 20 years since I looked at any MSRB 
rules. I think in my experience in dealing with entities, both 
entities in financial trouble and entities that are financially 
strong, is that the auditing firm often is the only consistent 
source of information. And well done, they require that numbers 
in one place match up with numbers in another place. And it is 
a very valuable service that they provide and they typically 
are very loath to sign off on anything that they haven't had a 
chance to verify what the source of the information was.
    And that is something we don't want to discourage companies 
from having; having someone who sees all the numbers, so you 
don't have a case where companies can show part of the numbers 
to one audit firm and another set of numbers to another audit 
firm and no one ever compares the two.
    So I think you want to try to have your verification things 
in one place. But I think what you don't want to do is take the 
person who is doing verification and then have them doing 
fundamentally different things that will get them off of what 
their particular expertise is and into this.
    There was an unfortunate phase in the auditing profession 
where they stopped looking at themselves as auditors and 
assurance firms and got into being full-scale multipurpose 
professional services firms. And I think that was a mistake, 
and I think most of the auditing firms are correcting that 
mistake now. But I do believe that there is importance in 
having one firm that looks at all the numbers when you are 
verifying and making representations to the public, so you 
don't have things falling between the cracks.
    Mr. Livingston. I would comment, a couple of years ago when 
we did pass the--the SEC enacted those rules they extended the 
list of services that auditors should not do, which resulted in 
a product on which they might end up relying upon. And the 
problem is, is that it gets--that is a good list of things that 
they shouldn't prepare the books and then audit the books or 
build receivable systems and then audit receivable systems.
    But the problem gets into when a company is doing very 
complex transactions and they show the transactions to the 
auditor. And I think in the Enron case, the auditor may have 
gotten too involved in the actual design and then auditing the 
transactions. It takes ethical conduct and professional 
standards at the local level to regulate that gray area.
    Mr. Bentsen. And I think that was the problematic situation 
with respect to Enron.
    Let me ask you one other question, Mr. Livingston. In your 
testimony, you briefly referenced the need that your 
organization is calling for to review FASB and their rules. Can 
you expand upon that a little bit?
    Mr. Livingston. Yeah. We have gotten into a bad 
circumstance in accounting standards over the last 10 years, 
and we have had accounting standards like FASB 133 which is 
accounting for derivatives, which is 850 pages long and is 
unusable by the most sophisticated local audit partners out in 
the field. There are a handful of people in the world that know 
how to apply this accounting standard. And that is the 
unfortunate circumstance we have gotten ourselves into.
    We have gone too far in getting away from principle-based 
accounting standards. In this Enron and accounting for 
derivatives, FASB 133 has exposed the need to have a new 
process, a new mind-set, principle-based accounting standards 
that get back to substance of reform.
    When I learned accounting and I studied for the CPA exam, 
there was one principle called ``substance of reform'' that we 
have lost in the last 10 years. Form over substance has taken 
over. And it is an unfortunate lesson, but I think the lesson 
has been learned and I think we are heading toward faster 
standard setting that are principle-based, that get back to 
substance of reform.
    Mr. Bentsen. You sound like the architects have taken over 
FASB, but I always thought of FASB as being more of an 
accounting-based institution, as it was. And you say it doesn't 
work in its current form.
    Mr. Baker. That has to be your last question.
    Mr. Livingston. It has gotten too focused on narrow 
problems and not prioritized. It hasn't kept pace with the 
modernization of technology and hasn't thought about financial 
reporting as much as here is a problem and we are going to 
swarm in and spend a lot of time on that. The consolidations 
project, we spent a lot of time on that. There were many of us 
that encouraged the FASB to break up the consolidations 
project, which they worked for 20 years on, and break it up and 
focus on the SPE issue. And a lot of people said that. And they 
couldn't step back and divorce themselves of the other part of 
the consolidations project. They wouldn't let that go and focus 
on SBEs.
    And that is part of the whole problem that has been going 
on for the last 10 years. I think we have a new mind-set and a 
new attitude, and I think we will get to the right place.
    Mr. Baker. The gentleman's time has expired.
    Mr. Royce.
    Mr. Royce. Thank you, Mr. Chairman. I was going to ask Mr. 
Frank Raines of Fannie Mae, a lot of what we talked about 
today, one of the things we have focused on is compensation 
structure and making sure that when you have got a board of 
directors that you are increasing their independence and that 
you are ensuring that the interests of the shareholder are 
being represented there on the board and not the interests of 
management. And I was going to ask, how does Fannie Mae 
compensate its own board of directors and its audit committee, 
with an eye toward that specific objective?
    Mr. Raines. Well, it has been our philosophy for quite some 
time not to concentrate the compensation of our directors or of 
our management using only one tool, so we use a variety of 
tools. Our board is compensated through an annual retainer, 
meeting fees, and then they also have stock options. And the 
idea there is to have their focus not just on what is happening 
this year, but also the longer-term interest of the 
shareholders.
    Similarly for our executives, we compensate with a 
combination of salary, bonus that is focused on 1 year's 
performance. In some cases we have focused on 3 years of 
performance and then options, which is for the longer term. So 
we don't have any one focus. And, indeed, we provide a 
disincentive to try to move the stock in the short run, because 
if stock then goes down, you will disadvantage your 
compensation which is not going to be paid to you for 3 or 4 or 
5 years. So we found that a mix gives us the right balance, 
that no one tool does the job, but also you don't overweight 
toward one thing or another.
    Mr. Royce. You know, if there is a best practices approach 
to this, what would be gained or lost by requiring all publicly 
traded companies to submit to a structure--or do you think that 
is feasible?
    Mr. Raines. I think you can suggest best practice, but I 
don't know that any of us are smart enough to think that 
something is going to work in all of these different companies. 
The companies really all have different personalities and 
different circumstances. So I would be loath to say that I 
would know that our structure would be perfect for everyone. 
But I do think that in the compensation philosophy, these are 
the kinds of things that should be looked at. And, indeed, now 
the SEC requires that in proxy statements there be a report 
from the compensation committee stating the philosophy. And if 
investors believe strongly in one philosophy or another, that 
is their opportunity to communicate that to the company. And I 
think that process has worked for other kinds of reforms, 
including holding down the number of options so as not to 
dilute the interest of the shareholders.
    Mr. Royce. One other question I was going to ask. How does 
Fannie Mae report management trades that occur in the company? 
How do you report those to the marketplace and what timeframe 
do you report those management trades in company stock?
    Mr. Raines. Fannie Mae is a non-SEC registrant. It doesn't 
report or use the forms of the SEC. But we have had an insider 
trading compliance program for many years which prohibits 
executives from trading at all, except during an open period, 
and that open period only occurs after we have reported our 
earnings for the quarter. So we only permit very limited 
windows. All trading done during that period has to be reported 
to the company, which is then--all the trading is reviewed by 
our counsel and reviewed by our regulator.
    We have, though, taken note of the proposals that Chairman 
Pitt has suggested on contemporaneous reporting of these 
trades. And so we intend starting next month to provide 
contemporaneous reporting. So within several days of the 
trades, we will post on our websites all trades by all insiders 
of the companies. And I believe that will make us one of the 
first companies to, in fact, implement the idea that Chairman 
Pitt has put forward.
    Mr. Royce. I think that is a good move, and I would hope 
all corporations follow suit with the SEC's suggestion there. 
And, frankly, I think having that reported in real-time will do 
a lot to end the abuse there. But I thank you for answering 
those questions.
    Mr. Baker. Ms. Carson.
    Ms. Carson. Thank you very much Mr. Chairman. Let me assure 
you, gentlemen, that I come here with no preconceived notion in 
terms of what we need to do. What I seek personally are quality 
control, disclosure, consumer confidence and integrity, 
business ethics, fairness, understand what constitutes 
wrongdoing and how the shareholder and then the stakeholders 
are protected throughout the process.
    And I would also hasten to add that I think it is very 
troublesome that an institution like Arthur Andersen, who has 
for years been one of the premier accounting firms in this 
country, has had to go down based on the acts of a few bad 
apples in a bushel. I am not one who believes you need to throw 
the bushel out.
    I have two quick questions, one of Mr. Raines in terms of 
on behalf of the Roundtable. You said it is the responsibility 
of management under the oversight of the board and its audit 
committee to produce financial statements that fairly present 
the financial condition of the company and make sufficient 
disclosures to investors to permit them to access the financial 
and business soundness of the company.
    Can such responsibility be legislated by the United States 
Congress? I just sent back my shareholder proxy yesterday, and 
always check yeah. Want to know if you want these people to be 
on the board, yeah; do you want this kind of committee. It 
doesn't make to me any difference because I trust the company.
    I don't know how in the world Congress can legislate all 
these things. And additionally, because I know we have a vote 
on, there was an article in the Wall Street Journal, Mr. 
Chairman, that talked about Enron, and that is why we are here, 
this one company. Information was that servicing Enron's 
derivatives, trading may have been used to mask weaknesses in 
the company's other businesses such as fiber optic bandwidth, 
retail gas and power, and water systems.
    Can any of you gentlemen tell me how we can as a Congress 
ensure that all of these lists of sundry outside entities under 
one big umbrella can be regulated and audited so that the 
stockholders and the shareholders will know fully well what the 
condition of a company is?
    Those were two questions. If you don't have time to answer, 
you can write me, because I know we have a vote on.
    Mr. Baker. Let me suggest Mr. Sherman has a remark, and if 
you will work with me here, we have an end in sight; because if 
you don't, we are going to have to come back after a 20-minute 
delay. And hopefully that will encourage a prompt and courteous 
response to Mr. Sherman's inquiries.
    And thank you, Ms. Carson, for your comments. We are asking 
for a direct written response, Ms. Carson.
    Mr. Sherman. Thank you. I first want to comment that I hope 
that we move toward the most thorough rules with all the 
identifiable loopholes plugged, rather than just announce that 
we want to be principles-based.
    I would point out that the form over substance principle is 
part of the rule now, and we never raised that, and it was 
completely insufficient. I think if we all sing patriotic songs 
and rededicate ourselves to form over substance, that might 
work for a year or two. But eventually the people who come to 
head the aggressive firms will be the aggressive financial 
managers, and the firms that are selling for 25 times reported 
earnings will be the aggressive firms, and maybe it will be the 
aggressive firms that claim that they are not aggressive.
    And I am an old tax guy and I can just imagine what would 
happen if we went to a principles-based tax system. And keep in 
mind, the Tax Code and FASB regulations are doing the same 
things. There are two different systems for determining what 
your net income is. And if we just urged taxpayers to pay their 
fair share and relied on principles rather than the most 
definitive rules, we would have a lot larger deficit than we 
have now.
    I wish I could ask a question, but you would have to stay 
for another 20 minutes. What I hope that we do is have a third 
day of hearings and invite those who represent investors to be 
here. One of the things that I think is one of the problems in 
this Enron situation is that those who represent investors, 
mutual funds, pensions, are not represented in Washington given 
the degree of their importance to our economy, and that most of 
the people who have come before us are issuers of financial 
statements, not those who read them with an interested eye. And 
I look forward to a third day of hearing, but not a 1 minute of 
questioning.
    Mr. Baker. I want to thank each of the witnesses for their 
appearance today, and I want to say a word, Mr. Livingston. I 
appreciate some of the recommendations your organization has 
made in the testimony today. The Chairman would want me to 
encourage you, in the days that remain before the committee 
would proceed to markup of this important bill, that you 
forward any recommendations or suggestions based on the 
exchanges you heard today. We have a significantly important 
task ahead of us, and we need all the best minds we can get to 
succeed.
    Thank you for your testimony and our hearing is adjourned.
    [Whereupon, at 2:45 p.m., the hearing was adjourned.]



