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

     THE ENRON COLLAPSE: IMPLICATIONS TO INVESTORS AND THE CAPITAL MARKETS
    =======================================================================

                                    HEARINGS

                                   BEFORE THE

                                SUBCOMMITTEE ON
                        CAPITAL MARKETS, INSURANCE, AND
                        GOVERNMENT SPONSORED ENTERPRISES

                                     OF THE

                                  COMMITTEE ON
                               FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                          ONE HUNDRED SEVENTH CONGRESS

                                 SECOND SESSION

                                   __________

                              FEBRUARY 4, 5, 2002

                                   __________

           Printed for the use of the Committee on Financial Services

                           Serial No. 107-51, Part 2

                           U. S. GOVERNMENT PRINTING OFFICE
    82-103                          WASHINGTON : 2002
    ___________________________________________________________________________
    For sale by the Superintendent of Documents, U.S. Government Printing Office
    Internet: bookstore.gpo.gov  Phone toll free (866) 512 1800; DC area (202) 512-1800  Fax: (20) 512-2250  Mail: Stop SSOP, Washington, DC  20402-0001

                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                        MICHAEL G. OXLEY, Ohio, Chairman

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

                 Terry Haines, Chief Counsel and Staff Director
                Subcommittee on Capital Markets, Insurance, and
                        Government Sponsored Enterprises

                     RICHARD H. BAKER, Louisiana, Chairman

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

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearings held on:
        February 4, 2002.............................................     1
        February 5, 2002.............................................   109
    Appendixes:
        February 4, 2002.............................................   185
        February 5, 2002.............................................   481

                                   WITNESSES
                            Monday, February 4, 2002

    Pitt, Hon. Harvey L., Chairman, U.S. Securities and Exchange
      Commission.....................................................    28
    Powers, William C., Chairman of the Special Investigative
      Committee of the Board of Directors, Enron Corporation.........    69

                                    APPENDIX

    Prepared statements:
        Baker, Hon. Richard H........................................   186
        Oxley, Hon. Michael G........................................   189
        Israel, Hon. Steve...........................................   191
        Kanjorski, Hon. Paul E.......................................   194
        LaFalce, Hon. John J.........................................   196
        Ney, Hon. Robert.............................................   198
        Paul, Hon. Ron...............................................   199
        Royce, Hon. Ed...............................................   202
        Pitt, Hon. Harvey L..........................................   204
        Powers, William C. Jr........................................   210

                  Additional Material Submitted for the Record

    Baker, Hon. Richard H.:
        EITF Abstracts...............................................   243
    Powers, Willam C. Jr.:
        Report of Investigation......................................   263

                                    WITNESS
                           Tuesday, February 5, 2002

    Berardino, Joseph F., Chief Executive Officer, Arthur Andersen
      LLP............................................................   119

                                    APPENDIX

    Prepared statements:
        Castle, Hon. Michael N.......................................   482
        Clay, Hon. William Lacy......................................   483
        Berardino, Joseph F..........................................   484

                  Additional Material Submitted for the Record

    Oxley, Hon. Michael G.:
        Arthur Andersen L.L.P. letter on the FASB's Exposure Draft,
          Jan. 16, 1996..............................................   501
    Sherman, Hon. Brad:
        ``Enron's Many Strands: Early Warning; '99 Deal Failed After
          Scrutiny of Enron Books,'' New York Times, Jan. 27, 2002...   509