                 H.R. 3763, THE CORPORATE AND AUDITING



                   ACCOUNTABILITY, RESPONSIBILITY AND



                       TRANSPARENCY ACT OF 2002

                              ----------                              


                         TUESDAY, APRIL 9, 2002

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                    Washington, DC.
    The committee met, pursuant to call, at 2:05 p.m., in room 
2128, Rayburn House Office Building, Hon. Mike Ferguson 
presiding.
    Present: Chairman Ferguson; Representatives Roukema, Baker, 
Gillmor, Cantor, Ryun, Biggert, Rogers, LaFalce, Kanjorski, 
Watt, Bentsen, Carson, Sherman, Inslee, Shakowsky, Capuano, 
Hinojosa, Israel, Maloney of New York, Meeks, and Maloney of 
Connecticut.
    Chairman Ferguson. The hearing is called to order.
    Today, the Committee meets for the third day of hearings on 
H.R. 3763, the Corporate and Auditing Accountability, 
Responsibility and Transparency Act. Today's hearing is being 
held at the request of the Minority.
    The Chair now recognizes himself for a brief opening 
statement.
    Good afternoon. Welcome to the Committee's third 
legislative hearing.
    Last December, this Committee, which oversees the financial 
and capital markets, held the first congressional hearing on 
the Enron collapse and its impact on investors and employees in 
the financial markets. When the Committee set out to 
investigate the Enron collapse, we had several clear goals in 
mind.
    First, we wanted to make sure the Congress now knew how the 
biggest corporate collapse in American history occurred.
    Second, we wanted to work toward restoring the confidence 
of investors in accounting, regulators and the rules governing 
our markets.
    Third, we wanted to formulate an appropriate response that 
would ensure that the free market system and the regulatory 
system that underpins it emerged stronger as a result of our 
work.
    The American people deserve to know the facts directly and 
to hear them specifically from those most directly involved. I 
commend Chairman Oxley for working closely with major 
investigators, the Justice Department, the SEC and Enron and 
Andersen's internal teams to achieve these goals.
    The introduction of the Corporate and Auditing 
Accountability, Responsibility and Transparency Act, or CARTA, 
represents the culmination of this process. It has allowed us 
to move forward and investigate comprehensive and practical 
solutions that will undoubtedly strengthen the overall 
financial system.
    The past few legislative hearings have been very 
constructive. We have heard from a diverse group of witnesses 
representing a broad spectrum of views regarding the securities 
market and the Government's role in protecting investors. The 
distinct difference is in the testimony of these individuals, 
including former SEC officials and representatives from the 
securities industry, a leading consumer organization and the 
accounting industry have confirmed that the Committee has taken 
the necessary steps to improve the current regulatory system 
through CARTA.
    CARTA is clearly the product of a multitude of views and 
months of work by the Committee to improve the public's 
confidence in the capital markets and to strengthen the overall 
financial system in the most appropriate manner. CARTA is 
effective because it gets to the heart of these foundational 
issues that will prevent future Enrons without drowning 
businesses in a sea of red tape. It is important that this 
legislation avoids the temptation to overreact and legislate in 
a manner that will cripple the entire business community.
    In fact, Federal Reserve Chairman Alan Greenspan has 
testified that the Enron collapse has already generated a 
significant shift in corporate transparency and responsibility, 
highlighting the market's ability to self-correct. 
Overlegislating would be counterproductive and make it 
impossible for the markets to function properly.
    Despite these concerns, there is no dispute that Congress 
must be involved in some capacity to ensure that the free 
market will emerge stronger than ever. America needs a strong, 
vibrant and healthy accounting industry to keep companies 
financially sound and to provide investors with solid 
information. CARTA was carefully crafted by Members of Congress 
to provide our current system with this base without 
overstepping our boundaries in a way that could ultimately have 
a negative impact on the world's strongest markets.
    CARTA rightfully establishes new firewalls and increased 
oversight to ensure independent reviews and avoid conflicts. It 
establishes a new public regulatory body under the SEC with 
strong oversight authority and prohibits firms from offering 
certain controversial consulting services to companies they are 
also auditing.
    This legislation also requires accountants who audit 
financial statements of publicly traded companies to be 
federally certified by the public regulatory organization and 
highlights the concept of corporate responsibility by requiring 
companies to ensure their accountants are in good standing.
    The oversight board has the authority to discipline 
individuals who violate securities laws or breach standards of 
ethics or independence.
    Investors of all types rely on accurate and accessible 
information to make their financial decisions. In the Enron 
debacle, thousands of investors were deprived much-needed 
resources to make sound investment decisions. It is an outrage 
that any company would prohibit its employees from selling 
their stock within their retirement plans, while at the same 
time its executives were selling millions of dollars of stock 
because they were privy to more up-to-date information.
    This legislation meets our responsibility to shareholders 
and employees of publicly traded companies who deserve to know 
more and know it in real-time about a company's financial well-
being. It also fittingly prohibits corporate executives from 
buying or selling company stock when 401(k) plan participants 
are unable to buy or sell securities.
    We have a moral obligation to ensure that safeguards are 
established to prevent the disasters of this magnitude in the 
future. CARTA correctly holds corporate America more 
accountable to the employees and shareholders through stricter 
accounting standards and stiffer disclosure requirements.
    But legislating should not be the end of Congress's role in 
addressing these issues. The collapse of Enron represents a 
combination of irresponsible actions on the part of 
decisionmakers with knowledge of the company's financial well-
being and a meltdown of the financial safeguards used to 
identify problems at a stage when corrective action might still 
be taken.
    We must work directly with the private sector to instill a 
spirit of corporate responsibility by challenging America's 
business leaders to meet the highest standards of ethics and 
responsibilities to their employees and shareholders.
    There have been dozens of legislative measures introduced 
by both sides of the aisle to address these issues. It is time 
to put partisan squabbling aside and to move forward with 
practical solutions that will actually help. These hearings 
have helped the Committee assess the effectiveness of CARTA in 
preventing future accounting and stock irregularities in 
publicly traded companies. However, to ensure that no questions 
are left unanswered, Chairman Oxley has agreed to this final 
hearing before we move forward with the consideration of CARTA.
    I want to thank the witnesses for their attendance, and at 
this time I would like to yield to the distinguished Ranking 
Member, the gentleman from New York, Mr. LaFalce.
    Mr. LaFalce. Thank you very much, Mr. Chairman.
    Let me put this in perspective. In your opening statement, 
you just said that the Chairman has agreed to this hearing. 
This is a hearing which we demanded as a matter of right under 
the rules of the House and the rules of the Committee. The 
timing for it was set over the recess for 2 o'clock today, a 
day when the Congress does not begin voting until 6:30. If we 
didn't demand our rights, we would have just proceeded to a 
markup on Thursday with but 2 days of hearings.
    So you have said it is time to put partisan squabbling 
aside. What does that mean, that we should just discuss and 
vote upon exclusively the bill that was prepared by the 
Republican staff to the Chairman of the Committee without 
Democratic input? That is not putting partisan squabbling 
aside. That is just saying ``succumb to our will.'' So let us 
not kid ourselves or kid the public as to is going on here.
    The Minority Members of this Committee wanted today's 
hearing out of a concern that we mark up legislation as soon as 
Thursday on issues facing our securities markets without giving 
adequate consideration to many aspects of the legislative 
proposals before us. There are many aspects of the legislative 
proposal before us in which no one has testified, much less 
haven't had a diversity of testimony. And there have been 
significant developments.
    On Monday, you all read in the New York Times, the 
Washington Post, and so forth, about the role of investment 
banks that has been added to the Enron lawsuit. We have not 
explored that. That is certainly within the jurisdiction of our 
Committee. It is an important issue to which we have given no 
consideration.
    Today, you read in the New York Times and the Washington 
Post and the Wall Street Journal, and so forth, about the 
action of the Attorney General of the State of New York with 
respect to securities firms who were violating their own rules, 
flagrantly. These are allegations, but he was able to obtain a 
court order.
    Under any circumstances, though, these come within the 
jurisdiction and concern of our Committee; and before we mark 
up legislation, we should give attention to those issues.
    It is clear to me that this should not be the last hearing 
before we go to markup. It seems to me there would be a rush of 
judgment, and the judgment should be a very partisan one. That 
is, go along with the bill prepared by the majority staff ab 
initio.
    Well, there is consensus on certain things. There is a 
consensus that we need a new public oversight body for the 
accounting profession, but there is not a consensus on the 
attributes such a regulator must have to be credible and 
effective, and there has been no conversation between the 
Democrats and the Republicans, at least as far as I am 
concerned, on this issue.
    For example, my bill explicitly establishes the powers and 
duties of the new regulator, while H.R. 3763 leaves these 
matters exclusively to the SEC rulemaking, effectively leaving 
these rules up for jump ball, totally up to the SEC.
    Now, certainly the SEC must make rules and they must have a 
certain amount of discretion, but I think, given what we have 
seen, we ought to have certain legislative powers that are 
clearly established. And that is a serious issue. I think that 
the new regulator should have the authority to set quality 
standards rather than just enforcing industry standards and 
should have clear disciplinary and investigative powers. And 
that is not in the Chairman's mark, and it is in my bill.
    We need a discussion of that issue. What should the 
legislation have? Should the legislation establish the clear 
disciplinary and investigative powers of the regulatory body?
    Auditor independence. We have barely scratched the surface 
in considering that issue. We have not discussed the services 
that create conflicts for the auditor or measures to give the 
audit committee authority to determine the non-audit services 
the auditor should provide. Other corporate governance reforms 
that would enhance the functioning of the audit committee and 
are inextricably linked to auditor dependence. As the Enron 
collapse made sure, we also must ensure that the independent 
directors of our public companies are truly independent.
    Now, my bill includes these provisions. They deserve 
further discussion. They have not been discussed before our 
Committee.
    The Committee has given little consideration to the role of 
the securities analysts in the Enron collapse. My bill would do 
more to reduce the conflicts that cause analysts to look the 
other way when companies present rosy but misleading pictures 
of financial health.
    As the New York State Attorney General said yesterday in 
bringing action against Merrill Lynch, such actions jeopardize 
the integrity of our securities marketplace, and we should 
examine that issue fully.
    Finally, we must consider the need to enhance the ability 
of private litigants to enforce the securities laws, 
particularly with respect to aiding and abetting by accountants 
and other professionals. We restored the ability of the SEC to 
bring aiding and abetting actions in 1995, and we should 
consider restoring the ability of private litigants to do the 
same, and we have had no hearing devoted to that extremely 
important issue.
    Further, I am pleased to announce that today I introduced 
another bill, a bill that would give legislative substance and 
real teeth to meritorious portions of President Bush's 10-point 
plan on corporate disclosure and accountability. The Corporate 
Responsibility Act of 2002 requires disgorgement of incentive 
compensation and certification of financial statements and 
allows the SEC to administratively bar unfit officers and 
directors from serving in public companies.
    There is much to be done. I look forward to working with 
Chairman Oxley and all of the Members of the Committee to bring 
about a strong legislative response. I think we need additional 
time and hearings and consultation and conversations and 
compromise in order to bring that about, and I thank the Chair.
    Chairman Ferguson. The gentleman's time is expired.
    The gentlelady from Illinois, Mrs. Biggert, you are 
recognized for an opening statement for 5 minutes.
    Mrs. Biggert. Thank you very much, Mr. Chairman.
    Mr. Chairman, this morning hundreds of Andersen employees 
in my district rolled out of bed with a simple question on 
their minds. When I return home tonight, will I still have a 
job? If I do make it through the day, will my job be there at 
the end of the week or the month? Sadly, for many of them, the 
answer will likely be no. Through absolutely no fault of their 
own, they will be looking for employment elsewhere. As Andersen 
finalizes plans to cut its workforce, my thoughts and prayers 
are with the more than 500 Andersen employees in my district 
and the thousands more across the Nation who had nothing 
whatsoever to do with the case at hand, but nonetheless are 
feeling the aftershocks.
    We can debate privately or publicly the end result of the 
actions taken over the past months and how actions can lead to 
unintended consequences. As one Andersen employee from my 
district asked in a letter to me last week, if one out of our 
535 Congressman and Senators gets in trouble, should you all be 
fired? The short answer is no; and yet it is true that, to a 
certain extent, we all lose public confidence when one Member 
abuses his or her office. It is not right, and it is not fair, 
but it is what happens.
    I think everyone can agree that change is needed in the 
accounting industry, and I think several good proposals are on 
the table. We must, however, strike the right balance to ensure 
that the decisions we make in the coming days will help solve 
the problems at hand without creating those unintended 
consequences down the road.
    H.R. 3763 is an important step in the right direction. With 
this legislation, we will avoid any more blanket charges 
against groups of accountants and instead punish the particular 
accountants at fault. H.R. 3763 provides more immediate and 
closer scrutiny of the accounting profession in general and 
specific accountants in particular.
    I should add that, at the same time, there is much more 
that the accounting industry must do. They should not wait for 
Congress to point them in the right direction.
    A good place to start is with the recommendations of former 
Federal Reserve Board Chairman Paul A. Volcker. I commend the 
efforts that he has made to begin to restore some of the 
credibility that is much needed in the accounting profession.
    I look forward to hearing from the witnesses today and 
thank you very much and yield back the balance of my time.
    Chairman Ferguson. The gentlelady yields back.
    The gentleman from California, Mr. Sherman, is recognized 
for 5 minutes for an opening statement.
    Mr. Sherman. Thank you very much.
    It is good that we are having these hearings. It is 
unfortunate who is not here. We have those very many 
organizations who don't get fees as investment bankers, but do 
control trillions of dollars of capital--professional 
investors, mutual funds, pension advisers--who have been, I 
think, underrepresented in the overall process before Enron and 
even after Enron in giving us guidance as to what information 
they need and what steps need to be taken so that they can rely 
on that information.
    CARTA I think is a good bill, but it is less than the 
minimum we should do, and I think our constituents will be 
unimpressed with those Members of this Committee who vote for 
final passage of CARTA, but vote against the amendments 
necessary to make it a strong enough and meaningful enough 
piece of legislation.
    Alan Greenspan is correct when he points out that there has 
been a shift in business culture so that the greatest abuses of 
the past will not be repeated in the immediate future, but that 
is only the immediate future. The pressures that created the 
atmosphere of 2001 will return within a few years. The hottest 
executives at the hottest companies will be those reporting the 
hottest growth in their earnings and reporting the lowest 
liabilities. We need to legislate, not just rely upon what I 
fear is a short-term change in the business culture.
    There are three amendments I am certain to offer to this 
bill.
    The first is to tell the SEC they have to read the 
financial statements of the 2,000 largest companies every year, 
and then when they find something that is incomplete or 
confusing, they will then demand that additional material be 
filed. The request or demand for additional information will be 
immediately public. The material filed in response would be 
made immediately available to the public, and this is an answer 
to the fact that an awful lot of what is in those Enron 
financial statements isn't false. It is just unintelligible. 
Not unintelligible to the uninitiated. Unintelligible to 
anyone. The SEC doesn't read the financial statements filed by 
the big companies. They only read financial statements filed by 
the small companies. That has got to stop. And by the small 
companies, I mean the IPOs.
    Second, Arthur Andersen was the one of the Big Five--then 
Big Five--that had its salespeople, the people in charge of 
selling more services to Enron and collecting the fee, the 
engagement partner, in final control of whether to sign the 
audit opinion. The other Big Four accounting firms--or the 
other of the Big Five--put their quality and technical review 
people in charge of making that final decision. We should not 
leave it to the accounting firms to structure themselves any 
way they want. The people insulated from the sales decision and 
who are steeped in accounting literature need to make the final 
decision.
    Finally, Mr. Chairman, recently Arthur Andersen indicated 
that, while it had offered over $700 million to settle, it was 
now cutting its offer to only $300 million because, oops, they 
don't have any capital. We need a minimum capital requirement 
for accounting firms of at least half a year's audit fees. 
Right now, Arthur Andersen is saying they don't have any money 
to pay those damaged by their inaction, and we cannot tell 
accounting firms that they can go practice virtually without 
malpractice insurance, with virtually no capital and then, if 
they make a mistake, the investors get nothing.
    There are two other issues. One is that if we are going----
    Chairman Ferguson. If the gentleman could just wrap up 
here.
    Mr. Sherman. OK.
    Chairman Ferguson. We are past expired.
    Mr. Sherman. My time is expired. Let me simply say that 
those who don't learn from history are doomed to repeat it, and 
those who do not pass legislation triggered by recent history 
are doomed to see those same mistakes repeated.
    Chairman Ferguson. The gentleman's time is expired.
    The Chair recognizes the gentleman from Louisiana, the 
distinguished Chairman of the Subcommittee on Capital Markets, 
Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman.
    I think in the aftermath of the demise of one of the 
largest corporations in American enterprise it would be 
inappropriate for us to rely on additional lengthy studies or, 
worse yet, lengthy investigations with a failure to act. It 
would be really unacceptable consequences for the market as 
well as individual investors, and if we start in good faith 
today and act quickly, I can suggest to you that the 
congressional process will require a very long and tortuous 
path before we all wind up in the Rose Garden and exchange good 
wishes. So moving quickly at this juncture is not ill-advised. 
I think it is highly appropriate, especially in light of the 
fact the SEC, FASB, the GAO, the SROs and many other outside 
observers all have strongly held opinions about the directions 
we should be taking, coming to the consensus those elements 
will be enhanced by the legislative process. And I think it 
entirely appropriate for us to proceed.
    I am particularly pleased with the panel of witnesses we 
have here today, to get their insights on the remedies 
appropriate in light of the consequences we face and to quickly 
implement not only their recommendations, but the 10-point plan 
outlined by the President, which I think was responsive to our 
current difficulty.
    In fact, there are too many employees today watching every 
morning the fund balance in their 401Ks erode. Where retirement 
plans were certain, now we are thinking about second careers. 
The consequences of this are enormous not just for the 
individual employee, but for capital formation itself. The 
enhanced volatility in market performance is directly related 
to the fear that there is an undisclosed liability or 
inappropriate revenue stream that is not creating a correct and 
accurate picture of true financial condition. We all agree, 
disclosure, transparency and consequences for those who fail to 
comply by the rules. I think how we construct those rules are 
the difficult aspect, but as to the principles underlying the 
resolution of this terrible difficulty, I think we are in 
agreement, and we should move forward.
    Thank you, Mr. Chairman.
    Chairman Ferguson. The Chair recognizes the gentleman from 
North Carolina, Mr. Watt, for an opening statement, 5 minutes.
    Mr. Watt. Thank you, Mr. Chairman. I hope I don't take 5 
minutes, but sometimes we don't know how long these things will 
take.
    I, during the consideration of the Gramm-Leech-Bliley bill, 
was accused of being one of the few Members of the Committee 
who actually read the bill, and I have to confess that I have 
made the same mistake again, this time over the break. I have 
actually been reading these bills, and I want to start by 
saying something complimentary about the Chairman's bill. It 
clearly moves in the right direction. It would be a substantial 
improvement over nothing, and I think we should keep that in 
mind, but I hope that this hearing today and the markup itself, 
if we are going immediately to a markup, will result in a 
deliberation about improvements or revisions that can be made 
to the bill to make it stronger.
    I think there are a number of instances in which I would 
prefer to have stronger language, stronger provisions in a 
number of respects. The Chairman's bill punts just a whole 
panoply of issues to the Securities and Exchange Commission or 
other bodies. Maybe some of that is necessary and desirable to 
get more information and input over time, but I think there are 
some basic principles that the legislative process has already 
agreed upon or should agree upon to put into the bill before we 
punt the rest of it to the SEC for further study.
    The way to get there can be one of two ways. We can either 
do it by discussions off the record outside the context of a 
markup, or we can have a very, very protracted markup. Because, 
as many of you remember in the Gramm-Leech-Bliley process, 
there will be a number of amendments to be debated and 
considered. If we don't have the opportunity to put those 
amendments into the process, have some discussion about them 
before we get to the markup, then I think this markup is going 
to be a lot longer than perhaps is being contemplated at this 
point.
    So one of the things I particularly feel strongly about is 
that there is a very important role for private litigants to 
enforce rights in this context. We can't give responsibility 
solely to the SEC and say you have got absolute authority to do 
this, and if you don't do it, then nobody is going to have the 
authority to do it. Our whole accountability system in this 
country is based on the rights of individuals to hold 
corporations and other individuals accountable when they feel 
like they have been wronged. So, at a minimum, we need to put 
some of those provisions in the bill to provide for private 
litigants to protect their own rights, and that I think is a 
hallmark of the way our system should work.
    I appreciate the gentleman bearing with me, and I will 
yield back the balance.
    Chairman Ferguson. The gentleman has, in fact, used the 
balance of his time.
    The Chair recognizes the gentlelady from Illinois, Ms. 
Schakowsky, for an opening statement for 5 minutes.
    Ms. Schakowsky. Thank you.
    I want to thank the Chairman and particularly Ranking 
Member LaFalce for his leadership in assembling these witnesses 
here today that I think will make a very important contribution 
to the ultimate legislation, and I want to associate myself 
with the concern expressed by my colleague from Illinois for 
the Andersen employees who have, through no fault of their own, 
lost their jobs. For this reason, as well as many others, it is 
important that we do act in order to prevent those kinds of 
layoffs and to protect investors and pension holders from 
conflicts of interest and from corporate greed.
    We all know that, if not for Enron's collapse, we would 
almost certainly not be considering these important matters 
today. I am concerned that some want to characterize the Enron 
collapse as just a case of one bad actor in the marketplace. I 
disagree with that interpretation, as I think do most people on 
this Committee, and that is why we are considering legislation. 
Because Enron's collapse does have systemic causes. Corporate 
boards of directors, Wall Street analysts and the Big Five 
accounting firms all have an economic incentive to provide 
biased analysis of large profitable companies.
    Enron used its political ties to persuade the Government to 
carry out its business plan. Just take a look at California. 
President Bush, his regulators and congressional Republicans 
who opposed price caps for consumers, while Enron manipulated 
the market, causing the energy crisis. Enron had incredible 
access to the White House. President Bush received over 
$736,000 throughout his career as an elected official. Vice 
President Cheney had at least six meetings with Enron officials 
while drafting the Administration's national energy plan. 
Enron's economic and political power effectively muted people 
who were skeptical of the company's economic stability. Enron 
is not an isolated case, and this is not only a business 
scandal, but I am afraid it is also a political scandal.
    The fact of the matter is we do not have the laws and 
procedures in place to protect common investors. If we don't 
take swift action, I have little doubt that corporate 
executives' greed and deception will victimize more people.
    Simply relying on free market dogma will not suffice. 
Employees and pension managers must be involved in corporate 
decisionmaking. Boards that are dominated by corporate 
executives are inherently flawed.
    Enron's collapse had a significant impact on working 
families. In the case of Enron, hard-working people lost their 
life savings, while Enron's executives gained millions. It is 
estimated that Illinois' State pension fund lost $25 million. 
That means that hard-working teachers, police officers and 
firefighters who worked for the public good may not be able to 
enjoy their hard-earned retirement, and that I don't think is 
what public servants deserve for their future.
    Of course, I agree that we must proceed in a careful and 
deliberate manner, but we must proceed. That is why I am a 
proud cosponsor of the Comprehensive Investor Protection Act, 
and I look forward to making sure that, as we move to the 
markup, that critical provision of that bill will be included 
in any measure that passes out of this Committee. This 
legislation will help protect investors and workers in the 
future.
    I thank Congressman LaFalce for his efforts on this 
legislation. We have the responsibility to enact significant 
reforms. I look forward to hearing the witnesses' testimony 
today, and I yield back. Thank you.
    Chairman Ferguson. The time of the gentlelady is expired.
    The gentleman from Texas, Mr. Hinojosa, for 5 minutes for 
an opening statement.
    Mr. Hinojosa. Thank you, Mr. Chairman.
    I want to say that I come from Texas. I have travelled 
throughout my district, and that is the first thing that our 
constituents want to know, just what are the members of the 
financial services going to do with regard to the losses that 
they have experienced, and I am looking forward to listening to 
the witnesses today so that, as we go through the markup, that 
we can make intelligent decisions and come up with a national 
policy that is going to protect not only the investors, but 
protect employees of Andersen and companies like Andersen who 
have lost their jobs as a result of somebody at the top who 
made decisions that obviously were incorrect and very damaging.
    I look forward to listening to the facts that the witnesses 
are going to present, because I am very interested in both of 
the bills presented by Chairman Oxley and our Ranking Member 
that I think is much more comprehensive and one that is, in my 
opinion, going to be necessary to consider and give every 
opportunity to pass through this Committee so that it can go 
down to the whole Congress. Mr. LaFalce, I commend you for the 
comprehensiveness of the bill that you have given us to 
consider, and I yield back the balance of my time.
    Chairman Ferguson. The gentleman yields back.
    The gentleman from New York, Mr. Israel, for 5 minutes for 
an opening statement.
    Mr. Israel. Thank you, Mr. Chairman.
    I also spent a considerable amount of time in the last 2-
and-a-half weeks travelling throughout my district and hearing 
from constituents who routinely asked what we are going to do 
to ensure the integrity of investments; and I want to commend 
the Ranking Member, Mr. LaFalce, for the work that he has done 
on his bill. I also commend our Chairman for his work.
    Ultimately, it is my hope to support legislation that has a 
number of features: number one, that provides the strongest 
oversight protections; number two, that facilitates 
transparency; number three, that ensures accountability; and, 
finally, that ensures an even standard among investors and 
management.
    I look forward to working with my colleagues on the 
Committee to these ends, and I yield back the balance of my 
time.
    Chairman Ferguson. The gentleman yields back.
    The Chair sees no other Members seeking time for an opening 
statement.
    The Committee will now hear testimony from our panel of 
witnesses. We thank the witnesses for their patience and for 
their presence here today. They are, from the Chair's left to 
right, the Honorable David Walker, Comptroller General of the 
United States, U.S. General Accounting Office; the Honorable 
Richard Breeden, former Chairman of the SEC, now with Richard 
C. Breeden and Co.; Professor Donald Langevoort from the 
Georgetown University Law Center; and Mr. Damon Silvers, 
Associate General Counsel of the AFL-CIO.
    Mr. Walker, you are invited to give your testimony. You 
have 5 minutes. Thank you for being here.