     THE ENRON COLLAPSE: IMPLICATIONS TO INVESTORS AND THE CAPITAL MARKETS

                                  ----------

                            MONDAY, FEBRUARY 4, 2002

                 U.S. House of Representatives,
            Subcommittee on Capital Markets, Insurance
                  and Government Sponsored Enterprises,
                               Committee on Financial Services,
                                                        Washington, DC.
        The subcommittee met, pursuant to call, at 2:10 p.m., in
    room 2175, Rayburn House Office Building, Hon. Richard H.
    Baker, [chairman of the subcommittee], presiding.
        Present: Chairman Baker; Representatives Shays, Cox, Paul,
    Bachus, Castle, Royce, LaTourette, Shadegg, Weldon, Ryun,
    Biggert, Ose, Ferguson, Oxley, ex officio; Kanjorski, Ackerman,
    Bentsen, Sandlin, Maloney of Connecticut, S. Jones of Ohio,
    Sherman, Inslee, Moore, Gonzalez, Lucas of Kentucky, Crowley,
    Ross, and LaFalce, ex officio.
        Also Present: Representatives Leach, Capito, Tiberi, Frank,
    Watt, and Jackson-Lee.
        Chairman Baker. I would like to call this hearing of the
    Capital Markets Subcommittee to order. Today's purpose is to
    continue the subcommittee's work with regard to the matter of
    Enron.
        In order to prepare for the hearing today, I wish to
    announce by prior agreement the method by which the
    subcommittee will proceed with regard to opening statements.
    After consultation with Mr. Kanjorski and others, we would have
    a 30-minute block of time for each side, proceeding in regular
    order, in which Mr. Kanjorski would manage his 30 minutes. I
    will manage our side, and we would do a similar pattern not
    only for today's hearing, but for tomorrow as well.
        And I make that announcement for those who offer opening
    statements today; you would not then be subsequently authorized
    for an additional opening statement tomorrow to give as many
    Members as is possible the chance to be heard at the outset of
    today's hearing and tomorrow's hearing. Without objection, that
    process is adopted for opening statements.
        I wish to further acknowledge that Members are in
    participation today who are not Members of the Capital Markets
    Subcommittee, but are Members of Financial Services generally;
    and also to recognize Ms. Jackson-Lee, who is sitting as an
    additional Member of the panel today to participate as
    appropriate in the proper order of recognition.
        I wish to also announce by way of process for those who
    will be heard here today with no implication from the citation
    being sent inappropriately, except as otherwise provided in
    this section, whoever in any matter within the jurisdiction of
    the legislative branch of Government knowingly and willfully
    falsifies, conceals, covers up by any trick, scheme or device a
    material fact, makes any materially false, fictitious or
    fraudulent statement or representation, or makes or uses any
    false writing or document knowing the same to contain any
    materially false, fictitious, or fraudulent statement shall be
    fined under this title or imprisoned for not more than 5 years
    or both. This is to make clear in the record that non-
    responsive or misleading answers to questions posed by Members
    of this panel are indeed serious offenses and will be dealt
    with appropriately.
        Chairman Baker. I yield to the gentleman.
        Mr. Kanjorski. Mr. Chairman I understand the Chair is
    attempting to exercise its prerogative, but under clause
    2(k)(8) of Rule 11, the subcommittee's prerogative is to decide
    whether witnesses should be sworn in at a hearing. It is not
    the prerogative of the Chair. Under those circumstances, Mr.
    Chairman, I would like to ask unanimous consent that it be the
    policy of this hearing and all future hearings that all
    witnesses be sworn in.
        Chairman Baker. I appreciate the gentleman's perspective.
    We had discussed how we would proceed in advance of the
    commencement of the hearing today, and it was my recommendation
    to the subcommittee that we not swear in witnesses today and
    that we move appropriately through the course of our inquiry in
    making a determination as to when that requirement may be
    imposed.
        Mr. Kanjorski. Mr. Chairman, I understand that, but that is
    the exercise of a prerogative. As I suggested to you under
    clause 2(k)(8) of Rule 11, that is not the prerogative of the
    Chair. I have a motion before the subcommittee to make it a
    rule that all witnesses before this subcommittee be sworn in.
        Chairman Baker. If the gentleman will restate his motion,
    is it a unanimous consent request?
        Mr. Kanjorski. I make it in the form of unanimous consent,
    but if that is not satisfactory to pose it that way, I will
    make a motion that it is the position of the subcommittee. I
    ask for a recorded vote that all witnesses appearing in this
    matter before this subcommittee be subject to being sworn in.
        Chairman Baker. I understand the gentleman's point. I would
    object to the unanimous consent resolution, understanding that
    the gentleman has now placed before the subcommittee a motion
    which would require the subcommittee to proceed by the swearing
    in as it relates to consideration of matters relating to the
    Enron resolution.
        That being the question before the subcommittee, the
    question now occurs--we need to have a clerk at the desk to
    record the proceedings here. We have to wait momentarily. We
    have gotten ahead of ourselves.
        Is there somebody that wishes to be recognized?
        Mr. Inslee. Yes.
        Chairman Baker. Mr. Inslee.
        Mr. Inslee. May I be heard on the motion briefly?
        Chairman Baker. Yes, certainly.
        Mr. Inslee. Mr. Chairman, we want to have a bipartisan
    approach to this, and you have always acted in the spirit of
    that, so we don't want to get off to a partisan--but I'm trying
    to understand why the Chair would not think it appropriate in
    this matter of great public moment to swear witnesses,
    particularly where quite a number of people who will be
    testifying to us have potential civil and criminal exposure;
    and it seems to me that when people have that looming over
    their heads, if Congress really wants to get down to the truth,
    it might be better to make sure they are under oath.
        Mr. Bachus. Would the gentleman yield?
        Mr. Inslee. Yes.
        Chairman Baker. If I may respond to the gentleman's
    question first, and then I will recognize Mr. Bachus, I merely
    read the statute which acknowledges that it is already
    inappropriate to misrepresent to a subcommittee of Congress to
    an extent a 5-year criminal penalty will ensue.
        Secondarily with regard to the gentleman, with regard to
    those individuals who are believed to be participants in the
    wrongdoing of this matter, I felt it inappropriate where we are
    getting assistance from others who are not participants--as in
    the case of the Chairman of the Securities and Exchange
    Commission, who appears here to help the subcommittee
    voluntarily and is not a participate in the Enron failure, I
    felt that that was not an appropriate step in light of the
    statutory requirements and the distinction between the
    enforcement of the existing law and the swearing in of a
    witness.
        But that is the answer to the gentleman, and I yield back.
        Mr. Inslee. I will yield to the gentleman.
        Mr. Bachus. I will simply say, bottom line, Chairman Pitt
    is not under investigation. And the tradition of the House is
    to swear witnesses in when they or the organization they
    represent are under investigation, and I don't think at this
    time that any Member of this subcommittee wants to make a
    determination or take any action in any regard that indicates
    that Mr. Pitt is guilty of any wrongdoing. The subcommittee is
    under----
        Chairman Baker. It is Mr. Inslee's time.
        Mr. Inslee. I yield to Mr. Kanjorski.
        Mr. Kanjorski. Mr. Chairman, I certainly have the highest
    regard for Mr. Pitt and for many, many of the witnesses that
    are here. Quite frankly, I do not know who is responsible for
    the Enron debacle.
        I thought the purpose of this hearing was to find out the
    facts and circumstances. Quite frankly, I am enraged--enraged--
    with the rush to judgment of the media and some of the Members
    of Congress, both in the House and the Senate, that I have
    observed over the last several weeks.
        The purpose for this hearing, as I understand it, is to get
    to the question of what the facts are. What happened? Was there
    any public policy, rules, regulations or laws that should have
    stopped this from happening? Were they inadequate? Were there
    loopholes that need to be closed? Is there any action that we
    should take in the legislative form?
        We are not a grand jury. We are not a trial court. I can
    tell you that I have made no judgment. I do not know whether
    the facts and circumstances will indicate if something went
    wrong, whether it was wrongdoing, or whether it was criminal or
    civil liability. I do not know if anything went wrong.
        All I want to say is: Anybody who comes in here and gives
    this subcommittee facts on the record should not, in any way,
    object to taking an oath. It will assure us that they not only
    will be subject to the penalties enunciated in the statute that
    you read from, but they also will be subject to perjury if they
    do not relate the facts correctly. I think we should implement
    a policy that everybody coming before this subcommittee will be
    subjected to an oath, and perhaps even a subpoena if that is
    necessary. I will support that.
        I think what we want to have is a very bipartisan effort
    not to rush to judgment or conclusion on any matters. But, to
    suggest that because someone is an official----
        Chairman Baker. The gentleman's time has expired.
        Mr. Ose.
        Mr. Ose. Thank you, Mr. Chairman. I am curious. Is there an
    expectation that Mr. Pitt is not going to tell us the truth?
        Mr. Kanjorski. Not on my part.
        Mr. Ose. What is the purpose of swearing him in?
        Mr. Kanjorski. If I may respond, I have no expectations
    that any particular witness who comes before the Congress of
    the United States does not intend to tell the truth. But, I
    have had experience over the last 17 years in the Congress,
    knowing full well that sometimes witnesses have been brought
    before Congress whose testimony has been questionable. They
    unfortunately did not quite fall under the standard and the
    capacity of enforcement as enunciated in this statute, but
    could have been prosecuted under perjury. If we are going to
    decide----
        Mr. Ose. If I may reclaim my time, this gentleman has been
    confirmed by the Senate as the Chairman of the Securities and
    Exchange Commission. My question remains. Is it the expectation
    of some that he is not going to tell the truth?
        Mr. Kanjorski. Is it not the case that the committees of
    Congress have had Presidents of the United States, who have
    been elected by all of the people in the United States, testify
    before Congress under oath?
        Mr. Bachus. Would the gentleman from California yield?
        Mr. Ose. I reclaim my time and yield to the gentleman from
    Alabama.
        Mr. Bachus. Let me say this. This subcommittee has not
    traditionally, and it is not our normal practice to swear in
    witnesses who testify before us. If we are going to start doing
    that today, then we need to swear in every witness at every
    hearing, and we need to make a decision if we are going to do
    that. And if we do that, we will be departing from our
    tradition, and our tradition is to swear people in when they
    are under investigation, when there was a question that they
    may have committed wrong.
        That is certainly not the case today. Mr. Pitt is not under
    investigation. If we swear him in, we will be changing our
    procedure.
        Mr. Kanjorski. Will the gentleman yield?
        Mr. Bachus. Do you acknowledge that?
        Chairman Baker. It is Mr. Ose's time. He would have to
    answer.
        Mr. Ose. I would be happy to yield to the gentleman from
    Pennsylvania.
        Mr. Kanjorski. I just want to say I do not know how many
    Members of the subcommittee have been here as long as I have.
    Sometimes I have the assumption that everybody has been here as
    long as I have. But, I went through the Whitewater hearings,
    and to the best of my recollections, I remember that we did
    swear in all witnesses regardless of who they were, where they
    came from, or who were their appointing authorities.
        I do not want to, in any way, suggest that I do not expect
    Mr. Pitt will be truthful. He is an honorable man. He is a
    lawyer. How could he be anything other than an honorable man?
        Mr. Ose. If I could reclaim my time, two out of three isn't
    bad.
        Mr. Bachus. We swear in witnesses for investigative
    hearings. This, as such, is not an investigative hearing.
        Mr. Kanjorski. We are not investigating?
        Mr. Bachus. It is not an investigative hearing. It can be,
    but it is not.
        Mr. Kanjorski. What type of hearing is this, may I ask?
    Maybe I prepared incorrectly.
        Mr. Bachus. The House has its definition and rules and this
    does not fall into that category.
        Mr. Ose. If I may reclaim my time.
        Chairman Baker. You have 2 minutes and 15 seconds, if you
    would be happy to share with me.
        Mr. Ose. I would be happy to share with the Chairman.
        I would be happy to swear Mr. Pitt in if I have some
    evidence that he is not going to tell the truth, but if he is
    going to tell the truth, I am not so sure that I need to swear
    him in.
        Chairman Baker. Would the gentleman yield?
        Mr. Ose. Certainly, I would be happy to yield.
        Chairman Baker. Thank you, Mr. Ose.
        To try to get us on point here, this hearing at the outset
    was to be a solution to the systemic problems created by the
    Enron failure. It is not, as Mr. Kanjorski noted, a criminal
    proceeding nor are we in a prosecutorial setting. The gentleman
    has made the absolute correct observation that we are assuming
    that people are innocent until they are proved guilty here; and
    to that end, we are only to require, at my suggestion, those
    who have some clear, defined role in the events of the Enron
    failure potentially to the swearing-in requirement.
        In light of the fact there exists a statute which says, if
    you sit in front of that microphone and say something that is
    not true, you can go to jail, now, that is pretty clear; so I
    am hoping that that level of confidence will instill the
    subcommittee for us to move quickly to resolution, since I have
    now expired your time, Mr. Ose. And I appreciate your courtesy.
        Mrs. Jones. Mr. Chairman.
        Chairman Baker. If I may move next to Mr. LaFalce, and he
    can decide the time. You are recognized for 5 minutes, sir.
        Mr. LaFalce. I thank the Chair, and I am going to suggest a
    compromise, because I think it is important that our
    subcommittee proceed in a very bipartisan fashion. And the
    Chairman of the subcommittee has exercised his prerogative and
    the Ranking Member has exercised his prerogative to have it the
    way he thinks would be best, but what is most important is that
    we proceed to discern not just the Enron problem, but the
    systemic problems that gave rise to Enron, and we devise some
    legislative regulatory scheme that can prevent future Enrons.
        A year ago, as you recall, I opposed strongly the reduction
    in the SEC fees bill, because I thought and called for an
    increase in the budget of the SEC of some 300 percent. Had we
    given more time and attention to the systemic problems that I
    was pointing out at that time, perhaps Enron would not have
    happened, but that is history.
        What I am going to suggest is that with respect to the
    Chairman of the SEC, he be asked if he realizes the existence
    of the law that the Chairman of the subcommittee just read off,
    and if he realizes that any wrongful testimony would subject
    him to the laws of perjury just the same as the swearing-in
    would; and that with respect to private sector parties who
    might not be as aware of the law, that they be sworn in if
    their testimony relates to the Enron situation.
        So we would distinguish between public officials and
    private sector parties, so that Mr. Pitt would not have to be
    sworn in, but he would acknowledge that he understands the law
    and that any deliberately willful testimony of his would
    subject him to the laws of perjury; and that all the other
    future witnesses would be sworn in.
        I offer that as I compromise, Mr. Chairman.
        Chairman Baker. I thank the gentleman for his offering.
        Does Mr. Kanjorski wish to opine?
        Mr. Kanjorski. May I have some time to respond?
        Chairman Baker. Yes.
        Mr. Kanjorski. I love my Chairman and my Ranking Member. I
    believe compromise is excellent, but this is not the reason for
    my asserting the right to have a motion to swear in witnesses
    that appear before us.
        This individual is among the first witnesses that will
    appear before this subcommittee over months and months in the
    future. We do not know who the others will be or what offices
    or authorities they might come from. It just seems to me that
    to the maximum extent possible we ought to treat them all
    uniformly. There is no more reason not to swear in Mr. Pitt
    than there is reason to swear in Mr. Powers.
        Are we suggesting that if you are an expert and dean of a
    law school that your understanding of the law, or intention to
    avoid it, is any greater than if you are a public official? I
    do not believe so. Rather than us making predetermined
    conclusions as to the veracity of potential witnesses, all we
    should do is protect ourselves by uniformly making the rule
    that all witnesses in this matter, who come before the
    subcommittee to give testimony and will ultimately be
    publicized across America, be subject to being sworn in.
        I think that is the most rational conclusion. Quite
    frankly, this motion is not intended in any way to be a
    partisan effort. I am putting this idea forward based on my own
    experiences. I have gone through the Whitewater hearings, in
    this committee and the Government Reform Committee, that
    stretched over 2\1/2\ or 3 years. Never did I suggest that a
    witness in those matters should not have been sworn in. They
    all were, and properly so.
        Moreover, when the Energy and Commerce Committee had
    hearings on the tobacco matter, it had five or six presidents
    from some of the major corporations in America. It was very
    embarrassing, but they were sworn in. I find nothing wrong with
    that. Ultimately that proved very important that they subjected
    themselves to an oath, because if they had not, the question of
    whether or not they could have been prosecuted in that matter
    would have been compromised.
        So, rather than making this a big to-do, I have made my
    motion. It is not the prerogative of the Chair to make this
    decision, but it is the prerogative of the full committee. Mr.
    Chairman, I suggest we call a vote on the full committee and
    those who do not want people sworn in, vote against it. I feel
    very secure in saying to everyone out here and every future
    witness, I hold no ill-will against anyone. I think you all
    intend to do the best and tell the truth, but I still like the
    protections of your testimony under oath.
        Chairman Baker. I thank the gentleman.
        Mr. Chairman, Mr. Oxley.
        Mr. Oxley. Thank you, Mr. Chairman.
        I would simply point out, when we had the first hearing in
    the Congress on Enron in December, the witnesses were not sworn
    in; and that was a joint hearing, if you will recall, between
    your committee and the Oversight Committee. And if there is
    ever a committee that probably ought to have the ability to
    swear witnesses in, it would be the Oversight Committee, as
    opposed to a Legislative committee.
        With that, Mr. Chairman, I move the previous question.
        Chairman Baker. We have a motion for the previous question.
    Is there objection?
        Mrs. Jones. Yes.
        Chairman Baker. Objection having been heard, now the
    question occurs on the previous question.
        All in favor of moving the question?
        All those opposed?
        Roll call. I say the ayes have it.
        Mrs. Jones. Roll call.
        I think that I ought to have an opportunity to be heard, as
    everybody was, Mr. Chairman; and I raised my hand and asked to
    be heard, and so that is the only reason I am asking. All I
    want is a minute-and-a-half, gentlemen and gentleladies.
        Chairman Baker. Without objection, the motion is withdrawn
    and the gentlelady is recognized for 5 minutes.
        Mrs. Jones. Maybe 2.
        Chairman Baker. OK, great, 2.
        Mrs. Jones. Thanks, Mr. Chairman, subcommittee Members.
        Because of the importance of this issue to the American
    public, it seems to me that we are treading on an area that we
    could very easily erode by allowing all the witnesses to be
    sworn in. Having served as a judge and prosecutor, I understand
    the import of having someone take an oath, and it would at
    least give to the public, who is sitting here on the edge of
    their seats trying to figure out what exactly happened in this
    instance, that if we had the witnesses sworn in, at least that
    would add some additional belief that we, the Members of
    Congress, are attempting to get to the issues in this case. And
    I am confident that if you asked Mr. Pitt, he wouldn't care
    whether we swore in him or not. He would probably voluntarily
    say, I will be sworn and we could get on.
        I yield back the balance of my time.
        Chairman Baker. I thank the gentlelady for yielding.
        Mr. Bachus.
        Mr. Bachus. Mr. Chairman, I think we all know and everybody
    in this room knows that there were illegalities, there was
    misconduct and there were non-disclosures, but no one has even
    made a suggestion that this witness is involved in any way
    whatsoever. To change the rules of this House and to swear in
    this witness without any discussion, to start this hearing with
    that is the wrong thing to do.
        If anyone on the Democratic side says that there is
    suggestion of an illegality by the Securities and Exchange
    Commission that might change my mind.
        Mr. Kanjorski. Mr. Chairman, will you yield?
        Mr. Bachus. Well, I've said what I have said. Again, I am
    going to say, bottom line, Chairman Pitt is not under
    investigation. He's not under investigation.
        Mr. Kanjorski. Will you yield for a response?
        Mr. Bachus. I will yield.
        Mr. Kanjorski. First of all, I want to assure you that I do
    not suggest he is under investigation for anything that I have
    remotely heard about. I want to exclude myself from your all-
    inclusive statement.
        This is one Member that does not know whether any
    illegality occurred at Enron or whether there was any
    corruption. I do not know what happened at Enron. The reason I
    came here to this hearing is to begin to find out what
    happened. What I am suggesting to you is, too many in the
    Congress and in the public have jumped to conclusions and
    judgments that may be----
        Mr. Bachus. Let me reclaim my time. I have about 20
    seconds, but I don't in any way discount what I said. I will
    say it again.
        There were illegalities in the Enron case, there was
    misconduct and there were non-disclosures, and if anyone on
    this panel hasn't figured that out by now, they should have.
    They should also realize and use discretion that there is no
    suggestion that this witness is involved in any way whatsoever.
        Chairman Baker. The gentleman's time has expired.
        Mr. Ackerman. Mr. Chairman.
        Chairman Baker. Mr. Ackerman.
        Mr. Ackerman. Thank you.
        The remarks of the previous gentlemen are really why I
    believe we must swear in every witness, because if everybody
    agrees that the first witness is not guilty of anything and
    therefore we don't swear him in, then, by inference, everybody
    we swear in after that is going to be considered guilty because
    we have made a decision not to swear him in, because that
    becomes the criterion.
        I don't know why this is a partisan issue, and it shouldn't
    be, and we shouldn't divide this on party lines. I would think
    everybody here wants to make sure that everybody who testifies
    before the subcommittee is telling the truth and that they are
    subject to the full implication of the weight of anything legal
    we could put on them while they are testifying. Otherwise, it
    is like saying, let's just swear the guilty people in. And if
    that is what we are going to do, let's vote ahead of time who
    is guilty, and then we will swear those people in.
        I don't know how you are going to do it if you don't swear
    everybody in, because you are tainting certain people.
        I will be glad to yield to the gentleman.
        Mr. Bachus. I will just say on many occasions when there
    has been at least some discussion before a hearing that I have
    chaired, should we swear someone in, there was holy heck on the
    other side over the mere suggestion.
        So we are changing our procedure today if we start swearing
    in these witnesses; and there has been at least some suggestion
    that I have heard from the other side that we ought to start
    swearing in all witnesses at all hearings. That is a change of
    policy, and to ambush this subcommittee with such a suggestion
    without any notice has already delayed this hearing for an
    hour.
        Mr. Ackerman. I think the motion before us is just to swear
    in witnesses with regard to the matter before us on this
    particular issue, not every issue that comes before us. Those
    decisions could be made----
        Chairman Baker. Would the gentleman yield?
        Mr. Ackerman. I would be glad to yield, Mr. Chairman.
        Chairman Baker. I would make the point that the gentleman's
    motion would be as to the subcommittee activities. It would not
    preclude at a full hearing of the full Financial Services
    Committee, after we do the preparatory work, the Chairman's
    swearing in anyone deemed advisable. I just don't think we are
    giving away any rights, and I would certainly hope we could
    bring this matter to conclusion. Even if there are differing
    opinions, let's try to get it to the point where we close the
    debate, if we may.
        Mr. Ackerman. I just think that it has nothing to do with
    the full committee or the subcommittee. At the full committee
    level, that decision could be made upon the recommendation of
    the Chairman with the prerogatives of the full committee being
    observed as they are here.
        I yield back my time.
        Chairman Baker. The gentleman yields back his time.
        Mr. Castle.
        Mr. Castle. It seems to me that the distinction between
    what is in the rule and what is being stated here is not that
    great, and I tend to agree with what the Ranking Member of the
    full committee, Mr. LaFalce, has suggested.
        I think we should resolve this question, so I would move
    the previous question.
        Chairman Baker. The question has been called for. Is there
    an objection to the question?
        Without objection, the previous question is ordered.
    Therefore, those who are in favor of the Kanjorski motion,
    which is to swear in all witnesses appearing before this
    subcommittee with regard to the Enron matter would vote yes;
    those opposed to that motion would vote no.
        The clerk will call the roll.
        The Clerk. Mr. Ney.
        [No response.]
        The Clerk. Mr. Shays.
        Mr. Shays. No.
        The Clerk. Mr. Shays, no.
        Mr. Cox.
        Mr. Cox. No.
        The Clerk. Mr. Cox, no.
        Mr. Gillmor.
        [No response.]
        The Clerk. Mr. Paul.
        Mr. Paul. No.
        The Clerk. Mr. Paul, no.
        Mr. Bachus.
        Mr. Bachus. No.
        The Clerk. Mr. Bachus, no.
        Mr. Castle.
        Mr. Castle. No.
        The Clerk. Mr. Castle, no.
        Mr. Royce.
        Mr. Royce. No.
        The Clerk. Mr. Royce, no.
        Mr. Lucas of Oklahoma.
        [No response.]
        The Clerk. Mr. Barr of Georgia.
        [No response.]
        The Clerk. Mr. Jones of North Carolina.
        [No response.]
        The Clerk. Mr. LaTourette.
        Mr. LaTourette. No.
        The Clerk. Mr. LaTourette, no.
        Mr. Shadegg.
        [No response.]
        The Clerk. Mr. Weldon of Florida.
        Mr. Weldon. No.
        The Clerk. Mr. Weldon, no.
        Mr. Ryun of Kansas.
        Mr. Ryun. No.
        The Clerk. Mr. Ryun, no.
        Mr. Riley.
        [No response.]
        The Clerk. Mr. Fossella.
        [No response.]
        The Clerk. Mrs. Biggert.
        Mrs. Biggert. No.
        The Clerk. Mrs. Biggert, no.
        Mr. Gary G. Miller of California.
        [No response.]
        The Clerk. Mr. Ose.
        Mr. Ose. Aye.
        The Clerk. Mr. Ose, aye.
        Mr. Toomey.
        [No response.]
        The Clerk. Mr. Ferguson.
        Mr. Ferguson. No.
        The Clerk. Mr. Ferguson, no.
        Ms. Hart.
        [No response.]
        The Clerk. Mr. Rogers of Michigan.
        [No response.]
        The Clerk. Mr. Oxley.
        Mr. Oxley. No.
        The Clerk. Mr. Oxley, no.
        Mr. Kanjorski.
        Mr. Kanjorski. Aye.
        The Clerk. Mr. Kanjorski, aye.
        Mr. Ackerman.
        Mr. Ackerman. Aye.
        The Clerk. Mr. Ackerman, aye.
        Ms. Velazquez.
        [No response.]
        The Clerk. Mr. Bentsen.
        Mr. Bentsen. Aye.
        The Clerk. Mr. Bentsen, aye.
        Mr. Sandlin.
        Mr. Sandlin. Aye.
        The Clerk. Mr. Sandlin, aye.
        Mr. Maloney of Connecticut.
        [No response.]
        The Clerk. Ms. Hooley of Oregon.
        [No response.]
        The Clerk. Mr. Mascara.
        [No response.]
        The Clerk. Mrs. Jones of Ohio.
        Mrs. Jones of Ohio. Aye.
        The Clerk. Mrs. Jones, aye.
        Mr. Capuano.
        [No response.]
        The Clerk. Mr. Sherman.
        Mr. Sherman. Aye.
        The Clerk. Mr. Sherman, aye.
        Mr. Meeks of New York.
        [No response.]
        The Clerk. Mr. Inslee.
        Mr. Inslee. Aye.
        The Clerk. Mr. Inslee, aye.
        Mr. Moore.
        Mr. Moore. Aye.
        The Clerk. Mr. Moore, aye.
        Mr. Gonzalez.
        Mr. Gonzalez. Aye.
        The Clerk. Mr. Gonzalez, aye.
        Mr. Ford.
        [No response.]
        The Clerk. Mr. Hinojosa.
        [No response.]
        The Clerk. Mr. Lucas of Kentucky.
        Mr. Lucas of Kentucky. Aye.
        The Clerk. Mr. Lucas, aye.
        Mr. Shows.
        [No response.]
        The Clerk. Mr. Crowley.
        Mr. Crowley. Aye.
        The Clerk. Mr. Crowley, aye.
        Mr. Israel.
        [No response.]
        The Clerk. Mr. Ross.
        Mr. Ross. Aye.
        The Clerk. Mr. Ross, aye.
        Mr. LaFalce.
        Mr. LaFalce. Aye.
        The Clerk. Mr. LaFalce, aye.
        Mr. Chairman.
        Chairman Baker. No.
        The Clerk. Mr. Chairman, no.
        Chairman Baker. The clerk will report.
        The Clerk. Mr. Chairman there are 14 ayes and 13 nays.
        Chairman Baker. The motion prevails. Therefore, the
    subcommittee will proceed to swear in each witness as they
    appear in accordance with the subcommittee decision.
        I have a further piece of business which I think, or hope,
    will be received in a bipartisan matter. Given the events of
    the last 24 hours, the Chair would like to place a motion
    before the Members of the subcommittee that requires unanimous
    consent because of Rule 2(b) of the rules requiring prior
    notice.
        I would ask the clerk to report the motion.
        The Clerk. A motion offered by Mr. Baker of Louisiana: Mr.
    Baker of Louisiana moves that the Subcommittee on Capital
    Markets, Insurance and Government Sponsored Enterprises
    authorize the issuance of a subpoena ad testificandum to Mr.
    Kenneth Lay for testimony before this subcommittee at a date
    and time to be determined by the Chairman and Ranking Minority
    Member.
        Chairman Baker. The Chairman is recognized for as such time
    as he may consume to explain the motion.
        Under House procedure, we, as a subcommittee, in the effort
    to subpoena witnesses must do so with the request of the
    Chairman of the full committee. This motion only permits the
    Chair to make such request of Mr. Lay should at such time
    appropriate for committee's work that Mr. Lay be asked to
    appear before the committee. The decision is not made at this
    time that he will be subpoenaed, only authority being granted
    to the Chair.
        Is there discussion on the motion?
        Mr. Kanjorski.
        Mr. Kanjorski. Mr. Chairman, I am in full support of the
    Chair's motion.
        Chairman Baker. Is there any further discussion on the
    motion?
        Mr. LaFalce. As I understand the motion, it is to be
    determined by the Chairman and the Ranking Minority Member?
        Chairman Baker. That is correct.
        Any further comment?
        Mr. Bentsen. Mr. Chairman.
        Chairman Baker. Mr. Bentsen.
        Mr. Bentsen. So you are saying at this point, it is not
    necessarily the intent of the Chair or the Ranking Member to
    issue a subpoena? You just want the authority to do so and will
    issue it based on how the hearings flow?
        Chairman Baker. The gentleman is correct. This is not an
    announcement that a subpoena will be issued; only setting in
    place the proper authority should the Chairman and the Ranking
    Member concur that his presence is required.
        Mr. Bentsen. I, for one, support the motion and I would
    predict that as the hearings go on, we will find that it will
    be necessary to hear from him.
        Chairman Baker. In that event, we will be prepared.
        Is there further discussion?
        Without objection, the previous question is ordered. Is
    there any objection to the motion as reported by the clerk?
        Without objection, the motion is adopted unanimously. The
    Chair, for the record, notes the presence of a quorum, and that
    is important for the issuing of the subpoena.
        There being no further business, I wish to move to
    organizational business, I wish to move to opening statements.
        As I indicated earlier, each side will manage 30 minutes in
    regular order; and I've got to start the clock on myself.
        On December 12, this subcommittee conducted the first
    congressional hearing concerning the failure of Enron. From
    that time until now, there have been a series of vital
    determinations, which have enabled the staff to construct a
    disturbing picture of events. The misrepresentations,
    obfuscation and acts of secrecy should certainly warrant full
    investigation by appropriate enforcement officials to bring
    those to justice who have violated their fiduciary
    responsibilities.
        Whether the Powers Report is appropriately balanced or not,
    given the limited information on which the Report is based, it
    does establish a basis on which to conclude that the corporate
    financial reporting was intentionally complex and misleading.
    On further examination, it may be determined that the rules
    aimed at requiring disclosure were so misused that they were
    warped into a black bag from which no information was able to
    escape.
        It should be made clear as to the role I envisage for this
    subcommittee in light of these disturbing revelations. We are
    not prosecutors. In fact, inflammatory accusation will only
    inhibit our ability to get to the facts--facts which are
    essential for us to reconstruct the regulatory environment so
    that these events will not reoccur. We should carefully assess
    the record, find how and if the system failed, and enact the
    appropriate corrective remedies.
        It is clear, in Baton Rouge, Louisiana, this afternoon
    there are employees wondering if their corporation is really
    telling the true story, pensioners wondering if they are safe,
    investors worrying about the analyst's report. This singular
    event has created a crisis of confidence that must be
    reconciled.
        How is it that the auditors, the analysts, the board
    members, the investors, the regulators and even the financial
    press could not find anything to alert the public that Enron
    was not all it appeared to be? Even if it was the Enron plan to
    dupe the entire financial marketplace and abscond with millions
    of dollars for a chosen few, how is it possible for that to
    occur in our technological society with watchdogs on every
    corner?
        The historical facts may answer that question. It wasn't
    possible. I direct your attention to a New York Times article
    published January 27 of this year in which it is described how
    a German-based energy company balked at a merger with Enron
    principally over concerns with Enron's accounting practices.
    These events occurred in 1999, long before anyone had the nerve
    to suggest that Enron had problems.
        I find a quote from the article very instructive:
    ``consultants from PriceWaterhouseCoopers told Veba that Enron,
    through complex accounting and deal-making, had swept tens of
    millions of dollars in debt off its books, making the company's
    balance sheet look stronger than it really was, according to
    the people involved in analyzing the failed deal. The
    consultants drew on public sources like trade publications,
    securities filings and interviews.''
        The story goes on: `` `We were wondering why this wasn't
    common knowledge, or why it wasn't discovered by those people
    whose business it was to discover these things,' said one of
    the people who worked on analyzing the deal. He agreed to
    discuss the episode on the condition that his firm remain
    anonymous.''
        I remind you, this occurred in 1999.
        In accordance with full transparency and disclosure
    standards, I must also acknowledge that the article goes on to
    point out that the SEC and FASB should have taken more
    responsibility to intervene to protect the public interest.
    That is where I feel the subcommittee's attention should be
    appropriately focused.
        If the rules are not clear, if there's any doubt in
    anyone's mind, I feel we must make it very clear. If in your
    professional judgment, Mr. Auditor, Mr. Analyst, Mr. Board
    Member, or any other person in a fiduciary role, if you see it
    and it doesn't look right, it is your obligation to report it
    to the appropriate authority. The practice of walking by the
    accident scene and leaving the victims to their own demise will
    no longer be an act tolerated by the Congress.
        It is the principal obligation of this subcommittee to find
    out how the system failed and then to act to ensure the system
    not only works, but to ensure there is redundancy. We must
    guarantee protection of the shareholders, the employees, and
    every pensioner whose lifelong savings may be tied to the
    truthfulness of the required disclosures.
        It is clear that some were able to find the truth to
    protect their own interests. The big question is, why was it
    impossible for others to see the truth?
        To that end, I feel it is an absolute necessity to
    establish audit independence. The reported numbers should add
    up properly and tell the true corporate story. I believe there
    are two very different ways to accomplish this goal.
        One is to require dramatic new standards of responsibility
    for everyone, from the corporate board to the audit committee
    to the SEC, to ensure the individual auditor is not intimidated
    by management.
        The other approach, one which would change the culture on
    Wall Street and across America, is to separate auditing from
    the corporation entirely by requiring external audits to be
    paid for by someone other than the corporation. Perhaps, as
    some have suggested, it is time to have the stock exchanges
    engage the auditors and report their findings simultaneously to
    the exchange and the corporation. After all, should we really
    be surprised when you pay the piper, the piper plays your tune?
        I intend to explore these ideas more fully with Chairman
    Pitt today in the effort to propose the best remedy, if
    possible, for this problem. But we won't take long to evaluate
    proposals as this subcommittee will act in days, not months or
    years.
        The simple point is this: In viewing the corporate
    landscape today, I do not like what I see. Although most
    corporations are very well run and responsible, it is difficult
    to accept when a corporation closes its doors due to
    competitive pressure. But that is an unfortunate consequence of
    a free market system, losers finally lose.
        But it appears there is a new threat in our complicated
    market that did not seem possible in the slower, contemplative
    world of typewriters and white out. It is clear now that it is
    possible for an aberrant corporate manager to take corporate
    assets, manipulate the books, enrich himself, and leave others
    to pay the price by making the transaction complicated,
    convoluted and computerized.
        As a result, faithful employees lose it all. Life savings
    evaporate, investors are duped, lives are ruined--not in
    innovative competition, but from dark, sinister manipulation.
        We will bring the sunlight in. Whether we just add some
    really big windows or whether we take the roof completely off,
    sunlight will shine in the corporate board room. Those who
    choose to ignore their responsibilities and enrich themselves
    while bringing harm to others shall have no safe harbor.
        Those who labor long, build value, and create opportunity
    should be rewarded. We should all have confidence that the
    American dream is within our reach.
        [The prepared statement of Hon. Richard H. Baker can be