 STATEMENT OF HON. DAVID M. WALKER, COMPTROLLER GENERAL OF THE 
         UNITED STATES, U.S. GENERAL ACCOUNTING OFFICE

    Mr. Walker. Thank you, Mr. Chairman, Members of the 
Committee.
    With your permission, I would like the entire statement to 
be entered into the record.
    Chairman Ferguson. Without objection, so ordered.
    Mr. Walker. Thank you. I will now summarize that statement.
    I appreciate the opportunity to share our perspectives on a 
range of issues emanating from the sudden and largely 
unexpected bankruptcy of Enron Corporation and financial-
related activities relating to several other large 
corporations.
    As the Committee knows, GAO has conducted an extensive 
amount of work dealing with the accounting profession and has 
issued a number of reports over several years. More recently, 
in order to assist the Congress in framing needed reforms, on 
February 25th, 2002, we convened a forum on corporate 
governance, transparency and accountability to discuss a 
variety of systemic issues. On March 5, 2002, we issued 
highlights of the forum meeting which, Mr. Chairman, we will 
make available for the record if you so desire.
    As you requested, my comments today will primarily focus on 
oversight of the accounting profession and related auditor 
independence and corporate governance issues raised by Enron's 
failure.
    The issues raised by Enron's failure are multi-facetted, 
involving many different problems and players with various 
roles and responsibilities. In that respect, needed changes to 
the Government's role should vary depending upon the specific 
nature and magnitude of the problem. Specifically, the 
Government's role can range from direct intervention to 
encouraging certain non-governmental and private sector 
entities to take certain steps designed to enhance trust and 
better protect the public interest.
    With regard to the possibility of a new oversight body, the 
issues of fragmentation, ineffective communication and 
limitations on disciplines surrounding the accounting 
profession's self-regulatory system strongly suggests that the 
current self-regulatory system is not adequate in effectively 
protecting the public's interest, particularly in the auditing 
area. We believe these are structural weaknesses that require 
congressional action. Specifically, we believe that the 
Congress should create an independent statutory Federal 
Government body to oversee financial audits of public 
companies.
    The functions of the new independent body should include:
    Establishing professional standards dealing with auditing 
standards, including standards for attestation and review 
engagements, independence standards, and quality control 
standards, for both public accounting firms and key members of 
those firms who audit public companies.
    Second, inspecting public accounting firms for compliance 
with applicable professional records and standards;
    And investigating and disciplining public accounting firms 
and/or individual auditors of public accounting firms who do 
not comply with applicable professional standards.
    This new body should be independent from, but should 
closely coordinate with the SEC in connection with matters of 
mutual interest.
    There are alternative models which we would be more than 
happy to discuss if you so desire.
    In addition, we believe that the issues concerning 
accounting standard-setting can be addressed by the SEC working 
more closely with the FASB, rather than putting that function 
under the new body.
    The new body should be created by statute as an independent 
Federal Government body. The new body should have resources of 
funding independent from the accounting profession. For 
accountability, we believe the new body should report annually 
to the Congress and the public on the full range of its 
activities, including setting professional standards, 
inspections of public accounting firms and related disciplinary 
activities. The Congress may wish to have GAO review and report 
on the performance of the new body after the first year of its 
operations and periodically thereafter.
    We believe that the effectiveness of boards of directors 
and committees including their working relationship with 
management of public companies can be enhanced by the SEC 
working with the stock exchanges to enhance certain other 
listing requirements for public companies.
    We also believe that the issues surrounding the financial 
reporting model can effectively be addressed by the SEC in 
conjunction with the FASB without statutorily changing the 
standard-setting process. However, we do believe that more 
active and ongoing interaction between the SEC and the FASB is 
needed in order to facilitate a mutual understanding of 
priorities for standard setting, realistic goals for achieving 
expectations and timely actions when expectations are not met.
    Over the last decade, securities markets have experienced 
unprecedented growth and change. At the same time, the SEC has 
been faced with an ever-increasing workload and ongoing human 
capital challenges, most notably high staff turnover and 
numerous staff vacancies. We believe it is important for the 
SEC to be provided with the necessary resources to effectively 
discharge its current and any increased responsibilities that 
the Congress may wish to give it.
    Finally, we believe the SEC should be directed to report 
annually to the Congress on certain matters that I outline in 
my testimony.
    In closing, Mr. Chairman and Members of the Committee, the 
United States has the largest and most respected capital 
markets in the world. Our capital markets have long enjoyed a 
reputation of integrity that promotes investor confidence. 
However, this long-standing reputation is now being challenged 
by certain parties.
    Today, I have discussed our suggestions to assist the 
Congress in crafting needed reforms. We strongly believe that 
an independent Federal Government body created by statute to 
regulate audits of public companies is needed in order to 
better protect the public's interest. However, currently we do 
not believe that it is necessary or appropriate for the 
Government to assume direct responsibility for other key areas, 
such as generally accepted accounting principles or corporate 
governance requirements. We do, however, believe that Congress 
should provide the SEC with direction to address certain 
related issues.
    In the end, no matter what system exists, bad actors will 
do bad things with bad results. We must, however, strive to 
take steps to minimize the number of such situations and to 
hold any violators of the system fully accountable for their 
actions. Thank you, Mr. Chairman.
    [The prepared statement of Hon. David M. Walker can be 
found on page 422 in the appendix.]
    Chairman Ferguson. Thank you, Mr. Walker.
    I would ask the witnesses to do your best to stay within 
the 5-minute time constraint, something that we all up here 
have enough difficulty doing on our own. Thanks very much.
    Mr. Breeden, 5 minutes.

    STATEMENT OF HON. RICHARD C. BREEDEN, FORMER CHAIRMAN, 
  SECURITIES AND EXCHANGE COMMISSION, RICHARD C. BREEDEN & CO.

    Mr. Breeden. Thank you, Mr. Chairman, Ranking Member 
LaFalce, Members of the Committee. It is a great pleasure to 
have the opportunity to testify before you today at your 
request to discuss the provisions of H.R. 3763 and H.R. 3818, 
as well as to address various issues raised by the Committee 
arising out of the tragic and disturbing events at Enron.
    I had the great privilege of serving as Chairman of the 
Securities and Exchange Commission back when dinosaurs roamed 
the earth. It was an era in which we were successful in passing 
several major pieces of legislation, both when I was in the 
White House, the savings and loan reform legislation and the 
Market Reform Act and Securities Enforcement Remedies 
Enhancement Act of 1990. And both in our legislation and the 
work of the Commission in that era, I had the great pleasure of 
working with both sides of the aisle in Congress.
    It has been a great tradition in the area of financial 
services regulation and particularly in the areas governed by 
the SEC of bipartisanship, and it is a good thing to see you 
working together to try and address these problems. It is 
important that that tradition of bipartisan cooperation remain 
the prevailing spirit in this area.
    At the outset, I would like to congratulate all the Members 
and the staff of the Committee for the fine work you have done 
in developing legislative proposals to respond to the 
weaknesses in our current system that this situation has 
brought to light. Both bills contain many sensible provisions 
that should enhance our extremely good system and make it more 
resistent to problems in the future. Both bills follow 
generally similar principles and demonstrate many areas of 
common agreement. This is particularly apparent in the 
provisions of both bills concerning a new approach to oversight 
for the accounting profession, enhancements to the quality and 
speed of disclosure and enhancing healthy practices in 
corporate governance.
    While H.R. 3818 goes beyond the provisions of H.R. 3763 in 
a number of areas, it appears clear to me that there is good 
common ground in the two bills and plenty of room to craft a 
bill that is reasoned and measured. Certainly the President has 
shown leadership in this area as well, and with Presidential 
leadership in both Houses of Congress and both parties 
considering these issues, there is plenty of room to try and 
craft a bill that would reflect a consensus approach to these 
issues.
    Of course, some have said the market has already fixed all 
of the problems of Enron, and with that I respectfully 
disagree. There is no question the market has reacted to the 
events at Enron. Boards of directors and audit committees are 
more sensitive and wary about conflicts and overstatements of 
income. Many people have learned more about SPEs than they ever 
thought they would learn in their life in recent weeks, and I 
doubt if many boards will be suspending corporate codes of 
conduct and conduct standards any time soon.
    Hopefully, auditors at other firms realize both the 
importance of sharing concerns with the audit committee, rather 
than keeping silent about major issues and alternatives, and 
investors are exacting a price from companies where they 
perceive a higher level of accounting risk and lower levels of 
transparency. These are all very healthy and welcome 
developments.
    While improvements have been made, market responses can be 
short-lived, and many memories can be too short. Unfortunately, 
companies that don't need the reforms often adopt the better 
practices, but companies that pose the greatest risk to 
investors may not change their policies at all.
    There are many issues involved in the Enron-Andersen case 
that cannot be solved entirely by market, and there is not any 
reason we should be reluctant to admit where our system has 
weaknesses we should address.
    The system for oversight and discipline of the performance 
of audit firms and their personnel is one area that would 
benefit from a legislative change. Our previous system of peer 
review and self-regulation of certain types of issues through 
the Public Oversight Board did not work. The SEC needs at least 
some additional resources to allow it to handle the volume of 
financial fraud cases it should be pursuing, as well as 
providing more frequent review of filings by high cap and 
widely held issuers.
    Legal standards today for disciplining accountants and 
their firms for audit failures are subject to more litigation 
than is desirable. Certain enhanced types of remedies such as 
stronger officer and director bars and disgorgement authority 
to recover profits on sales of stock by insiders prior to a 
bankruptcy would be desirable. Standards need to be set 
regarding consulting services by audit firms for audit clients, 
and the system for developing and interpreting accounting 
principles through the FASB needs to be improved.
    These and other modest steps can complement market 
disciplines and help restore balance and confidence to our 
system. None of these steps need involve excessive regulation 
or interference with healthy market developments.
    In drafting the specific bill, we should not stake all on 
trying to do too much, and we should not allow ourselves to do 
too little. We have to make sure, for starters, that existing 
law is vigorously enforced, because much of the Enron-Andersen 
case involves violations of existing laws. Beyond that, you 
have identified a number of reasoned and careful steps that 
will enhance the qualities of the existing system.
    My written testimony responds to a number of questions from 
the Committee, and I would be happy to discuss any of those 
questions further, and I would only like to very, very briefly 
summarize my views on the establishment of a new oversight body 
for the accounting profession.
    Both bills contain provisions concerning establishment of a 
new oversight body. In my testimony I urge you not to create a 
new governmental body, but rather to reinforce the role of the 
SEC in dealing with such issues. Whatever body is created and 
whatever its exact mission, any such group should be a private 
sector entity with oversight by the SEC. We should not repeat 
now the mistake that was made when the CFTC was created that 
set us on a course of endless competition of jurisdiction 
between Government bodies with closely paralleled missions.
    The SEC is there. It has the history, the culture and the 
tradition and the tools for dealing with these kind of 
problems; and it should be the body that then provides 
oversight to an effective self-regulatory organization, along 
the lines of the NASD or the New York Stock Exchange. There the 
organizations have strong staffs, a good record of promoting 
healthy ethics and law enforcement, while not creating 
additional Government bodies.
    Again, thank you very much for having me, and I commend the 
strong efforts of both parties to date in seeking to build 
legislation that can command broad-based support. Our 
disclosure and accounting system has stayed viable over the 
years because we have not been afraid to learn from major 
problems and to change some of the rules of the game. In my 
judgment, this case demands a reasoned and measured response, 
but a response nonetheless. Thank you.
    [The prepared statement of Hon. Richard C. Breeden can be 
found on page 454 in the appendix.]
    Chairman Ferguson. Thank you very much.
    Professor Langevoort, you are recognized for 5 minutes for 
an opening statement.

    STATEMENT OF PROFESSOR DONALD C. LANGEVOORT, GEORGETOWN 
                     UNIVERSITY LAW CENTER

    Mr. Langevoort. Thank you, Mr. Chairman, and let me try and 
be very brief.
    The last few months have brought public attention to bear 
on the seriousness of a problem--that economic forces have 
increased the temptation and techniques many companies' 
executives face to be dishonest with the investing public and 
that these temptations and techniques have translated into an 
unacceptable level of corporate fraud, mismanagement and 
concealment.
    My invitation here today is not to address all of the 
possible reforms that could come from this but, rather, touch 
on private securities litigation as one touchstone for reform; 
and I will try to be very, very brief by focusing my oral 
remarks, as opposed to my written testimony, on the two reforms 
that I consider most important and indeed whose merits to me 
are beyond doubt.
    First, restoring a system in which those who aid and abet 
securities fraud become liable to the victims. When the Supreme 
Court in 1994 eliminated aiding and abetting and private rights 
of action, it didn't do so on policy grounds or through careful 
legal reasoning. Rather, it said, as a matter of statutory 
construction, that job is for Congress, not the courts. I urge 
you today to take up the court's invitation and respond 
accordingly.
    It is very difficult to argue that somebody who provides 
substantial assistance to a securities fraud shouldn't have to 
compensate the victim. The common law has for centuries imposed 
that liability. Congress has recognized that aiding and 
abetting is a Federal crime and in 1995 gave the SEC specific 
authority to proceed in that direction. It is clearly wrongful. 
Why then wouldn't you make the aider and abetter compensate the 
victim? The answer, we are told, is fear of litigation abuse, 
that these kinds of claims can be abused.
    Now, I have to confess, I am one of those people who takes 
litigation abuse seriously. I think Congress in 1995 acted 
appropriately in addressing the issues, even if I don't agree 
with all of the specific outcomes. But litigation abuse and its 
fear is no excuse for saying that somebody who provides the 
brains, the talent, often the motivation behind a fraud should 
avoid responsibility to the victims simply because their 
appearance is not made visible to the investing public, and 
sadly that is the state of the law that we have today. Those to 
whom the fraud is not attributed and who are not identified to 
the investing public have grounds to avoid liability.
    It seems to me clear that we ought to change that rule in 
the name of common sense, without regard to debate about the 
statistics of whether the incidence of private securities 
litigation has gone up or down. It simply makes sense to impose 
liability on those people.
    Second, the other reform I want to address in my oral 
testimony is redressing the rather foolish statute of 
limitations that we have today for private securities actions. 
The Supreme Court once again gave us this rule, again as a 
matter simply that since Congress hadn't done anything about it 
since 1934, who are we to impose a different standard? The 
result is that we have in private securities litigation a rule 
that was adopted in 1934 before Rule 10b-5 existed, before 
class actions existed, before the depth of our securities 
markets and its breadth could have been imagined. It is silly 
to assume that a rule adopted then should be the rule adopted 
today simply a result of history.
    That rule that actions have to be brought within 1 year 
after notice is much too short today to develop a complex, 
well-grounded lawsuit. And, even worse, the rule that if 
somebody can hide the fraud for 3 years they get away 
completely simply as a result of their success is also 
something that makes no sense in our highly complicated, highly 
complex financial markets.
    Now, I make no claims that these two reforms or the others 
that I address in my written testimony would prevent the next 
Enron, would change things dramatically, but they are very 
important first steps, very important pieces of the puzzle that 
we ought to take as we begin to address the problem.
    Thank you.
    [The prepared statement of Prof. Donald C. Langevoort can 
be found on page 482 in the appendix.]
    Chairman Ferguson. Thank you very much.
    Mr. Silvers, 5 minutes for your testimony. Thank you for 
being here.

 STATEMENT OF DAMON A. SILVERS, ASSOCIATE GENERAL COUNSEL, AFL-
                              CIO

    Mr. Silvers. Thank you and good afternoon, Mr. Chairman, 
and Ranking Member LaFalce.
    On behalf of the AFL-CIO 65 member unions and our 13 
million working family members, I want to thank the Committee 
for the opportunity to appear here today.
    The collapse of Enron and similar events at Global 
Crossing, Waste Management and other public companies are a 
window into a set of pervasive conflicts of interest that 
defeat the purposes of corporate governance and threaten the 
retirement security of America's working families.
    This Committee has heard in prior hearings from those who 
would still have you believe what Enron used to preach in this 
town, that unregulated markets will solve all problems if they 
are just left alone. Now that may be the view from the K Street 
offices of the people who do the heavy lifting for the audit 
firms here in Washington, but it is not how things look for 
thousands of working families in Houston and Portland, Oregon, 
and Rochester, New York, and clearly in Chicago who have lost 
their jobs or their retirement savings and their health care 
because they believed what they were told by their employers, 
by their employers' accountants and the analysts that 
interpreted the accountants' numbers.
    H.R. 3813, the aptly named Comprehensive Investor 
Protection Act of 2002, is the most comprehensive legislation 
introduced in this Congress in response to the conflicts of 
interest in the capital markets and in the boardrooms of 
America's public companies.
    Let me briefly review the areas where Congress needs to act 
to protect investors, the provisions of H.R. 3818 that respond 
to that need, and the key differences between H.R. 3818 and 
H.R. 3763, which the Chairman discussed in his opening remarks.
    First, public company boards need strong, independent 
directors, so investors need complete disclosure of all the 
ties that exist between the board members, the company and 
company management. H.R. 3818 requires just that, while 3673 
has no such requirement. This higher standard of independence 
should be the relevant standard for measuring the independence 
of company auditor and compensation committees.
    Furthermore, shareholders should have access to 
management's proxy not just for shareholder proposals on a 
handful of subjects, but for director candidates, independent 
director candidates. We urge these corporate governance 
provisions be added into any reform package this Committee 
takes up.
    The second area in need of reform is the practice of public 
accounting. Here again H.R. 3818 takes the right approach to 
auditor independence by giving the SEC the authority to ban a 
wide range of consulting by auditors and requiring that the 
audit committee or the full board of directors of a company 
approve in advance the provision of consulting services by the 
company's audit firm that are still allowed by the SEC.
    In contrast, H.R. 3673 bars only certain types of 
consulting and would allow the sorts of consulting that led to 
the most egregious abuses at Enron by Arthur Andersen to 
continue.
    The next issue is auditor oversight. Former SEC Chair 
Arthur Levitt has outlined in testimony before the Senate 
Governmental Affairs Committee what we believe are the key 
characteristics of a much-needed auditor oversight body: 
members independent of the Big Five, full investigative and 
disciplinary powers, and independent funding. H.R. 3818 creates 
a public accounting regulatory board that meets these tests. 
H.R. 3763's provisions do not meet these tests.
    Then there are the Wall Street analysts. H.R. 3818 requires 
the SEC to ban analyst compensation tied to investment banking 
performance. The Majority's bill goes no further than requiring 
a study.
    All these reforms, though, are of little benefit if there 
is no enforcement. The Ranking Member's bill provides both 
adequate resources to fund pay parity for the SEC and to expand 
the Commission's oversight and enforcement activity. The 
Majority's bill has no such provision.
    Finally I want to address the ultimate accountability 
measures available to shareholders: recourse to the courts. As 
Professor Langevoort has mentioned, the restoration of 
investors' right to sue those who aid and abet securities fraud 
is a vital and important step that must be taken immediately. I 
would add, in addition to the statute of limitations issue, 
that the restoration of joint and several liability is critical 
in cases where the wrongdoers start filing for bankruptcy. 
These provisions are included in H.R. 3818 and not in the 
Majority's bill.
    In conclusion, H.R. 3818 gets at the heart of the problem 
of conflicts of interest, whereas H.R. 3763, the Majority's 
bill, leaves untouched the central conflicts of interest, 
conflicts of interest that brought us Enron and will no doubt 
continue to cause losses to workers' retirement savings if not 
addressed. At the heart of what happened at Enron are systemic 
problems that need systemic solutions. These solutions will no 
doubt offend powerful interests, but they will protect 
America's working families. H.R. 3818 contains within it these 
necessary solutions and has the AFL-CIO's strong support.
    The AFL-CIO is grateful for the opportunity to share our 
views with the Committee on these bills and welcomes the 
opportunity to continue to work with the Committee as you move 
forward in addressing these important issues. Thank you.
    [The prepared statement of Damon A. Silvers can be found on 
page 492 in the appendix.]
    Chairman Ferguson. Thank you very much to all of our 
witnesses. We appreciate your presence here and lending of your 
insights and expertise to some of the very important matters 
before the Committee particularly regarding this legislation.
    We are now going to be begin our question period. Each 
Member will be allotted 5 minutes to ask questions of the 
witnesses. I would like to begin the question period by 
yielding to the distinguished subcommittee Chairman of the 
Capital Market Subcommittee Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman, for that courtesy. I do 
appreciate it very much.
    Mr. Walker, I noted in your written testimony reference to 
the fact that the audit clients should have clearly an 
understanding that he has a primary responsibility to the 
shareholders. I recall having read in the earlier report also 
another line which indicated it should be made statutorily 
clear that the financial statement is the property of the 
shareholder.
    In testimony before this Committee Mr. Berardino, the 
former CEO of Andersen, in response to a question from me 
indicated that the financial statement was the property of 
management and the shareholder, which I thought flew in the 
face of Accounting 101 in that the audit committee's engagement 
of the audit team is to prepare an accurate and true picture of 
the financial condition for the shareholder. Although the 
financial data must be arrived at in consultation with 
management to understand the true operations of the business 
plan, management should not be involved in the alteration, 
manipulation or intimidation of the preparation of the numbers 
as the audit team sees them in light of this responsibility. Is 
that an accurate reflection of your understanding?
    Mr. Walker. My understanding, Mr. Baker, is that first the 
board of directors work for the shareholders. Second, under the 
current literature, management is responsible for the financial 
statements, but the financial statements are for shareholders 
and other stakeholders.
    I personally believe that one of the real keys that has to 
be focused on here is determining who is the client and who are 
the parties that are representing the client. I would assert 
that when you are talking about an audit, when you are talking 
about related financial reporting associated with that audit, 
that the client should be the shareholders and other 
stakeholders who are relying upon that information. But their 
representatives should be the audit committee, which would be 
an independent body that is part of the board which should be 
responsible for hiring the auditors. The audit committee should 
assume additional responsibility above and beyond what it has 
right now in order to ensure that there is a convergence of 
interests between the board, which is supposed to be working 
for the shareholders, and the independent auditors, who should 
be working for the shareholders, but in addition to that, 
should serve a broader public interest.
    Mr. Baker. If I may, let me take that as a long yes, 
because I have a follow-up. There is inherently a conflict 
between the management's interest to enhance stock performance, 
thereby enhancing their own remuneration, perhaps at the 
expense of the shareholder in unfortunate cases. To 
disincentivize that type of manipulative conduct in relation to 
the preparation of the statement, would it be advisable for us 
to consider making the CEO personally responsible and liable 
for the accurate preparation of the financial statement? I know 
there is clearly a responsibility, but do we need to make that 
more clear?
    I will jump to the next one while you are rolling that one 
around because I would like Mr. Breeden to comment as well.
    To go perhaps further, it has been represented that there 
are cases in which management, through collusive efforts of 
many, have enhanced appearances of the corporation to increase 
the value of stock, exercise no cost options granted as a part 
of their employment arrangement, and then subsequently have a 
restatement of earnings so that the shareholder takes the net 
effect of loss, and the executive remains enriched through that 
manipulative process. For example, in that case, should we 
authorize the SEC to make inquiries into matters of that sort 
and be given the rules and authority to take appropriate action 
including disgorgement, so if there is a downturn as a result 
of manipulative bookkeeping, that there are consequences for 
the corporate executive?
    I make these comments in light of Chairman Greenspan's 
remarks and others' who have encouraged us to find ways to 
disincentivize short-term earnings pressures and long-term 
corporate asset growth. Would either of you comment, please?
    Mr. Walker. There are several things in my testimony where 
I talk about things that I think the SEC should be required to 
look into in order to provide better checks and balances, and 
to better protect not only the shareholders' interests or the 
public's interests. They include the composition of the board, 
the composition of the key committees on the board, and 
providing additional transparency and checks and balances, 
again the kind of actions you are talking about.
    Right now management does have a responsibility to sign a 
management representation letter in conjunction with an audit, 
and they are supposed to make certain assertions that to the 
best of their knowledge and belief, that certain things are 
true and correct. I think that could be an area that you may 
want to have whichever body that you decide should be 
responsible for the auditing area for better protecting the 
public interest to take a look at that and determine whether or 
not additional steps should be necessary.
    Mr. Breeden. Congressman, it is nice to see you. I would 
only add, number one, on your question of the financials 
themselves, financial statements have to be prepared by 
management. The starting point is--the only correction to what 
you said, the auditors are not engaged to prepare the 
financials. That is management's duty and responsibility. The 
auditors are there then to check those financials and test 
them, and that check-and-balance system is at the heart of how 
we go about preparing financial reports.
    I think absolutely CEOs should be responsible for what is 
in the financial statements. I think they are legally today 
already. The system today, however, provides also full 
indemnification from the company as well as insurance if they 
have any liabilities. So you have liabilities.
    Mr. Baker. With your due diligence, I know time has 
expired, I just want to emphasize that one point in the event 
there is an allegation against the corporate CEO for 
misrepresentation of material elements of the preparation of 
the financials, the corporate attorney defends the CEO, where 
the shareholder has to fund the personal litigation expense out 
of their pocket. My point is should there be a down side where 
it is defined after appropriate inquiry that the manipulation 
that did, in fact, occur, there was a loss incurred, should not 
the CEO then out of his own pocket have some liability which 
does not now today exist?
    Mr. Breeden. I think your point of there being a down side 
is important. I think the President's messages have emphasized 
that. Chairman Pitt's remarks have emphasized that. My own 
testimony suggests that we do need to do more in the 
disgorgement area.
    I am particularly worried about the situation where an 
executive may be selling, in Gary Winnick's case in Global 
Crossing, $750 million worth of stock on the eve of bankruptcy 
and whether or not you should trigger it by a restatement. I 
think Congress should consider whether stock sales within a 
certain period of time of the company going into bankruptcy, 
whether the profits from those sales by senior officers 
shouldn't be recaptured into the bankruptcy estate.
    Mr. Baker. I have much more, but I am way out of time. 
Thank you very much.
    Mr. Cantor. [Presiding.] The Chair now recognizes Ranking 
Member LaFalce.
    Mr. LaFalce. Thank you very much.
    Today, I introduced a bill to give legislative teeth to a 
number of the recommendations that President Bush called for: 
Number one, with respect to disgorgement of bonuses and other 
incentive compensation for either false or misleading 
statements or other misconduct; number two, requiring the CEO 
and CFO to personally vouch for and certify to the veracity, 
fairness of their company's public disclosures, including their 
financial statements and certification that certain internal 
control procedures are in place; and third, enhancing the 
ability of the SEC to bring an enforcement case prohibiting a 
person from acting as an officer or director of a public 
company by lowering the standard. Right now the standard is 
substantial unfitness. We would simply eliminate the word 
``substantial.''
    It may be unfair to ask you to comment on a bill that you 
have not been asked to testify on at this juncture, but it 
would be fair, I think, to ask you to submit a letter to the 
Committee giving your views on that bill once you have had time 
to consider it, hopefully before markup on Thursday.
    OK. Now to go on.
    Mr. Walker, you have indicated, I believe, correct me if I 
am wrong, that a new oversight body for the auditing profession 
is necessary; that it should have the authority to establish 
professional standards for the auditors of public companies; 
that this new regulatory organization should be able to set 
independence standards; that the new regulator should be able 
to charge annual fees to public companies as a means of 
financing itself. Is that basically correct?
    Mr. Walker. That is true. Our recommendation----
    Mr. LaFalce. You find those provisions in H.R. 3818, I 
would assume, and not in the other bill.
    Mr. Walker. I would find----
    Mr. LaFalce. Wherever they are found, would you favor them?
    Mr. Walker. Some of the provisions are in H.R. 3818.
    Mr. LaFalce. Why do you think they are important?
    Mr. Walker. My personal view is that we should not have 
direct Government intervention unless we believe that it is 
called for. If there are other bodies which Government could 
encourage to take the right steps, we should first try to do 
that. If they fail to act, direct Government intervention 
should be considered.
    I think the area where direct Government intervention is 
necessary is in the auditing area. I do not believe that you 
are going to achieve the objective of best protecting the 
public's interests without more direct Government involvement 
dealing with the independence setting for auditors of public 
companies, the quality assurance procedures associated with 
those auditors, the disciplinary process associated with those 
firms and the individual members, and certain other matters 
laid out in our testimony.
    Mr. LaFalce. I appreciate that. Both Mr. Oxley and I 
believe that we do need a new auditing body. The question is 
what power should it have. It certainly should have at least 
those powers and maybe more. It is something that Mr. Breeden 
suggested, subject to compromise, we can talk about. But 
another question is who should be on that board? And that is a 
very important question. And I have said that the SEC should 
appoint them, but from lists that were submitted from certain 
type of organizations such as pension plans of private 
employees, pension plans of public employees, and so forth. 
Otherwise you might have a situation where you have Mr. Pitt 
appointing a board that Mr. Boucher would look at and say, this 
is so bad I am resigning, which is exactly what happened.
    So do you have any thoughts as to the type of individual 
that should be on that board? Do we leave it totally to the 
discretion of the SEC, or do we put some language in the 
legislation which tries to make sure that the individuals on 
that board will be interested first and foremost and 
exclusively in the protection of investors?
    Mr. Walker. My personal view is there should be some 
standards for the individuals who would be appointed to the 
board. I would note in your bill, Mr. LaFalce, there is one 
provision in there that I think may raise a constitutionality 
issue, and that is----
    Mr. LaFalce. I will take that one out, whatever it is.
    Mr. Walker. It is the one that talks about the Comptroller 
General being part of the appointment process. The Comptroller 
General can make recommendations.
    Mr. LaFalce. You don't want it, you don't get it. You are 
out.
    Mr. Breeden, you described two concerns with the non-audit 
services that auditors currently provide to audit clients, one 
specific service that creates conflicts for the auditor, and, 
two, the volume of non-audit fees in relation to audit fees. 
Does either bill address it adequately, more adequately? Are 
both inadequate? Do you have a preferred approach other than 
the approach in either of the two bills?
    Mr. Breeden. Congressman, I think both bills have made a 
very good start looking at what is--I tried to--in my usual 
excessively wordy way, I tried to in my testimony show that 
there are some real complexities in that issue. It is hard to 
just say no consulting at all, because things like tax services 
are not pure audit, but would rob the audit of its vitality if 
you took them away.
    Mr. LaFalce. Which I specifically say should not be done.
    Mr. Breeden. Neither bill takes the tax services away, 
although some of the proposals in the marketplace have done 
that. I think they would do significant damage if you went that 
far.
    Consulting on internal controls is something I used to do 
in the 3 years I spent at Coopers & Lybrand, and I think that 
it contributes to the quality of audits. So I think that we 
need to identify any cases where the auditors are, in essence, 
auditing themselves. If they have built a data system that is 
the system used for financial reporting, if they are doing 
something in the consulting side that their own auditors are 
supposed to go and audit, it is unreasonable to expect that 
they will give the same level of diligence that they would if 
an independent person had done that. The magnitude of all the 
whole shebang is too much; then you also have distortion.
    Mr. Cantor. The gentleman's time has expired.
    Mr. Walker. Real quickly, Mr. Chairman, can I?
    In my testimony we recommend that the Committee consider a 
principles-and-safeguards-based approach that we have already 
promulgated for Federal entities and entities that receive 
Federal funds. As you know, Mr. LaFalce, the GAO actually 
promulgates auditing standards for Federal entities and 
entities that receive Federal funds. We believe that that 
guidance would be helpful in considering what should be done 
with regard to public companies. Thank you.
    Mr. Cantor. The Chair thanks the gentleman.
    At this time the Chair would like to address for a moment 
Mr. Breeden. I take it you are familiar with Chairman 
Greenspan's remarks when he addressed this Committee several 
months ago. While he was here, he expressed a concern that 
Congress could go too far in overregulating the capital markets 
in response to the issues at hand. Can you comment on that? 
What do you make of those concerns?
    Mr. Breeden. Well, I think any time you have a scandal of 
this kind that has touched so many people and caused such 
widespread losses, and between the losses to investors in Enron 
and the losses to Andersen employees and so on, there is an 
enormous amount of damage here. And so I think Chairman 