    found on page XX in the appendix.]
        Chairman Baker Mr. Kanjorski.
        Mr. Kanjorski. Mr. Chairman, we have learned much since our
    last hearing in December about the factors contributing to the
    collapse of Enron. We have, for example, begun to understand
    how many of the checks and balances, which are supposed to
    contain excesses in our capital markets, either failed or
    short-circuited. We have also started to ascertain exactly how
    Enron's executives, directors, attorneys and auditors
    contributed to the corporation's demise. We have further
    discovered more about how the decisions and actions of
    regulators, stock analysts, credit raters and investment
    bankers helped to cause Enron's disintegration.
        Additionally, many of my colleagues helped to create the
    environment that resulted not only in the insolvency of Enron,
    but also in the bankruptcy of numerous other high-flying
    companies in recent years. In the 1990s, many of my colleagues
    successfully pushed for the passage of deregulatory efforts and
    blocked the development of new regulatory safeguards. As we
    proceed, we therefore need to reflect on the Congress' own
    culpability for the current events.
        More than a decade ago our committee helped to clean up the
    savings and loan crisis. Deregulatory efforts contributed
    significantly to that debacle. Once again, it appears that we
    may have gone too far in deregulating. Enron's failure and the
    collapse of other companies may be the revenge of the rush of
    some to deregulate the securities markets.
        In light of recent events, the Private Securities
    Litigation Reform Act of 1995, which became law despite a
    Presidential veto, deserves careful review. This statute, part
    of the so-called Contract with America, was supposed to prevent
    ``frivolous'' lawsuits. This law, however, has apparently
    helped businesses to manipulate their financial results.
    Evidence now indicates that earnings restatements by companies
    have more than tripled since the early 1990s. This law may also
    prevent investors from recovering billions of dollars they lost
    in Enron.
        And last year, before examining the resources needed by the
    Securities and Exchange Commission, many of my colleagues
    rushed to cut the fees collected on securities transactions.
    The Commission was and is the regulator with primary
    responsibility for overseeing Enron, yet it appears that the
    Commission has failed to review Enron's financial disclosures
    since 1997. I want to know why that occurred. Moreover, it
    seems that the Bush Administration has decided to recommend an
    insufficient increase in the Commission's budget for fiscal
    2003. To protect investors from other Enrons, we must
    significantly increase these resources in the months ahead.
        The financial devastation caused by Enron warrants our
    thorough investigation. We need to examine quickly and
    comprehensively the deficiencies in our public policies that
    contributed to this corporate bankruptcy. We must also
    determine appropriate ways to reform our Nation's securities
    laws and regulations.
        There are, however, many of my colleagues who want to rush
    to pass legislation before we uncover the entire set of facts
    in this case. To each of them, I urge restraint. If we take our
    time and learn the complete story, we have an opportunity to do
    something meaningful and responsible on a bipartisan basis. We
    should ultimately develop strong, effective and appropriate
    policy to prevent similar debacles in the future, and gathering
    all the pertinent facts will facilitate attaining this goal.
        When we do consider a bill, I have already identified many
    issues that we should address. In addition to reviewing the
    consequences of the Private Securities Litigation Reform Act,
    we must fix the problem of auditor independence. My feeling is
    that no accounting firm should serve as both auditor and
    consultant to the same company. Although I applaud the efforts
    to the industry in recent days to mitigate these conflicts, we
    may need to pursue further reforms.
        We must also improve supervision over the accounting
    profession. The current oversight system resembles a Rube
    Goldberg contraption. As a result, we must develop a new
    regulatory regime that involves genuine public oversight and
    real accountability. Moreover, we have learned of the excesses
    of Enron only because it failed. We should take this
    opportunity to better understand the problem of earnings
    management and how it affects other companies.
        Many other issues fall firmly within our jurisdiction and
    demand our examination in the months ahead. We must return to
    the issue of analyst independence. We must also study the
    corporate governance systems of public companies. We must
    further scrutinize the financial disclosure requirements of
    American businesses. We must additionally analyze the flaws of
    our accounting standards and the deficiencies of credit rating
    agencies. Finally, we must review the responsibilities of the
    Securities and Exchange Commission.
        In closing, Mr. Chairman, we must move with diligence to
    dissect what went wrong first, and then take action to restore
    faith in our Nation's capital markets.
        [The prepared statement of Hon. Paul E. Kanjorski can be
    found on page XX in the appendix.]
        Chairman Baker. The gentleman yields back the balance of
    his time.
        Chairman Oxley.
        Mr. Oxley. Thank you, Mr. Chairman; and let me first thank
    our good friend, Chairman John Boehner, for the use of the
    committee room. As many of you know, our committee room is
    being renovated and will not be completed until sometime late
    this month. So we appreciate the hospitality.
        Our committee began its work on the Enron collapse with our
    first hearing over a month-and-a-half ago, in mid-December of
    2001. Today and tomorrow, we continue our review of Enron and
    its impact on investors, employees and the financial markets.
        We on this subcommittee are working to achieve three basic
    goals; First, making sure that Congress knows how the biggest
    corporate collapse in American history happened; second, to
    restore investor confidence in accounting regulators and in
    rules governing our markets; and third, making sure that the
    free market system and the regulatory system that underpins it,
    emerge stronger and better as a result of our work.
        This subcommittee oversees the financial and capital
    markets. We oversee the regulation of those markets, so we have
    a fundamental responsibility. We take our work very seriously,
    and we are committed to doing what is right. We are also
    working hard, but we are not working alone. We are working
    closely with the major investigators, the Justice Department,
    the SEC, and Enron's and Andersen's own internal teams. We
    greatly appreciate their active assistance and cooperation and
    their insights, and we will make sure that our work complements
    theirs and does nothing to impede it.
        I am also gratified that the President in his State of the
    Union address told us to make our work here a top priority. The
    President believes, and I agree, that ``corporate America must
    be made more accountable to employees and shareholders, and be
    held to the highest standards of conduct.'' That is exactly
    where we as a committee are headed.
        There has been a lot of talk from a lot of people about
    what might have happened at Enron, but Congress and the
    American people deserve to know the facts directly and from
    those who are most directly involved. That is what is going to
    happen today and tomorrow.
        We have with us three of the people most directly involved,
    the chief securities regulator, SEC Chairman Harvey Pitt;
    Enron's chief internal investigator, Mr. William Powers; and
    the company's outside auditor, Mr. Berardino, CEO of Arthur
    Andersen, who will be making his second appearance before the
    subcommittee. We thank them all for being so willing to be
    here.
        Everyone should know, they all wanted to come here and
    testify, though these are very difficult circumstances for
    them. Until last night, we were expecting Mr. Ken Lay, former
    CEO of Enron.
        Chairman Baker. That is the ghost of Enron, Mr. Chairman.
        Mr. Oxley. I take back that thanking of Chairman Boehner.
    We don't have strange whistling in our committee room.
        At the last minute, we were notified, as you all know, that
    Mr. Lay would not appear; and I know all the Members join me in
    saying we are extremely disappointed that he broke his
    commitment to our subcommittee; and indeed, the unanimous
    resolution that the subcommittee passed giving Mr. LaFalce and
    me the ability to issue a subpoena will be acted on forthwith.
        Congress' job is different from those of the judges, juries
    and prosecutors who will deal with the many individual
    instances of alleged wrongdoing. Our job is not to convict,
    prosecute or persecute. Our job is to understand what happened,
    address the problems and make our free market system better and
    more impregnable than ever before. I think I speak for all my
    colleagues in saying, we are committed to that goal and we will
    be working hard together to achieve it in the weeks and months
    ahead.
        I yield back the balance of my time.
        [The prepared statement of Hon. Michael G. Oxley can be
    found on page XX in the appendix.]
        Chairman Baker. I thank the Chair.
        Mr. LaFalce.
        Mr. LaFalce. I thank the Chairman.
        First of all, I want to explain that the Chairman of the
    full committee and I, as Ranking Member, are ex officio Members
    of all the subcommittees. In previous Congresses, it was as
    non-voting Members, and in this Congress it is as voting
    Members, but we had agreed to abstain from voting in
    subcommittee matters unless the other Members were given notice
    in advance; and it was only because Mr. Oxley voted that I
    voted during the course of the subcommittee markup with respect
    to the issue before us.
        In January of 2001, our committee was given jurisdiction
    over the securities industry, and from that time I began
    warning that earnings manipulation and deceptive accounting,
    along with analysts' hype, threatened the integrity of our
    capital markets. And from early 2001 on, I began calling for a
    significant increase in the SEC's budget to strengthen its
    personnel, oversight, and enforcement--not a 2 or 3 percent
    increase, but a 200 or 300 percent increase before this
    subcommittee, before the Rules Committee and on the floor of
    the House of Representatives.
        I think that Enron's colossal failure and its devastating
    impact on investors and the working men and women at Enron have
    more than justified those concerns.
        Today, we are going to hear from Mr. Powers on what went
    wrong at Enron and how a culture of corporate arrogance and
    greed resulted in losses of over $60 billion to investors and
    employees. The Special Investigative Committee's Report is a
    devastating indictment of Enron's senior management, its board
    of directors, its auditors, its lawyers, securities analysts
    who were supposed to be representing the public, and so forth,
    all of whom failed to fulfill their responsibilities to Enron
    shareholders. The safeguards that should have protected
    investors failed at every level.
        But they have also failed at every level for countless
    other publicly held corporations, a number of whom have had to
    have their earnings restated in record numbers; and I suspect
    that there are many, many more to come. But Enron, in
    particular, has been a wake-up call, because Enron is what it
    took to challenge investors' faith in the integrity of our
    capital markets. My hope is that Enron has what it takes to
    have us do something about it.
        We must address the systemic problems that Enron's failure
    has made all too apparent. We must restore the faith of
    investors in our capital markets, and we must restore the faith
    of workers in their employers; but to do so, we must engage in
    a bipartisan, if possible--collective in any event--rethinking
    and reformulation of how we oversee our capital markets and our
    financial disclosure system. We must also give the SEC the
    resources it needs to do its job.
        I was extremely disappointed to learn that the
    Administration has not seen fit to provide the SEC with any
    increase in its resources to address these challenges or even
    to fund pay parity for SEC employees. The budget that I became
    aware of today apparently calls for a 4 percent nominal
    increase in the SEC budget. That is grossly inadequate to even
    fund pay parity for the present employees, much less strengthen
    the resources that are needed to do the job.
        I have been engaged in what I think have been productive,
    so far bipartisan, discussions, with both Mr. Oxley and Mr.
    Baker, along with Mr. Kanjorski, to attempt to craft
    legislation to deal with the serious policy issues that cases
    such as Enron give rise to. We are not there yet. We still have
    serious areas of disagreement, but I hope we will be able to
    come to some consensus.
        But, at a minimum, I believe we must address the following
    areas: Seriously consider the recommendations that were made by
    Arthur Levitt, that I strongly supported when he made, to
    separate the audit and consulting functions to ensure that
    auditor judgment is not tainted by the fees received for non-
    audit services.
        Data now available under the SEC's disclosure rule on non-
    audit fees makes clear that for the auditors of many large
    public companies, audit fees are often a minor percentage of
    the fees they receive. Even in the absence of Enron, I think
    that data alone justifies a reexamination.
        Some have also suggested that we should consider going
    beyond that, that in order to improve auditor independence, we
    should consider term limits for auditors. The suggestions have
    been made by serious individuals and should at least be
    considered seriously.
        Second, exclusive self-regulation has brought us to where
    we are today, and I don't think can work in and of itself. We
    need significantly enhanced public oversight and regulation of
    both the auditing and securities industries, including a strong
    new auditing regulator with a full range of powers. I would
    like to see representatives of working men and women on that
    regulator. I would like to see representatives of institutional
    investors on that regulator.
        With respect to the securities industry, we have to hold
    them to a much higher standard. The fact that in the year 2000,
    when the market was falling precipitously, only one in 100
    recommendations were ``sell'' recommendations gives cause for
    great concern. The public relies on the securities analysts for
    counsel and advice, and they have been relying on their advice
    at their own peril.
        Third, we must find a way to provide a massive increase in
    SEC resources. The President's proposed budget just doesn't do
    it and given the mechanisms where the SEC has to work in
    concert with the OMB, we are not going to find out from them
    what resources are really necessary.
        And it is not just the resources of the SEC. It is the FBI
    resources to work with the SEC; it is the Justice Department
    resources to work with the SEC.
        We offered amendments in committee and when we're
    considering the totality of the governmental response, we
    consider not just the SEC, but the FBI and Justice Department
    amongst others, and our amendments were defeated. That is
    regrettable. There are a number of other items that I think are
    extremely important, but with your consent, Mr. Chairman, I
    would simply ask that the entirety of my statement be included
    in the record at this time.
        [The prepared statement of Hon. John J. LaFalce can be
    found on page XX in the appendix.]
        Chairman Baker. Without objection, Mr. LaFalce.
        I had a prior discussion with Ranking Member Kanjorski and
    if I could suggest the following procedure for the remaining
    time to be allocated. In order to facilitate as many Members
    being heard as is possible with the remaining 10 minutes per
    side, we have agreed to recognize each Member for a 2-minute
    statement, and on the Majority side the five Members who would
    be recognized to help prepare for that would be Mr. Shays, Mr.
    Cox, Mr. Paul, Mr. Bachus and Mr. Royce in that order today. On
    the Minority side it will be Mr. Ackerman, Mr. Bentsen, Mr.
    Sandlin, Mr. Sherman and Mr. Inslee in that order on the
    Minority side. Without objection, so ordered.
        Mr. Shays, you're recognized for 2 minutes.
        Mr. Shays. Thank you, Mr. Chairman, for having this
    hearing.
        Enron was a disaster to its employees and stockholders and
    it has raised tremendous concern among my constituents. How
    could the seventh largest company in the United States of
    America nearly evaporate before our eyes? They want to know
    will standards, regulations and laws be strengthened and will
    people be held accountable, not just company fines paid.
        Enron is a story of risky investments and greed, regulators
    not regulating, analysts not digging deep enough, auditors not
    auditing, directors not directing, lenders not checking
    creditworthiness. It is also a story of cover-up and fraud.
        Enron is also a story about big campaign dollars, buying
    access and influence. Enron has given to both Democrat and
    Republican parties, raising serious questions about who is
    setting the agenda in Washington. We need to end the abuse of
    corporate treasury and union dues contributions and campaigns,
    and I think Enron is a clear example of that.
        Congress has to also consider, among other issues,
    separating consulting and accounting work, dividing investment
    banking from analysts and making disclosure of stock holdings
    and investment banking ties more prominent in research reports,
    potentially term limiting auditor contracts for individual
    companies, requiring outside entities be incorporated into
    financial disclosure statements so as not to understate
    liabilities and overstate earnings, and encourage diversity by
    employees with 401Ks.
        There's lots of work to be done. I am eager to participate
    in all the hearings you may call, Mr. Chairman.
        Chairman Baker. Thank you very much, Mr. Shays.
        Mr. Ackerman, you are recognized for 2 minutes.
        Mr. Ackerman. Thank you, Mr. Chairman, and thank you, Mr.
    Kanjorski.
        I am amazed, confused, bewildered, astonished, and a lot of
    other adjectives, by the sequence of events that has brought us
    here today, and the American people are equally outraged and
    concerned. We have convened this hearing on the Enron debacle
    to learn what happened and what we might do to make sure that
    this kind of thing never happens again. It would have been much
    easier if former Enron CEO Ken Lay had decided to join us.
        We are faced with the single largest bankruptcy our Nation
    has ever seen. We have people who have invested in and/or
    worked all their lives for Enron only to have their life
    savings and dreams stolen from them. These employees were sold
    snake oil, told that the stock their employer was peddling to
    them was sound even as the Enron bosses were dumping Enron
    shares left and right. Workers and investors were told stay in
    ``steerage'', and all the time that was happening the crew was
    bailing out.
        One of the key failures that has come to light is that the
    major accounting firms, including Arthur Andersen, have engaged
    in cozy business relationships with their clients. The
    accountants would consult with, advise and set up business
    arrangements for their clients and then turn around and audit
    the very same companies, thereby providing the imprimatur of
    sound business practices on the schemes they themselves may
    have helped to devise. That's absurd. During the night, why do
    we allow the fox to guard the chicken coop and why are we
    surprised when the sun comes up that all we're left with are
    feathers?
        The GAO has recognized the problems inherent to the company
    providing both auditing and non-auditing services to the same
    client. They have announced this business practice will no
    longer be allowed when doing business with the Federal
    Government. Today, I am introducing, and I invite all Members
    who wish to join me in introducing, legislation to require that
    the SEC revise its auditor independence rules so they are at
    least as tough as the GAO practices. If the Federal Government
    will no longer tolerate this potential for abuse in business
    practices, why should it be allowed to continue in the private
    sector?
        I am almost afraid to ask what I think is the real
    question: Is this the tip of the iceberg? How many other
    corporate giants may have smoking mirror businesses peppered
    over by prestigious CPA firms?
        I am pleased that the subcommittee will have the
    opportunity today to hear from these witnesses to learn what
    went wrong and how we work to make sure this type of systemwide
    failure never happens again. Will these hearings be sufficient?
    Maybe, maybe not, for too many influential people aren't going
    to be talking.
        Chairman Baker. The gentleman's time has expired.
        Mr. Ackerman. We may need to have a special prosecutor who
    will be diligent in uncovering the truth. The people broke the
    law, they should go to jail.
        I thank the Chairman for calling the hearing.
        Chairman Baker. Mr. Cox, recognized for 2 minutes.
        Mr. Cox. Thank you, Mr. Chairman. I want to welcome the
    Chairman of the Securities and Exchange Commission, and we are
    very much looking forward to your testimony and that of the
    board special committee to follow you.
        I am also very pleased as we meet here today that as we try
    and pick up the pieces, as the victims of the Enron debacle try
    through both civil and ultimately criminal proceedings to gain
    vindication, that we can rely upon the very pro-shareholder
    legislation that this Congress enacted some years ago in the
    form of the Securities Litigation Reform Act, because many of
    the Members of this subcommittee, given our change in
    jurisdiction in the Congress----
        Chairman Baker. Pull your mike up.
        Mr. Cox.----were not present at the birthing and the
    drafting of that legislation. I just want to bring to the
    Members' attention some of what it is going to do for the
    shareholders of Enron who are now seeking vindication. In the
    old days it used to be that the first lawyers of the courthouse
    got to represent you in a class action. We ended that abuse. We
    ended that process and now the court is going to pick the best
    class representative.
        The Securities Litigation Reform Act gives the court the
    power to review unconscionable attorneys fees so that the
    recoveries for abused shareholders will be greater. It imposed
    new responsibilities on auditors to detect and report illegal
    acts. It eliminated the professional plaintiffs that used to
    victimize shareholders in fraudulent and extortionate lawsuits.
    It strengthened the conflict of interest rules relating to
    attorneys, ensuring that shareholders are going to get fair
    representation.
        Mr. Chairman, as you know, the Securities Litigation Reform
    Act broadened the SEC's aiding and abetting enforcement
    authority, strengthening the ability of the Commission to
    prosecute those who aid and abet violations of our securities
    laws.
        I also wanted to point out, in conclusion, that far from
    making it more difficult to bring these kinds of lawsuits, it
    seems to have advantaged meritorious cases. In the 5 years
    preceding the enactment of the Securities Litigation Reform Act
    the average number of securities laws fraud suits filed in our
    Federal courts was 189. That's increased now 250 percent, so
    that for 2001 the actual number of cases filed was 486, and the
    average settlements have gone way up, from an average of--pre-
    enactment to $18 million post-enactment so that shareholders
    are getting more as a result of these important reforms.
        I think it is very important that we also take a look at
    the rating agencies, Mr. Chairman, and I am pleased that you
    have done that in your testimony. You have brought that to our
    attention. We are going to be looking at the role of the
    accounting profession and corporate governance and the
    independence of the auditing committee. Many of these questions
    your testimony is going to be especially valuable on.
        I thank you for being here this afternoon and thank you,
    Mr. Chairman.
        Chairman Baker. The gentleman's time has expired.
        Mr. Bentsen, you are recognized for 2 minutes.
        Mr. Bentsen. Thank you, Mr. Chairman, for having this
    second hearing on the collapse of Enron. Mr. Chairman, if this
    had been just a normal bankruptcy for economic reasons or bad
    business decisions, we probably wouldn't be having these
    hearings, but this isn't just a normal bankruptcy.
        I want to read a quote from an e-mail that was sent by a
    person who ought to be here this week and is not here, but I
    think it is pretty telling. This was done at the end of August,
    and it says, ``One of my highest priorities is to restore
    investor confidence in Enron. This should result in a
    significantly higher stock price.''
        This was an e-mail that was sent to one of the many
    thousands of employees, one of my fellow Houstonians, last fall
    at the same time that senior executives of Enron were dumping
    their stock, either through selling it in the open market or
    selling it back to the company, which in some instances they
    appeared to use as their own private bank.
        The fact is, Mr. Chairman, that a number of my fellow
    Houstonians were hoping today and tomorrow that the Congress on
    their behalf would be able to ask questions that they don't
    have a right to ask, that the Congress would be able to ask
    questions that they don't have at the table in the bankruptcy
    court. And before us today in the audience we have a number of
    former Enron employees who traveled up here because they're
    looking for some answers. They are trying to find what happened
    to the company that they put their heart and soul in, what
    happened to their savings accounts, where are their cash
    balance accounts, why were some employees given retention
    bonuses after the company filed bankruptcy. Unfortunately, Mr.
    Chairman, they are not going to get those answers today,
    because Kenneth Lay, who agreed to testify after you and the
    Ranking Member had been exceedingly generous, I think, in
    trying to structure the hearing, chose to back out in the
    eleventh hour under the lame excuse that somehow they didn't
    appreciate comments made by colleagues of ours on the talk
    shows yesterday. And I think that is truly unfortunate, because
    what we need to find out is whether or not this was a case of
    the end of the ``rational exuberance,'' whether or not this is
    the new form of the savings and loan model that we went through
    in the 1980s, who was minding the store, what did they know and
    when did they know it.
        And I appreciate the fact that you and the Chairman of the
    full committee have taken the authority to issue subpoenas,
    because we will have many questions to ask and we will need to
    have these individuals come here, and I appreciate you calling
    this hearing today.
        Chairman Baker. Mr. Paul, you are recognized for 2 minutes.
        Mr. Paul. Thank you, Mr. Chairman.
        I see that there have been two driving forces pushing this
    Enron story. One has been the politics of it. I find that
    unfortunate. I wish that politics would be less involved than
    the policy issues. But the other driving force is the attack on
    capitalism, which I think is misplaced, and it is driven by
    those who would like to have a lot more regulations and use
    this as an example of the failure of capitalism. I see exactly
    the opposite.
        This is an example of the failure of corporatism. We have
    large corporations who buy influence, and they come up here to
    get subsidies in the form of corporate welfare. Enron received
    $1.6 billion worth of corporate welfare from the Eximbank and
    the Overseas Private Investment Corporation. That is where I
    see the problem.
        Also, we have a responsibility for our monetary system, and
    yet we do very little to monitor the excessive easy credit
    system that allows banks to make billions of dollars worth of
    credit that are uncollateralized. This can only happen in a
    funny money, fiat paper money system, and we ought to look at
    that more carefully.
        We have been talking about the accounting, and I think the
    accounting is a very serious problem. The idea of creating debt
    and calling it an asset, that is outrageous. That's almost like
    what Social Security does, what we do here. It looks like they
    learned some of the lessons from us.
        So I find this rather tragic to attack capitalism on this
    issue. We should not think this is a reason for more regulation
    in a free market when the market fails and the market takes
    care of these companies. But what did we do with Long-Term
    Capital Management? We bailed them out and sent the wrong
    message. No wonder we have encouraged companies like Enron, and
    there are a lot more around.
        Fraud--you say we have to do this investigation for fraud.
    Sure, we would like to know about it, but that's never been the
    prime responsibility of the Federal Government. That is a State
    issue. In many ways we are connected, but I would like to see
    us address the subject for which we are directly responsible--
    the Federal Government's subsidy of corporations like Enron who
    are created with a monetary system that is illogical that we
    have seen with the financial bubble.
        [The prepared statement of Hon. Ron Paul is found on page
    XX in the appendix.]
        Chairman Baker. Thank you, Mr. Paul.
        Mr. Sandlin is recognized for 2 minutes.
        Mr. Sandlin. Thank you, Mr. Chairman.
        On December 12, the Capital Markets Subcommittee held the
    first of what I hope are several hearings on the financial
    implications of the Enron bankruptcy and its auditor, Arthur
    Andersen. In a remarkable 6-week period, a series of troubling
    and at times stunning revelations, we have been exposed,
    highlighting possible corporate malfeasance, testing our faith
    in self-regulation. Crafting the necessary legislative and
    regulatory remedies can only occur by identifying the
    deliberate misdeeds and illegal activities that precipitated
    this historic meltdown.
        Most pertinent to this subcommittee's investigation of
    Enron's collapse are the numerous questions surrounding the
    vast arrays of entities and partnerships created by senior
    Enron officials. With the blessing of Enron's executive
    committee of the Board of Directors, deceptive and illegal
    partnerships were created to conceal hundreds of millions of
    dollars of debts from Enron's balance sheet. I am deeply
    troubled that the most volatile and complicated partnerships
    were created by Enron's former Chief Financial Officer, Andrew
    Fastow, and blessed through the paternal ignorance or sly
    acquiescence of Enron's former CEO, Ken Lay.
        America's securities laws are designed to prevent the
    creation of stocking horses whose only intent is to deceive
    investors for the benefit of the company's stock price. I am
    deeply disappointed that Mr. Lay has canceled his appearance
    before this subcommittee--please note I change that--Mr. Lay
    has canceled his appearance before this subcommittee and is
    taking the fifth amendment by absentia. Americans want to know
    about the role that senior officers played in engineering and
    executing the hundreds of special purpose entities that
    enriched select employees while deceiving shareholders, Federal
    and State regulators, and Enron employees.
        All of America now knows Enron, to paraphrase a former
    company vice-president, ``imploded in a wave of accounting
    scandals,'' as Enron's Arthur Andersen signed off on the
    veracity of Enron's financial statements, financial statements
    that Enron admitted overstated its earnings by almost $600
    million over 5 years. Further, I believe that the actions taken
    by Andersen's employees to destroy documents after the company
    knew of the SEC inquiry into Enron's bankruptcy raises the
    prospect of criminal penalties and civil liability.
        Chairman Baker. Can you begin to wrap up?
        Mr. Sandlin. I applaud Harvey Pitt for putting forward a
    very modest proposal. I believe it is only a first step.
        Mr. Chairman, we appreciate you calling this hearing today.
        Chairman Baker. Thank you, Mr. Sandlin.
        Mr. Bachus is recognized for 2 minutes.
        Mr. Bachus. Mr. Chairman, I would ask unanimous consent to
    use my 2 minutes at the opening of the Powers testimony because
    my statement focuses on the 11,000 Enron employees who lost
    their retirement.
        Chairman Baker. Any objection to Mr. Bachus being
    recognized for 2 minutes prior to the next witness on this
    panel? Any objection? Without objection, so ordered.
        Mr. Inslee. I'm sorry. Mr. Sherman, you're next.
        Mr. Sherman. I join with Mr. Shays in pointing out the need
    for campaign finance reform. I echo Mr. LaFalce's comments that
    we need a revved up SEC. We need a SEC staff that will review
    every financial statement and demand the clarification of every
    fuzzy footnote. I join with Mr. Ackerman in his fear that there
    may be more Enrons out there. We need better accounting rules.
        As I said in December, it is as if we found a SUV had
    plowed into schoolchildren driving 101 miles an hour in a
    school zone. Arthur Andersen should have pulled them over, but
    then we find out that the posted speed limit in that school
    zone is 100 miles an hour.
        Today's Washington Post indicates the Chewco partnership
    could have been kept off the books. Even today, if only $4.4
    million of capital had been rounded up, over $1 billion of
    financial statement impact would still be hidden and Enron
    might still be alive, suckering in more investors.
        We need better accounting rules for addressing special
    purpose entities, addressing derivatives, addressing
    transactions in the company's own stock and especially
    addressing derivatives in the company's own stock, including
    puts and calls and options in the company's own stock. We
    should explore whether audit firms should be allowed to provide
    substantial tax and management consulting services. But I would
    point out that if we shrink these firms to half their present
    size, which would happen if we did that, then a fee of half the
    size might still have the same conflict of interest impact.
        Chairman Baker. Begin to wrap up, sir.
        Mr. Sherman. I would point out that if Arthur Andersen was
    just its own auditing department, it would have received a fee
    of only $25 million from Enron, but that would represent 1
    percent of its total revenue.
        Finally, we need to explore whether there should be tenure
    and term limits for auditors so they serve 5 years and then
    leave. We need new accounting standards and we need to explore
    new limits on the relationship between auditors and clients.
        Chairman Baker. The gentleman's time has expired.
        Mr. Royce, you are recognized for 2 minutes.
        Mr. Royce. Enron's efforts to disguise its bad investment
    losses and to increase its earnings by about $1 billion higher
    than they should have been through financial sleight of hand
    were intentionally deceptive, and it was a blatant attempt to
    undermine the fundamental purpose of financial accounting,
    which is transparency. Corporate executives of publicly held
    companies have a moral responsibility and a legal
    responsibility to make their balance sheets representative of
    the financial reality that exists and to make them
    understandable to the investing public, and that is one of the
    things that the SEC needs to address here today. Enron's use of
    questionable special partnerships clearly runs contra to the
    principles of consolidation and transparency, upon which our
    fair and successful free market system is predicated.
        And at the same time, Enron employees involved in the
    partnerships were enriched by self dealings to the extent of
    millions of dollars that they should never have received. That
    should be investigated.
        Also Enron's collapse raises the issue of the culpability
    of the accounting and auditing industry in ensuring that
    corporations live up to these moral obligations. Emerging
    behind the scenes accounts of document shredding at Arthur
    Andersen raise serious concerns about the degree to which
    Andersen was willing to subjugate its fiduciary responsibility
    to shareholders in pursuit of lucrative internal auditing and
    consulting contracts, posing a potential conflict of interest
    within the industry, and that we must address. And Enron's
    accounting treatment was determined with structural advice from
    Arthur Andersen. Arthur Andersen, amazingly enough, billed
    Enron $5.7 million for the advice in terms of how to set up
    these partnerships and did that on top of its regular audit
    fee.
        And finally, the fact that those individuals charged with
    overseeing the auditing community were unable to prevent
    Enron's collapse casts serious doubt over the efficacy of the
    peer review process by which accounting firms currently review
    each other's work. The Public Oversight Board and the peer
    review process seems untenable in its current form, and that
    creates the necessity for a new system to ensure that public
    accountancy is correct, impartial and free of the moral hazard
    associated with the conflict of interest currently plaguing the
    auditing process.
        [The prepared statement of Hon. Ed Royce can be found on
    page XX in the appendix.]
        Chairman Baker. Mr. Inslee, you are recognized for 2
    minutes.
        Mr. Inslee. Thank you, Mr. Chair. I think Joe Lewis had the
    best comment about Mr. Lay's nonappearance when he said ``They
    can run, but they can't hide.'' And I think if Mr. Lay thinks
    that he is going to avoid us getting to the bottom of this, he
    is sadly mistaken. But for us to do that I hope that we have a
    very broad approach in our subcommittee rather than just a
    narrow one. And what I mean by that is that it wasn't just
    investors who are in the tentacles of Enron. It was consumers
    of electricity, particularly on the West Coast. And for months
    and months and months last year, Enron and other companies
    strangled the consumers of the West Coast and the
    Administration did nothing for months and months and months,
    and the evidence would suggest at the request of Enron, and Mr.
    Lay specifically.
        Now we need to know if this is true or not. Mr. Lay
    apparently isn't going to tell us. The Vice President
    apparently isn't going to share that information with us, but I
    hope that this subcommittee will get that information for the
    American people to find out why its Government sat on its hands
    for almost half a year while the West Coast bled millions of
    dollars in outrageous electrical prices, 50 percent increases a
    month and more.
        So Mr. Chair, I hope to be working with you on a subpoena,
    and perhaps we can discuss this tomorrow with Enron as a whole,
    to obtain this information for the American people that the
    Vice President has seen fit not to share with the American
    people. And I hope to have discussions with you and perhaps we
    can resolve this tomorrow. Thank you.
        Chairman Baker. I thank the gentleman. I think we are at
    the point now where we can engage our first panel. Chairman
    Pitt, by a vote of fourteen to thirteen, I wish to welcome you
    to the subcommittee this afternoon. You may be aware that the
    subcommittee has decided to take testimony under oath. Do you
    have objection to testifying under oath?
        Mr. Pitt. None at all, sir.
        Chairman Baker. Under the rules of the House and the rules
    of the subcommittee you are entitled to be advised by counsel.
    Do you have any desire to be advised by counsel during your
    testimony today?
        Mr. Pitt. No, I do not.
        Chairman Baker. In that case, if you would please rise and
    raise your right hand, I will swear you in.
        [Witness sworn.]
        Consider yourself under oath. And I wish to sincerely
    welcome your presence here. I think your leadership and insight
    will be of value to the subcommittee and to the country.
        I point out for the record you assumed your new duty on
    what date, sir?
        Mr. Pitt. I was sworn in on August 3, but I actually
    started at the beginning of September.
        Chairman Baker. And how does that comport with the
    disclosure of Enron's public demise?
        Mr. Pitt. Well, I think that I had been in the service
    about 2 months when the Enron debacle exploded.
        Chairman Baker. I just thought for the record it would be
    important for everyone to know your lack of relationship to the
    events that have unfortunately now unfolded. If you would
    please proceed, sir. Your testimony will be made part of the
    record.
        Mr. Pitt. Thank you, Mr. Chairman. My remarks may extend a
    bit and I apologize for that, but with the subcommittee's
    permission and Chair's permission.
        Chairman Baker. We hope you will take all the time needed
    to give all the explanations that would be informative.