Greenspan was--as many others have done--noting a concern that 
Congress be careful in responding to events that naturally 
cause outrage on the part of good people everywhere, that we 
not go too far in fashioning a legislative response, and I 
agree with that sentiment.
    At the same time I also believe that there are some areas 
that have been exposed in this overall situation that would 
benefit from legislative changes, that we not do too much, but 
we not do too little. I think actually that Mr. Oxley's 
legislation together with Mr. LaFalce's legislation, both bills 
here attempt to--and one goes further than the other, but maybe 
something in between is an area where people can coalesce 
around. It is important not to go too far, but I think there 
are some areas where real change needs to be made.
    Mr. Cantor. Mr. Walker, can you respond to those concerns?
    Mr. Walker. Yes. As I said in my statement, you should only 
have direct Government intervention where you believe that the 
problem cannot be effectively addressed by other parties. In 
that regard, we believe the greatest need is in the auditing 
area, and what we are recommending is that there be a 
qualified, independent and adequately resourced body to be able 
to assume those responsibilities rather than the Congress 
trying to get into the details, trying to make those decisions 
through legislation. I think that is critical in order to make 
sure that you don't over react, that you have a balancing of 
interests.
    As you know, Chairman Greenspan has also said that he 
believes that additional action is necessary in certain areas 
such as in the auditing area and has expressed some concerns 
about current accounting and reporting with regard to certain 
types of compensation arrangements.
    Mr. Cantor. Thank you.
    If I could turn to Mr. Silvers for a moment. In 2000, 
former SEC Chair Levitt proposed auditor independence rules 
targeting 10 consulting services for prohibition, the final SEC 
rule prohibiting seven of these services. Another was dropped 
because it was deemed unworkable. The Oxley bill bans the other 
two. The LaFalce bill bans all 10. Again, seven are already 
prohibited under the current rules. Isn't this provision 
redundant?
    Mr. Silvers. I am sorry, sir, which provision do you think 
is redundant?
    Mr. Cantor. The Oxley bill bans the other 2, but the 
LaFalce comes in and bans all 10, while 7 are already 
prohibited by the rules as they exist now.
    Mr. Silvers. My understanding from reading the bills, Mr. 
Chairman, is that Mr. LaFalce's bill provides the Commission 
with the authority to take a look at a practice such as that 
which occurred at Enron where Arthur Andersen participated in 
structuring SPEs and then came back, and partly did so, I 
believe, under the rubric of tax consulting. Certainly they 
could have done so under the rubric of tax consulting. They 
structured the SPEs and came back and audited the SPEs and 
generated a $5 million fee for doing so.
    The challenge of this problem of conflict of interest is 
that the Commission needs to have the authority to draw these 
fine lines, and the Chairman's bill simply does not give the 
Commission the clear authority and direction to do that. Mr. 
LaFalce's bill does that. The difference, frankly, is that 
under the Chairman's bill, if a firm was to feel that it made 
sense for them economically to go and do what Arthur Andersen 
did at Enron, there really would be no reason per se under the 
Chairman's bill that they couldn't do that, whereas Mr. 
LaFalce's bill clearly directs the Commission to promulgate 
rules under that conduct. I don't believe that distinction is 
by any means redundant, as you would suggest.
    Mr. Cantor. Mr. Breeden, if I could turn to you in an 
attempt to elicit a response about the potential redundancy in 
one of the bills that attempts to address the rules that are 
already in place.
    Mr. Breeden. Mr. Chairman, I have not looked in detail at 
the language of the Commission's current rules compared to the 
bill to see whether they are completely overlapping or whether 
there are gaps there. I could do so afterwards and send you a 
letter about it, but I really haven't done so, and so I can't 
tell you whether they are fully redundant or not.
    Mr. Cantor. It would be appreciated. Thank you.
    Mr. LaFalce. Would the gentleman like me to give an answer? 
Number one, they are not fully redundant at all because there 
were carve-outs within the rule. Number two, if the worst sin 
in redundancy is that codification into law of regulations, I 
will accept that sin.
    Mr. Cantor. The Chair thanks the gentleman.
    The Chair now recognizes Mr. Kanjorski.
    Mr. Kanjorski. All of the testimony in the pending bills 
makes certain presumptions that, one, we know the full extent 
of the Enron disaster, and also obviously in regard to its 
accounting firm, Arthur Andersen, with its $25 million in 
auditing fees and $27 million in consulting fees. I would like 
to know whether these were overcharges, whether the work 
performed was unethical or improper, and if it was, to what 
extent. Are any of you aware of any studies that have analyzed 
what work was done, how competent the work was, and whether or 
not, in fact, any of it was improperly done?
    Mr. Walker. I am not aware of a study. I am also aware of 
the fact that Arthur Andersen at least was performing certain 
internal audit services that would be banned under both of 
these bills, which I think is noteworthy.
    Mr. Breeden. Congressman, I am not aware of any studies, 
but $52 million in fees combined for auditing and consulting is 
an enormous fee. That would put--Enron's payments to Andersen 
clearly would have had to have been among the top of not only 
Andersen's clients, but any accounting firm's clients.
    Mr. Silvers. Mr. Kanjorski, I would make two points in 
response to your question. One is the conflict that was alluded 
to in response to the Chairman's questions is discussed on page 
5 of the Powers Report and gone into in some detail later on in 
the report in terms of the specific conflicts that were at work 
here. I would add that prior to the appearance of the Powers 
Report, that both Andersen and Enron made some efforts to 
conceal from Congress in several different committees, 
including this one, the extent of those conflicts, but the 
Powers Report itself documents them quite adequately.
    I could also say that although that fee is very large, it 
is very interesting that the multiple of the consulting fee in 
relationship to the audit fee at Enron was not even close to 
the high end. There have been several surveys of the ratios 
that the SEC's recent disclosure rules have divulged to us of 
these ratios in other major public companies which I would be 
happy to provide to the Committee. I would know one sticks in 
my mind, which is Motorola, which had a board overlap with 
Enron until very recently. Motorola was 16-to-1, the ratio of 
consulting fees to audit fees.
    Mr. Kanjorski. The consulting fees were 16 times more than 
the audit?
    Mr. Silvers. Precisely.
    Mr. Kanjorski. So maybe Andersen undercharged?
    Mr. Silvers. Perhaps you could raise that with them.
    Mr. Kanjorski. The reason for that question is, obviously, 
that the Congress is going to act. Whenever anything happens in 
our society, we either pass a law or we form a commission. 
Obviously, we are not going to be able to form a commission to 
address this problem, so we are going to pass a law.
    I am a little worried about the unintended consequences of 
what we may be passing. I am not absolutely certain that the 
Congress has the clarity of either the Enron problem, if it 
represents an endemic problem, and just how endemic that 
problem is, or whether or not we are in a position to move this 
legislation through as quickly as we seem to be. Should we take 
more deliberative time? Do any of you see some great risk to 
our economic system if we take a couple of more months in 
resolving this problem, or do we have to do this before 
Memorial Day because it fits into the political schedule?
    Mr. Silvers. I am the only person willing to take a risk on 
this proposition. Obviously I think the people that I represent 
here would like Congress very much to take action in this 
session. I would defer to the wisdom of the Committee as to 
what precise calendar that requires. It seems to me that the 
more important question is are you going to take the right 
direction or not.
    I think, Mr. Kanjorski, your questions get at one issue in 
which I am not sure that this Committee is heading in the right 
direction. It would be better to take the time to get it right 
than to do something that won't protect America's working 
families against a future Enron.
    Mr. Kanjorski. I tend to agree, too. That question is 
structured along the idea that we have 17,000-plus public 
corporations. It would seem to me they do not all fall into 
Enron's category. Anything we do will also cause additional 
expenses for those corporations and to the Government in order 
to police the law we are enacting. I am just worried: are we 
going to do what sometimes we have done in other Congressional 
actions? We could just end up just ignoring the cost and the 
burden to struggling companies that have to get equity and have 
to get out there. They have not done anything, but they will 
have to comply with all these rules and regulations at great 
expense to the company and ultimately to the shareholders, and 
maybe actually put their long-term success in jeopardy.
    What I am thinking, is whether or not we should put a tier 
operation into effect with any bill and look at only the top 
1,000 or 5,000 corporations. But all 17,000 of these companies? 
We initially did that with all banks when we enacted CRA. To a 
large extent, it was my experience that we initially put 
unusual burdens on small community banks to go through the 
legal work and expense to comply with CRA. Before we changed 
the law, I visited banks that were spending a sixth of their 
income on legal and accounting fees to prove compliance with 
CRA--little banks that could not exist outside of their 
community. So, anything they were doing, they were complying 
with CRA.
    Yes?
    Mr. Cantor. Will Mr. Walker answer the question, then the 
gentleman's time has expired.
    Mr. Walker. I think in the final analysis it is better to 
get it right rather than do it fast, but I think there is a 
need for some expeditious attention to the critical area, 
especially in connection with the auditing area. Obviously, as 
you know, Mr. Kanjorski, this is the beginning of the 
legislative process on this side of the Hill, and the Senate 
has to act as well. There are a lot of things that have to 
happen before this will get finalized.
    We do recommend in our approach that it is important to 
have qualified, independent and adequately resourced bodies 
deal with a lot of the details. The Congress may want to ask 
for those bodies to look at certain issues and to make sure, 
for example, that in the area of independence that they 
consider a principles-and-safeguard-based approach, that they 
can look at certain services in particular as to whether or not 
they should be allowed, and if so, under what circumstances. I 
think if you take that approach where you are making sure you 
have a qualified, independent, adequately resourced body, you 
are providing that body with the power to do what needs to be 
done, you are providing it some guidance, but not getting too 
detailed with regard to how much you are prescribing 
legislatively, that might be a reasonable balance because, 
after all, markets evolve over time. What you say today may not 
be appropriate tomorrow. So some other body has to be empowered 
to deal with changes over time.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    Mr. Cantor. The Chair recognizes Mr. Rogers from Michigan.
    Mr. Rogers. Thank you, Mr. Chairman.
    I am going to take maybe a bit of a different direction. 
One of the concerns I have is in this whole episode, we have 
been--we being Congress--in a hurry to find a villain, and I am 
not sure exactly we have identified the crime yet. I was hoping 
to ask Mr. Breeden, one of the things I am concerned about is 
that we are trying to treat this with a pill rather than laser 
surgery. I am not so sure that laser surgery isn't the order of 
the day here. We have a real possibility here to cause some 
real problems for lots of folks, UAW members and you name it 
out there, families who are investing more and more in 401K 
plans all across the United States. And sometimes just 
questioning the company's accounting practices by any official 
entity can be devastating to the stock of that particular 
company. We haven't done any investor in the United States any 
good if we do that maliciously or at least without good intent.
    I want you to help me understand how we can make the 
corrective actions I think we all know we have to make here, 
certainly for transparency, without jeopardizing investor 
confidence. And those families out there who are working very 
hard every day, they send their money into their mutual funds 
knowing that that is what they are going to retire on, and they 
are counting on all of us, those here in Congress as well as 
you, auditors, regulators and those in the business community, 
to make sure that there is honesty and true brokering going on 
out there in those companies.
    Mr. Breeden. Congressman, I think both you and Congressman 
Kanjorski raise similar, in a way, concerns and good points. 
One of the best things we have been able to accomplish over the 
last couple decades is to foster a broader participation in our 
capital market, and as my colleague here from the AFL-CIO 
points out, we have working men and women through pension 
plans, we have investors through mutual funds and directly to 
the tens of millions, and that has been a wonderful 
accomplishment.
    So we have as a Nation a great deal at stake in protecting 
the confidence those people have that our markets work with 
honesty and integrity, and they can believe the numbers they 
look at and that they make investment decisions on, and that 
this is a huge system with 17,000 public companies, and in 
fixing it a couple things are apparent. Number one, we have to 
be careful that we don't go too far, we don't fall into the law 
of unintended consequences when we try to fix one problem that 
we create another one, that we don't go too broadly and don't 
create excessive costs, as the Congressman is mentioning, in 
CRA, which is a very real risk.
    We need to start with what we have, which is the world's 
finest system. It is not perfect. It has some flaws. No system 
designed by human beings and run by human beings is ever going 
to be perfect. But I genuinely believe, notwithstanding Enron, 
that the U.S. accounting and disclosure system is the best in 
the world. So let's not throw the baby out with the bath water. 
Let's start with what we have and look to see how can we build 
on that. If there are gaps here and there that we need to 
address, then let's do it.
    I think that now on the question of investor confidence, I 
don't think there is--I am not aware of a situation where 
anyone has maliciously questioned people's financials, but 
certainly the market itself should raise questions about 
companies that have very aggressive accounting practices. We 
certainly have seen that post-Enron with aggressive selling 
against Tyco and other stocks that are perceived to have some 
accounting issues. I think those market disciplines are very 
healthy. In fact, I wish we had more of them, not that people 
should do it based on rumor or fear, but that a healthy 
skepticism looking hard at what numbers companies are reporting 
and making sure that investors do their homework to worry about 
the risk that they may be undertaking.
    So this whole area is one in which it is extremely complex, 
and we have to be extremely careful that we don't get things 
out of balance. But at the same time I think it is clear that 
we can do things to speed up disclosure and make disclosure 
more comprehensive. For 40 percent of the assets of Enron to be 
hidden off the books was unacceptable. That is disclosure? That 
is a joke. It shouldn't have happened. The parties responsible 
should have known there was--whether or not it was proper 
accounting, it was lousy disclosure.
    And so we need to look starting at the Commission, but also 
here at Congress, are there things we can do to make disclosure 
faster and make it more comprehensive? Can we have better 
information about executive stock sales? That is very important 
to individual investors across the country. They know enough to 
know--they may not understand an SPE, but they know if the CEO 
is bailing out of the stock, they don't want to be investing 
themselves at the very same time the top guys are getting out. 
So speeding up those disclosures is another healthy thing.
    Making sure that auditors don't sell their integrity. We 
can't station an SEC enforcement agent at the shoulder of every 
accounting professional, but at the top trying to make sure 
that the system encourages quality auditing, and that the firms 
themselves realize how important their public trust is, and the 
strong efforts they themselves need to make to do a good job.
    So there are a lot of things where I think we can make some 
improvements that are consistent with our traditions and 
consistent with our systems and make it a little better.
    Mr. Cantor. The Chair thanks the gentleman.
    The Chair recognizes Mrs. Maloney.
    Mrs. Maloney. I thank the Chairman and the Ranking Member 
and all of the panelists.
    I am sure all of you are aware that today Andersen 
announced they are laying off 7,000 of their employees and that 
this represents a quarter of their total employees. And 
furthermore, the long-term viability of the company is truly in 
question. And as I have said many times before, the 
overwhelming majority of the professionals in the industry are 
hard-working and honest and have a great respect for the title 
``certified public accountant.''
    I am concerned, quite frankly, about some of these 
employees, many of whom are my constituents. I would like to 
ask Mr. Breeden from what you know, do you think it is 
appropriate for the Justice Department to have targeted the 
whole of Andersen, or should we allow the Volcker plan to go 
forward and have it put in place and go after a limited number 
of employees known to have been involved in the Enron audit? Do 
you have feelings on this?
    Mr. Breeden. Congresswoman, thank you. The Andersen 
situation is a very sad one. It is certainly one that is 
regrettable on many different planes, and I certainly hope that 
anything possible that Paul Volcker or anyone else can do to 
stabilize the firm and allow it to survive and then worry in 
the future about rebuilding, I wish it every possible success.
    On the other hand, we used to have debates when I was in 
the White House working on financial services about whether 
banks were too big to fail, and I don't believe Arthur Andersen 
is too big to fail, and I don't believe any of the other Big 
Four are too big to fail. If they ever got that notion in their 
head that they somehow have carried their monopoly on auditing 
and the oligarchy that exists in competition in this world that 
no one could bring an action against them if they broke the 
law, then that would be a mistake. We went through Watergate to 
prove that the President of the United States is not above the 
law. I think that the general counsel and the CEO and other 
staff members of Arthur Andersen are also not above the law.
    I don't take a position on whether or not the Justice 
Department has the--we can only know when a trial takes place 
and we see what evidence the Justice Department has. But in my 
experience working with the Department of Justice in law 
enforcement over many years, they don't indict people or firms 
capriciously. They do it on the basis of a very sober and 
careful calculation of whether they have the evidence of 
wrongdoing, and it is a responsible act.
    I think some of the people worrying about the consequences 
for Andersen should be asking the question about isn't it sad 
that Andersen's management engaged in the acts that led to the 
permanent injunction in Waste Management; that Andersen's 
management tolerated massive destruction of documents on the 
eve of Government investigation; that chimpanzees could know 
that the documents at Enron were going to be subpoenaed high 
and low by every Government agency and private litigants all 
over the place, and if you destroy documents, you may be 
affecting the rights of the University of California to recover 
against Enron executives or others, and in that context 
destroying documents is wrong.
    And so it is a tough issue, because nobody likes to see 
what is happening to other people at Andersen, and yet Andersen 
finds itself where it is largely through its own actions.
    Mrs. Maloney. You mentioned earlier, Mr. Breeden, that we 
should have faster and fuller disclosure, and one area that 
really isn't disclosed now except by consent or individual 