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

        Chairman Baker, Congressman Kanjorski, Members of the
    subcommittee, I am pleased to appear on behalf of the SEC under
    oath to testify about possible legislative solutions to abuses
    and weaknesses that Enron's failure exposed in our disclosure
    and financial reporting system. I commend you, Mr. Chairman,
    and Congressman Kanjorski, as well as Chairman Oxley and
    Congressman LaFalce, for your leadership. These hearings are
    timely and appropriate.
        The Enron debacle is tragic, and too many Americans have
    felt its consequences. Innocent investors were betrayed by
    abuses of our system of disclosure and accounting. Most tragic
    are investors, who entrusted some portion of their life savings
    to a company that purported to be profitable, placing
    confidence in the company, its auditors, research analysts,
    rating agencies and our federally--mandated disclosure system.
    Equally betrayed are those who held Enron stock in retirement
    accounts and made life--altering decisions based upon the
    stock's perceived value, only to find themselves locked into a
    rapidly sinking investment that ate up years of hard work. The
    fate of these Americans fuels our markets. They have no lobby,
    no trade associations. Their interests are and must be
    paramount, and I am appalled at what happened to them as a
    result of Enron's collapse. The Commission as an institution
    and I, both as its Chairman and personally, are committed to
    doing everything in our power to prevent abuses of our system
    from happening again.
        Our primary responsibilities, as you know, are to protect
    public investors and to promote the fairness, effectiveness and
    efficiency of our capital markets. In the face of Enron's
    meltdown and tragic consequences, our staff is currently
    conducting an enforcement investigation to find out if there
    had been violations of the Federal securities laws and by whom.
    When Enron began to implode, my fellow commissioners and I
    immediately--and unanimously--ordered a no-holds-barred
    investigation, which is still underway. Until the investigation
    is completed, we cannot fairly assign blame. The public can be
    confident, however, that our Enforcement Division will conduct
    a thorough investigation and the SEC will deal with any
    wrongdoing and wrongdoers swiftly and completely.
        Congress wisely permeated the Federal securities laws with
    a philosophy that investors must be fully informed and
    confident that our markets are free from fraudulent, deceptive
    and manipulative conduct. We are tasked with defining and
    enforcing these laws. Congress has already given us enormous
    power to do so.
        Even prior to Enron, we had been working to improve and
    modernize our corporate disclosure and financial reporting
    system to make disclosures in 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 have languished
    for far too long.
        I am committed, as is the Commission, to reexamining every
    assumption, every rule and regulation in light of Enron. There
    are fundamental and longstanding flaws in our system, and now
    they are on the table. No one yet knows the final answers, but
    at the end of the process we will have a better system of
    corporate disclosure and financial reporting.
        In his State of the Union address, the President
    appropriately demanded ``stricter accounting standards and
    tougher disclosure requirements.'' He wants corporate America
    to ``be made more accountable to employees and shareholders and
    held to the highest standards of conduct.'' We at the SEC share
    and embrace these principles, and we are firmly committed to
    achieving them. We are at work on numerous initiatives to
    improve and modernize our current disclosure and regulatory
    system.
        These initiatives include, but are no means limited to, the
    following:
        A system of ``current'' disclosure. Investors need current
    information, not just periodic disclosures, along with clear
    requirements for public companies to make affirmative
    disclosures of, and to provide timely updates to,
    unquestionably material information on a real-time basis.
        Public company disclosure of significant current ``trend''
    and ``evaluative'' data. Providing current trend and evaluative
    data would enable investors to assess a company's evolving
    financial posture. It would also preclude `` wooden''
    approaches to disclosure and encourage evaluative disclosures
    that begin where line item and GAAP disclosures end. This
    information, upon which corporate executives and bankers
    already base critical decisions, can be presented without
    confusing or misleading investors, without prejudicing
    legitimate corporate interests or exposing companies to unfair
    assertions of liability.
        Financial statements that are clear and informative.
    Investors and employees concerned with preserving and
    increasing their savings and retirement funds deserve
    comprehensive financial reports they can easily and quickly
    interpret and understand.
        Conscientious identification and assessment by public
    companies and their auditors of critical accounting principles.
    Public companies and their advisers should be required to
    identify the most critical accounting principles upon which a
    company's financial status depends and which involve the most
    complex, subjective or ambiguous assessments. Investors should
    be told concisely and clearly how these principles are applied
    as well as information about the range of possible effects in
    differing applications of these principles.
        Accounting standard--setting that responds expeditiously,
    concisely and clearly to current and immediate needs and
    reflects business realities. Improved standard--setting is a
    high priority of ours. The FASB, the private standards setting
    board for accounting principles, is the appropriate place for
    resolving debate on technical issues, but it must act. For too
    many years the FASB has been allowed to fail at setting
    standards for accounting for special purpose entities. In the
    wake of Enron, it must act and act quickly to give guidance.
        An effective and transparent system of private regulation
    of the accounting profession, subject to our rigorous
    oversight. We recently initiated discussion of how best to
    restructure the regulatory system governing the accounting
    profession. We suggested creating a new Public Accountability
    Board to assume responsibility for auditor and accountant
    discipline and quality control. At least a predominant majority
    of the members of the new disciplinary body we envision must be
    unaffiliated with the accounting profession. Our proposed
    oversight body would be funded not by the accounting
    profession, but from the entire private sector, giving no group
    the ability to dictate, control or influence their decisions
    and efforts.
        A system that ensures that those entrusted with the
    important public responsibility of performing audits of public
    companies are single-minded in their devotion to the public
    interest and are not subject to conflicts that might confuse or
    divert them from their efforts. Those who perform audits must
    be truly independent and, in particular, must not be subject to
    the conflict of increasing their own compensation at the risk
    of ensuring the public's protection. Their fidelity to the
    cause of full, fair and understandable financial reporting must
    be ironclad and unequivocal.
        More meaningful investor protection by audit committees.
    Audit committees must be proactive, not merely reactive, to
    ensure the quality and integrity of corporate financial
    reports. Especially critical is the need to improve interaction
    between audit committee members and senior management and
    outside auditors. Audit committees must understand what and why
    critical accounting principles were chosen, how they were
    applied, and have a basis for believing that the end result
    fairly presents their company's actual status.
        Analyst recommendations predicated on financial data they
    have deciphered and interpreted. This subcommittee, through
    your leadership, Chairman Baker, and Congressman Kanjorski's
    and the full committee, led by Chairman Oxley and Congressman
    LaFalce, brought sadly needed attention to the shortcomings and
    the conduct of Wall Street analysts. We see these shortcomings
    again in the Enron situation. Changes here are long overdue.
    Working with the Congress and the securities industry, we are
    on the threshold of new self-regulatory rules that will create
    more transparency for analyst recommendations.
        These are just some of the initiatives that we are
    considering and resolutions we are proposing for consideration.
    We are committed to making disclosures more meaningful and
    intelligible to average investors, and toward that end we are
    soliciting broad input. We will hold our first ever ``Investor
    Summit'' this May, to solicit investor input on the policy
    issues that confront us as we begin reforming our disclosure
    and financial reporting process. We also plan to hold a series
    of roundtables to discuss significant issues regarding our
    ideas for reform and the suggestions of others. We must
    consider the issues, put forward the most responsible proposals
    we can, and engage in dialogue with all parties willing to
    participate. This is the process we have begun, and we are
    committed to following through promptly on this process by
    taking all steps necessary to reassure the public and preserve
    confidence in our disclosure and financial reporting process.
        We have the requisite authority to enforce the Federal
    securities laws vigorously. We also believe that we already
    have statutory authority to adopt rules that would implement
    the important improvements that I just mentioned, as well as
    others necessary to address the problems in our system brought
    to light so vividly by Enron's collapse. By the same token, if
    major and sweeping changes are to be made, even by rulemaking,
    Congress should, and must, be an active participant in the
    process.
        Congress is the body of Government most directly
    accountable to the people. We intend to work closely with you
    to ensure that the regulatory framework we ultimately propose
    meets your view of what is appropriate and in the interests of
    the public. In our view, any such changes should include
    provisions broadly reaffirming and enabling the SEC to improve
    the current disclosure and accounting system.
        One area of possible legislation already identified is the
    need to require corporate insiders to make public their trading
    activities more quickly than current law requires. Under the
    current law, which dates back to 1934, the principal provision
    covering reporting by insiders calls for filing by the tenth
    day of the month after the month when the trading occurred.
    That may have been good enough in 1934, but it is not nearly
    good enough for our markets today.
        Our system must be modernized and improved. We are up to
    the task, but only if we are able to tap our best minds to
    produce our most creative solutions and only if we are able to
    discuss these issues openly, honestly and as constructively as
    possible. The SEC is committed to that end, and we seek
    participation by everyone with an interest in our capital
    markets. Together, we can, we must and we will make a
    difference. That is our vision and our unalterable mission.
        On behalf of the Commission, I appreciate the opportunity
    to submit our views on legislative solutions, and I am happy to
    try to respond to any questions the subcommittee Members may
    have.
        [The prepared statement of Hon. Harvey L. Pitt can be found
    on page XX in the appendix.]
        Chairman Baker. Thank you, Chairman Pitt. We do appreciate
    very much your appearance here and your insights. I first want
    to thank you for your work on behalf of the committee over the
    past months in an announcement which will be made on Thursday
    relative to recommendations for analyst conduct.
        Chairman Oxley, Ranking Members LaFalce and Kanjorski and I
    have worked together for some time to take a positive immediate
    step which I think will be very responsive to the circumstances
    that have been revealed by the Enron matter, but that is not
    something that happened overnight. It has been a great deal of
    effort with a number of parties and it will be a meaningful
    first step.
        In looking at the recommendations in your testimony, I
    certainly agree with all of them and perhaps have additional
    ideas to consider to perhaps go a bit further. Corporate
    governance for boards of directors are constructed at the State
    level, and, audit standards obviously don't recognize State
    lines. Theoretically boards of directors are to hire the audit
    team through an audit committee, to remain independent of
    management interest and to report to the board on behalf of the
    shareholder.
        It is my view that that practice in business theory is not
    necessarily the practice in business reality, and there are two
    ways, I think, to address that problem. One, as you propose,
    would be to put larger windows on the house so we can see into
    the boardroom and have more disclosure by virtue of that
    transparency. And I have other ideas to add to your very good
    list.
        The other would be, as I said in the opening statement, to
    take the roof off the House and change the way the auditor is
    reimbursed. Today, the corporation pays the auditor. Some have
    suggested that another alternative would be to have the
    exchanges engage the audit and have the report made available
    to the corporation and to the exchanges, again to the benefit
    of shareholders since the transactions are engaged through an
    exchange. I don't know if that makes a great deal of market
    sense or not, but if you are paying someone to perform a task,
    there is a great deal of pressure, I think, for you to perform
    that task to their satisfaction.
        Some have suggested simply barring consulting from the
    audit function might be the advisable remedy. I am not sure. It
    doesn't seem the pressure is any less to have a $12 million
    audit and a $12 million consulting contract than it is to have
    a $24 million audit. You still want to make management happy.
    What is your view?
        Mr. Pitt. Well, I believe that the question of independence
    is a critical question. The place where independence is the
    most significant is on the front lines with those who are
    actually doing the auditing. Those individuals could be
    influenced by an extra $100,000 or $200,000. What we need is a
    dual approach: First, one that ensures that those who are on
    the front line do not have any conflict in their loyalty and
    obligation to the shareholders of the corporation they're
    auditing.
        And the second is to impose on the firms the ability to
    supervise and the incentives to make certain that no effort has
    been spared to produce the highest quality audit. There are
    many ways in which that can be done. One of the things that I
    think is critical is that we and this proposed Public
    Accountability Board should be given authority to remove
    auditors where the conduct of the auditors is found to be
    illegal or is found to be unethical or is found to be
    incompetent or where supervisory problems have created major
    issues.
        The question of who pays for the audit I think, is a fair
    one to put on the table. I can't tell you that the right answer
    is necessarily to try to find another entity to select the
    auditors, but it is worth looking into, and I do believe in any
    event that no audit should be deemed to be a prerogative or a
    right. Firms should be susceptible to losing audits if they do
    not adhere to the public trust.
        Chairman Baker. It is my opinion after consulting with many
    boards of directors that it is not uncommon today for
    management to have significant influence on the audit team
    report. So I am very interested in finding ways to preserve
    audit integrity and to eliminate any intimidation by management
    to direct the outcome. To that end I prepared a letter that
    outlines the specifics of both approaches, and certainly not to
    exclude any others you might deem appropriate, but for the
    committee's purpose. I will forward that to you immediately and
    ask that the agency respond within the next month, as the
    matter is of extreme urgency, as to the highest and best
    standards, in addition to what you have recommended today, as
    to those elements which I have outlined in that correspondence.
    Is that 30-day window all you have to do a reasonable request
    of your time at this moment?
        Mr. Pitt. Under the circumstances, it is very reasonable.
    We will respond in 30 days. If it is possible to respond
    sooner, we will certainly do that.
        Chairman Baker. In looking at the public record, in 1999,
    an enterprise, a private enterprise, able to surveil the SEC
    disclosures, newspaper accounts and a handful of interviews, I
    presume with energy analysts, came to the conclusion that there
    were off balance sheet indebtedness in the Enron portfolio that
    was apparently not that visible to others. Having reached that
    conclusion, that entity withdrew from a proposed merger. Where
    is it in the structure of the SEC, recognizing that this is
    before your time, when does the SEC have an obligation, or
    FASB, to proactively act and intercede with what is obviously
    an accounting myth that created real dollar losses 3 years
    later for innocent third parties? Shouldn't FASB, or the SEC in
    that day, have taken some action to preclude what was obviously
    a house of cards?
        Mr. Pitt. Let me respond to that in several ways. First, I
    think it is impossible to say that we can expect any agency of
    Government, even one I think as expert as the SEC and even one
    that might have significant additional resources, to review
    every single corporate filing and to find problems where they
    exist before they do damage to the public. It would be nice if
    that could happen, but I don't think that's possible. What I do
    think is possible is to have a system that avoids some of the
    gamesmanship that we have seen, or at least that's been
    reported. If people cannot read a financial statement and
    understand it immediately, if they cannot understand dense
    footnotes in what is being disclosed, then our system is a
    failure in that regard.
        Chairman Baker. I will make my point this way because I
    have exhausted my time. Even if FASB identified the problems,
    they really don't have authority to take any enforcement
    action.
        Mr. Pitt. FASB is not an enforcement agency.
        Chairman Baker. And even when they are standard--setting
    it, seems to take them a decade or longer to get something set.
    We do need a much more responsive mechanism to identify and
    respond to market impropriety where it obviously is publicly
    identifiable.
        Mr. Pitt. I agree completely. We need three levels. One is
    illegality. The SEC always has had that as its responsibility,
    and I believe we are doing a vigorous job in ferreting out
    illegality. We want an effective disciplinary process, however,
    that will extend to unethical practices; that is, practices
    that may not be illegal, but are unethical as well as practices
    that reflect incompetence. All of those three pose significant
    risk to investors, and we believe we can set up a private
    sector body that will give us not only protection against
    illegal conduct, but also unethical and incompetent conduct as
    well.
        Chairman Baker. Mr. Kanjorski.
        Mr. Kanjorski. Thank you, Mr. Chairman. You didn't have any
    ill effects from taking the oath, did you, Mr. Pitt?
        Mr. Pitt. I feel perfectly fine.
        Mr. Kanjorski. Mr. Pitt, you have had a chance, of course,
    to start your targeted investigation of what happened at Enron.
    But I assume, based on some of the information and allegations
    and high media hype on Enron, you have seen a potential for
    systemic problems of accounting analyst effects, and so forth,
    on other corporations.
        Can you tell us now whether or not there are any other
    Enrons out there potentially?
        Mr. Pitt. My concern is not directed to Enron. It existed
    before Enron, and Enron only exacerbated the circumstances with
    the outrageous conduct that occurred. I think our system is
    capable of being gamed. I think it has been capable of being
    gamed for a long time. We intend to fix it to eliminate any of
    the gamesmanship. It is my hope that if we do so and do so
    promptly we will avoid further Enrons, but of course, there can
    never be a guarantee of that.
        Mr. Kanjorski. In your opinion, are there other Enrons out
    there?
        Mr. Pitt. I believe that we are in the process now of
    investigating a number of financial frauds. The number seems to
    be a large number, and some of it may be an outgrowth of Enron,
    but there are over 17,000 public companies. And my sense is
    that Enron presents a combination of factors. It is my hope
    that there are not other Enrons out there, but I am not willing
    to take the chance and rely on hope. We are investigating a
    number of situations, and we want to change the rules so that
    we are satisfied that there are no other Enrons out there. But
    at the present time no one can give you the assurance that you
    seek.
        Mr. Kanjorski. During the period of ``irrational
    exuberance,'' I have been struck that average individuals have
    been buying shares of stock from their employees' pension funds
    that are sometimes 100 times their profit ratio. With almost
    abandonment, sometimes the pension funds, with extraordinary
    Wall Street management, also engaged in these activities. I
    just want to make sure that we do not have more employees, more
    investors over the next several months or years doing the same
    thing, until we close whatever loophole has to be closed or we
    arm your agency with whatever powers you need. I am convinced
    that the average investor presently does not have the insight
    or the capacity to make some of these judgments, which
    obviously, the most sophisticated Wall Street analysts cannot
    penetrate. More precisely, one of the things I wanted to look
    at: Were you aware of the special enterprises?
        Mr. Pitt. Special purpose entities.
        Mr. Kanjorski. It would seem to me that if SPEs were listed
    on the documents of a corporation and you could see the size
    and the transaction on a cursory read, one might say I do not
    want to go there, I do not know enough, or I want to spend the
    time to find out what they are. If SPEs are not listed, they do
    not appear in accounting reports. It certainly goes to the
    question of what is accounting all about if not transparency.
        One of the things that I have discussed with other Members
    of the subcommittee--about which I am most disturbed--is that
    all of this occurred in a private market. This is not a public
    market. This is not publicly controlled corporations. These are
    private corporations, completely removed from Government
    responsibility. And certainly the practice of accounting is the
    same thing. It is a profession, and if the profession does go
    awry and it does injure the general public because it
    influences the markets and how securities are sold and who
    suffers losses, the Government has some role in this, but our
    role should be limited to need. I am just a little worried
    about the baby going out with the bath water here. We obviously
    have several thousands--17,000, did you say--public
    corporations. We do not want to authorize a governmental agency
    to put its imprimatur on their audits. I do not think you could
    handle enough accountants to do that, and certainly you would
    not want to. But, we do have to have somebody look these
    disclosures over.
        I just spoke with a major accounting firm in Pennsylvania
    over the weekend, in the top 50 nationwide. Its entire business
    is the cost of the audit in the Enron case. That figure
    represents its entire revenues for a year. We have the five big
    accounting firms doing these huge audits and consulting. We
    also have many smaller firms. So we are really talking about a
    two- or three-tier situation here.
        I met with the Chairman of Andersen, and their revenues per
    year are in excess of $10 or $12 billion, I think. So the $25
    million audit fee or $27 million consulting fee for Enron is
    really minuscule to him and to his firm. To the rest of us, it
    is quite substantial.
        Our problem is maybe there is a time when certain size
    public corporations through public trades should fall under a
    category of special examination or certification by someone,
    hopefully a private entity. Also, we should look at some of
    these larger accounting companies and encourage them to go back
    to the days when the accounting profession was a profession and
    not a business, and apply the same standards of
    professionalism.
        I do not think our problem goes to all accountants. My
    experience is you can rely on audits by most accounting firms
    in this country and that the individuals are not easily
    persuaded by consulting fees or the price of the audit. They
    carry on the standard in the profession in a very high order,
    probably the best in the world. We are wreaking havoc and
    injury on them to many other well-functioning corporations
    because of this case.
        Do you think that the Congress, running full speed ahead in
    putting legislation forward to solve some of these problems,
    superficially may not be too early? Should we instead
    participate in your summit in May and listen to some of the
    problems before legislating? Can you also accommodate Members
    of this subcommittee and Members of the Congress to listen or
    participate in some way in that event?
        Mr. Pitt. Yes. I think the answer to your question is
    unquestionably yes. My view is we need to take action. We need
    to do it quickly. It is up to Congress to decide whether you
    want to do it through legislation or whether you want to do it
    by working with us and making sure that you are comfortable
    with whatever regulatory approach we finally select. Either
    way, you have our complete and undivided cooperation and
    attention. I am committed to solving this problem. It has roots
    that have gone on for far too long; and, either by legislation
    or by regulation, I am determined to solve the problem.
        Chairman Baker. The gentleman's time has expired. Thank
    you, Mr. Kanjorski. And I want to echo your point with regard
    to corporate conduct. By and large, the vast majority of
    individuals and corporations attempt to conduct their business
    in a professional and responsible manner, and we have an
    aberrant actor which does not represent a systemic problem.
        Chairman Oxley.
        Mr. Oxley. Thank you, Mr. Chairman.
        Chairman Pitt, the Chairman of one of the Big Five
    accounting firms recently suggested that the strength in audit
    committee independence should be hired and fired by the audit
    committee of the board of directors, and one auditor suggests
    that it should be a crime to lie to an outside auditor. Do you
    have views on those particular positions?
        Mr. Pitt. Let me say a few things. I think the audit
    committee should have the power to select and to discharge
    auditors based on their work with the audit firm and their
    understanding of their capabilities and competence and
    performance. I also think, as I indicated before in response to
    Congressman Kanjorski's question, that the SEC and the Public
    Accountability Board should have the ability to take away
    audits where people engage in inappropriate conduct.
        With respect to lying to an auditor, there are already
    provisions in the Securities Exchange Act which make it a crime
    as well as a civil misdemeanor to prevent an auditor from
    performing his function in accordance with the law, which
    should include some of this behavior. It is not a provision
    that has been widely utilized in the past, but there already is
    authority in the statute that would enable the SEC to take
    action against those who obstruct the filing of public reports
    that would be honest and accurate.
        As to whether or not we need additional legislation, I
    guess I come back to my original suggestion. If this is
    something that you would like us to consider, we will work with
    you closely. It is not an idea we are prepared to reject out of
    hand. It is a logical suggestion. We want to see where it fits
    in and make certain that we know what the ramifications of it
    are, but we are willing to work with you on all sorts of
    proposals.
        Mr. Oxley. The issue of auditor independence and scope of
    service within the audit profession has been in the news and
    the minds of corporations. You have spoken on this topic many
    times. Your views on this subject change in light of the action
    of the Big Five firms and several major companies last week,
    and what are your current views on this subject?
        Mr. Pitt. I view what the Big Five firms have done to be a
    very positive step. It is a recognition of public concern, and
    I commend them for taking that action. It does not have any
    impact, however, on all the additional changes in our system
    that we need. If this is an approach that the firms take to
    assure public confidence, I think we should support it. And in
    light of Enron, every position that anybody has taken should be
    subject to careful review. That's the way we can prevent
    another Enron from occurring.
        So I am not adverse to what the firms have done. I support
    it completely. I just think it's important for everyone to
    understand there is much, much more that needs to be done and
    that this recent action alone will not solve the problem.
        Mr. Oxley. Mr. Chairman, in the Enron Report released this
    weekend, Enron's outside attorneys were criticized for not
    bringing a stronger, more objective, and more critical voice to
    the disclosure process. What oversight role and enforcement
    power does the Commission have with respect to the work of
    outside attorneys, and should the SEC have additional authority
    in that area?
        Mr. Pitt. The SEC has authority over attorneys who appear
    in practice before the agency if they engage in conduct which
    is inimical to the integrity of the system we have. We can take
    action to prevent them from appearing and practicing before the
    agency in a representative capacity. In addition, we have the
    ability to proceed against lawyers whose conduct rises to the
    level of having either violated the Federal securities laws or
    aided and abetted or caused a violation. There have been a lot
    of tensions between the SEC and the private bar, and times when
    the SEC had been accused of putting its judgment in the place
    of the private firms. I think the Commission has authority, but
    the question becomes what the nature of the conduct is that
    would give rise to the Commission exercising it. Where lawyers
    are giving good faith advice, the position that the Commission
    has taken under my predecessors is that the Commission will not
    take action against those lawyers. That's been the longstanding
    policy now for about 20-some odd years.
        Mr. Oxley. Thank you.
        Mr. Chairman, thank you.
        Chairman Baker. Thank you, Mr. Chairman.
        Mr. LaFalce.
        Mr. LaFalce. Thank you very much.
        Chairman Baker. I don't think your mike is on.
        Mr. LaFalce. Thank you. Thank you, Mr. Chairman.
        Mr. Pitt, one of the first cases that I ever handled after
    I was admitted to the bar in 1964 involved a professional
    malpractice where I went after an insurance broker for failing
    to advise a retailer of the desirability, or indeed, necessity
    of product liability insurance. There's a difference between
    proceeding in good faith and proceeding in good faith
    negligence, and so do you have the capacity to go after
    attorneys or accountants who may have proceeded in good faith
    or were still violative of the basic principles that lawyers
    and accountants should hold themselves to, for example were
    violative of professional malpractice?
        Mr. Pitt. There is some ambiguity about the Commission's
    authority to proceed against professionals in cases where the
    conduct is simply negligent. In my view, the ambiguity----
        Mr. LaFalce. Is that something we could clarify for you
    legislatively?
        Mr. Pitt. Those ambiguities could be clarified
    legislatively. They may also be capable of being clarified by
    rulemaking. I believe that some of the ambiguities arose from
    the wording.
        Mr. LaFalce. I am now specifically asking you to consider
    very clear rules that could be articulated and enforced by the
    SEC.
        Mr. Pitt. I would be, speaking for the Commission, more
    than willing to consider whether there is a need for that type
    of either legislation or regulation.
        Mr. LaFalce. All right. My next question is to what extent
    did the securities legislation that passed the Congress about 5
    years or so ago preclude civil actions for the aiding and
    abetting of inappropriate practices by accountants, lawyers,
    and so forth, and leave it exclusively in the hands of the SEC?
        Mr. Pitt. The legislation, which is the Private Securities
    Litigation Reform Act, did not affect the ability of private
    parties to bring an action for aiding and abetting. It left in
    place a decision by the Supreme Court that challenged the
    existence of a private aiding and abetting cause of action.