choice is the code of ethics for the board of directors or the 
code of ethics for firms. Do you think it would be helpful that 
the code of ethics was printed in the annual report, and if the 
board of directors took the unusual step of overriding the code 
of ethics of their board, that it be reported to the SEC and 
printed in the annual report?
    As you know, in Enron, as reported in press accounts, the 
board of directors voted to overturn their own code of ethics 
to allow their CFO Mr. Fastow to head these special SPEs. So I 
was wondering when I called for fuller disclosure, would this 
be an area that you think might be helpful to the investor, to 
the general public?
    Mr. Breeden. Yes, Congresswoman, I think very much so. In 
fact, in both testimony on the Senate side and in this 
testimony, I did say I believe that any time a board acts to 
suspend the corporate code of ethics, that not only publication 
in the annual report is way too slow, they should have to file 
an 8(k), do it within 10 days anyway, but almost immediate 
disclosure should be made. I think corporate codes of ethics 
should be at least posted on their website. It might add quite 
a few pages to the annual report, but I think somewhere it 
should be noted.
    I did call for disclosure in the proxy statement or in some 
other vehicle for the board to set forth its policies on 
conflicts among senior executives. The conflicts in Enron at 
the CFO level were among the most dangerous possible things 
that a corporation could do, because the outside auditors and 
the audit committee and the full board all are looking at 
numbers provided by a CFO. So if the CFO has got a personal 
financial reason to give distorted numbers, it can defeat 
simultaneously the ability of the board, the audit committee 
and the outside auditors to check up on that. It is the one 
vital spot where--it is the hub and the spokes of the wheel. So 
any conflicts involving a CFO should be, in my judgment, 
prohibited under State law, and there should be required to be 
immediate disclosure if a company goes down that road, which 
hopefully they will not.
    Mr. Cantor. The gentlelady's time has expired.
    The Chair now recognizes Chairman Baker.
    Mr. Baker. Thank you, Mr. Chairman.
    Mr. Cantor. He was assuming the time of the Chair who was 
here before I was. So this is on his own time.
    Mr. Chairman.
    Mr. Baker. Thank you very much for clarifying. Don't want 
to misrepresent my account here.
    In the earlier round, Mr. Breeden, we talked about 
disgorgement and insider trading prohibitions, bailing out on 
stock the night before the bankruptcy filing. We talked about 
clarity in the liability for the CEO for the preparation of the 
financials. There are other elements that I think I would like 
to get your comment on. One is the subject of a cooling-off 
period where the auditor is the principal engaged as an outside 
auditor for company X; upon retirement immediately goes to work 
for that company as the chief financial officer. There are 
prohibitions which apply to Members of Congress, for example, 
in what we can do in post-congressional life. Do you look at 
that in an advisable way? Is that something we should consider?
    Mr. Breeden. Yes, sir, I believe that you should. I 
remember back in my days at the Commission, we had the then 
infamous Lincoln Savings collapse. An awful lot of people were 
hurt in that. That was another case where this CFO that was in 
place at Lincoln Savings had come over from the outside 
auditor, which means the people who audit his work the very 
next year are all the people who used to be his subordinates at 
the audit firm.
    So without knowing exactly how it should be done, I think 
cooling-off periods are healthy and is something that would 
probably make sense.
    Mr. Baker. As to structure on all of these, it is my 
thought to authorize, mandate the SEC to study and implement 
rules governing these points raised by the Congress as a policy 
matter. I think it may be difficult and take us years to get a 
plan that is enforceable and not disruptive to markets if we do 
the specifics, but at least to have a goal within 6 months, a 
year for the SEC and staff to determine the most appropriate 
manner for prohibiting whatever is an unreasonable corporate 
practice.
    Audit committee and their ability to do their work. 
Provisions for independent counsel. In other words, not having 
to rely on internal corporate officials to do the work for the 
audit committee. It's difficult if you have a CFO who is 
conflicted, but if you are really trying to do the job on the 
audit committee, and you are asking the guys who are employed 
by the corporation, isn't that equally troubling?
    Mr. Breeden. I serve on three audit committees, and I chair 
two of them. I can't imagine anybody telling us--and I don't 
think it is just me--I can't imagine anyone saying to an audit 
committee that they can't hire outside counsel. The board can 
do what it wants. The problem is that--it is a little bit of a 
chicken-and-egg situation. One of the problems in both Waste 
Management and Enron was that the auditors never said boo to 
the audit committee. They knew there were problems and didn't 
bring the audit committee into the loop. So they were, in many 
respects, oblivious or appeared to be ignorant to many of the 
issues that might have caused them to go and hire outside 
counsel, but they have to know that they need it.
    Mr. Baker. That was my point is that rather than making it 
a permissible activity to do it, is that a mandatory obligation 
to construct your audit analysis based on outside counsel?
    Mr. Breeden. I think we have enough make work acts for 
lawyers, but I wouldn't require it, but I think certainly as a 
matter of good corporate practice and maybe through listing 
standards it is something that can be encouraged. Certainly any 
audit committee has to have the right to speak to independent 
counsel and independent financial advisors if they believe they 
need the advice.
    Mr. Baker. Lastly, with regard to stock option plans, 
shouldn't that require shareholder approval?
    Mr. Breeden. I believe so.
    Mr. Baker. And there is one other piece of work may I 
compliment you on. In 1992, there was a report issued by the 
SEC, and it also supports a statement of Chairman Pitt before 
the Committee just before the Easter recess relative to the 
reporting to the SEC by the GSEs. As I recall it, your work at 
that time indicated it was advisable policy for the GSEs to 
file as all other Fortune 500 companies do in compliance with 
SEC standards. Is that still your view?
    Mr. Breeden. Congressman, I don't remember that specific 
report. I seem to remember getting the tar beat out of me by 
folks at the time over that issue. I haven't looked at it since 
then. So with respect, I will just stay out of that hornet's 
nest.
    Mr. Baker. If your bruises haven't gone away, I can assure 
you that the report contains that information, because I have 
the bruises myself.
    Mr. Breeden. One of the great things about being in the 
private sector as opposed to being in Government service is you 
can duck a few of the fastballs that you have to go ahead and 
stand at the plate when you are in Government.
    Mr. Baker. I commend you for your bravery while on duty.
    Mr. Cantor. The Chair now recognizes the gentleman from 
North Carolina, Mr. Watt.
    Mr. Watt. Thank you, Mr. Chairman.
    I want to start by applauding the testimony of Professor 
Langevoort. I may not be pronouncing his name right. His 
testimony has gone unnoticed in the question-and-answer period, 
but he should know that as far as I am concerned, it is among 
the most important testimony that has been given here today. In 
my opening statement I emphasized the importance of allowing 
individuals to hold people accountable and corporations 
accountable in addition to Government bodies, and your 
testimony seems to me to be consistent with that.
    First of all, we have to reestablish the legal standard 
that makes other parties have legal liability to anybody, and 
then we have got to give individual people who are damaged by 
those activities the right to take up their own private 
litigation and enforce those rights, and in some cases that may 
result in less Government bureaucracy. I keep having trouble 
convincing my Republican counterparts of that, but they may 
come around.
    The problem is that--and I am certainly going to try to 
pursue this in the course of this markup--the problem I have 
already identified, however, is that the rules of germaneness 
in the legislative context are probably more rigorous than the 
rules of evidence in the evidentiary context. If we start with 
the Chairman's bill, I am not sure we can craft an amendment 
that gets that on the table for discussion and debate, so I am 
not going to spend a lot of time asking you questions about it. 
But I did want you to know that what you said did not go 
unnoticed by at least one Member of this Committee.
    Mr. Langevoort. Thank you. I was actually happy not to get 
all the fastballs.
    Mr. Watt. Now I want to go to another issue that I am 
trying to resolve or reconcile, the differences between Mr. 
Walker and Mr. Breeden, and try to figure out which one of them 
I agree with more. As I understand it, Mr. Breeden--no, I am 
sorry, as I understand it, Mr. Walker thinks that we ought to 
have another Federal board of some kind in addition to FASB and 
the SEC. We ought to have some third agency. And as I 
understand Mr. Breeden's testimony, he rigorously disagrees 
with that. I would like for the two of you to try to reconcile, 
if they are reconcilable, your views on that issue. I tend, I 
think, to come down more on Mr. Breeden's side than Mr. 
Walker's side, I believe.
    It is coincidental that right across the hall here where I 
am on the Judiciary also, as you may have gathered by my legal 
bent here, we are debating whether to break up the INS into 
about five or six different parts on the theory that if you 
break it up, it will all of a sudden become more efficient even 
if you keep the same people and the same rules and regulations 
and everything. It seems to me that one approach we might be 
using is trying to make the SEC and FASB more efficient rather 
than creating another institution in the process.
    So let me hear from Mr. Walker first. Then I want to ask 
another question. I will give Mr. Breeden equal time to defend 
his position.
    Mr. Walker. Mr. Watt, right now you have one Federal 
Government entity involved, and that is the Securities and 
Exchange Commission. As you know, the FASB is not a Federal 
Government entity, it is a self-regulatory body.
    Mr. Watt. But wouldn't this bill put those kind of agencies 
kind of under the jurisdiction, supervision of the SEC?
    Mr. Walker. What we were proposing at GAO is that the SEC 
has more than enough to say grace over right now. Some can 
debate----
    Mr. Watt. One way to solve that is to add some more people.
    Mr. Walker. That is one issue. Mr. Watt, we are saying that 
the area of most acute need for intervention is in the auditing 
area. The SEC is already overtaxed as it relates to enforcing 
the securities laws and dealing with significant accounting and 
reporting issues that have to be dealt with.
    There are many people on this Committee and others in 
Congress who believe that the CFTC ought to be merged with the 
SEC. So the point is there are a lot of things that the SEC has 
to do right now.
    Our view is that you could have an independent entity 
within the SEC. You could have a body within the SEC that would 
have Presidential appointees with Senate confirmation who have 
the authority to make final decisions with regard to certain 
auditing activities, but would allow them to be able to 
coordinate as appropriate with the SEC on accounting issues and 
on securities regulation. We think that is possible to be able 
to do that, but one of the concerns that we have is that the 
auditing area is the one that we think there is the most need 
and there needs to be appropriate accountability to the 
Congress, and we don't know that you get appropriate 
accountability to the Congress unless you have the parties 
responsible and reportable to the Congress.
    Furthermore, we question whether or not the commission 
members and their staff can effectively discharge these 
additional responsibilities because they are already having 
difficulty dealing with their current responsibilities.
    Mr. Cantor. The gentleman's time is expired. Thank you.
    Mr. Breeden. Mr. Chairman, if I could have the liberty of 
responding to this, because I think it really is a pivotal 
issue.
    Mr. Cantor. Without objection.
    Mr. Breeden. Thank you very much. I, of course, have 
boundless regard for GAO and its analytic capabilities. This is 
a matter that is a matter of principle and philosophy, I 
suppose, but I could not feel more strongly about it than I--
and Mr. Watt, I appreciate your asking the question and giving 
me a chance to give you my side of things.
    For about 68 years now, the SEC has been the Federal agency 
with responsibility for overseeing the accounting profession. 
It has a long history. It has a long culture and a long 
tradition of being able to put the public interest first to 
have an effective enforcement program. I do not think there is 
any wrongdoer out there, be it corporate, individual or a 
partnership, that the SEC and its history would not tackle. It 
has built up a long history there without fear or favor of any 
person, irrespective of party, irrespective of any other 
factor, and to say that, well, that is very nice, but they are 
awfully busy doing some other things, we should put it aside 
and start all over again and build a brand new agency that has 
no history, no culture, no existing staff, nothing. We are 
going to start from the beginning and build it all up, and 10 
or 15 years from now it will have experience and culture and 
tradition, and we are going to hope at that time it is going to 
do a better job than the agency that for 68 years has done a 
great job for America's investors.
    Now the Commission is starved for resources and has been 
underfunded since 1934, and I would appreciate the efforts of 
many Members of Congress to expand its staff so that we could 
keep pace with growth in the markets, and that is an ongoing 
problem today. But I really think that there is not a need for 
another Federal agency.
    Now I agree with a great deal of what Mr. Walker has said 
in terms of the importance of integrity and independence and 
good powers, and all of those things can be in a body like the 
NASD that would be a subsidiary, private sector organization, 
out doing a lot of work, doing a lot of enforcement, bringing 
all those fine qualities to bear, but reporting up through the 
existing Government agency so we don't lose the benefit of 
nearly 70 years of public service.
    Mr. Cantor. Thank you.
    The Chair now recognizes Mr. Bentsen.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Let me thank my colleague from North Carolina, because I 
wanted to be the devil's advocate on that, but he is much more 
eloquent than I am, and I agree with his line of reasoning, and 
I think it is problematic.
    I think, Mr. Breeden, you are right on point that what we 
are talking about doing now is starting over from scratch to 
create a new agency, and I guess--that John is correct. 
Redundancy is not necessarily a sin, but what I keep coming 
back to is does not the commission already have a tremendous 
amount of authority in this area? And perhaps the commission 
should be under some attack for not necessarily exercising that 
authority, and perhaps the commission can argue that they have 
been underfunded and haven't had the resources, but it seems to 
me--I have always been under the impression that the commission 
had this authority. You yourselves stated that, in fact, 
audited financials are--in fact, the financials themselves are 
prepared by the public company as a function under the 1934 
Act, and then audited and given a blessing by the auditor, but 
in fact they are all compelled by securities law in the first 
place, and it is the commission that governs securities law. 
And so I think that your point is right or--your line--of 
reasoning is right on point.
    I furthermore think that now we are talking about in the 
GAO--and I don't think John's bill goes this way or Mike's bill 
goes this way, necessarily, but the idea of registration of 
auditing firms with this new authority. And the next question 
is, which I have asked with other panels, are we going to have 
to have qualified opinions with an audit that is given, for 
each audit that is given, that it meets certain standards? And 
do we know exactly where we are going in setting the standards?
    But let me ask--I want to move on to some other points. 
Everyone talks about the need of sort of a division of labor 
between audit and non-audit services, and I do not disagree 
with that, but we have a number of lists that are out there, 
what ought to be precluded or prohibited, and what ought not to 
be prohibited. Are we better off trying to write in the statute 
what services can be provided and what services cannot be 
provided, or are we better off providing the commission, if 
that is the route we go, or whoever the ultimate authority is--
and again, I would argue that it is the commission--with the 
same authority that we have done in banking law, for instance, 
to say something that creates the appearance of a conflict and 
leave it up to the rulemaking bodies to determine what is 
appropriate and what is not appropriate? Would we be better off 
than providing a list? Either one or all.
    Mr. Breeden. Congressman, I think the question of what is a 
permissible service is a very important one. Certainly at a 
minimum, if it were left to an agency, there would have to be 
some guidelines and standards of what should the policy be 
here, and I think Congress has an important role to play in 
trying to answer that. You know, in my mind, if Arthur Andersen 
had not done one penny's worth of consulting work for Enron, 
the exact same problem would have happened. We are in part 
discussing a red herring here, because the audit fee that 
Andersen was collecting from Enron was more than big enough to 
correct the behavior and create all the pressure, whether or 
not they were also on top of that getting consulting fees. And 
so let us don't kid ourselves that if we forced the people to 
get out of all consulting, these pressures on independence are 
not going to go away. In some ways they get worse, because if 
you have said that the entire firm is dependent on nothing but 
the audit fee, then the CFO who can threaten to take away the 
audit fee has even more leverage over the auditor than not.
    So, on the other hand, we want the public to understand 
that audit opinions cannot be bought and the audit relationship 
ought to be the primary focus, and as one of the other 
witnesses pointed out, we have now seen some cases where 
companies have many multiples, the consulting fees, as the 
audit fee.
    So what should the policy be? And if Congress sets out 
standards, whether it is conflict or specific types of risk, 
yes, then you could give the jobs of drawing the lines to an 
agency.
    Mr. Bentsen. My time is coming up and I want to follow up 
with two other points. Mr. Breeden----
    Mr. LaFalce. Mr. Walker, is----
    Mr. Cantor. The gentleman's time is expiring.
    Mr. Bentsen. Well, I do not think it is expired, because it 
is----
    Mr. Cantor. I said ``is expiring.'' Yes, you are correct.
    Mr. Bentsen. I would like to hear from Mr. Walker, but I do 
want to ask one other thing of Mr. Breeden. An issue was raised 
with respect to Enron that goes back to some of the law and 
rule changes in the 1980s with respect to insider trading as we 
know it, not sales by insiders and sort of the Chinese wall 
that was established between underwriting and sales and 
trading, and some have raised the question that the unintended 
consequence of that was that deals that were being structured, 
primarily private placement deals that were being structured 
for Enron that had the effect of diluting stock value and 
taking debt off balance sheet while increasing the leverage of 
the company, had the brokerage side known that, they may well 
not have made a market in their public securities. Is that an 
unintended consequence, and is there a way to address that in 
going back to that 1980s law, or was that just something we 
have to live with?
    Mr. Breeden. The whole idea of Chinese walls is to 
deliberately deprive certain parts of an organization of 
information that is possessed by other parts, and so assuming 
that that information is valuable, it is almost always the 
case, for example, that the investment banking side of a firm 
might know that a tender offer is going to happen or that there 
might be an LBO going to--something is going to happen to 
change the capital structure that would cause your brokers to 
either recommend the stock or not recommend it and you 
consciously and deliberately say we cannot allow that 
information to be used, because only the customers of that firm 
would have that information. It is not out in the broad 
marketplace. So I think Chinese walls are not perfect, and they 
do have the effect that you mentioned in particular cases, but 
they also prevent essentially institutionalized insider trading 
that would happen if knowledge from the banking side can filter 
over into one group of brokers, but not everybody else in the 
rest of the marketplace.
    Mr. Bentsen. But under--and if----
    Mr. Cantor. The gentleman's time is expired.
    Mr. Bentsen. With the indulgence of the Chair. Under things 
such as Reg FD and others, when deals are being structured that 
are increasingly leveraging the company to the detriment of the 
public shareholders, should the underwriting side be dutybound 
to disclose that? And I understand the original intent, why you 
would put the Chinese wall in. It made perfect sense. But now 
you have the reverse effect occurring. Or is that just an 
unintended consequence we have to live with?
    Mr. Cantor. Mr. Breeden, if you can expedite your answer, 
as the gentleman's time is expired.
    Mr. Breeden. Always a problem. I guess I would just say I 
think that is worth taking a look at, in the context of what we 
have seen in this case, and see if there are not ways we can 
mitigate those negative effects.
    Mr. Bentsen. Thank you. Thank you, Mr. Chairman.
    Mr. Cantor. The Chair now recognizes Mr. Sherman.
    Mr. Sherman. Mr. Chairman, thank you. Let me make sure I 
anger virtually everyone in the room with at least a couple of 
quick points. First, as we praise the SEC, let us remember that 
that is the Government agency responsible for our capital 
markets, and we have just had the largest capital markets 
failure in history. And while we focus on an accounting 
industry that is about to go down from the Big Five down to the 
Big Four, we should remember that we could have an SEC rule 
that no one firm can audit more than 15 percent of the publicly 
reporting issuers and force the breakup of the Big Four and do 
something that has kind of a catchy title, the Big Eight. To us 
old guys, that has a catchy title. And I do not have time for 
oral responses, but I hope our panel would respond on whether 
having only 4 accounting firms auditing publicly traded 
companies is a good idea for our capital markets.
    It has been pointed out that management prepares these 
financial statements and the auditor just expresses an opinion 
on them. We should point out that what auditors do is demand 
changes to those financial statements which management can 
implement or not implement. The reason I make this point is 
that there has been a lot of talk of criminalizing speech, that 
is to say, prohibiting the ``undue influence of management on 
the auditors.'' And what worries me is that that is just a 
pejorative vagueness for talking, and that if we are going to 
criminalize some discussions between auditors and management, 
we ought to figure out how financial statements are going to be 
created or who is going to decide which talking is necessary 
and which is criminal.
    Shifting to a question to Messers. Langevoort and Silvers, 
you folks have pointed out the importance of private 
litigation, which is the only economic incentive auditors have 
to do a good job and to stand up to that other economic 
incentive they have to do whatever Ken Lay wants them to do. 
The one concern I have is back in those old days, these 
accounting firms were general partnerships. Everybody was 
liable for whatever the accounting firm was liable for. All 
multithousands of partners and an awful lot of assets. Now they 
are all limited liability companies. Does it make any sense to 
allow lawsuits against accounting firms unless we have a 
requirement that they have malpractice insurance or malpractice 
reserves or some other capital? And should that capital 
requirement be set at one half a year's audit fees or at some 
other level?
    Mr. Langevoort. Certainly you need to address the question 
of whether there is money. I think we have yet to learn what 
the protective shield of limited liability partnership or 
limited liability company is, but you are absolutely right. If 
the deterrent effect is going to be there, there has to be some 
way of reaching the wealth generated by performing the services 
and capturing that.
    Mr. Sherman. I am not so much thinking of this as a hammer 
that is going to take away the house of every partner of Arthur 
Andersen, so much as a compensation fund. If we are going to 
tell people they can sue because they have been harmed, they 
ought to be able to recover something, and I would point out 
that the amount being offered by Arthur Andersen now is just 6 
years' fees to one client.
    Mr. Langevoort. I do not disagree with that, but I would 
keep the club and the hammer there, too.
    Mr. Sherman. Shifting to the scope of service, there is 
discussion of making a laundry list, perhaps 10 items, that 
auditors are not allowed to do. But the main impetus for this 
is to say, well, maybe $25 million in fees is a necessary evil 
if you are going to have privately paid-for audits, but $52 
million is way too much. Do we need just a laundry list of 
services not to be provided, or do we need a rule that says 
your total non-audit fee cannot exceed, say, 50 percent, 80 
percent, 100 percent of your total audit fee? The ratio was 
commented on by, I believe, Mr. Silvers, should there be a 
requirement that that ratio not exceed 50 percent or 100 
percent?
    Mr. Silvers. I think that the issue here really is, as you 
mentioned, with the laundry list, that it is possible to evade 
the intention, which is to end the conflict, by the change in 
practices within the marketplace. Our view is, is that what you 
need here is a--and I believe one of the witnesses--one of my 
co-panelists spoke to this earlier. You need a statutory 
mandate to the commission, right, that in general bars 
consulting services, allows for consulting services that are 
intrinsic to the audit function, all right, and gives the 
commission the discretion to sort out as the marketplace and 
practices change which are which. Right?
    Mr. Sherman. But if, say, tax services are an integral part 
of the traditional accounting function or auditing function, is 
it acceptable to have a million dollar audit fee in a $3 
million tax fee?
    Mr. Silvers. Well, I think there are two answers to that. 
One is, as I said earlier, there are tax services and there are 
tax services that are preparing the audit. Then there is 
structuring the partnership designed to keep everything off the 
books. They are very different and that is why you need the 
commission to have this discretion. But to answer your question 
directly, the question of the ratio, it seems to me that if we 
have got the general rule right and the SEC is complying with 
the intent of Congress here, that you would never see a 
situation in which audit firms exceeded by multiples, right, 
consulting fee--audit fees exceeded by multiples consulting 
fees. Thus the kind of measure you are suggesting might be a--I 
think what Mr. LaFalce referred to as a helpful redundancy.
    I think, though, that what really is critical here is, is 
that the Commission be given both the discretion and the clear 
direction.
    Mr. Sherman. I would point out that the commission----
    Mr. Cantor. The gentleman's time has expired.
    Mr. Sherman.----has for the last 50-plus years--I believe 
my time is expired.
    Mr. Cantor. Thank you, gentlemen.
    The Chair now recognizes Mr. LaFalce.
    Mr. LaFalce. I thank the Chair very much.
    Mr. Silvers, we have not really spent too much time 
considering the issue of mandatory rotation of auditors, and I 
might say that all of my accounting provisions or auditing 
provisions were discussed at great length with the former chief 
accountant to the SEC, Mr. Lynn Turner. As you know, in my 
bill, I would say that you could have an audit for a 4-year 
period, and it could be renewed. It could be renewed basically 
if you have got the Good Housekeeping Seal of Approval of the 
SEC for an additional 4-year period. But then that would be it. 
I think that might well ensure for 8 years of good audits and 
then another auditor could come in and say what a great job the 
previous auditor did or point out where there is need for 
improvement.
    No, what are your thoughts on that concept? It seems to me 
that that concept is even more important, or at least equally 
as important, as the separation of the auditing and non-
auditing functions.
    Mr. Silvers. Yes. I would very much agree with your 
characterization of that language. I think that--and the AFL-
CIO has proposed a rulemaking petition to the SEC that the SEC 
put such a requirement in place by rulemaking. I think that the 
critical issue here again goes to what Chairman Greenwood was 
talking about, which is the sort of confluence of forces that 
are at work to compromise the audit. All right? And one of the 
most important is this sense of cash flows in perpetuity that 
come from keeping a client happy, and the way in which there is 
a kind of melding of the audit firm and the staff of the people 
they are auditing. I think that Chairman Baker made some 
reference to his concern about that earlier in this hearing. 
Both the firm rotation and the prohibition on individuals 
flipping over that Chairman Baker alluded to would get at that.
    Mr. LaFalce. Well, prohibition and flipping over and 
cooling-off period is a provision of my bill.
    Mr. Silvers. I left that to you to say.
    Mr. LaFalce. OK. And you favor that.
    Mr. Silvers. Absolutely.
    Mr. LaFalce. Let me just ask the other gentlemen. On the 
issue of the cooling-off period, I have a 2-year time period 
wherein the chief auditors of a particular company could not 
then be employed by that company. Would you favor that, Mr. 
Walker, Mr. Breeden?
    Mr. Walker. I think the issue of a cooling-off period needs 
to be looked at. Some changes are necessary. I think you have 
to recognize that there are ways to potentially get around 
that. While it is not appropriate for them to serve in the CFO 
position, some of the things that Chairman Breeden has talked 
about, you also can hire people as consultants, and they are 
not employees, and the question is, what are they doing. So I 
think you have to recognize and look at substance over form and 
make sure you are accomplishing the objective.
    Mr. Breeden. Congressman, as I said earlier, I think the 
cooling off is an important principle. Without looking at the 
specifics of how to do it--for example, I would let a company 
hire someone from their audit team to come in and have another 
position in the company for 2 years without being CFO. I think 
the real risk comes when the CFO is dealing with his or her own 
former staff over at the audit team, and I----
    Mr. LaFalce. Let us not kid ourselves. Some accounting 
firms have a policy of encouraging early retirement, creating 
incentives for early retirement, so that you do become the CFO 
of the company that you have been auditing, and you cement the 
relationship, the tie between the firm and your former auditing 
firm. We have got to deal with that problem in some way.
    Now we can always point out, well, this is not crossed 
right or that T is not dotted right, but there is a fundamental 
problem. And let us cure the problem. If we do it imperfectly, 
well, then we can correct it, but let us deal with the very 
imperfect problem that exists. Let me go on, though, because I 
have so many other questions I want to ask.
    Mr. Langevoort, you have been neglected and I do not want 
to neglect you any more, because Mr. Watt was talking about 
what he considers to be so important. But that is one of the 
most important provisions of our bill. We specifically would 
give legislative sanction to aiding and abetting liability for 
accountants and other professionals, and we specifically alter 
the statute of limitations.
    Now there has been some confusion. Everybody says you ought 
not to change the 1995 Securities Reform Act or the 1998 
Securities Reform Act. Do either of those provisions change the 
1995 or 1998 Securities Reform Act?
    Mr. Langevoort. No, and thank you for the softball 
question.
    Mr. LaFalce. See, everybody here is under the impression 
that we are undoing what is done in 1995 and 1998.
    Mr. Langevoort. These two changes would carry out things 
that predate the 1995 legislation and that the SEC has endorsed 
previously. They are compelling as a matter of public policy.
    Mr. LaFalce. And yet witness after witness from industry 
comes in and says, oh, you cannot do this, because you would be 
undoing the 1995 and 1998 legislation, and they really do not 
know that it has nothing to do with the 1995 and 1998 
legislation.
    Mr. Cantor. The gentleman's time is expired. The Chair is 
going to yield himself time for an additional round of 
questions.
    Mr. Breeden, I would like to ask you on the question of 
rotating audits, do you feel that there will be an increased 
quality of audit if a company is required under all 
circumstances to replace its auditors every 4, every 8 years? 
Do you really feel there will be an increase in quality of 
audits, given the subsequent increase and expense the company 
will incur?
    Mr. Breeden. Mr. Chairman, in my testimony I said that I do 
not personally favor mandatory rotation because I think 
rotation in some cases would be a benefit, and in other cases 
would be a disadvantage. In a very complex company, it takes a 
number of years to get up to speed and really understanding 
where the risks in that company are, and if you rotate--and 
particularly if you rotate every 4 or 5 years, I think you 
would have periods of time, blackout periods, almost, where the 
auditors are getting up to speed. That could be overcome. 
People could spend more money to throw more people at getting 
up to speed faster, but in general I think that is something as 
a requirement that goes farther than we need.
    What I would like to see us do is to move more to a system 
where auditors are engaged for a 3 or 4-year period, not for a 
1-year period, and that at the end of that time, the audit 
committee has to go out for proposal and at least hear what the 
other firms propose and how they would structure the audit and 
how many hours they think should be involved, and then leave it 
to the audit committee to make a decision on whether that firm 
should be retained or whether you should rotate.
    Mr. Cantor. I would respond and ask you what value would it 
be for there to be an imposition and to require going out for 
bid again under all circumstances, because that, too, does take 
time, and obviously someone participating in a response to a 
bid will not have the knowledge of the company the way that an 
existing auditor will have, and is that the best way? Are we 
really gaining some safeguards there?
    Mr. Breeden. I am not sure I understand the question. You 
are saying what value is there in going out for proposal?
    Mr. Cantor. Just for going out's sake.
    Mr. Breeden. Well, I would not require that as a matter of 
legislation. But I think as a matter of audit committee good 
practice, that every few years you should put your periscope up 
above the surface of the ocean and take a look around and see 
what other options are out there. I think the audit committee--
I wrote on this subject in the Wall Street Journal a week or so 
ago. The audit committee needs to become more active than has 
been traditional, and we have been moving in that direction for 
the last 10 or 20 years. We keep--through the exchanges they 
keep encouraging better literacy, higher quality membership on 
audit committees. They are positioned to be a check-and-balance 
on the CFO, but we cannot expect audit committees to attract 
good people, and you want them to have the responsibility, and 
yet put them in a straitjacket and say, well, the law itself 
tells you what you have to do and not do.
    So I would leave some of these questions to the audit 
committee.
    Mr. Cantor. Thank you.
    The Chair now recognizes Mr. LaFalce.
    Mr. LaFalce. Well, thank you very much. I do think that 
there are a number of threshold questions that are important. 
First of all, we ought to not lose sight of the fact that it is 
more than accounting and auditing that we have to be concerned 
about. We had problems with corporate officers. We had problems 
with boards of directors. We had problems with the auditing 
firms. We had problems with the rating agencies. We had 
problems with the securities firms and their analysis. We had 
problems with the law firms and probably an awful lot of 
others, too. What I am fearful of is that--or not fearful, that 
we are going to overreact. Industry is too strong, too 
powerful, too influential. Let us not kid ourselves. It is 
going to be tough to get anything at all passed that is 
meaningful, that is more than cosmetic. Our problem is not 
overreacting. Our problem is underreacting, coming in with a 
cosmetic. And let us not kid ourselves. If we don't understand 
that, we do not understand the governmental process as it 
really works, as opposed to you know how it is supposed to 
work.
    I want to go into some differences between the bills, and I 
really--it is not a question of his bill, my bill or anything 
like that, but I want these issues to be addressed. I would 
like for there to be dialogue between us. There has been no 
dialogue. Before we have a markup. I make a public call for an 
opportunity to have dialogue, private dialogue, on these issues 
that we can come to some compromise on them. But I would like 
at least a public comment on some things that are new.
    To the extent that you have knowledge, and you probably do 
not have too much knowledge other than newspaper knowledge, but 
please give me your thoughts about it.
    The lawsuit against Enron has been expanded to include a 
number of the investment banks, about 10 or so. What is the 
theory of liability there? It is not just lending. I think it 
is more than lending. It is some type of active participation. 
Is it more than aiding and abetting?
    And then also some people think that aiding and abetting in 
an action brought by the SEC simply requires a show of 
negligence, and I think the standard is substantially higher 
than that. I would like some explanation on that. And then also 
the Attorney General of the State of New York has obtained a 
court order. I am not exactly sure what the order says or does, 
but it was against Merrill Lynch, apparently--and, again, only 
speaking now from what I know about it from the newspaper--for 
making recommendations that are contrary to opinions that were 
expressed by an overwhelming percentage of the analysts of the 
firms in their e-mail conversations. Who wants to swing at that 
one?
    Mr. Langevoort. Let me start with what I think was the 
first question. With respect to the pending lawsuit against a 
variety of participants in Enron, I have not read the 500-and-
whatever-page complaint so I cannot address the specifics.
    Going back to my testimony, the uphill battle plaintiffs 
have is in trying to trace a way in which the investor banker's 
involvement was more than just behind-the-scenes assistance. It 
tries to do that by saying the investment banks used their 
analyst conduits to speak directly to the market. That is more 
than assistance. There may have been some participation in 
preparation of documentation that made it into the hands of the 
investing public. Those are all possibilities, but I guess my 
bottom line concern is that is really an unfair burden to put 
on the plaintiffs, if what you are really complaining about was 
that the bankers were the brains in some respect behind all of 
this.
    Second, with respect to aiding and abetting----
    Mr. LaFalce. One of the difficulties I have is we have not 
examined that before our Committee. We have not examined what 
the nature of the law is that would cover and what the nature 
of the law should be to cover them, and that could be a large 
part of the problem. I do not say that it is.
    Mr. Silvers. Congressman, I am not familiar with the 
complaint, obviously, as it has been amended, but I am a little 
familiar with some of the transactions that may be part of the 
complaint. There have been--and because there has been 
litigation both in the bankruptcy court and in the Southern 
District of New York around some of these banking transactions, 
and essentially what some of that litigation seems to show--and 
there are traditional opinions backing up what I am about to 
say--is that in at least the case of JPMorgan Chase, that 
company engaged in what was treated as a market derivative 
transaction, but in effect was a loan to Enron, because it was 
a loan paired with two energy derivatives contracts which 
essentially canceled each other out, and in one case they both 
ran through--JPMorgan Chase subsidiaries based in the Island of 
Jersey off the United Kingdom, which is an offshore bank haven, 
and the result of that transaction was that Enron got a billion 
dollar loan, did not show up on Enron's balance sheet.
    Mr. LaFalce. The whole issue of derivatives and the 