    There was some ambiguity as to whether the SEC might be
    foreclosed from bringing aiding and abetting actions and the
    legislation overturned that ambiguity and made it clear that we
    could sue.
        Mr. LaFalce. By making it clear you could sue and in not
    dealing with the Supreme Court decision, didn't they, in fact,
    ratify the Supreme Court decision, and therefore preclude in
    the eyes of most people civil suits, and shouldn't we at the
    very least come in with a legislative remedy if we believe that
    civil litigation is an appropriate recourse to clarify that
    fact?
        Mr. Pitt. Well, I believe that case, which is the Central
    Bank of Denver case, interpreted the laws as they were passed
    in 1934. I think it would be hard to----
        Mr. LaFalce. With respect to at least one issue you said is
    grossly outmoded, and that was the issue.
        Mr. Pitt. I have said that the statute is outmoded in its
    regime of financial and reporting and disclosure. With respect
    to aiding and abetting, one of the things that I think we would
    need to do is to look at whether any of the conduct that
    ultimately becomes actionable in the Enron situation is conduct
    that might be foreclosed from being pursued. I have no problem
    going back and reconsidering whether there should be a private
    cause of action for aiding and abetting. I'm just not aware at
    the moment as to whether there has been a material adverse
    impact on investor rights. If there has been, that's obviously
    something we would react to.
        Mr. LaFalce. I think when you rely so much on SROs, you
    need strong possibilities of civil litigation and if we are
    going to continue relying on SROs, it would seem imperative to
    me, but we can pursue that. Let me pursue another issue, and
    that is the heavy reliance that investors make not on auditors,
    not on boards of directors, not even on corporate management,
    but on securities analysts. These securities firms have been
    around for a long time. They are prestigious worldwide and they
    have some young 25-year-old kids who have never seen a
    depression or a recession or a stock go wrong and they hype
    these stocks unbelievably.
        Analyst hype has been significantly responsible for so much
    of the rise and so much of the precipitous fall. I don't get
    angry at the fact that Ken Lay is not going to come here. I'm
    disappointed at that. I get angry at the securities firms,
    though, who permit their analysts to sucker in individuals
    across America and across the world, to make investments when
    they knew or should have known better, at the very least should
    have known better, and if they didn't know better, then their
    rights to be analysts should be taken away from them.
        Now, I'm not sure that the SROs are doing a good enough
    job. I know they want to make improvements. So far, I think the
    securities SROs are doing a better job than the accounting SROs
    and trying to get to the point where they should be, but I
    don't think they are close to getting there yet. And to what
    extent does the SEC have the authority, to what extent has it
    exercised it in stripping individuals of the right to hold
    themselves out as securities analysts for securities firms?
        Mr. Pitt. We have brought actions in the past against
    analysts for conduct that violated statutory provisions.
        Mr. LaFalce. Are you talking about conflicts of interests
    or are you talking about professional competency?
        Mr. Pitt. Illegality. What we have sought to do is have
    ethical standards imposed on top of that so that we are not
    limited to legal violations.
        Mr. LaFalce. That is important, but in the total scheme of
    things, Mr. Pitt, I don't think that most of the injury that
    has been experienced by investors has come about because of
    criminal or unethical behavior, although to be sure, that has
    been real. I think much more of it has come about because of
    incompetency, and I'm wondering what ability the SEC has to
    deal with that issue, the incompetency of securities analysts.
        Chairman Baker. Your time has expired. We will certainly
    let the gentleman respond and we can move on.
        Mr. Pitt. As I believe you're aware, working with the
    Chairman of the subcommittee and the Ranking Member and working
    with the Chairman of the full committee, and with you as the
    Ranking Member, we have facilitated an effort by the self-
    regulatory bodies in the securities industry to carefully
    revisit the conduct that was involved. The fact that there were
    people recommending Enron stock when it was pennies away from
    total zero is appalling. I don't understand how people could do
    that. But I don't believe that the problem needs to go
    unsolved. I believe we have come up with a methodology under
    the guidance and leadership of this subcommittee to come up
    with some very rigorous requirements that go well beyond legal
    requirements and that will be enforced both by the self-
    regulators, but also by us. If you look at what happened in the
    CS First Boston case with respect to IPOs, the Commission, for
    the first time, enforced--in an injunctive action that wound up
    with a fine and penalty of a $100 million--self-regulatory
    organization rules.
        So if we have proper rules, the SEC will make sure that the
    self-regulatory bodies enforce it. If they don't, we will
    enforce it, and we still have the right to inspect for all of
    those violations as well, which I can assure you, we intend to
    do.
        Chairman Baker. And Chairman Pitt, on top of that, the
    subcommittee fully intends to be a full level of supervision
    over the implementation and compliance aspect of those
    proposals. So I think we are entering into a new era. Thank
    you, Mr. Chairman.
        Mr. Shays.
        Mr. Shays. Thank you, Mr. Chairman.
        Mr. Pitt, thank you for being here. I appreciate it and I
    know you've got quite a task ahead of you. I would like you to
    comment on Secretary O'Neill's suggestion that penalties should
    be strengthened for CEOs----
        Chairman Baker. Mr. Shays, if you would pull that mike
    closer.
        Mr. Shays. I'm sorry. Thank you. Mr. Pitt, I'd like you to
    comment on what Secretary O'Neill suggested in the Wall Street
    Journal today that CEOs who release misleading financial
    statements, including barring them from using insurance to
    cover costs of some stockholder lawsuits.
        Mr. Pitt. I believe very strongly that there needs to be
    personal exposure on the part of those who manage and oversee
    public companies. The ability of managers to have their fines
    paid by their companies or not to suffer personal consequences,
    in my view, leaves open the necessary deterrent effect. We have
    been meeting with Secretary O'Neill as part of the President's
    working group, and we have discussed these proposals, and I
    believe that there are ways in which we can strengthen the
    penalties against individuals.
        Mr. Shays. I have a number of questions, so the bottom line
    is you want to strengthen them. Several commentators have
    suggested that the companies be required to change audit firms
    every few years, and others have suggested at least within a
    firm, that they rotate the auditors. I mean Enron--excuse me,
    Arthur Andersen can say that their business with Enron was only
    1 percent of their total billings, but it was 100 percent to
    those Arthur Andersen employees who had the account.
        Mr. Pitt. You raise two very good points. The first is that
    I think we need to deal with conflicts on the front line, those
    people who are doing the audits in an office, and make sure
    that they don't have any diversion of their loyalty. With
    respect to rotation of auditors, that's an idea that has been
    around. It's something that I think we all have to look at. Way
    back when, some 20 or so years ago, there was a study and it
    concluded that a great number of the financial frauds occurred
    in the first 2 years of an auditor's engagement. One of the
    things I think we would all want to be sure of is that we
    aren't creating more problems rather than less, but mandatory
    rotation is definitely a serious idea worthy of consideration.
        Mr. Shays. Is it true that in the year 2000, the
    corporation and finance division of the SEC decided not to
    perform the regularly scheduled review of Enron's filing with
    the Commission? I understand the last time they did it, it was
    1997, and that they do it every 3 years. One, is this true, and
    second, why? And if they had done it, is it likely the SEC,
    taking this review, would have been able to spot the problems
    at Enron?
        Mr. Pitt. I can tell you only the information that's been
    supplied to me, because, obviously, I wasn't there at the time.
    My understanding is that in 1997, there was a full review. The
    next scheduled one would have been 2000, but that it was
    deferred. The expectation was that there were new standards
    that were coming up and that there would be a greater basis for
    evaluating the financial statements. I think there was also
    some suggestion that, because the company was apparently
    performing so well, there were decisions made that that could
    be deferred.
        One of the first things that I have done in response to the
    Enron debacle is to direct our staff to review all of the
    Fortune 500 companies to do an immediate inspection of their
    financials to see whether there's anything that jumps off the
    page. The question as to whether, if there had been a review
    done, it would have uncovered Enron, is unfortunately
    impossible for anyone to answer. I don't think that it's
    necessarily the case that had our staff, back in the year 2000,
    done this, we would be in any different position than we are
    now. The fact of the matter is, I believe, that there were
    sound reasons why they didn't do the review at that time, but,
    of course, all of us wish that they had.
        Mr. Shays. Are we going to be well served by going from the
    big--what used to be the Big Eight, now the Big Five, to the
    Big Four? I mean, I would think that would be a big concern,
    not to use the word again, that we just are seeing that number
    collapse.
        Mr. Pitt. I share your concern on that, and it's part of
    the reason why I say solving the conflict issues will not solve
    the problem. If you had only one audit firm, just one, it would
    be the most independent audit firm possible, but it would have
    the least incentives, since there would be no competition, to
    improve quality control or competence. So as a result, these
    are two separate issues. I believe that there has been a need
    for greater capital in the accounting firms, and one of the
    issues that we have to perceive is how we can avoid dictating
    to the firms how much income they can generate instead of
    applying appropriate protections to make sure that there is no
    allegiance to anyone but public investors. That's the critical
    element.
        Mr. Shays. I will.
        Chairman Baker. Your time has expired.
        Mr. Shays. Thank you. Thank you, Mr. Pitt.
        Chairman Baker. Mr. Ackerman.
        Mr. Ackerman. If this indeed was a scheme if that's the
    right word, was this difficult to set up?
        Mr. Pitt. I can't answer that. If it was a scheme, my
    concern is that because it occurred under any set of
    circumstances, by definition it was too easy to set up. It
    should not have been possible for this to happen.
        Mr. Ackerman. It should not have been, but evidently it was
    easy enough to fly well below the radar.
        Mr. Pitt. Apparently this was set up and there are a
    variety of factors that contributed to it. The one thing that I
    think your question appropriately focuses us on is to fix the
    flaws in the system that have been allowed to exist that would
    have permitted this kind of thing to occur. That is what is
    critical.
        Mr. Ackerman. I think there's a lot of public concern about
    transparency, and one of the things that gives the public
    confidence is when you have a certified public auditing company
    with some great prestige, especially that they are acting as
    well in the public's interest, to be the guarantor that
    everything was, shall we say, kosher, and they certified that
    somebody's cooking the books was kosher, if that's the right
    term of art to use.
        If a CPA firm is doing that, should the public not be
    skeptical and come to a conclusion, why are they only doing
    this with one of their clients, maybe they are doing it with
    others?
        Mr. Pitt. I believe that the public, in light of the
    disclosures and revelations that have come out, has a perfect
    right to be skeptical. I want to try to remove that skepticism
    by giving them renewed confidence that our system is the very
    best, but there is no doubt that if people have done some of
    the things that have been alleged to have occurred, investors
    will lose confidence in our markets. And that would be a
    detriment to all Americans and something that we at the SEC
    have a sworn oath to avoid.
        Mr. Ackerman. I don't know if you addressed this earlier,
    because I stepped out for a few minutes, but you had previously
    said that you are not sure as to whether or not anybody is to
    blame in this episode; is that right?
        Mr. Pitt. No. What I said was that there is an
    investigation that is underway in which I am not a participant.
    Until that investigation is complete, I don't believe that we
    can reach conclusions about who is to blame and what laws, if
    any, were violated. Once our investigation is completed,
    however, I think we will have the facts on which we can make
    those assessments and judgments.
        Mr. Ackerman. Could you help the public, in just simple
    terms, understand the function of your agency?
        Mr. Pitt. Yes. Our agency is designed to assist investors
    who buy ``intricate merchandise,'' as this subcommittee's
    predecessors called it way back in 1933, that is, it is not a
    car, an automobile where you can kick the tires and see what
    you're getting. It's something that's much less tangible than
    that, and so our role is to make sure that the system gives
    investors all of the information that they need to make a fair
    judgment as to whether to buy or sell a stock and to understand
    the information that they are given. We have many other roles,
    but in the Enron context that's the principal one.
        Mr. Ackerman. Is it also your function to regulate the
    auditing companies as well as the corporation itself that's
    being audited by the auditing company?
        Mr. Pitt. I believe that the statutes that we administer
    give us authority over accounting firms. I would say that the
    Commission's approach in past years has not been to regulate as
    much as it has been to rely on private sector entities.
        Mr. Ackerman. You say it's not as simple as kicking the
    tires. I guess that's a good analogy as any for people to
    understand. I think you can kick the tires. Isn't there
    responsibility to check to make sure that assets are what they
    are said to be and debts that are written off, if they really
    exist should not be written off? I mean the salad oil case, I
    mean, you know, somebody should have looked into the tank to
    make sure it was salad oil and not water.
        Chairman Baker. And you're out of order, Mr. Ackerman--
    time, excuse me.
        Mr. Ackerman. My water has drained.
        Chairman Baker. Would the gentleman yield back.
        Mr. Ackerman. Can he just answer that?
        Chairman Baker. Sure.
        Mr. Pitt. I would just say, of course, that's a
    responsibility, and it's one that we think has to be overseen
    and enforced by the SEC, but there's no question that the
    audits of public companies are designed to give investors
    confidence that the financial statements have been prepared by
    management in an acceptable and proper way.
        Mr. Ackerman. Thank you, Mr. Chairman.
        Chairman Baker. Mr. Cox, you're recognized.
        Mr. Cox. Thank you, Mr. Chairman.
        Chairman Pitt, you mentioned in your formal remarks, your
    opening presentation, that one of the areas that the SEC is
    investigating is the role of the rating agencies. The report
    that we are going to cover with Chairman Powers in just a short
    while makes fascinating reading. I haven't read anything so
    scandalously convoluted since the equity funding scandal, but
    as the report puts it rather simply at the beginning of the
    1990s, even before these SPEs were created, Enron had a
    substantial load of debt and they were looking to acquire
    assets and build businesses around them without putting new
    debt on their balance sheet.
        And the reason--according to this special report of the
    board--they didn't want to put new debt on their balance sheet
    is Enron wanted to present itself more attractively to the
    rating agencies, particularly in light of the ratios that were
    favored by the rating agencies. That suggests what is obvious,
    in any case, that the rating agencies weren't of much help here
    at getting beneath what was apparent on the surface. Some time
    ago, when the treasurer of my county where I live in Orange
    County, California, committed some notorious criminal acts and
    bankrupted the whole county, and it became the largest
    municipal bankruptcy in American history, I got very interested
    in the role of the ratings agencies because they didn't blow
    the whistle on that in a timely fashion either, and I inferred
    that perhaps it was something about the inadequacy of municipal
    disclosure and the fact that the Federal Government doesn't
    regulate that nearly the way it does corporate disclosure, but
    now we've got the biggest municipal bankruptcy in American
    history and the biggest corporate bankruptcy in American
    industry, and the ratings agencies in both cases were
    essentially useless. What is the SEC doing by way of looking
    into the role of the rating agencies in the Enron matter?
        Mr. Pitt. One of the things we are doing is taking a much
    closer look at how the rating agencies perform, what their due
    diligence is. They have an enormous amount of impact on the
    stock market and on corporate bond offerings and the like, and
    yet they are essentially totally unregulated. We believe that
    we need to understand how they are performing and come back
    with a recommendation as to whether we need rules or statutes
    to deal with some of the abuses that some people believe may
    have occurred in this area.
        Mr. Cox. Let me ask you also whether or not you think that
    given that presently there is not much regulation, in addition
    to potential new regulation, we might give potential new powers
    to rating agencies to discover information?
        Mr. Pitt. I think that, again, there's another avenue that
    if the rating agencies are under an obligation to do the kind
    of diligence you're talking about, they could provide another
    safeguard to public investors, and that's something that's
    worth exploring.
        Mr. Cox. I thank you very much, Mr. Chairman, for your
    comments on that subject and I yield back, Mr. Chairman.
        Chairman Baker. I thank the gentleman.
        Mr. Bentsen.
        Mr. Bentsen. Thank you, Mr. Chairman and Chairman Pitt.
        Chairman Pitt, in your testimony you talked about
    legislation that would update the filing period for insiders
    when they're selling stock to the public, and I think that's
    the bill that Mrs. Carnahan has introduced in the Senate. I'm
    looking at more introducing the bill in the House, but there is
    another factor, and I'm curious your position on that, and that
    has to do with sales of stock back to the company, whether to
    pay off loans or what, and how loans are disclosed on the
    books, and this doesn't just involve Enron. We have seen it
    with respect to Tyco and other companies, and it appears, in
    some respects, these companies are being used almost as a
    private bank. Is that something that you would be supportive
    of, of having a more efficient disclosure mechanism?
        Mr. Pitt. I think the answer is that we do need to take a
    closer look at that and there may be a need for greater
    disclosure and greater requirements. I think that, in terms of
    the disclosure issues, we probably have sufficient regulatory
    authority, but I can understand why Congress might deem it
    appropriate to legislate here.
        Mr. Bentsen. Maybe you all can go ahead and change the
    rules, and we won't have to do that. Let me ask you this: There
    was a story in the New York Times a week or so ago about the
    partnerships and the Chinese wall conflict between investment
    banks that were structuring the partnerships, and in effect,
    doing private placements and the information that they were
    giving to potential investors in the private placement, and
    that that information was not being provided with general
    stockholders, the public stockholders, and whether or not
    current law would preclude a banker on one end who's
    underwriting a private placement from providing any information
    to the brokerage side as it would relate to the stock, and
    whether or not you believe that maybe trips the wire of
    Regulation FD, and whether or not that's selective disclosure.
        And furthermore, I would ask, particularly as we look at
    some of the Chewco and Jedi deals that they were backstopped,
    as I understand it, with the ability to issue additional Enron
    shares as a credit enhancement, which would appear to me to be
    somewhat material, because that would dilute the value of
    existing shares that were out there. Would that make sense to
    you that maybe that's something where there was a violation of
    Regulation FD?
        Mr. Pitt. Well, I don't know whether it will constitute a
    violation of Regulation FD or not, but, if the information was
    material and it was not disclosed to the public, that's a
    violation of existing law. And that's what our enforcement
    division is looking into right now. I think if that case can be
    made they will make it.
        Mr. Bentsen. And then with respect to the Jedi deal based
    upon the Powers Report, and all it appears in one instance that
    there really wasn't true ownership, equity ownership, on the
    part of the purchaser. I mean, these deals all look to me, in
    some respects, sort of like the old S&Ls where you took bad
    loans, flipped them, booked a lot of goodwill that didn't exist
    to buoy your balance sheet, and then you backstopped it with
    stock and sort of bet, and the stock went south and so did the
    company.
        But, is there a similarity in your mind where you set up a
    partnership to move this bad asset off your books, book
    goodwill that may or may not exist, you create a corporation to
    purchase it, you guarantee the 3 percent so there really isn't
    a 3 percent equity contribution on the part of the purchaser? I
    mean, isn't this--and you guarantee in effect to buy it back.
    This sounds a lot like parking.
        Now, it's not parking per se, because it's not stock and
    the like, but it sounds very similar to that. Do the existing
    securities laws take that into account?
        Mr. Pitt. I believe they do. We have many cases in which
    companies use devices like window dressing, and right before
    the end of a quarter, move assets off their books to try to
    create an impression. The Commission has brought many such
    cases. So, if there is the equivalent of parking, as you say,
    and I think that's an excellent analogy, that means there is no
    economic reality to the transaction. If that's the case, then
    it's a fraud.
        Mr. Bentsen. Are you able to determine whether or not that
    may be going on in other companies, public companies, besides
    Enron at this time?
        Mr. Pitt. At the present time, we have started to take a
    very close look at what other companies are doing with respect
    to off-the-book treatment of liabilities. This is an area where
    20 years ago the FASB was asked to give guidance, and with one
    or two modest exceptions, they have not given any guidance to
    either the profession or the public. Therefore, it's something
    that we have demanded and they have agreed they will do prior
    to the end of this year.
        Mr. Bentsen. Thank you. Thank you, Mr. Chairman.
        Chairman Baker. Thank you, Mr. Bentsen.
        Mr. Paul.
        Mr. Bachus.
        Mr. Bachus. Thank you, Mr. Chairman.
        Chairman Pitt, I was going to ask you what your plans were
    and what your proposals were and to outline where we go from
    here, but you have done an excellent job of doing that in your
    opening statement, so I am going to refrain from doing that. I
    do want to say that I'm very glad that it's become evident, I
    think to all of us, that the dogs of ruin that were unleashed
    on Enron were done in 1997 and 1998, and you took over in
    August as Chairman of the SEC, and as I think every Member here
    said, there's no suggestion that you did anything improper, and
    I'm glad that that's been made pretty clear. With that, I'm
    going to yield to the gentlelady from West Virginia, for the
    balance of my time.
        Chairman Baker. Thank you for that.
        Mrs. Capito. Thank you, Mr. Chairman. I suppose the most
    disturbing thing for me has been the fact that executives were
    allowed to sell their stocks and that company employees were
    unable to sell their stocks and ended up losing a lifetime of
    savings. You mentioned in your remark corporate insiders
    disclosure reform that you would like to have, but my
    understanding is that insider trading has always been and is
    illegal. How could this situation be prevented in the future,
    and what is your SEC oversight on insider trading? And I would
    like to hear your insights.
        Mr. Pitt. I think we are talking about two different types
    of activity. One is insider trading, which is illegal, and the
    other are trades by insiders, which are not necessarily illegal
    under current law. But, the point you make is, nonetheless, I
    think, quite valid that the situation arose where executives
    were free to sell their stock, as I understand it, while rank
    and file employees were precluded from doing so. And I consider
    the notion that that could happen to be outrageous.
        It doesn't necessarily mean that the actual trades by the
    executives were insider trading, but it does mean that
    something is terribly wrong with our system if those in power
    can sell, but those who have worked with their blood and sweat
    to make the company a better place have no such opportunity. My
    understanding is that these things are governed by laws
    regarding pension plans, and the SEC is given no authority with
    respect to the conduct of pension plans. We are given authority
    if a pension plan engages in trading that has an illegal
    impact, but basically it's the Secretary of Labor and the
    Secretary of the Treasury who, I think, possess the direct
    authority to deal with pension plan violations.
        Mrs. Capito. Thank you. I have no further questions. I
    yield back.
        Chairman Baker. The gentleman yields back the balance of
    his time?
        Mr. Bachus. I yield back the balance of my time.
        Chairman Baker. Mr. Sandlin.
        Mr. Sandlin. Thank you, Mr. Chairman. I would like to ask a
    few questions that were begun by Mr. LaFalce and Mr. Bentsen,
    not particularly dealing with just the accountants or the
    attorneys for Enron, but having to do with the investment
    banking. Someone has to underwrite these----
        Mr. Pitt. Sorry?
        Mr. Sandlin. Someone has to underwrite these transactions,
    someone is extending credit. It's being looked at by stock
    analysts and investment bankers and credit rating agencies, and
    of course the analysts are making money through the
    recommendations, and it's tied to bringing in deals to the
    investment banks. Do you think that the Stock Exchange should
    require that firms and analysts clearly note all current
    holdings in an investment relationship with the companies that
    they themselves rate?
        Mr. Pitt. Well, I think that the rules should prohibit any
    potential conflicts without certainly full disclosure of them.
    There are a number of ways that can be done, but I agree with
    you that the basic concept is that anyone who has a conflict
    should have to have to disclose it in plain English so that
    investors understand that the recommendations they are getting
    are not unbiased.
        Mr. Sandlin. And is that going to be a part of your
    investigation and part of the things you look at in making your
    recommendations in your list of initiatives to try to make
    corrections?
        Mr. Pitt. There is no doubt that that's being looked at. I
    think the SROs and the securities industry recognize the issue
    and they have moved to take steps to curtail it.
        Mr. Sandlin. Mr. Pitt, in talking about Andersen, I believe
    the public would be very surprised to learn that Andersen
    recently passed its triennial peer review. I noted in the press
    that on January the 2nd, Andersen touted a newly completed peer
    review that did not identify the systemic failures of Andersen,
    and it seems that the peer review erroneously gives the public
    confidence in these audits performed by Andersen, and due to
    the fact that we have had these fundamental failures of the
    system, why did the SEC staff stop work on a lengthy report
    identifying the shortcomings and how the industry regulates
    itself as was reported recently in the Wall Street Journal?
        Mr. Pitt. I'm delighted you asked that question.
        Mr. Sandlin. I only get about 5 minutes.
        Mr. Pitt. The first I learned about any such report was
    when a Wall Street Journal reporter called the SEC the day
    before the article appeared. Somebody thought it was clever to
    try to tie me into that report, and, as the article in the 27th
    paragraph indicated, the fact is that I had no idea there was
    such a report. Moreover, when we've looked at this, we have
    found that the so-called report was not really a report at all.
    The former chief accountant of the SEC apparently wanted a
    report done that would have established all of the things that
    the Commission did in this area, a kind of a score card. When
    former Chairman Levitt left, his staff thought that the project
    was in such a woeful state that it should not be continued.
    After Chairman Levitt left, apparently the former chief
    accountant insisted that the report still be worked on from
    time to time, but kept taking portions of it home and never
    allowed the report to be finished. It is my understanding,
    although I have no first-hand knowledge of this, that sometime
    before I took over, people made a decision that this was a
    useless exercise. So, that is the explanation of what happened
    there.
        Mr. Sandlin. Let me ask you this and I'm not trying to
    assign blame here. I'm not saying that. Obviously, the report
    was stopped no matter who began it or what the process was. Do
    you think that that would be a valuable thing to do now or do
    you think that would not be helpful?
        Mr. Pitt. What I think is valuable is to devise a system of
    thorough review and not peer review, and one of the things we
    have committed to do is exactly that. It has been our position
    that the current system of peer review is not working. You have
    firm-on-firm review. It doesn't provide the kind of discipline
    that we need, and so we have proposed an approach that
    basically would provide an independent board that would oversee
    the reviews instead of having firms review each other, and we
    would do it on a continuing basis, plus we would give them
    disciplinary powers and the like. That is one of the reasons
    why we concluded that the existing public oversight board,
    while an excellent idea and comprised of very capable
    individuals, was effectively a failure.
        Chairman Baker. Mr. Sandlin, your time has expired.
        Mr. Sandlin. Thank you, Mr. Chairman. Thank you, Mr. Pitt.
        Chairman Baker. Mr. Castle.
        Mr. Castle. Thank you very much, Mr. Chairman.
        Mr. Pitt, I have before me a chart which I don't expect you
    to read from there, sir, but I will read it, a little bit of it
    too, and I think some other Members may have it. It was
    presented to us, but it's entitled at the top, ``Investor
    Information Ensnared in Web of Corporate Reporting Conflicts,''
    and then it shows Enron Corporation and then it has Arthur
    Andersen, Auditing, Consulting. It has special purpose
    entities, it has investment banks, Merrill Lynch, and so forth,
    lenders, creditors, Citigroup, JP Morgan, research analysts,
    credit agencies, which were mentioned by Mr. Cox, and I added
    law firm to it because somehow it seemed to be omitted from it,
    and it seems to me all of these entities have something very
    much in common.
        All of these entities have a tremendous vested interest in
    keeping the price of Enron stock as high as they possibly can
    by whatever means they can, whether it be proper or improper.
    That's not to suggest that people who work in this business,
    for the most part, would do anything improper at all, but it
    does mean the temptation is there when you start to deal with
    stock options or whatever. I think if you look at these
    people--I've been thinking about this a little bit. It probably
    involves about a thousand people total who are really involved
    in wanting to keep that stock price as high as they possibly
    could.
        As a matter of fact, if you want to break it down for the
    House of Representatives, it probably involves about 6
    congressional districts, be they in Houston, in New York, in
    Connecticut, in northern New Jersey, or wherever it may be.