regulation of derivatives is very important, because the 
industry officials that engage in derivatives have said, well, 
these are counterparties who are so sophisticated that there 
need not be any type of regulation for them at least, and yet 
there are innocent people who are not parties to those actions 
that can suffer serious consequences, and then that is an issue 
smack dab before the jurisdiction of our Committee which we 
have not looked into.
    Mr. Cantor. If the gentleman will expedite his answer. The 
gentleman's time has expired.
    Mr. LaFalce. Well, I want to take another round.
    Mr. Silvers. Just to conclude, that transaction, unless 
some particular facts have arisen, that would--Chase directly 
communicated that transaction to Enron investors. That 
transaction will not be litigable because of this aiding and 
abetting issue. But, nonetheless, as you point out, real people 
were very badly hurt here. I spent some time with some of them 
in Houston on Friday, and those people have no--if it is merely 
aiding and abetting, those people have no cause of action.
    Ironically enough, Chase Manhattan Bank, though, is acting 
on their behalf on the creditors committee of Enron and 
depriving those same people their severance money, while they 
see if they can bob and weave out of the liability generated by 
these transactions. It is really scandalous, frankly.
    Mr. LaFalce. Mr. Chairman, I know my time is expired, but 
Mr. Langevoort did not respond, did not have the opportunity to 
respond to the question of the standards that have to be met in 
aiding and abetting liability, whether it is negligence or 
something considerably greater than negligence.
    Mr. Langevoort. Congress made absolutely clear when it 
restored the SEC's aiding and abetting authority that 
intentional misconduct was the standard, and that is clearly 
the law with respect to aiding and abetting generally.
    Mr. LaFalce. And, therefore, if we extend aiding and 
abetting liability to private litigation, we would adopt the 
same standard, and so you would have to prove intent.
    Mr. Langevoort. The bill 3813 would mirror the standard for 
intent in private securities.
    Mr. LaFalce. It need not, but----
    Mr. Langevoort. Yes. That is correct.
    Mr. Cantor. The Chair yields to himself this time for an 
additional question. Mr. Breeden, in your written testimony, 
you unequivocally state that you would not support any steps to 
restore joint and several liability, aiding and abetting 
liability and other measures. Can you speak just sort of 
briefly to the adequacy of the remedies available under the 
1995 Act?
    Mr. Breeden. The 1995 Act was discussed earlier. I guess 
the only thing I would add to the 1995 Act was this same issue 
of whether aiding and abetting should be--whether Central Bank 
should be overturned was before the Congress in the 1995 Act. 
The Congress in that legislation could have done so, and it did 
not. The absence of action rather than the actuality of action 
was part of what Congress ended up doing there.
    My own view is that we have struck a balance in the private 
litigation area, and there will always be cases that will cause 
us to say we should give more rights of action, but there are 
also--that opens the door, in my opinion--and I respect the 
differences from others on this point, but I believe it does 
open the door to abusive litigation, and the costs of that are 
very, very real, not only to the economy and to businesses, but 
to shareholders, too, who pay the ultimate cost of that whole 
process.
    Mr. LaFalce. Mr. Chairman, if I can just follow up with the 
question with Mr. Breeden on that point.
    Mr. Cantor. If he can just finish his response and I will 
yield back to you for plenty more time.
    Mr. Breeden. I guess my view would be twofold. One, in the 
context of this legislation of trying to do something positive 
and meaningful to respond to the Enron situation, I think if we 
refight the battle of litigation reform all over, as part of it 
I think it will make the chances of doing anything constructive 
here much lower and, therefore, I would not like to see that 
happen, because I think there are some improvements that should 
be made and there are a lot of good things in your bill that 
ought to be done.
    Second, even if it were not a question of tactics and 
timing, I do not substantively favor the expansion of the 
rights as has been described.
    Mr. Cantor. Thank you very much.
    The Chair now recognizes Mr. LaFalce.
    Mr. LaFalce. Mr. Breeden, I just do not know how any 
person, unless they have a philosophic disposition, that says 
individuals should not be able to go into a court of law to 
obtain redress for a wrong, can say that if an individual or a 
firm has intentionally aided and abetted in false or misleading 
statements, that they should not be able to be held liable. You 
know, it is absolutely beyond the capacity of the SEC on its 
own to go after all of those instances when it is done. They 
have got a paltry record on this in the past. The FTC, which 
has the ability to go into court--and you can't go into court 
if you are an individual--has come into Congress and said, 
restore the right of an individual who has been aggrieved, 
because it is wildly beyond our capacity to bring lawsuits 
where lawsuits are necessary to be brought.
    And, Mr. Breeden, I understand the philosophic mind that 
just wants to cut back--for example, the mind of this 
Administration. They want a terrorism insurance bill, but only 
if it is coupled with the cutback of an individual's right to 
go after individuals who may have participated in that 
terrorism and caused injury.
    Well, having said that, let me just say that that is one 
issue where you and I have profound differences on, and I hope 
that the Congress, at least this Committee, will be given the 
opportunity to consider that as you--and not confuse it with 
undoing the 1995 or the 1998 legislation which simply did not 
address those issues. And I will not be offering the joint and 
several. I will be offering the aiding and abetting and I will 
be offering the statute of limitations and I will be offering 
them separately so that we can have discrete issues before us.
    Now, going back to the issue of mandatory rotation, Mr. 
Silvers, you favor it--I do not know that you have an opinion 
one way or the other, Mr. Langevoort. Mr. Breeden, you have 
said you opposed it. Mr. Walker, you said you certainly think 
it should be on the table for study. Is that fair enough?
    Mr. Walker. We are saying two things. One, more things need 
to be done on key personnel on the engagement and that the 
other issue should be studied. I have some personal concerns 
about mandatory rotation of audit firms.
    Mr. LaFalce. Well, I brought this up with Mr. Lynn Turner, 
the former chief accountant, who favors rotation, and he said 
to me, let me tell you, he says, I used to be one of the Big 
Five, he says, and mandatory rotation of the chief partner just 
does not work. He says no partner is going to go in and replace 
another partner and blow the whistle on the other partner and 
say everything he did was wrong. He says it does not work. If 
you are going to get to the heart of it, you are going to have 
to go to mandatory rotation.
    Now he may be right and he may be wrong, but my 
recommendation in the bill is not without significant 
authoritative support. But let us assume we should not do that. 
Now, Mr. Breeden, you have said, well, what we ought to do is 
have audit committees, consider hiring audit firms for maybe a 
3 or 4-year period and then consider other audit firms, too. 
Maybe submit proposals.
    Well, the only thing is, if we do not mandate that, how do 
we get at the bad guys rather than the good guys? Won't we have 
a situation where the good guys are the ones who are going to 
do that and the bad guys are the ones who will not do it 
voluntarily? And that is the problem with volunteerism.
    Now you would have the SEC do it, but, look it, you have 
sang the praises of the SEC. The problem is the SEC has 
deferred almost 100 percent over the years to the SROs. They 
have had almost no watchdog role over the SROs, whether it is 
the securities industry, and most especially the accounting 
industry. They have been silent.
    Mr. Breeden. Congressman, on the issue of rotation, while I 
do not personally favor mandatory rotation, it is an extreme 
step, and I do not think we are necessarily sure that applied 
to 17,000 companies in this country, that it would be a good 
idea.
    On the other hand, my idea of having a 3 or 4-year 
engagement could lend itself to having a statute that said that 
beyond, say, one initial term and two renewals, that specific 
standards and findings might have to be made by the audit 
committee in order to pick the incumbent and keep going. You 
could encourage and the commission itself could encourage 
through proxy rule its audit committee--require the audit 
committee to say why after a dozen years or so, but some--pick 
some number, why they did not consider--or did they consider 
rotation. If so, why did not they do it. There are ways you can 
put a little pressure on to make sure people do look hard at 
the question. Would it serve the shareholders' interest to 
rotate.
    Mr. LaFalce. Mr. Walker.
    Mr. Walker. As far as the interest of full and fair 
disclosure, I am a CPA and practiced for a number of years; 
and, number two, I have been with two of the Big Five firms and 
I know how things work; and, number three, I think if you look 
at the issue of rotation of the key personnel, right now the 
rules are not adequate. You could have an individual or a 
person who was serving as engagement manager, then engagement 
partner, then the second partner, so they can end up being on 
the engagement for many, many years in a row.
    Mr. LaFalce. You mean the SEC, having the power to change 
that since their existence, has not?
    Mr. Breeden. Congressman, I think this is an excellent 
issue, though, that pointed out why the proposal of both Mr. 
Oxley and yourself, both bills call for a body here to be 
created that would begin to resolve some of these issues, and I 
think you have put your finger on this is one of the number of 
such----
    Mr. LaFalce. That is why I wanted to have this hearing, 
because we have not discussed this issue, and I would love to 
discuss it, and I would love to reach a compromise short of 
legislatively mandating rotation, if it is a good compromise.
    Mr. Cantor. The gentleman's time is expired, and Mr. 
Sherman is in wait.
    Mr. Walker. One quick thing, Mr. Chairman, please. I think 
one of the things you have to be concerned about is if you are 
looking at the public interest, I think you have to be 
concerned with how many firms are there that can perform the 
service. I think the number of firms does matter.
    Mr. LaFalce. That is an important issue, too. Now are there 
not a lot of auditing and accounting firms below the Big Five 
that really could do much more work than they presently do.
    Mr. Walker. They could do more work, except when you are 
dealing with highly complex and global enterprises.
    Mr. LaFalce. But an awful lot of the publicly traded 
companies--what are there, about 17,000?
    Mr. Walker. They do not fit this----
    Mr. LaFalce. They can do it for--we have got to be able to 
encourage--I had a chairman of an accounting firm in my office 
today saying I favor mandatory rotation. It is the only way we 
are going to be able to get a piece of the action.
    Mr. Walker. I understand. It depends where you sit. Number 
one, the number of firms that are qualified to do the work is 
important. Number two, we need to be concerned with firm 
quality and related internal quality assurance procedures. And 
number three, the quality of the people is key.
    One of the concerns that I have about mandatory rotation is 
that could end up putting more pressure on price, and the last 
thing you want to do is create a further commoditization of the 
audit business, especially if you are going to end up taking a 
way a lot of non-audit services, because in the end you have 
got to have a viable economic model, and if you do not have a 
viable economic model, you are not going to attract and retain 
quality people.
    Mr. LaFalce. It is a pittance and----
    Mr. Cantor. The gentleman's time has expired and the Chair 
is going to recognize Mr. Sherman.
    Mr. Sherman. Thank you, Mr. Chairman, for giving me a 
chance to combine my third, fourth and fifth round questions 
into one block.
    One of the witnesses mentioned Jersey Island, and of course 
we have also seen a lot of Enron activity in the Cayman 
Islands. I commend this Committee and the Ranking Member and 
the Chair for having these hearings on Enron and responding, 
but the Ways and Means Committee is strangely silent. There are 
two sets of accounting games that were played by Enron. One, to 
cheat the shareholders; the other, to cheat the United States 
Government and all taxpayers.
    Now, the first is a little bit more apparent, because the 
victims are there. The employees, everybody who held stock at 
Enron, and in a way every stockholder in every company in the 
country, because I am convinced the market would be several 
hundred points higher if everybody didn't have to factor into 
their investment decisions the fact that the company that they 
invest in has a number of risks, including the risk that they 
might be the next Enron.
    The hidden cost and victims of the accounting games, the 
trips to Cayman Islands that had nothing to do with snorkeling, 
are the taxpayers, the citizens of the country, everyone who 
depends upon Government, our efforts to combat world terrorism, 
and it is not just Enron, but hundreds of companies that have 
each established dozens of subsidiaries in the Cayman Islands, 
in Jersey Island, in Barbados, in the other tax havens, and I 
would call upon our sister committee to be as vigorous as this 
committee has been. We have to defend investors. They have to 
defend citizens.
    But shifting to our responsibility and the scope of the 
outside auditor, the whole problem arises, because financial 
reporting is the only game where the umpire is paid by one of 
the teams. And that means under the current system if you say 
no, we will not give you an unqualified opinion, you are not 
just giving up this year's audit fee, you are giving up this 
year's consulting fee. And you are not just giving up this 
year's auditing and consulting fee, but those fees could 
continue for ten or 20 or 30 years into the future.
    Now one thing that I do not think will solve the problem 
right away--and I used to work for one of what we call the 
Little Six accounting firms--as long as investors, as they 
have, always demanded from the big companies they buy stock in 
that are widely traded that a Big Five, Big Eight, Big Four 
firm be the auditor, I do not know a way to break that up just 
with rotation. I think you would end up rotating among the Big 
Four, which may have some advantages and disadvantages. I think 
if you want smaller firms, we would have to break up the firms 
we have got now, because I do not think Horwath is going to be 
able to stand up and say, we audited General Motors or we 
audited even Pacific Gas and Electric, and you should buy their 
stock, or at least rely on our financial statements to decide 
whether or not to buy the stock.
    We then focus, though, on that financial relationship that 
an accounting firm has with its clients, and one thing that Mr. 
Silvers and I were talking about is the non-audit fee. And the 
question there is whether you can just list a number of 
different services and say, OK, from time to time we will 
change the list and we will prevent the client from having too 
much clout with the accountant because we will always have a 
list of prohibited services or limited services that prevent 
the client's total fee package from being too important to the 
accounting firm, and I wonder whether that is even possible 
without the backstop that I have suggested Mr. Silvers referred 
to as a perhaps useful redundancy. And I would like the members 
of the panel to comment. Is there any way you could list some 
services, but not other services and not have a situation where 
the client's total fees to the accountant might possibly be as 
large or larger than the audit fee? Can we do this by 
enumeration, or must we do it by ratio?
    Mr. Walker. My personal view is--and as our testimony 
states--you may want to have certain principles that you say 
that under no circumstances can the auditor violate certain 
principles, which are clearly articulated.
    Second, you may want to have certain safeguards to make 
sure that people are not auditing their own work, either firms 
or people within the firm. You should delegate to an 
independent qualified authoritative body which is able to make 
the tough decisions on what should and should not be allowed 
based upon changing market conditions. I think it is difficult 
to establish any particular level to say that merely because 
non-audit fees exceed a certain number, that there is a problem 
per se.
    Mr. Sherman. So if I can interrupt, let us say it was 
thought to be acceptable that an accounting firm also provide 
executive recruitment. You are not auditing your own work, 
except to the extent that----
    Mr. Cantor. The gentleman's time is expired. If we can 
expedite the answer.
    Mr. Sherman. I didn't even get through to the question. So 
I would withdraw it.
    Mr. Cantor. The gentleman may proceed.
    Mr. Sherman. If we--whatever the allowable service is, say 
executive recruitment, is there--if it makes sense to allow a 
little bit of it, can you allow so much of it that the 
accounting firm is receiving more from those services than from 
the auditing fee?
    Mr. Walker. Under the approach that we have taken under 
generally accepted Government auditing standards, which is 
outlined in my testimony, we say there are certain things you 
cannot do irrespective of the comments involved. There are 
other things that you should be able to do, but certain 
safeguards must be met, and we do not propose any arbitrary 
dollar or percentage limit. We also think that the audit 
committee should end up being more actively involved in 
reviewing and approving certain types of services.
    Mr. Sherman. I believe my time is expired.
    Mr. Cantor. Thank you.
    Mr. LaFalce. Yes. I just want to thank the panel very, very 
much. I think this has been very constructive and helpful. I 
just wish there were more Members from both sides of the aisle 
who could have listened to the issues that were discussed by 
both of you.
    Also, Mr. Breeden, I do want to say that it was a pleasure 
working with you in the Bush Administration when 
representatives of the Administration used to talk with 
Democratic Members of the House. That is not the case. I used 
to virtually live with representatives from the Treasury 
Department and from the White House in those days, maybe 
because we were in the majority then and they used to talk with 
us. That is why I developed such a close working relationship, 
not only with you, but with the President himself and so many 
of his cabinet officials. That is missing in Bush 2, and it is 
a sad--I am sad that it is missing. Thank you.
    Mr. Breeden. Congressman, can I only say and just respond 
and say it was a great pleasure working with you then and all 
of the Members of--some of the Members who are still on the 
Committee here, that I really think the savings and loan 
legislation was an opportunity--a great challenge faced by the 
country, and you played a tremendous leadership role then and 
it was a great pleasure. I have never forgotten working with 
you.
    Mr. LaFalce. Well, let me say this, that one of the 
difficulties--probably, in my judgment, the biggest 
difficulty--is that there was a cutback in examiners and in 
regulators for our savings and loan in the mid-1980s. I think 
that was the single greatest contributing factor. In the 
beginning of 2001, when our Committee assumed jurisdiction, I 
pointed out that the biggest shortcoming in Government today 
was the inadequacy of resources at the SEC, and I called at the 
beginning of 2001 for another 2 or 3 percent increase, but a 
200 or 300 percent increase in the resources of the SEC. I was 
at least figuratively laughed at in calling for such a huge 
increase.
    Now that Enron has happened, at least the President has 
called for a 6 percent increase in his budget. But that is not 
good enough.
    Mr. Cantor. The Chair would also like to express his 
thanks, and members of the panel, for your indulgence and 
patience. The hearing now stands adjourned.
    [Whereupon, at 4:52 p.m., the hearing was adjourned.]
                            A P P E N D I X



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                            A P P E N D I X



                             March 20, 2002
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                            A P P E N D I X



                             April 9, 2002
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