    Over here on the other side, we have the investors, the
    employees, and the shareholders, with the exception of the
    chieftains obviously, who get stock options, whatever it may
    be.
        Employees and investors and shareholders also have that
    same interest in keeping that stock as high as they possibly
    can, but they can't do a doggone thing about it, unlike these
    people who can do all kinds of things about it if they want to,
    and that is a very serious problem. This side over here
    actually represents directly probably hundreds of thousands of
    people. I don't know that, but stockholders, people directly
    involved, employees or whatever it may be, and indirectly when
    you look at pension plans and that kind of thing, it involves
    millions of people in the United States of America and they are
    all losers by what happened here today from a financial point
    of view by what happened with Enron in the course of this last
    year.
        Chairman Baker. Mr. Castle, I'll just help you with your
    visual aid. That chart up against the wall over there is the
    large of what you have before the Members to help those
    following you. I didn't put attribution on it. I circulated
    that little pile.
        Mr. Castle. Thank you. I didn't know that, Mr. Chairman.
    That chart's pretty hard to read too, sir, but I won't get into
    that. I only have 5 minutes.
        You have a huge impact on the economy of the United States
    of America about all this, and that's why I think all of us are
    as frustrated and as upset as we are, and we're not frustrated
    and upset at you. You're trying your very best to resolve these
    problems. But I want you to understand the intensity of what we
    are dealing with.
        I saw your proposals which you have outlined here which I
    think are good, although I think they need to be fleshed out a
    heck of a lot, and I'd sort of like to get a time line on some
    of them as well, but these are the kinds of things that we
    should be doing, and I think you have the right attitude about
    going about doing these things, but I think most of us feel and
    a few Members have asked this, are there other Enrons out
    there? I mean, Andersen was involved with, I think, Sunbeam and
    a few other corporations that had rather questionable
    accounting and other practices along the way. Are there others
    out there? Are we going to look at a whole year of these
    reports coming out? That question has been sort of been asked,
    but I'd like to ask you directly, if you have any indications
    of anything else going on out there that we need to be worried
    about since, and then I have a couple of other questions along
    those lines.
        Mr. Pitt. Let me say two things. One is, I share your sense
    of outrage. I assure you that this conduct is egregious, it is
    outrageous, and it is incredibly troublesome for our entire
    capital market system, which is still the best in the world,
    but this has undermined a great deal of investor confidence in
    it. I believe that there are many possible bases for this
    problem to have arisen, and we have to start working on those
    that are most apparent and evident and that give us the
    greatest chance of preventing another one of these from
    occurring.
        What I cannot tell you is whether there are other Enrons
    out there. I can tell you that there are other companies now
    that are doing restatements. In the first 2 months that our
    chief accountant, Bob Herdman, was on the job, not a single
    public company and not a single accounting firm walked in the
    door to ask a single question about appropriate accounting
    treatment. They were so afraid of dealing with the SEC. We put
    out the word that if they came in in good faith and they took
    care of investors, we would work with them to get the
    accounting right, and now his telephone is ringing off the
    hook. The best way to prevent another Enron is to have people
    ask the questions they need to ask and have the SEC give
    guidance to prevent those problems from arising. That's what we
    are all about, and that's what we're trying to do.
        Mr. Castle. Just remember there is a huge amount of self-
    interest in all this, and keep that in mind as you make
    decisions on this. Let me ask this question which I don't think
    has been asked that was written out here and that is--and I
    think you started to answer it just then, but have you seen
    indications from whatever filings you're receiving now that
    these various entities, the auditors, the company management,
    the attorneys, analysts, credit rating agencies--all the ones
    we have named, banks, and so forth, are being more diligent and
    conservative in their filing, not just the questions they are
    asking you, but are you seeing that thread through this?
    Because we have to stamp this problem out.
        Mr. Pitt. Yes. I think there are indications throughout the
    system that people are reacting and reacting positively, but
    what I will tell you is I won't rely on that. I think we have
    to fix what's wrong with the system; but, yes, I think those
    people are starting to take important measures to prevent these
    kinds of problems from arising again. It still will require
    action by the SEC or by the SEC and the Congress in order to
    make sure they can't do it anymore.
        Mr. Castle. Thank you, Mr. Pitt. You and the SEC may be the
    only ones with your finger in the dike right now. So do your
    job as well as you can. Thank you, sir.
        Mr. Pitt. Thank you.
        Mr. Castle. I yield back.
        Chairman Baker. Thank you, Mr. Castle.
        Mr. Sherman.
        Mr. Sherman. Thank you. I would also say that I agree with
    the proposals that you've made. I look forward to putting some
    flesh on those bones. Usually people who administer Government
    agencies would like to see their budget increased. So perhaps
    you'll enjoy this question. The President has proposed simply
    increasing your budget basically by inflation. What is the
    largest increase that you could imagine that you would need to
    do everything possible to give us the maximum possible
    confidence in our financial and capital markets?
        Mr. Pitt. I'm going to answer what I think the substance of
    your question is, but I have to start by telling you I don't
    think there's a number big enough to give us what you're
    asking. I just don't think it is possible for a Government
    agency to provide a guarantee of the entire system.
        Mr. Sherman. Excuse me. I didn't ask for a guarantee. I
    just said what would it take to do the best job that could be
    done?
        Mr. Pitt. We proposed--bear in mind that my approach when I
    got to the job was to start with the assumption that we would
    ascertain whether we needed more people and, as a result, we
    were prepared to have a limited increase in budget as the
    President's budget provides. But, we also asked for $76 million
    for pay parity. That pay parity has not been funded. That is a
    disappointment to me, and it is my hope that we can get that
    corrected working with OMB and the Congress. With respect to
    whether we need more people or not, there are a lot of
    variables. I had wanted to take 2 to 4 months to kind of get a
    sense of where people are. Unfortunately I have spent my first
    several months dealing with 9/11, and now Enron, and that has
    somewhat delayed me. But, I intend to make a very careful study
    of our manpower needs, and you can be sure that, if we need
    more people to do the job, we will not be shy about asking for
    them.
        Mr. Sherman. Let me follow up on that. Part of the problem
    with the Enron financial statements is some truly
    incomprehensible footnotes, footnotes that just demand
    clarification, footnotes that beg for additional questions.
    Now, back in a prior life, I have dealt with the SEC in public
    offering registrations, initial public offering. You submit a
    document when you first register a company, they first go
    public, and you get questions and they insist that you
    actually--that every paragraph be clear. What would it take for
    you to provide that kind of read, review, demand clarity, ask
    questions, review of every quarterly filing and every annual
    filing by every publicly traded corporation, not just the day
    they come in the door, but every quarter that they stay up
    there on the board?
        Mr. Pitt. I'm willing to answer that question, but I have
    to state that I couldn't possibly begin to guess at it sitting
    here. It's a fair question. I'm willing to try and look into
    the issue. It may be hard to quantify.
        Mr. Sherman. Rather than answer it now, but perhaps you
    could get back to us for the record. But I would point out that
    if only the SEC had read those footnotes and asked questions,
    we might be in a better position now. I went through a very
    scary experience at the cost of your agency, 2 hours of the
    time of your chief accountant and deputy chief accountant, as
    they explained to me Raptors and Chewco, and what shocked me
    was how close Enron came to being completely legal. They
    explained how Enron had failed to meet the standards for these
    special purpose entities not to have to be consolidated. The
    whole issue is about consolidation. And for roughly $30 or $40
    million of outside capital, they could have adhered to all
    these rules and kept all their billions of dollars of
    restatements off their financial statements and their tens of
    billions of dollars of capital worth, and we might not have
    seen, heard of Enron, except through their commercials and
    their funny ``E'' and their impression of the people of the
    West Coast when it came to their energy prices. What concerns
    me is what are you proposing to do to make sure that even if
    you adhere to those rules--because Enron would still be a
    basket case, it would still be a sham, $30 million isn't going
    to cure Enron, it's just going to bring them into compliance
    with the extremely flawed accounting rules that we have.
        Chairman Baker. The gentleman's time has expired.
        Mr. Sherman. I would like the witness to be able to
    respond.
        Chairman Baker. Certainly.
        Mr. Pitt. You have put your finger on one of the principal
    problems, and I echo your concerns. What we want is a system in
    which people don't try to take a very narrow approach and say,
    ``well, if we can squeeze it in between these two boxes, then
    we can do almost anything.'' We want the reality of the
    situation to govern. Even if a company meets the technical
    requirements of GAAP, if a picture presented of the company is
    not accurate, then we believe that that is a violation of law.
    We have to work our disclosure system to make certain that
    people can't do that.
        Chairman Baker. The gentleman's time has expired. I'd also
    direct the committee to the 1990 FASB decision with regard to
    this matter as well.
        Mr. Pitt. That is correct.
        Chairman Baker. Mr. Royce.
        Mr. Royce. Thank you, Mr. Chairman.
        Chairman Pitt, we had the Chief Accountant of the
    Securities and Exchange Committee, Mr. Herdman of the
    Securities and Exchange Commission, here in December, and at
    that time, I asked him a question which I would like to repeat
    to you, and I understand that he had a role in creating the 3
    percent rule that actually helps keep these special purpose
    entities off the books, these partnership agreements, when he
    was on the emerging issues task force. I would caution that
    that really needs to be revisited in terms of that FASB rule.
        But, let me just repeat the question I just asked him. If
    fraud is discovered in this investigation with respect to Enron
    in terms of insider trading, what is the likelihood that the
    profits made through fraud through that insider trading would
    then be compelled to be paid back to Enron so the assets and
    stock held by the employees of Enron and shareholders of Enron
    who did not have access to this insider information could then
    at least be partially benefited?
        He said: ``That's beyond my personal expertise.'' I don't
    know about specific remedies the SEC has available. I think
    this is called disgorgement, and I would ask you for the policy
    there with respect to the investigation.
        Mr. Pitt. There are two ways in which moneys could be
    returned to investors. The first through the SEC comes from
    something known as disgorgement, which means that if there are
    ill-gotten gains, those who have made those ill-gotten gains
    will have to pay those back and those moneys will go to the
    class of people who are injured by the improper conduct.
        The SEC also has the power to levy fines, but that money
    goes into the U.S. Treasury. It does not go into the pockets of
    investors.
        A second way in which investors can recover is through
    private litigation, and there have been a number of private
    lawsuits filed where investors can demonstrate that they have
    been defrauded. They are entitled to recover damages under the
    Federal securities laws, and the courts have been quite active
    in permitting plaintiffs to recover damages where they have
    made out their case.
        So those are the two essential ways. I suppose there is a
    third way. Sometimes the Justice Department will require some
    form of restitution as part of its settlement of a criminal
    action, so in a sense that and disgorgement are really the
    same, but that's a third source.
        Mr. Royce. With respect to the self dealing with the
    partnership agreements where tens of millions were made by
    Enron employees, I would assume that arguably that would come
    under that provision as well.
        How about with respect to the accounting firm Arthur
    Andersen that may or may not--we haven't heard the Andersen
    side of this, but we know the initial report that came out this
    weekend with respect to Enron's analysis argues that those
    partnership agreements were set up with the structural advice
    of the accounting firm. The accounting firm supposedly was paid
    $5.7 million to set up those partnership agreements. What's the
    likelihood that there could be action there with respect to----
        Mr. Pitt. I think there have been a number of suits already
    filed against Andersen in the private litigation. And, again,
    the SEC also can bring action against Andersen.
        Mr. Royce. Can you do it in a way it doesn't make the
    beneficiary the Treasury, but makes the beneficiary the
    victims?
        Mr. Pitt. Through disgorgement? The answer is yes.
        Disgorgement and prejudgment interest, the answer, it could
    be done. We have done that in cases where we have found
    entities to have violated the law.
        Mr. Royce. The Enron collapse has generated an
    unprecedented level of media and public attention, but Enron is
    not the only significant bankruptcy to hit shareholders in
    recent months. K-Mart and Global Crossing recently filed for
    bankruptcy protection as well. Global Crossing was the largest
    bankruptcy filing in the telecom industry and the fifth largest
    corporate bankruptcy in the U.S. The SEC has recently announced
    it is investigating Global Crossing's accounting. Are there
    regulatory and policy issues that are common to these
    collapses? Are there concerns unique to Global Crossing or K-
    Mart that the Congress and the public should be hearing about?
        Chairman Baker. Mr. Royce, your time has expired.
        Mr. Pitt. I think the answer to your question is yes. I
    think that there may be aspects of this that are unique to the
    companies. That will have to await an investigation, which I am
    not involved in. But, as soon as we get the results of that, we
    will know that. But there are items that are common, and that's
    why I have talked today, and in the past, in trying to repair a
    system that has been allowed to languish in need of repair for
    far too long.
        Chairman Baker. For the record, before recognizing Mr.
    Inslee, I just have three documents relative to FASB actions
    relative to the 3 percent investment rule in 1990, 1991 and
    1996; and I would like to introduce them into the record for
    Members' review.
        [The information can be found on page XX in the appendix.]
        Chairman Baker. Mr. Inslee, you are recognized.
        Mr. Inslee. Mr. Pitt, I am down here on your left.
        Mr. Pitt, I want to be helpful. I am from the Seattle area,
    and I represent thousands of people who were victimized by
    Enron who never bought a single Enron share of stock, but they
    got hurt because Enron was successful in capturing the energy
    policy of the United States and making sure that the Federal
    Government took no action for months and months and months to
    restrain these very, very injurious electrical price hikes
    which were benefiting Enron and hurting consumers all up and
    down the West Coast in the billions of dollars. Now we're told
    that involved in that decision were secret meetings between Mr.
    Lay and the Vice President where that issue was discussed.
        I can't vouch for the total accuracy, but I have been told
    on April 17, 2001, Mr. Lay met in a secret meeting with Mr.
    Cheney and urged the Administration to take no action to
    restrain these huge price increases. I am told that the next
    day, on April 18, 2001, the Vice President announced to the Los
    Angeles Times that the Administration was against taking any
    action to help the consumers in the West Coast in this regard;
    and, for months thereafter, the Administration failed to take
    any action to restrain prices. Finally it did, after
    essentially, I think, being shamed into what was going on on
    the West Coast.
        Now the question I have, the Vice President has refused to
    talk about those secret meetings or give any information about
    them. I would like to know whether the SEC is investigating
    that situation where Enron was successful in exposing the West
    Coast to these predatory pricing factors?
        Mr. Pitt. One of the things that I have learned in my 6
    months in office is that we get very little credit for
    anything, but we do get blamed for just about everything. I
    cannot respond to that question because it does not fall within
    the SEC's jurisdiction. If there is something that relates to
    securities anywhere in that context, you can be sure that our
    Enforcement Division will leave no stone unturned. But in terms
    of general energy policy, that, frankly, is beyond our
    competence, and I couldn't begin to give you any answer on
    that.
        Mr. Inslee. Who is investigating how that occurred for the
    Federal Government?
        Mr. Pitt. I think there are a variety of investigations
    that are going on, including in the Congress. There appear to
    be more investigations than one could throw a stick at. So I
    assume that somewhere that is being dealt with. It is enough
    for us to try to deal with the problems that we do have
    jurisdiction over, and I can assure you that we are making a
    very concerted effort to deal with those problems in a way that
    will make both sides of the aisle pleased with our actions.
        Mr. Inslee. Mr. Pitt, we would like to help you in that
    regard. Many of us would like to make sure you have the
    resources, the cops on the beat to get this job done. And this
    is a big, big job. This is a systemic failure that we need your
    organization to be very aggressive on.
        I would ask you a question. There is a disagreement in
    Congress about resource allocation. Some of us feel that it's a
    high priority to give you more cops on the beat to work on
    these issues. Some of us feel that, no, it's more important to
    repeal the AMT adjusted tax and give Enron over $250 million in
    a retroactive tax break. What do you think is more important to
    this country right now, a $250 million tax break to Enron and
    other corporations or beefing up your security apparatus and
    giving you more resources to get this job done? If you had to
    make that call, what do you think is more important?
        Mr. Pitt. One of the blessed aspects of this job is that
    the SEC is an independent regulatory agency. As much as I would
    like to assist you on that question, I don't have any basis to
    believe that the SEC would take a position on that.
        What I will say is that there is, obviously, a need for the
    securities laws to be enforced in a way that gives investors
    the assurance that events that gave rise to Enron are not
    likely to recur. or me, that is not only my first priority
    right now, it's my only priority.
        Chairman Baker. Your time has expired, Mr. Inslee.
        Mr. Inslee. Thank you, Mr. Chairman.
        Thank you, Mr. Pitt.
        Chairman Baker. Mrs. Biggert.
        Mrs. Biggert. Thank you for your patience. We appreciate
    the time you have spent with us.
        I understand that the SEC has issued guidance about 2 weeks
    ago on the special purpose entities and the market-to-market
    accounting, and I think the third one was related-parties
    transactions; is that correct?
        Mr. Pitt. There was a petition filed, and we put out a
    release giving interpretative advice with respect to some of
    those issues. Yes, that's correct.
        Mrs. Biggert. What I was wondering was whether you received
    any feedback either from the accounting firms or from
    corporations, companies on this?
        Mr. Pitt. I will ask. Our Chief Accountant happens to be
    here. I know that the request for guidance came from the
    accounting firms. So my assumption is that either there was no
    feedback or it was positive. I don't know if we have heard from
    corporations.
        What I am told is that the feedback so far from
    corporations has been positive. But it's so new that it's still
    a little early to reach a definitive conclusion.
        Mrs. Biggert. So is there any deadline or any time period
    for any feedback, or is this just open-ended?
        Mr. Pitt. No, it's not open-ended. The interpretative
    release we put out is effective, and there is no further kick-
    in period. People will have to start complying with it.
        But we have put deadlines on every aspect, including what
    we have asked FASB to do in terms of coming out with guidance.
    We have given them a deadline. We are putting deadlines on
    ourselves.
        I must confess that, when I started this, many of the
    issues were identical. Enron was a poster child for this. I
    thought we would probably need about 2 years to implement the
    kind of changes that we're talking about. I no longer believe
    we have that much time, and we are rethinking our entire
    timetable.
        Mrs. Biggert. Has there been any feedback as far as the
    cost of compliance? Is there anybody saying that the cost of
    compliance would be too high?
        Mr. Pitt. I have not heard that yet, but you raise to me
    what is a very, very important point. We have a very difficult
    balance. We do want investors to be fully protected and
    confident. But if the benefits are outweighed dramatically by
    the costs, we need to know that, and we need to avoid trying to
    make the imposition of those things a normal course.
        One of the things I am trying to do is hire a Chief
    Economist who will assist us in making those determinations.
        Mrs. Biggert. So there really hasn't been any negative
    feedback?
        Mr. Pitt. We have not gotten any negative feedback. But I
    am sure if there's a concern, we will hear it.
        Mrs. Biggert. Thank you very much. Thank you for being
    here.
        Thank you, Mr. Chairman.
        Chairman Baker. Inquiry has been made as to how the
    subcommittee will proceed with the next panel. It is my intent
    to finish this round of questions with Chairman Pitt and then
    move immediately to Mr. Powers. We have limited opportunity to
    receive his testimony, so the subcommittee will stay engaged
    into the early evening if necessary to conclude that work.
    Nutritional considerations are at the Members' own choosing.
        Mrs. Jones.
        Mrs. Jones. Thank you, Mr. Chairman.
        Mr. Chairman, good afternoon. You know we only have 5
    minutes. I am going to keep my questions short if you keep your
    answers short for me.
        Let me ask you, before you became the Chairman of the SEC,
    what did you do?
        Mr. Pitt. I was a lawyer, and before that I worked at the
    SEC.
        Mrs. Jones. What was your practice as a lawyer?
        Mr. Pitt. General corporate and securities practice.
        Mrs. Jones. Did you ever represent any of the five
    accounting firms that are being discussed in the news?
        Mr. Pitt. I represented all five of them and the American
    Institute of Certified Public Accountants.
        Mrs. Jones. I used to be a judge, and often litigators
    would file before the court affidavits of prejudice or ask
    judges to recuse themselves because of some prior
    relationship--either they were a lawyer with the firm or some
    other reason. Do you have any reason to believe as a result of
    your prior practice that there could be--and you know, in the
    ethics law they don't say it has to be an impropriety, but an
    appearance of impropriety. Would you answer that for me?
        Mr. Pitt. Sure. I believe that any questions that anyone
    wants to ask of me are legitimate, and I have an obligation to
    try and respond to them. I want the Members of this
    subcommittee and of Congress to have confidence in me. There is
    not the least bit of concern that I can detect, either legally
    or from an appearance point of view, with my trying to resolve
    the very difficult issues of restructuring our system of
    financial and narrative disclosures. We have made a decision
    that I will not participate, and am not participating, in any
    investigation that is specifically focused on an accounting
    firm. So that is why I have not participated after authorizing
    the staff to investigate Enron. That's why I have not
    participated in the investigation.
        Mrs. Jones. That deals with the issue that you believe has
    the appearance of impropriety by you not involving yourself in
    the investigation.
        Mr. Pitt. This has been reviewed by the SEC's General
    Counsel, who predated me at the Commission. There is not any
    inhibition on my trying to solve generic problems. When I left
    private practice, I left my clients behind.
        Mrs. Jones. I don't mean to offend you, Mr. Pitt. I am
    really asking these questions on behalf of the public who needs
    to know just as we are talking about disclosure.
        But, I guess the final question I have in this range is
    then that if as we move along it would appear that there were a
    situation that you did not sit--sitting as you do today, recall
    that you gave some advice or counsel to one of these folks, you
    would then be willing to disclose or step away or whatever was
    required in that instance? Because it happens to everyone who
    practices for a considerable period of time that they may not
    recall that they gave advice or counsel, sir.
        Mr. Pitt. It's always possible. And if I became aware of
    something that I thought created an obligation to step aside, I
    would.
        Mrs. Jones. Thank you very much. I appreciate your
    response.
        Let me ask you, what is Regulation FD dealing with traders
    trade by insiders as it relates to what we have been discussing
    with Enron?
        Mr. Pitt. Regulation FD was a rule that was proposed and
    adopted by the Commission to require that if a corporation
    discloses material information to anyone it must disclose it to
    everyone.
        We have proposed a different approach to that issue,
    although we would not repeal Regulation FD. Our approach is to
    say the companies should be affirmatively required to disclose
    material information to everyone.
        Regulation FD is an anti-disclosure rule. You can satisfy
    it by not disclosing anything to anyone. What I want to see is
    a system in which companies are affirmatively required to tell
    all material facts to investors.
        Mrs. Jones. And that Regulation FD--and I am no securities
    lawyer by any stretch of the imagination--would allow insiders
    like the Enron folks to dispose of their stock as long as they
    had in place a plan for disposal of the stock and there was no
    information that they had that would not have already been in
    the public purview.
        Mr. Pitt. No. There is Rule 10b5-1, which the Commission
    adopted again in a previous Administration. It basically says
    is if you have a pre-existing intent to sell and you can
    demonstrate it as the rule requires so that you can show that
    you are not influenced by any additional information you get,
    then you will be able to continue along that plan as long as it
    meets all of the requirements of the rule and doesn't reflect
    any other fraudulent behavior.
        Mrs. Jones. So that would be a way in which the Enron folks
    could claim--and you don't know the facts--but if they could
    show that they disposed of this property with a plan in place
    and no further information, they may not have any liability or
    culpability for selling their own stock; is that correct?
        Mr. Pitt. That's a possibility.
        Chairman Baker. The gentlelady's time has expired.
        Do you want to follow up?
        Mr. Pitt. I disagree with you that you are not a securities
    lawyer. You're doing a very good job.
        Mrs. Jones. With that, I will say thank you very much.
        Chairman Baker. Mr. Chairman, try using a lot more of that.
        Mr. Ose.
        Mr. Ose. I first want to make sure that you receive the
    plaudits that are due you as you have in the past--for your
    efforts following September 11 in reestablishing and getting
    the capital markets opened. You did a remarkable job. And while
    Enron is a huge, huge issue, it is minuscule in comparison.
        Mr. Pitt. I appreciate that, and I would make one
    observation, that all of the techniques we used to solve the 9/
    11 problem are exactly the same techniques we are using to
    solve the Enron problem.
        Mr. Ose. I want to go on to my questions. I notice in your
    testimony in the third paragraph that you are effectively
    saying that this investigation into Enron is under way; is that
    correct?
        Mr. Pitt. That is correct.
        Mr. Ose. The second question I have is when I'm called and
    the responsibilities that fall on me as a subcommittee Chairman
    on Government Reform to inquire about the status of an
    investigation on the alleged favorable placement of IPO stock
    to certain elected officials, the response I get is the SEC
    cannot comment one way or the other as to whether or not an
    investigation is under way. So here you are in front of the
    whole world saying that an investigation is under way, and yet
    when I have called asking about the alleged placement of IPO
    stock with certain elected officials the response I get is SEC
    cannot offer any comment. Can you reconcile those two?
        Mr. Pitt. I can, but I hope it hasn't been a call you have
    made to me.
        Mr. Ose. You and I have talked about something else.
        Mr. Pitt. Let me explain it to you. The Commission's policy
    is neither to admit nor deny the existence of an investigation
    as a general proposition because the mere fact of investigation
    does not mean that anybody has done anything wrong. However, in
    a situation of national importance like Enron where the company
    itself discloses that it is under investigation, they made the
    disclosure first, it seems to me pointless for us to deny or
    not confirm the fact that they are telling the truth, that we
    are investigating them. And so that is the distinction that we
    have followed. We have done that in a number of other areas.
        Mr. Ose. Let me draw the parallels for you. The Enron
    investigation talks about alleged inappropriate behavior on the
    part of corporate officials. This situation I called asking
    about introduces the concept that perhaps there's inappropriate
    behavior by elected officials receiving preferential treatment
    in the place of IPO stock. I don't know of anything that is
    more important to the body politic in this country than whether
    or not their elected officials are being improperly rewarded,
    and I can't find out from SEC whether or not there's an
    investigation going on. Is there an investigation going on in
    this issue?
        Mr. Pitt. Since I am under oath, I can tell you with great
    confidence I don't know the answer to that question. I don't
    know whether there is such an investigation. If there is one or
    isn't one, I don't know. If there isn't one, I don't know why
    we haven't at least explored whether there are ways we can
    discuss this. But once we make an exception to our general
    rule, we undermine the integrity of our investigative process.
        Mr. Ose. My time is waiting here. My only point is that the
    parallels between the two sets of circumstances are uncannily
    similar: One is corporate officials; one is Government
    officials.
        Now I want to go to the third question I have, and that has
    to do with Enron. We have heard a lot of talk how people lost a
    ton of money because the stock collapsed. But on both sides of
    the transaction there is a seller and a buyer. If the stock is
    falling, the seller who might short sell or might buy puts or
    sell calls makes as much money as they would if the stock were
    appreciating. Is the SEC investigating what happened to the
    stock in these various--investigating whether or not people
    benefited from short selling the stock out of these SPEs?
        Mr. Pitt. I cannot tell you exactly what our enforcement
    staff is investigating because I am not involved in it. What I
    can say is that if there's any reason for them to believe that
    violative conduct took place in that connection, I am positive
    they are investigating it.
        Mr. Ose. I will commit this avenue of thought to you
    because I happen to think just intuitively--my instincts tell
    me something happened of this nature--can't prove it to you
    yet, but my instincts say something went on here.
        Chairman Baker. The gentleman's time has expired.
        Mr. Moore.
        Mr. Moore. Thank you, Mr. Chairman.
        Mr. Pitt, we've heard testimony today about Raptor,
    Braveheart, Chewco, LJM. You have you heard that testimony,
    sir?
        Mr. Pitt. I've read about them.
        Mr. Moore. Do you know those to be limited partnerships?
        Mr. Pitt. I have read that they are limited partnerships,
    but I have no direct knowledge about any of them.
        Mr. Moore. Are you aware that Enron had created a number of
    limited partnerships or have you heard that?
        Mr. Pitt. I'm sorry. Enron----
        Mr. Moore. That Enron created a number of limited
    partnerships?
        Mr. Pitt. I have certainly read that, yes.
        Mr. Moore. You don't have any personal knowledge of this?
        Mr. Pitt. I am not involved in the investigation.
        Mr. Moore. Do you have any idea or understanding as
    Chairman of the SEC why Enron would create limited
    partnerships?
        Mr. Pitt. There are reasons why limited partnerships might
    be created. What I cannot tell you is why the specific types of
    limited partnerships that appear to have been created here were
    created. It's just something that I can't address for you.
        Mr. Moore. All right. Is it your understanding that some of
    the principal officers or officers in Enron were involved in
    these limited partnerships?
        Mr. Pitt. That's what I have read, yes.
        Mr. Moore. Do you know William C. Powers, Junior?
        Mr. Pitt. I don't know him personally, but I know him by
    reputation and by reference to the report he issued yesterday.
        Mr. Moore. Have you read that report, sir?
        Mr. Pitt. I have not read the whole report, but I have read
    the executive summary. I am still wading through the whole
    report.
        Mr. Moore. In fact, is it your understanding that he served
    as Chairman of the Special Investigating Committee of the Board
    of Directors of Enron Corporation?
        Mr. Pitt. That is my understanding, yes.
        Mr. Moore. In the executive summary that you read, Mr.
    Pitt, did you see that Mr. Powers found that CFO Andrew Fastow
    and other Enron employees involved in these partnerships
    enriched themselves in the aggregate amount of tens of millions
    of dollars?
        Mr. Pitt. I have seen the number $30 million attached to
    it. That's what I have read.
        Mr. Moore. Do you have any reason to disagree with that?
        Mr. Pitt. I don't have a reason to agree or disagree. I
    would assume that they would have checked before they wrote
    their report, but I have seen a lot of things in writing that
    don't appear to be accurate.
        Mr. Moore. I have, too. Did you see his conclusion that we
    found that some transactions were improperly structured? If
    they had been structured correctly, Enron could have kept
    assets and liabilities, especially debt, off its balance sheet,
    but Enron did not follow the accounting rules.
        Mr. Pitt. That's what I understand to have been their
    conclusion.
        Mr. Moore. And did you also see his final conclusion, or
    one of his final conclusions, that there was a systematic and
    pervasive attempt by Enron's management to misrepresent the
    company's financial condition?
        Mr. Pitt. I believe that was one of the conclusions that is
    in the report.
        Mr. Moore. Would those conclusions, if they are true, be a
    concern to you as Chairman of the SEC?
        Mr. Pitt. They are an enormous concern to me as Chairman of
    the SEC and as a citizen, and I am outraged if they turn out to
    be accurate--outraged.
        Mr. Moore. I assume that's part of what you want to do, if
    in fact any of those conclusions are correct, to try to make
    sure these things don't happen in the future with regard to
    other corporations; is that correct, sir?
        Mr. Pitt. Absolutely. And in some respects, even if they're
    not illegal, we still have work to do to make sure that
    investors are fairly and fully informed. We are not responding
    solely to illegality.
        Mr. Moore. You have detailed a plan or a proposal to try to
    assure that. What can we do? Can you give us a short summary in
    the couple of minutes I have left as to what we can do to make
    sure that investors are not deceived in the future?
        Mr. Pitt. I don't have a monopoly on ideas, but what we
    have proposed is a substantial revamping and revision of our
    disclosure and financial reporting system, a substantial
    revamping of the way audit committees perform their functions,
    a substantial and significant improvement in the private
    discipline and oversight of the accounting profession and the
    promulgation of accounting standards that make common sense
    instead of just give people a target to shoot at so they can
    say they complied with GAAP.
        Mr. Moore. What kind of accounting standards would we have
    that would make common sense and give people an understanding
    of what information is intended to be conveyed?
        Chairman Baker. That would be your last question.
        Mr. Pitt. My concern is that the FASB has promulgated
    standards that are too detailed. I think what we need are
    standards that basically address what the concept is, what are
    the core principles we want to achieve and then have those
    articulated so that nobody can try to finesse their way around
    what the concepts are by relying on the literal language of
    some detailed provision in paragraph 12(6), which is what
    happens now.
        Chairman Baker. Thank the gentleman for yielding.
        Mr. Leach.
        Mr. Leach. Well, thank you, Mr. Chairman.
        There are a lot of public issues that have been raised
    properly, ranging from 401Ks to campaign reform issues, and I
    would just like to raise a couple that tie directly to this
    subcommittee's jurisdiction.
        The first is it seems to me that the Enron collapse in the
    bankruptcy proceedings and following it underscore the need for
    the Congress to move on to what's called netting reform,
    whereby when companies go into bankruptcy, there's an automatic
    netting of financial derivatives contracts, and the Enron
    example could be very chaotic if this had been a financial
    company instead of an energy company that had gone bankrupt.
        Second, it seems to me just as there's an issue of SEC
    resources there's also one of jurisdictional bifurcation; and
    my sense is that the Enron issue really underscores the need
    for Congress to review again whether the SEC and CFTC ought to
    be combined. Also, I think we are going to have to review
    whether certain derivatives, energy contracts should be outside
    the realm of regulation.
        Third, I am in some ways as concerned with the legal as
    well as the illegal or possibly illegal acts of Enron. For
    example, this whole notion that tax shelters in the Cayman
    Islands can be used to hide tax losses may be legal, but its
    fairly unconscionable; and likewise the full notion that you
    have tax shelters in the Caymans--and Enron apparently had 900-
    some--to shield the company from alleged tax liabilities is
    equally unconscionable. And I raise this from the perspective
    of a couple of questions.
        One is, as head of the SEC, do you have a position on the
    netting issue and whether Congress should move on something
    this subcommittee has twice passed?
        Second, given the particularly--this whole problem of
    derivatives, what is your view on combining of the SEC and
    CFTC?
        Finally, do you think the SEC and, for that matter, the IRS
    ought to give priority attention to all business schemes which
    organize offshore to avoid U.S. tax and U.S. regulatory laws?
    Do you have any recommendations to Congress and what steps you
    think might be taken in this particular area?
        Mr. Pitt. Well, let me try and respond briefly to those.
        I have joined Chairman Greenspan in supporting the netting
    provision change in the bankruptcy laws, and that was a
    position obviously that was intended to reflect realities that
    we believed at the time. It is my view, as I have said, that
    the more we learn about Enron, the more people have to rethink
    prior positions. It doesn't mean that you'll change those
    positions, but it means that at least everything has to be fair
    game and on the table.
        As for the combination of the SEC and the CFTC, I think
    that's a very complicated issue. It is not clear to me that we
    will enhance the effectiveness of either agency by combining
    the two.
        So, in one sense, I don't start by trying to increase our
    territorial reach. I think our territorial reach is quite
    broad, and I think we've in the past neglected some areas. It's
    something I would certainly be willing to work with this
    subcommittee on and with you on to consider, but I don't start
    out by advocating the position of the agencies. We have worked
    very closely with the CFTC, and I have worked very closely with
    Jim Newsome, and the President's Working Group on Financial
    Markets has provided a good forum for us to work
    collaboratively.
        With respect to foreign corporations using foreign tax
    havens and the like and bank secrecy statutes and the like, I
    think this has been a problem. Some of it is addressed in the
    PATRIOT Act, because using foreign jurisdictions is also a way
    that people can hide terrorist illegal activities and it's
    something that I think we have to take a very close and hard
    look at to see whether we are allowing illegality to go
    undetected.
        Chairman Baker. The gentleman's time has expired. Thank
    you, Mr. Leach.
        By regular order Mr. Watt would be next, and then you would
    follow. The gentleman defers.
        Ms. Jackson-Lee.
        Ms. Jackson-Lee. Mr. Chairman, I cannot thank you enough
    for your kindness and indulgence of this subcommittee and the
    Ranking Member, Mr. Kanjorski, and the full committee, Mr.
    Oxley and Mr. LaFalce.
        Mr. Chairman, you must recognize that many of us who have
    interacted with some of the bleeding that has occurred, looking
    at the human face, the ex-Enron employees, many of whom who
    have traveled here to Washington as well, the pensioners and
    retirees, many of whom live around Houston, Texas; and of
    course, the State of Texas, really look at what has occurred as
    a failing of our system for them. They had great faith, not
    only in their corporation, but in the structures of laws.
        One of the things that they have reminded me of, they look
    for several elements--objectivity, independence and integrity.
    That seems to have been a wash in the circumstances of Enron
    with respect to oversight.
        The other thing that we noted was, although it was a cause
    for great joy, the seemingly meteoric spiraling of stock prices
    in Enron starting in 1984 was about $5 or $6--it wasn't Enron
    then--but moved quickly between 1999 and 2000 to a $90 peak.
        Two questions I would like for you to explore for me in
    light of the pain that so many of these employees are facing.
    We will hear from them--people who can't get insulin, can't get
    dialysis, just a huge outpouring of occurrences. Where was our
    oversight as relates to the independence and objectivity of the
    auditing firm? Where did the glut of money start rising in the
    simple stereotype with the accountant with the glasses on and
    pouring over numbers and coming up with whatever the truth was?
    How do we get into this business where accounting firms felt
    obligated to be engaged in consulting on the basis of just
    needing money? And how quickly can you act to separate out
    those functions on the regulatory factor?
        Then, secondarily, whether or not any red flags at the SEC,
    knowing that it preceded your timing--I think the peak of the
    stock price was August 23, 2000, when it went to $90, but there
    were promises it would go up to $120--aren't those red flags
    that there ought to have been some intervention, some
    oversight, more in-depth review of the company at that time?
        Mr. Pitt. Those are critical questions. And the first one--
    it is not possible for me to address the specific situation of
    Enron and how the auditors performed there, but what I can tell
    you is that the sense of outrage and concern that you very
    articulately expressed is something that I completely agree
    with. If there has been a failure by accounting firms in any of
    these cases, speaking generically, they must first be brought
    to task to answer for what they have done; and, second, we have
    to repair the system so that it doesn't happen again.
        I am focused at this point in time on trying to repair the
    system so there aren't any more people in your district or in
    any other district in this country who suffer what these people
    have suffered. They were innocent victims, and I grieve for
    what happened to them. So we have an obligation to do something
    about those, and we will, and if we conclude that the auditors
    were derelict in their responsibility, you can be certain that
    we will take every step within our power to address that.
        With respect to the notion of independence and consulting,
    let me say that there are two levels. I believe independence is
    an absolutely critical requirement. It is the bedrock of
    financial statements in this country. In my view, the first
    place one has to look is on the front lines. The audit partners
    who are doing the audits are absolutely required to be above
    any question and not to be subject to any confusion about where
    their duties lie.
        I think, in terms of the way compensation has existed,
    there are considerable questions whether that was appropriately
    handled in the first instance.
        For the firms, to me the issue is making certain that the
    firms fulfill their responsibility to ensure that the people on
    the front lines do an honest count and an honest audit, just as
    you're referring to. I am very much concerned that all of the
    incentives in the system be geared toward getting exactly that
    result.
        How quickly can we respond? Well, in the first instance, it
    appears that the major accounting firms have suggested that
    they will voluntarily cleave off some of their consulting
    efforts that have raised questions in some people's minds. I
    believe that we have to look at this independence question
    also, and if there are problems there, we have to act quickly.
    I believe that we can take action generally within about a 90-
    to-120-day timeframe once we have concluded that there is
    something that we should do.
        We are going to try our best to make certain that we don't
    expend any extra time trying to solve these problems, but we do
    have to give people the opportunity to be heard and to share
    their views with us and make certain that we are not headed
    down some wrong path that might create a problem worse than the
    one we are trying to solve.
        Ms. Jackson-Lee. I appreciate the time that we have in
    questioning.
        Let me just quickly say, you offered or extended your
    agency's willingness to collaborate with Congress. I think the
    voluntary aspect is something that is commendable, but we need
    laws to change what has happened. I ask you to comment on the
    red flag--not specifically of the company--but red flag when
    you see the inflation of stock going up. Is there a time and
    place to intervene, to be able to look to ask the hard
    questions, what is happening?
        Mr. Pitt. In hindsight, it may well be that the rising
    price could have triggered some questions. What everyone hopes
    for when they invest in a company, obviously, is that the price
    will go up. Even though I don't invest in the stock market
    because of my job, everyday I keep hoping that the Dow Jones
    will jump dramatically and keep on going upward because that is
    better for the economy and the country.
        I think there's no direct correlation, however. Just
    because a company's stock price rises doesn't necessarily mean
    that there was something fraudulent.
        On the other hand, I think dramatic movements can sometimes
    contain the seeds of clues that would raise red flags, and one
    of the things we do is have a market stock ``watch.'' We have a
    very sophisticated computer system that kicks out strange
    movements in stock, but also correlates them to major news
    stories and looks back to see if people traded before the news
    came out. I think we can increase the sophistication of what we
    have, but your essential point is one that I completely agree
    with. We have to be alert to any signs that something may be
    amiss in the system.
        Chairman Baker. The gentlelady's time has expired.
        Mr. Chairman, I heard this admonition: ``If it grows like a
    weed, it probably is one.'' Not bad advice.
        Mr. LaTourette.
        Mr. LaTourette. Mr. Chairman, thank you for your patience
    both during our discussion on whether or not the witnesses
    needed to be sworn in and also during the questioning.
        When we get about this time of the panel, most of the
    innovative and thoughtful questions have been asked. I have
    been troubled and I want to talk about something that is
    parochial in the last couple of minutes of my time. But, Mr.
    LaFalce in his opening statement, and I think Mr. Sherman and
    even the benign Mr. Inslee, talked to you a little bit about
    your budget, and Mr. LaFalce made the observation that perhaps
    the President's request wasn't enough. Mr. Sherman threw you a
    beach ball and asked you to hit it out of the park. As a
    director of an agency, who wouldn't want more money? And Mr.
    Inslee asked you to balance alternative minimum tax repeal
    versus more cops on the beat, which is familiar rhetoric here
    on Capitol Hill.
        Does the President's proposal--and I understood your answer
    on pay parity, and you're going to have that out with Mr.
    Daniels at OMB, but does the President's proposal, in terms of
    what your budget is going to be, cause you any concerns at all
    that you will not be able to execute the things that you've
    laid out for us in your testimony today?
        Mr. Pitt. It doesn't, or at least let me say it didn't. We
    were amenable to a very modest budget increase to be consistent
    with national budget policy. What we had thought was there
    would be pay parity.
        In light of both 9/11 and Enron, obviously I have not had
    the time to see whether there are deficiencies in our manpower,
    but don't start by assuming the answer to every problem is more
    people and more money. I think we should use the people we have
    efficiently and smartly, and then if we need more, we should
    come back and make the case.
        Mr. LaTourette. Watching you for the last 3 hours, you
    don't strike me as the kind of person, likewise, who would be
    squeamish about asking for more stuff if you felt you needed it
    to do your job.
        Mr. Pitt. Nobody has accused me of being a shrinking
    violet.
        Mr. LaTourette. There is a similar problem in other parts
    of the country that has to do with fraud and neglect, and I
    just want to ask whether it has come to your attention. Ms.
    Jones and I are from Cleveland. There's a fellow who worked for
    Lehman Brothers--in charge of that office, and I understand
    that this is something that has been repeated in New York and
    also in Illinois--who for 15 years directed false statements to
    a post office box and walked away with about $300 million of
    investors' money, and I ask you is this the first time you have
    heard of it?
        Mr. Pitt. I don't know if I have heard of this specific
    situation. I would like to tell you that I never heard of
    anything like that, but even in the 6 months I have been on the
    job, unfortunately, I have seen a lot of comparable things.
        Mr. LaTourette. Like in the Enron situation where people
    have been on the line or over the line, I don't think we are
    going to have a problem there in that this fellow left a note
    behind for the FBI. He wrote a letter to his mom saying he
    would like to turn himself in. So, hopefully, he will turn
    himself in with the money.
        Mr. Pitt. I wouldn't take bets on the latter.
        Mr. LaTourette. I am not, either, but it is of great
    concern to the people who trusted him for 15 years.
        The only thing I'd ask of you is, if we get you the
    information, can I have your observation that you would give us
    a hand in trying to help the folks in Chicago and Cleveland
    out?
        Mr. Pitt. We would be very anxious to receive the
    information, and we'll do whatever we can to avoid anybody
    getting away with that kind of chicanery.
        Mr. LaTourette. Just so I understood your answer on the 3
    percent rule about--I took it to mean that you're going to
    impose some common sense, rather than just meeting this
    threshold of 3 percent and then who is in charge and so forth
    and so on. If I understood Mr. Powers' Report over the weekend
    correctly, these particular SPEs were designed not to transfer
    risk or do some laudable objectives, they were designed for the
    specific purpose of creating a favorable financial statement.
    What I took you to mean is that you are not going to look at
    the 3 percent rule. You are going to say there are good 3
    percent things and there's bad 3 percent things and we are
    going to sort of reward or recognize those that have merit and
    not those that can be used for trickery. Is that a fair
    summary?
        Mr. Pitt. That is fair.
        About 40 years ago, there was a criminal case in which it
    was articulated by the Second Circuit that compliance with
    generally accepted accounting principles will not save somebody
    from a fraud action and a criminal conviction if what they have
    done doesn't make sense and defrauds investors.
        Mr. LaTourette. Thank you, Mr. Chairman.
        Chairman Baker. Mr. Shadegg.
        Mr. Shadegg. Thank you, Mr. Chairman; and thank you for
    holding this hearing. It's been useful, and I look forward to
    it and the continuation tomorrow.
        Thank you, Mr. Pitt, for your patience and for your
    thoughtful answers.
        There are many different aspects of this issue we could go
    into. I want to look, and I think the Chairman has set the tone
    for this, on what we can do looking forward to try to make this
    system work. It seems to me there's nothing more important that
    this Congress can do. If Americans or people around the world
    don't have faith in our markets, if they don't believe that a
    company's value is accurately represented and that its stock
    represents fairly its value, we could have collapse of the
    entire capital system in the world.
        I've read through your recommendations, and I think most
    are well taken. I want to explore and follow up on Mr.
    LaTourette's questions about the 3 percent rule, and I kind of
    want to get down to the basics.
        Throughout the literature and the articles I have been
    reading these things are called special purpose entities. But
    for people back home, we in Washington often talk in code
    language that is not understandable. The term I like better is
    off-balance sheet entities.
        It is a little funny. I want to figure out how my wife and
    I, who want to borrow some money to build a new home, can
    create an off-balance sheet entity in which we dump all of our
    debt for our cars and our current obligations and qualify for a
    larger loan for our current home.
        I don't mean to be flip about that, but I think the average
    person out in America reading sees SPE and they read it is an
    off-sheet balance entity and then they discover it was created
    to hide debt to make a financial statement look a little bit
    better and they're going, well, wait a minute. Why in the world
    should they be able to do that?
        I would like you to explain to me why we shouldn't have a
    completely consolidated balance sheet. What is the legitimate
    reason for letting a company, if there is any, have an off-
    balance sheet entity to hide debt in?
        Then your specific testimony says, refer this issue to
    FASB, and says, well, for too many years the FASB has failed to
    set standards for accounting for special purpose entities.
    Should this Congress allow that duty to remain with FASB or
    should Congress step in and not allow these things to occur?
    Because if you can't trust what you're looking at in the
    report, if there's an off-balance entity in which debt is
    hidden, I don't think anybody can have confidence in the
    system.
        Mr. Pitt. Let me start with your last question, because it
    is one of major concern to me. I think that the concept of FASB
    makes enormous sense. I think having the private sector set
    standards makes sense. I think what does not make sense is to
    let FASB languish.
        The SEC did not exercise appropriate oversight over FASB
    for many, many years. That, I can assure you, is going to
    change. If it doesn't change, we won't recognize FASB. We would
    change the system.
        Mr. Shadegg. I appreciate that recognition that there is a
    problem here, that we have not overseen FASB.
        Mr. Pitt. That's a place where the SEC has a clear duty,
    and I intend to make sure that the Commission fulfills it.
        With respect to off-balance sheet items, first of all, if
    you and your wife figure out how to do this, without my being
    flip, I hope you will tell me, because my wife is very anxious
    for me to figure out how to do the same thing, particularly
    since I have come to work in the Government. There are many
    types of ventures in which companies can have relationships
    with other entities and the questions of consolidation go to
    whether or not the other entity is independently managed,
    whether there's any recourse against the public company for
    satisfying some of the obligations of the off-balance sheet
    entity.
        There are legitimate reasons why people might set up
    legitimate partnerships to perform a number of special
    purposes. What is not legitimate is basically to try to use
    them to siphon off liabilities and put them someplace else. If
    that is what happened--and certainly Mr. Powers' Report
    suggests that is what happened--if that is what happened, in my
    view, that's illegal, and that has to be addressed.
        Mr. Shadegg. You would agree that the 3 percent rule--just
    as a standard, if it's 3 percent independently owned, that is
    sufficient to keep it off the balance sheet, appears now, at
    least in hindsight, to be a bad rule?
        Mr. Pitt. You're asking a fair question. I'm not the best
    person to respond to that because, frankly, the nuances of SPEs
    and the accounting rules that apply to them are probably beyond
    my comprehension.
        Mr. Shadegg. I want to ask one related question. It appears
    from what I can read that in at least one instance the 3
    percent rule wasn't honored. But that's not a rule in a sense
    that violating it is something you can go after and enforce.
    That's a judgmental standard which in fact there was not a 3
    percent operation, and if in fact there was money kicked back
    so the independent entity had less than 3 percent, that may
    play into whether or not fraud occurred, but it is not a
    regulatory violation. Am I correct about that?
        Mr. Pitt. I don't necessarily agree with that. I'd have to
    know a lot more.
        But I would say that a failure to comply with GAAP for the
    purpose as alleged here of hiding or secreting liabilities is
    eminently redressable under our existing authority. That, where
    I come from, which is Brooklyn, is fraud.
        Chairman Baker. Mr. Shadegg, would you yield for a
    question?
        In my reading of the events in particular with one SPE, not
    only was the 3 percent trigger complied with, but Enron
    advanced the capital to the investor to put up the 3 percent,
    then advanced the money to the SPE to acquire the debt asset
    that was purchased by the SPE to get it off the books. So that
    the entire operation was Enron controlled, Enron funded, and
    they took the profit from the sale of that debt asset to the
    SPE and booked it as recurring revenue to the corporation.
        There is no explanation, in my judgment, that can justify
    that conduct.
        Mr. Pitt. I could not agree more. If that is what occurred,
    then it makes a mockery of the requirements and, as I say, that
    would be fraud.
        Chairman Baker. Thank you.
        Mr. Shadegg. That is, in fact, what I had read.
        Chairman Baker. Mr. Chairman, I certainly appreciate, and I
    speak for the entire committee, your tolerance in this lengthy
    hearing this evening and your contributions to the overall
    progress of our committee's work. I do appreciate your
    willingness to respond to my letter in the most timely manner
    possible.
        Legislative effort is eminent, and I hope that your input
    can be constructive for the subcommittee in offering the best
    product possible and again appreciate your generous work and
    effort in regard to the endless conduct rules which we will be
    announcing on Thursday of this week. We appreciate your
    courteous appearance.
        Mr. Pitt. Thank you very much. I have said from the outset
    of my tenure that I believe that Government is a service
    business, and we want to be of service to this subcommittee and
    to every individual Member, that if there are things that we
    can help with, please let us know and we will try to work with
    you in the public interest.
        Chairman Baker. Thank you for your courtesy.
        We would like to now call our next panel, Mr. William C.
    Powers, Junior, Director of Enron Corporation, who was directed
    by the board to conduct his own review of the activities within
    Enron and who is principally responsible for the release of the
    report which has been the subject of news stories yesterday.
        By prior agreement, before I recognize the witness, the
    panelist for the subcommittee work, Mr. Bachus had reserved his
    2-minute statement from the earlier opening prior to this
    panel. Mr. Bachus, you are recognized for your 2 minutes.
        Mr. Bachus. Thank you, Mr. Chairman.
        Mr. Powers, welcome to the subcommittee.
        Tragically, 11,000 Enron employees lost their retirement
    savings under a savings plan that was administered by a
    committee and trustee, all of which were handpicked by the
    company. The plan has written rules and guidelines that created
    duties on the part of the company, the directors and agents of
    the company to the employees. I have read the plan, takes about
    30 minutes to read it. My question is, was this a forgotten
    document?
        It is apparent to me that, had the plan been followed,
    those 11,000 employees wouldn't have lost their retirement
    savings. There are all sorts of illegalities, misconduct and
    nondisclosures associated with this catastrophe. Aside from all
    that, there was total disregard of the retirement savings plan,
    which is similar to the retirement savings plans most Americans
    participate in. A hundred million Americans or more participate
    in these 401K plans. My line of questioning will deal with this
    plan.
        It is clear, and I am sure that you will agree, this plan
    was violated. The plan gave discretion to the committee and to
    the trustee appointed by the company. The plan mandated, among
    other things, diversification in investment. It required the
    company to share all pertinent information with the committee.
        Whatever else we have here, we have an old-fashioned, plain
    vanilla violation of their fiduciary duties under the Enron
    retirement savings plan by the company's senior executives. How
    the heck did that happen?
        The plan requires that the committee and trustee under the
    direction of the company and with information supplied by the
    company shall do certain things, including specifically;
    ``diversify the plan with investments to avoid large losses.''
        How is this plan so utterly disregarded or ignored? Was
    this a case of everyone being asleep at the switch or was there
    a willful intention to withhold information? The actions of the
    company and its agent when reviewed against the backdrop of its
    fiduciary duties arising under the plan reveal a wealth of
    violations for Enron. Fiduciary failures are under ERISA which
    is administered by the Pensions and Welfare Benefits
    Administration of the U.S. Department of Labor. I will be
    contacting Labor Secretary Elaine Chao to urge her to launch an
    investigation of the named fiduciary about the failures of the
    committee and the trustee and senior executives of the company
    to comply with Enron's written savings plan.
        This investigation by Congress and any other agencies must
    be thorough and complete. If violations or improprieties have
    occurred, let the chips fall where they may. Thank you, Mr.
    Chairman.
        Chairman Baker. Thank you, Mr. Bachus.
        Mr. Powers, by action of the subcommittee earlier today, it
    is required that all witnesses before the subcommittee take an
    oath. Do you have any objection to testifying under oath?
        Mr. Powers. None whatsoever.
        Chairman Baker. I also have to ask, do you desire to be
    advised by counsel during your testimony today?
        Mr. Powers. No, I do not, Mr. Chairman.
        Chairman Baker. In that case, sir, if you would please
    raise your right hand, I will swear you in.
        [Witness sworn.]
        Chairman Baker. Thank you, sir. You may proceed at your
    leisure. Your statement will be included in the record as
    presented. You may summarize or proceed at your convenience.

      STATEMENT OF WILLIAM POWERS, JR., CHAIRMAN, ENRON BOARD OF
               DIRECTORS SPECIAL INVESTIGATIVE COMMITTEE

        Mr. Powers. Thank you very much, Mr. Chairman.
        Mr. Chairman, distinguished Members of the subcommittee, my
    name is William Powers and I'm the Dean of the University of
    Texas School of Law. For the past 3 months I've served as
    Chairman of the Special Investigative Committee of the Board of
    Directors of Enron, and I very much appreciate this opportunity
    to come before you today and testify.
        As you know, during October of last year, questions were
    being raised about Enron's transactions with partnerships that
    were controlled by its Chief Financial Officer, Andrew Fastow.
    In the middle of October, Enron announced that it was taking an
    after-tax charge of more than $500 million against its
    earnings, because of transactions with one of those
    partnerships. Enron also announced a reduction in shareholder
    equity of more than a billion dollars. At the end of October,
    the Enron board established a special committee to investigate
    these matters, and then asked me if I would join the Board for
    the purpose of chairing that committee and conducting that
    investigation. With the help of counsel and professional
    accounting advisors, we've spent the last 3 months, in fact,
    doing that investigation.
        Our committee's report was filed on Saturday. It covers a
    great deal of ground and it will, I hope, be helpful in
    providing a starting point for the necessary further
    investigations by congressional committees, by the Securities
    and Exchange Commission, and by the Department of Justice. A
    copy of the executive summary of our report is attached to my
    statement here.
        Many questions are currently part of the public discussion,
    such as questions relating to the employees' retirement savings
    that Congressman Bachus raises, very important questions, and,
    of course, one of the most tragic consequences of this sad
    story. The questions such as those related to the retirement
    savings or other questions related to sales of Enron securities
    by insiders were beyond the scope of the charge that we were
    given. These are matters of absolute vital importance. They
    need to be investigated. They were not part of our charge.
        In the 3 months that we had for our investigation, we did
    not investigate those vital questions. Instead, we were charged
    with investigating transactions between Enron and partnerships
    controlled by the Chief Financial Officer or people who worked
    in his department, and that's what our report discusses.
        Frankly, Mr. Chairman and Members, what we found was
    absolutely appalling. First, we found that Fastow and other
    employees involved in these partnerships enriched themselves in
    the aggregate by tens of millions of dollars that they should
    have never received. Fastow got at least $30 million, Michael
    Kopper at least $10 million, two others $1 million each, and
    still two more, amounts that we believe were in the hundreds of
    thousands of dollars.
        Second, we found that some of these transactions were
    improperly structured. If they'd been structured correctly,
    Enron could have kept assets and liabilities, especially debt,
    off of its balance sheet. And that raises significant policy
    issues in itself. But Enron did not follow those accounting
    rules.
        But, finally, we found something more troubling than those
    individual instances of misconduct or failure to follow
    accounting rules. We found a systematic and pervasive attempt
    by Enron's management to misrepresent the company's financial
    condition. Enron management used these partnerships to enter
    into transactions that it could not, or would not, enter into
    with unrelated commercial entities. Many of the most
    significant transactions were not designed to achieve bona fide
    economic objectives.
        As our report demonstrates, these transactions were
    extremely complex, and I won't try to describe all of them in
    any detail here, but I do think it would be useful to give just
    one example. It involves efforts by Enron to hedge against
    losses on investments that Enron had made.
        Enron was not just a pipeline and energy trading company.
    It also had large investments in other businesses, some of
    which had appreciated substantially in value. These were
    volatile investments, and Enron was concerned because it had
    recognized the gains when those investments went up and it
    didn't want to recognize the losses when those investments went
    down.
        So Enron purported to enter into certain hedging
    transactions in order to avoid recognizing the losses from
    these investments. But the problem was these hedges weren't
    real. The idea of a hedge is normally to contract with a
    credit-worthy outside party that's prepared, for a price, to
    take on the economic risk of the investment. If the value of
    the investment goes down, that outside company bears the loss.
    But that's not what happened here. Here, Enron was essentially
    hedging with itself.
        The outside parties to which Enron hedged were these so-
    called ``Raptors.'' The purported outside investor in them was
    a Fastow partnership. In reality, these were entities in which
    only Enron had a real economic interest and whose main assets
    were Enron's own stock. The notes of Enron's corporate
    secretary, from a meeting of the finance committee of the board
    regarding these Raptors, captured the reality of what was going
    on. Those notes said, quote; ``Does not transfer economic risk,
    but transfers P+L volatility.''
        If the value of Enron's investments fell at the same time
    that the value of Enron stock fell, the Raptors would be unable
    to meet their obligations and the hedges would fail.
        This is precisely what happened in late 2000 and early 2001
    when two of these Raptor vehicles lacked the ability to pay
    Enron on the hedges. Even if these hedges had not failed in the
    sense I just described, the Raptors would still have paid Enron
    on the hedges with stock that Enron had provided in the first
    place. In essence, Enron would simply have paid itself back.
        By March of 2001, it appeared that Enron would be required
    to take a charge against earnings of more than $500 million to
    reflect the inability of these Raptors to pay. Rather than take
    that loss, Enron compounded the problem by making even more of
    its own stock available to the Raptors, $800 million worth. It
    gave the false impression that the Raptors had enough money to
    pay Enron what the Raptors owed. This transaction was
    apparently hidden from the board and certainly it was hidden
    from the public.
        Let me say that while there are questions about who
    understood what information was available to whom concerning
    many of these very complex transactions, there is no question
    that virtually everyone, everyone from the board of directors
    on down, everyone understood that the company was seeking to
    offset its investment losses with its own stock. That's not the
    way it's supposed to work. Real earnings are supposed to be
    compared to real losses.
        So, as a result of these transactions, Enron improperly
    inflated its reported earnings for a 15-month period. That is,
    from the third quarter of 2000 through the third quarter of
    2001 Enron inflated its earnings by more than $1 billion. This
    means that more than 70 percent of Enron's reported income from
    this period was not real. It was attributable to these Raptor
    vehicles.
        Now, how could this have happened? The tragic consequences
    of the related third-party transactions and the accounting
    errors were a result of failures at many levels and by many
    people. It was a flawed idea. There was self-enrichment by
    employees, inadequately designed controls, poor implementation,
    inattentive oversight, simple and not-so-simple accounting
    mistakes, and an overreaching in a culture that appears to have
    encouraged pushing the limits.
        Whenever this many things go wrong, it is not just the
    action of one or two people. There was misconduct by Fastow and
    other senior Enron management. There were failures in the
    performance of Enron's outside advisors, and there was a
    fundamental default in the leadership of the management. And
    leadership and management begin at the top with the Chairman
    and CEO, Ken Lay. In this company, leadership and management
    depended as well on the Chief Operating Officer, Jeff Skilling.
    And the board of directors failed in its duty to provide
    leadership and oversight.
        In the end, Mr. Chairman and Members, this is a tragedy
    that could have and should have been avoided. I hope that our
    report and the work of this committee will help reduce the
    danger that it will happen to some other company and its
    employees and its investors in the future.
        Thank you, Mr. Chairman.
        [The prepared statement of William Powers Jr. can be found
    on page XX in the appendix.]
        Chairman Baker. Thank you very much. I'm not sure that's
    the appropriate response. I think your report has been one of
    the most disturbing things I have ever had the misfortune to
    read. I have never seen such an example of corporate collusion
    that your report paints, and I have got to show extraordinary
    restraint to stay focused on the real point at which I believe
    our work should be aimed. Your report raises many issues which
    I think will keep this subcommittee busy for some time to come,
    as I suspect the SEC will be also.
        Audit function. Is it your view that members of the board
    who engaged the audit team stood on the sideline while
    management managed the audit team?
        Mr. Powers. Much of the audit team was dealt with and
    initiated by people in the finance group, and we do think
    there's a lack of oversight by the audit committee. We
    chastised the audit committee.
        Chairman Baker. Let me be more specific. Is it your view
    that if an audit function were conducted and it was prepared
    inappropriately, in the perspective of a managerial member,
    would that audit be altered before presentation to the board?
    When an audit work is done and it would be presented to the
    board as a final report, in your view, is there evidence that
    before an audit report was finally concluded and handed to the
    board, that management intervened and restructured those
    reports so the board would get a different perspective of the
    audit work?
        Mr. Powers. I'm not aware of a specific instance of that,
    although there may be. I mean, there is a great deal of
    information in our----
        Chairman Baker. I'll come at it a different way. If the
    auditor came into that business environment and looked at the
    relationships between the Enron investments and the SPEs, the
    funding of the interested party who must hold the 3 percent,
    looked at the purchase requirements between the SPE and Enron
    wherein the capital to make that acquisition was advanced by
    Enron, how is it that an auditor conducting his professional
    responsibility would not red-flag those transactions as either
    inappropriate or wrong? What happened with that audit inquiry
    when looking at those specific facts?
        Mr. Powers. These are questions we would like to ask. We
    did have some access to Anderson's papers, but limited, and we
    did not in the end have an opportunity to ask Andersen those
    very questions.
        Chairman Baker. In 1999, a public corporation was engaged
    in negotiations with Enron for a merger purpose. That
    corporation surveilled the publicly available documents, news
    reports, and did interviews and concluded that the off-balance-
    sheet debt structure was so enormous they would not proceed
    with the merger.
        Mr. Powers. That's correct.
        Chairman Baker. Given that information, what was the
    board's response to that public determination not to proceed
    with the merger way more than 18 months ago, almost 3 years
    ago? Is there no record of board discussion about these
    revelations in the public light as to Enron's true financial
    condition?
        Mr. Powers. We weren't able to ascertain that there was any
    reaction by the board that then took that, as you pointed out,
    red flag and investigated further in these transactions.
        Chairman Baker. In your work in the preparation of this
    report, did you interview all the board members, or any of the
    board members?
        Mr. Powers. We interviewed all of the members of the audit
    committee and we interviewed many other board members. I don't
    think we interviewed all of the board members.
        Chairman Baker. The members of the audit committee, did
    they indicate to you they felt that the Andersen work was
    proceeding in an independent course, or was it their view that
    the audit report had been manipulated by internal management?
        Mr. Powers. It was their view that Andersen was doing the
    audit report and it was their position that they were relying
    on the audit report.
        Chairman Baker. So their position is that Andersen was
    incompetent and did not prepare the financials in an
    appropriate manner?
        Mr. Powers. To the extent there are mistakes and errors
    here, which there are, that's the position of the people on the
    board that we--the people on the audit committee----
        Chairman Baker. But there's no evidence to indicate that,
    anytime prior to the public bankruptcy, that the board took any
    corrective action to dismiss Andersen or otherwise engage other
    accountants?
        Mr. Powers. That's correct.
        Chairman Baker. I'm out of time, but I'm not out of gas. I
    have to relinquish my time.
        Mr. Kanjorski.
        Mr. Kanjorski. Thank you.
        You are probably the first witness that can give us
    substance about what happened at Enron. Thank you very much for
    coming forward and listening to this debate. I agree with Mr.
    Baker, it is most shocking. But I guess the first thing I am
    going to ask conceerns hedges. These transactions involve
    derivatives. Is that correct?
        Mr. Powers. Yes. Not all of the transactions. Some of them
    involve sale of assets to get them off the books, but many of
    these involve hedges.
        Mr. Kanjorski. Right. But the normal use of a derivative is
    that somebody is coming forward with a private insurer with
    independent assets to insure your risk that you are placing in
    their hands.
        Mr. Powers. Absolutely.
        Mr. Kanjorski. And a hedge is a good economic tool to
    prevent exactly what happened here if it is a legitimate
    derivative. The problem here is they did not have honest and
    substantial counter-parties.
        Mr. Powers. Absolutely. There's nothing--not only nothing
    inappropriate; a legitimate economic hedge is a very useful
    economic device. The problem here was these structures were
    structured to look as though they were hedges, and in fact it
    was Enron hedging with itself.
        Mr. Kanjorski. Instead of being in hedges in the sense of
    guaranteeing against the fluctuation of the market, Enron
    created transactions to take bad assets off the books,
    depreciated assets or lost assets, and make them appear as
    though they were not part of their company, or they were the
    counterparties' responsibility. Therefore, they would show the
    sale of the transactions as a profit, which would inflate their
    earnings and they would not have an asset that had a negative
    value on their books.
        Mr. Powers. Well, there are two different transactions. I
    did describe a hedge. Some of the transactions were sales of
    property to get them off the books, get the debt off the books.
    Many of those were bought back. The hedges themselves, the
    structure was so that the supposed counterparty that is paid on
    the hedge will owe Enron an obligation on the hedge that Enron
    could show as income to offset the loss in the investment. So
    those are two different issues, both of which were affecting
    the books.
        Mr. Kanjorski. Going to a simple example, because I'm sure
    the American public is still trying to figure out what this is.
    Let's say I had a transaction and I wanted to borrow money from
    a bank, and I had a home worth X and I had a mortgage of X or
    X-plus on that home. What I could do, under circumstances you
    use here, is construct a hedge vehicle or derivative and pass
    over the ownership of the properties of that hedge vehicle.
    They would pay me an inflated price, and they also would assume
    the mortgage so that my ultimate profit and loss statement, or
    balance sheet, would not show the existence of the mortgage,
    would not show the deflated value of the home, and would make
    me look rather substantial, when, in fact, I was not.
        Mr. Powers. I understand. That's correct. Some of these
    transactions moved debt off of Enron's books so Enron looked
    like it had less debt than it had.
        Mr. Kanjorski. My question is this: We have had these
    problems with hedging and derivatives before, and I have to
    confess they get so complicated that it is hard to understand
    whether, in fact, there is grave risk or not. But, do you think
    we have sufficient legislation and authorization to the SEC or
    other Federal agencies to look into what these derivatives or
    hedges are? When do they constitute a realistic honest hedge?
    When are they falsely constructed such as this? Do we have
    anybody watching over the derivative hen house?
        Mr. Powers. Congressman, you identify a major problem and
    that is not--these types of instruments were a large cause of
    what happened with Enron. Now, I must confess I am not a
    securities lawyer and was not a derivatives expert before I
    came into this. I helped find out what happened. I was
    surprised to see the ability to move assets in a way that
    affected the financial sheets rather than real economic
    consequences, and it is a problem that I think this
    subcommittee and committees and other regulatory agencies need
    to look into.
        I'm not sure I'm in a position, not having known a great
    deal about these entities before I got into this investigation,
    to give that kind of advice, but it is--you're identifying a
    very serious problem that needs to be looked into.
        Mr. Kanjorski. I have an honest problem, and we will have
    the accountants in here, I think tomorrow. I do not even know
    how you move approximately $800 million off your balance sheet
    without showing where the transaction happened, why, under what
    circumstances, what is the deflated value of the remaining
    stock, and so forth. It strikes me that this is a con, and you
    do not have to be terribly sophisticated to see that you are
    not getting anything from your counter-party, because your
    counter-party has nothing. You have created a false phantom
    counter-party, and it is all hinged on the stock going up. If
    everything goes up, if your stock value goes up and the asset
    transferred to the counter-party goes up, then nobody knows,
    nobody cares, and we all profit. But, at some point when there
    is a reversal, it is an implosion. Is that basically what
    occurred here at Enron?
        Mr. Powers. I think that's what did occur here.
        Mr. Kanjorski. This transaction is a billion dollars, but
    we keep hearing that Enron had a capital value of $70 or $80
    billion, and most of the employees had investments in the firm.
    Moreover, Enron's investors were looking at the net worth, or
    the cap value, of $70 or $80 billion, believing that they would
    have an ability to retrieve their investment. What happened to
    that $70 or $80 billion? We did not lose it all on this
    transaction. This restatement precipitated the company's
    collapse, and showed the false accounting. Is there any fraud?
    What happened in that nature? What happened to the other $70 or
    $80 billion?
        Chairman Baker. That will have to be the gentleman's last
    question. His time has expired.
        Mr. Powers. The billion dollars to which I referred was not
    merely a billion dollars in capital value, in equity; it was a
    billion dollars in earnings. And when the markets lost faith in
    the earnings reports, that is, Enron wasn't earning what people
    thought it was earning. Now, I don't think that they knew the
    details of how that happened, but people started losing faith
    in the earnings reports, and I think they started losing faith
    in the credit capacity and a number of other things with
    Enron's ability to do business as a counterparty. The market
    lost faith in Enron and then that precipitated the drop in the
    capital value of the stock.
        Mr. Kanjorski. I ask permission to ask one more question.
    Is it possible that this situation is systemic and occurring in
    other corporations in the United States today and that we are
    not aware of it?
        Mr. Powers. It's possible that that's occurring. I should
    say I hope most people in most corporations are doing their
    jobs in the right way. But it's certainly--these transactions
    are very complex and they're very hard to sort out and it
    certainly is possible.
        Chairman Baker. Chairman Oxley.
        Mr. Oxley. Thank you, Mr. Chairman. Let me, before I begin,
    yield to my good friend from Delaware, Mr. Castle.
        Mr. Castle. Thank you, Mr. Chairman.
        I'm only going to ask one question, Mr. Powers. I note that
    you're the Dean of a very significant law school in America, in
    Texas, and I'm sure you teach at that school criminal law,
    unless it's changed a lot since I went to law school. And
    you've made some very strong statements--and it is chilling to
    read your testimony here and to see this report--but, you've
    made some very strong statements, including ``improperly
    enriching themselves,'' and so forth. I'd just like to ask you,
    in your opinion as somebody who is knowledgeable, do you
    believe that any of these individuals that you have looked
    into, particularly Enron employees in this case, have committed
    violations of the law, criminal laws, either in the State of
    Texas or the Federal Government?
        Mr. Powers. Let me say that we did not focus on that and
    come to judgments as a matter of the committee. I'm not an
    expert in securities law violations, and I'm not sure it's
    appropriate for me. It's rather the SEC and the Justice
    Department who make those determinations. This is very serious
    conduct, and I'm sure those entities and agencies and the
    Justice Department are going to make those determinations, and
    certainly this warrants close attention.
        Mr. Castle. But it's not beyond the realm of possibility.
        Mr. Powers. Certainly.
        Mr. Castle. Thank you. I yield back. Thank you, Mr.
    Chairman.
        Mr. Oxley. Pleased to yield to my good friend from
    Delaware. Let me first of all, Dean Powers, say that this
    report was both comprehensive and a seminal view of what
    transpired, and you and Mr. McLucas and the other participants
    in this deserve a great deal of credit for not only writing
    this report, but making it quite understandable for myself and
    the other Members, and really gives us an idea for the first
    time how we can get our hands around this issue. And you're to
    be commended for that.
        Mr. Powers. Thank you.
        Mr. Oxley. According to your report, all of the checks
    built into our system appear to have failed in some way or
    another--attorneys, accountants, regulators, management, the
    board, bankers, analysts, and the rating agencies. Were these
    independent failures or were they interrelated, and was one
    failure the trigger or critical event leading to the others?
        Mr. Powers. It's an important point that you're raising
    that this was a systematic failure. It wasn't just one person
    engaged in misconduct. You would expect the checks and balances
    to check that individual failure. Within Enron, to which I can
    make a more direct statement, because that's what we looked at
    more--we didn't look at the credit agencies; for example, why
    didn't they see this? Within Enron, the checks and balances
    simply broke down and the people who were in the finance
    department, Fastow and others, and frankly in the accounting
    department, weren't checking each other. The deals were with
    Fastow, and nobody else around who knew what was going on
    provided a check and that oversight broke down at the board
    level, at the senior management level, and in the finance
    department.
        Mr. Oxley. Would board oversight of a company, specifically
    by the audit committee, improve if the board took over the
    responsibility for retaining and firing the auditors from
    management?
        Mr. Powers. That's that's not a question that I've given a
    great deal of thought to. There certainly is a problem. When I
    came into this, it was surprising to me to see how much, for
    example, that the auditors had helped design the vehicles and
    audited the vehicles, and how much management used the audit
    groups, and then the audit groups would come back and audit the
    management. It's a very serious problem.
        I don't know that I have--what you're suggesting sounds
    like a very plausible solution. Whether it ends up being the
    right solution, I don't know.
        Mr. Oxley. But it's worthy of pursuit?
        Mr. Powers. I think it's absolutely worthy of pursuit.
        Mr. Oxley. So your statement really was that the auditors
    were in on baking the cake here, that they were part and parcel
    of helping certain people in management essentially craft these
    partnership arrangements?
        Mr. Powers. The auditors were paid a great deal of money to
    help design these vehicles, that's correct.
        Mr. Oxley. And that in and of itself is an aberration? Is
    that outside of Enron? I mean, I'm trying to understand
    whether, in fact, the auditor himself concluded that in his job
    description.
        Mr. Powers. I haven't looked at other companies. My
    understanding is it's not unique, that aspect is not unique to
    Enron, that auditors both do what would be called real-time
    auditing, they're involved in the structuring of the
    transactions themselves, at least looking at them, and then
    they do the audit.
        Mr. Oxley. Thank you. Thank you, Mr. Chairman.
        Chairman Baker. Thank you very much, Mr. Chairman. I would
    concur with your view that they were in the room helping bake
    the cake. I think the problem is they were eating it, too, is
    the problem.
        Mr. LaFalce.
        Mr. LaFalce. Thank you very much, Mr. Chairman. Dean
    Powers, over here.
        Mr. Powers. Thank you.
        Mr. LaFalce. Could you tell me, when you're not being Dean,
    what your area of legal expertise is?
        Mr. Powers. Torts, products liability, and legal
    philosophy.
        Mr. LaFalce. OK, good. Could you tell me what you had as
    part of your job description, as a newly appointed member of
    the board of Enron, that you think you could have done better
    had you had greater power such as subpoena powers, and so
    forth? And second, what do you think entities other than your
    investigative committee should be doing; that is, what didn't
    you do that either the SEC or the FBI or the Justice Department
    or the Congress should be doing?
        Mr. Powers. Well, I think Congress should be looking at the
    policy ramifications, as this subcommittee is doing, and
    determine whether changes in the system----
        Mr. LaFalce. With respect to Enron in particular. The
    policy is much larger than Enron.
        Mr. Powers. As Congressman Bachus indicated, there are
    issues at Enron that we have not looked into like the 401K
    plans, and I think it would be appropriate for Congress to look
    into those.
        Mr. LaFalce. Let me get into some specific issues. It's my
    experience that very often corporate management decides who's
    going to be on the board, and they don't select board members
    on the basis of who's going to be toughest on us, who's going
    to give us greatest oversight. They select board members very
    frequently on the basis of who will go along with us more
    readily than somebody else, and who would it be nice to have as
    a board member so they will let management do their thing.
        First question I ask you is, how do we deal with that? And,
    second, so long as management is hiring an auditor or a lawyer
    or what have you, chances are that professional group is going
    to want to give management what management wants to hear, if
    it's at all humanly possible. So they will stay on as basically
    employees, and they are employees whether they'd like to call
    themselves that or not. And so how do we deal with that in a
    policy way, because I personally have believed for a long time
    that the Enron problem was systemic earlier this year. The
    first half of the year we had over 260 restatements of earnings
    that were mandated by the SEC, an absolute record number, and a
    number of us said at that time that this is the tip of the
    iceberg. And self-regulatory organizations, whether for
    accountants or for securities analysts, have not worked; and I
    question whether they can work, and I'm wondering what your
    thoughts are on that.
        Mr. Powers. I agree that it is incredibly important that
    boards have sufficient detachment from management that they can
    oversee management, and that professionals have sufficiently
    independent professional----
        Mr. LaFalce. How do you get from here to there, because
    most often it's management that recommends somebody to the
    board?
        Mr. Powers. I'm not that familiar with how boards are
    selected in other companies. Companies that want good advice in
    oversight ought to have board members who----
        Mr. LaFalce. Those are not the companies we need to be
    concerned about.
        Mr. Powers. I agree.
        Mr. LaFalce. It's the companies we need to be concerned
    about, and I don't think we can count on the officers of those
    companies or on the board of directors of those companies.
    There are too many conflicts of interests that I don't think
    could ever be eradicated. We have to rely, though, on the
    outside auditors and we have to rely on attorneys doing a
    better job, and most especially we have to rely on securities
    analysts, and not only with respect to Enron, but with respect
    to hundreds and hundreds of companies. They have fallen down on
    the job. They have been guilty in my judgment of professional
    malpractice, and the self-regulatory organizations for these
    so-called independent outside experts simply have not worked
    and cannot work. And I'm wondering if you have any policy
    prescriptions you might be inclined to recommend at this
    juncture.
        Mr. Powers. Well, I recommend that there are problems that
    the committee and other agencies ought to look into. As I say,
    this is not my ordinary field of expertise and I don't think
    I'm in a position to give particularly precise recommendations
    on them other than, as you suggest, to recognize it as an issue
    that needs to be addressed.
        Mr. LaFalce. I thank you.
        Mr. Powers. Thank you.
        Chairman Baker. I thank the gentleman.
        Mr. Bachus.
        Mr. Bachus. Thank you, Dean. Dean Powers, 11,000 Enron
    employees invested in the 401K plan and this is this plan right
    here, 68 pages, and they lost their life savings. Now, that
    plan is basically an agreement between the company and the
    employees. I have read that plan. It takes about 30 or 40
    minutes to read it. Did you and the committee read the plan?
        Mr. Powers. No, we didn't.
        Mr. Bachus. Let me go over some of the pertinent parts of
    it. First of all, the committee--and the administrator of the
    plan is designated as, quote; ``the committee,'' and the
    investment manager is designated as the trustee.
        Now, in sections 13 and 14, they are both selected with
    sole discretion of the company and could be removed for any
    reason at any time by the company. So they have total power in
    putting this committee together and designating the trustees.
    Now, that's an awfully important document, isn't it, between
    the employees and the company?
        Mr. Powers. It's a very important document.
        Mr. Bachus. And the senior executives of the company can't
    disregard this agreement, can they, legally?
        Mr. Powers. I don't believe they can.
        Mr. Bachus. That's right. Now, it's been stated in
    published reports that the company's contributions to the 401K
    plans were required to be invested in Enron stock, and I just
    assumed that to be the case until this weekend when I read this
    plan. And, in fact, that's not really correct. I don't know
    whether you're aware of that. Let me say, here is Article 15
    and that's the fiduciary provisions. Now, you are a professor
    who teaches torts; so fiduciary duty is a very serious duty
    that's owed, is it not?
        Mr. Powers. Absolutely.
        Mr. Bachus. And the duties owed--in fact, that article says
    that the article shall control over any contrary, inconsistent,
    or ambiguous provisions contained in the plan. So these
    fiduciary provisions take precedence, and it says in there and
    it specifically states that the committee and the trustee shall
    act solely in the interest of the participants--in other words,
    the employees--in discharging their duties. Not in the best
    interest of the company, but of the 401K participants, and I
    will quote the second provision, and this is something I've
    seen no focus in any of the media on, by, quote: ``diversifying
    the investments of the plan so as to minimize the risk of large
    losses.'' Now, they didn't diversify, as we all know, and we
    all know the result.
        Now, it also says in Article 8, ``the company shall supply
    full and timely information to the committee.'' Now, Dean
    Powers, do you think that the information Mr. Lay received from
    Ms. Watkins on August the 15th would have been pertinent and
    should have been given to the committee as important
    information about the financial condition of the company?
        Mr. Powers. Congressman Bachus, I have not gone through
    these plans, and not because it's not important. As I said
    earlier, this is one of the greatest tragedies of these whole
    events, are the employees losing their investments and savings
    and retirement hopes. I really feel that I'm not in a position
    to comment.
        Mr. Bachus. I will go on because I don't want to put you on
    the spot.
        Mr. Powers. Thank you.
        Mr. Bachus. But I think when we start looking at these,
    it's----
        Mr. Powers. These are very serious issues you raise.
        Mr. Bachus. It absolutely is. It also says one matter of
    great concern has been the lockdown that occurred on October
    the 26th that prohibited employees from diversifying the 401K
    plan. Now, the lockdown was characterized as necessary due to
    administrative changes; but under this same provision, the
    committee is required as a named fiduciary to discharge its
    duty with care, skill, prudence, and diligence under the
    circumstances then prevailing that a prudent man had.
        Now, we know what the senior executives were doing. They
    were selling their stock. I think they sold $350 million worth
    of stock during this period of time. But they were supposed to
    be giving these trustees and this committee the same
    information that they were acting on to sell their stock, but,
    in fact, just the opposite happened and they allowed a lockdown
    of this plan. I believe that that was a violation of the
    committee's fiduciary duty to the employees and one which
    basically resulted in them losing their retirement plan.
        And this document, and I think there is one other--well, I
    guess that's--I think my time is up, but let me simply say to
    you that I know that wasn't part of your inquiry. I think when
    you read that, you will see that the company had all sorts of
    obligations that they failed to do.
        Mr. Powers. And you're raising very important issues here,
    Congressman.
        Mr. Bachus. Thank you.
        Chairman Baker. Thank you, Mr. Bachus.
        Mr. Ackerman.
        Mr. Ackerman. Thank you very much, Dean Powers. In the 3
    short months that you've been in this business, you have
    basically shaken up the financial world, maybe the legal world,
    those who watch ethics as well, and covered things that are
    shocking and amazing, as so many people have said. You yourself
    have said that you were appalled. And yet when we look at some
    of these things, it seems if you could uncover them with your
    small group of investigators in 3 months, that a major
    accounting firm, with all of the resources that they have,
    should have been able to uncover and discover this. I mean, it
    doesn't take long if you stand on the street corner in New York
    to figure out that somebody has a shell game going or Three
    Card Monte or a Ponzi scheme, or anything else that you want to
    call it. And evidently from the looks of this, this has been
    what is occurring here: absolute world-class thievery. Now, how
    is it that an accounting firm couldn't figure that out?
        Mr. Powers. I'm not sure I'm in a position to answer that.
    As I said earlier, we would have liked to have discussed more
    fully those issues with the outside accountants. I will say
    these are extremely complex transactions and I had enormously
    able help to do this.
        Mr. Ackerman. I'm sure. But one would think that a major
    accounting firm would have extremely capable help as well.
        Mr. Powers. Yes.
        Mr. Ackerman. You're not a securities guy, as you said, or
    a derivatives guy, as you've told us, and you figured all this
    out.
        Here's a question, I think. If Arthur Andersen was hired to
    be the outside auditors, and it also appears that they're the
    inside auditors, that they would have some kind of mandate to
    advise the company, the board, as to the kind of checks and
    balances and controls that would have to be in place. Now,
    isn't there a failure on the part of the auditors as well as
    the company here?
        Mr. Powers. Our report makes that point, that we do think
    there's a failure on the advice and oversight of the outside
    auditors.
        Mr. Ackerman. Well----
        Mr. Powers. Absolutely.
        Mr. Ackerman. One would, you know, come to the conclusion
    that if that was the case or reasonably assured that that was
    the case, that some kind of collusion and fraud and conspiracy
    and all those kinds of words was taking place. And your mandate
    as you've described it, and as we know, was very narrowly
    focused on one area, and some of the other areas, as you
    pointed out, are exceptionally troubling. And one might infer
    from your report, if not conclude from your report, that there
    are other areas that bear looking into that was not within your
    mandate. Do you think that there's enough here to warrant a
    special prosecutor?
        Mr. Powers. Again, we tried to find out what happened, and
    I think our report is a start to help others who will have to
    make the determinations as to whether there ought to be
    prosecutions, whether there ought to be a special prosecutor
    and things of that sort. I don't think it's appropriate for me
    to make the policy as to whether those prosecutions ought to go
    ahead. We tried to find out. I think we have found out to a
    large extent what happened. And it wasn't our job to make the
    determination as to whether to prosecute people.
        Mr. Ackerman. I guess it's in part our job to make
    recommendations and to speak out on behalf of those kinds of
    things, and the report that you have done I think should give
    reasonably prudent people, hopefully Members of Congress, too,
    enough to chew on and consider as we make our deliberations.
    And I thank you and your small group of people for the service
    you've performed.
        Mr. Powers. Thank you.
        Mr. Ackerman. I yield back the balance of my time.
        Chairman Baker. Thank you, Mr. Ackerman.
        Mr. Shays.
        Mr. Shays. Wow, your report blows my mind.
        Chairman Baker. You need to pull your mike a little closer.
        Mr. Shays. I am absolutely dumbfounded by--I feel like I am
    in Sin City. I feel like every part was not just asleep, but
    they were kind of colluding with each other and compromised. I
    mean you talk about the attorneys, you talk about the
    accountants, you talk about the regulators, you talk about the
    management, you talk about the board, you talk about the
    bankers, you talk about the analysts, you talk about the rating
    agencies, and nobody looks good. But it's even worse than that,
    because when I start to go through your report, I just see
    extraordinary conflicts of interest, and I'd love you to just
    respond to one of them.
        Should the fact that in 2001, Vincent & Elkins received $36
    million in fees from Enron, from a variety of legal work, have
    disqualified them to respond to the accusations of Sharon
    Watkins, who in August had met with Lay and said, you know,
    we've got a problem with this company?
        Mr. Powers. Congressman, as I indicate in the report, I did
    not participate in the final judgments on Vincent & Elkins
    because they are a----
        Mr. Shays. Forget it. Should any firm that basically made
    $36 million in one year be the one to have been hired by the
    board to look into the accusations of an employee who said, ``A
    lot of crooked things are going on here''? Isn't there an
    inherent conflict of interest?
        Mr. Powers. With all due respect, Congressman, it's hard
    for me to answer that, other than in the context of Vincent &
    Elkins, and I didn't focus or look into that part because I
    felt it was inappropriate given the relationship that Vincent--
    --
        Mr. Shays. I'm just asking you a general comment. If you're
    going to be looking at the transactions of a company, does it
    make sense for you to ask the very group that was involved in
    the transactions and was hired by the company to decide whether
    these transactions made sense, to then hire that company? Is
    there logic to do that?
        Mr. Powers. I can comment on whether it makes sense for
    Enron to do that. I think it was questionable for Enron to do
    that. Vincent & Elkins certainly disclosed to Enron what its
    involvement was, and I don't have an opinion on what they did,
    but Enron might have looked to somebody else.
        Mr. Shays. But this was a law firm--I'm just taking this as
    an example. I could take others. This is a law firm that
    basically has been involved in some of the SPEs, it earned $36
    million. I think because we talk billions, we don't think $36
    million is a lot in one year, and yet they are the company
    that's asked to evaluate. Shouldn't a company simply say, we
    shouldn't be the ones to look at this because we were involved
    in some of these transactions? I mean, they are being asked to
    comment on the very transactions they were involved in.
        Mr. Powers. I think VE was cognizant of its obligations,
    and again I haven't looked into that because it was a part that
    I didn't focus on. But they disclosed all that to Enron, and
    I'm not in a position----
        Mr. Shays.They didn't disclose it to Enron. Enron is the
    one that paid them.
        Mr. Powers. Sure. I'm just saying I'm not in a position----
        Mr. Shays. You're really saying you don't want to. You are
    in a position, as a lawyer who's at a law school who deals with
    ethics, to talk about the merit of a company that does business
    and has earned $36 million to pass judgment on things that it
    basically allowed to happen while it was earning their fees. So
    I mean, it seems----
        Mr. Powers. I agree.
        Mr. Shays. You don't want to is really the answer; not that
    you can't.
        Mr. Powers. Well, I will agree with you that I don't want
    to, but I can say that Enron might have gone somewhere else.
    I'm not in a position----
        Mr. Shays. What about the company? You lawyers sometimes,
    it seems to me, are very willing to protect each other. But the
    bottom line is here are some lawyers who are basically hired by
    a company to comment on transactions they were involved in, to
    say whether they were appropriate or not, so I will let it
    stand on its merit. Did you interview Arthur Andersen?
        Mr. Powers. The committee looked at some Arthur Andersen
    papers. We didn't have access to all of Arthur Andersen's work
    papers. We talked with Arthur Andersen in order to try to have
    interviews with them, and there was back and forth. They said
    they would participate with us. And finally when Enron fired
    them, they would not participate with us. So we did not end up
    getting discussions, and we were not able to put in questions
    to Arthur Andersen as to what their position was.
        Mr. Shays. Did you interview Vincent & Elkins about their
    questionable activities?
        Mr. Powers. I didn't because I wasn't part of that part of
    the investigation. I think the committee talked to people at
    Vincent & Elkins.
        Mr. Shays. Extensively?
        Mr. Powers. I will have to check on that.
        I'm told we interviewed four or five lawyers at Vincent &
    Elkins.
        Mr. Shays. I'm sorry?
        Mr. Powers. I'm told we interviewed four or five lawyers at
    Vincent & Elkins.
        Mr. Shays. Viva was a company that is from Germany;
    described in the articulate statement of the Chairman, they
    were able to come in, hire an auditing firm and understand that
    this company, Enron, was not worth merging with, in fact, their
    debt was so high. They were able to know back a few years ago
    the incredibly poor condition of Enron. What does that tell
    you?
        Mr. Powers. Well, I think they saw risk in Enron because
    they were unable to figure out its debt structure, and they had
    red flags that caused them to not want to merge with Enron.
    That tells me that----
        Mr. Shays. That it wasn't too difficult to figure out?
        Mr. Powers. That there was risk there; that's correct.
        Chairman Baker. If the gentleman would yield on that point,
    they actually concluded in the written documents that 75
    percent of Enron's equity was encumbered. So that they did
    actually figure out the level of debt and it was not an
    indeterminate amount.
        Mr. Shays. Let me just make a statement, then, because my
    time is up. I think it says a world about the extraordinary
    failure of all these different groups that I listed that were
    in your report, that failed to step up to the plate, that a
    company from outside this country would hire someone inside
    PriceWaterhouse and basically exposed this company years ago.
    And even then nobody caught on, which is mind-boggling.
        Chairman Baker. The gentleman's time has expired. I thank
    the gentleman.
        Mr. Powers. Thank you.
        Chairman Baker. Mr. Bentsen.
        Mr. Bentsen. Thank you, Mr. Chairman and Mr. Powers. Mr.
    Powers, in your statement you say, we found a systematic and
    pervasive attempt by Enron's management to misrepresent the
    company's financial condition. Who is Enron's management, or
    who do you mean by that? Is that the board of directors, is
    that the CEO, or is that selected individuals?
        Mr. Powers. OK. The best we could ascertain the genesis of
    the scheme itself, certainly Fastow, there are people in the
    finance department who know about these transactions. We think
    people in the accounting department know about these
    transactions. It has been very difficult to ascertain precisely
    what people higher up in the management--we are told Skilling
    knew and was involved in a great deal.
        Mr. Bentsen. Is your investigation finding that this was a
    situation where basically some people in management were making
    these non-economic hedges and off-balance-sheet financings and
    skimming off the top, or is this a situation where the company
    itself--I mean, from reading your report it sounds like going
    back to the early 1990s, they started using off-balance-sheet
    financing a great deal. Not the only company in the world to do
    that certainly, for a variety of reasons. But, over time, was
    this a company where the bad bets kept piling up and they were
    trying to dig out, or was this a case where you had a handful
    of individuals at the top who were actually looting the
    company?
        Mr. Powers. Well, I think there were a handful of
    individuals, Fastow and others, who were designing these both
    to manage Enron's financial statements and to enrich
    themselves.
        Mr. Bentsen. After Skilling resigned last summer, in August
    or whenever it was, was the board--I guess in your statement
    you're sort of laying out that the board either was asleep at
    the switch or really didn't know what was going on; is that
    sort of correct?
        Mr. Powers. I think on particular facts, the evidence shows
    that they were misled.
        Mr. Bentsen. That they didn't understand that there's no
    economic value or these deals were underwater, that they had--I
    mean, effectively it looks to me like the Raptor deal--and a
    friend of mine--an analyst, who I know is an analyst or not,
    highly regarded this committee, but I was talking to--said
    these were basically naked puts, that they had pledged either
    stock or the agreement to issue stock.
        Now, who has the authority to issue stock for a public
    corporation? I mean, $800 million worth of stock is a pretty
    good chunk of stock, even for a company with $60 billion of
    market value. I mean, does the CFO have that authority, or is
    it the board of directors that has to make the determination
    that stock will be issued or that a put will be issued?
        Mr. Powers. This is actually stock that they had obtained
    or pre-existing contracts they had with other companies, but
    the board did approve of using that stock. The board didn't
    approve the particular hedging transactions.
        Mr. Bentsen. Let's follow the line of thought and let's
    assume that the board was misled--maybe. And so Skilling
    resigns in August or whenever it is this summer. Did the board
    find out at that point in time that the company was in serious
    trouble or did the board find out at that time that they had a
    bunch of deals out there that were underwater, whether they had
    been skimming or whatever?
        Mr. Powers. I think the board was not informed at that time
    that these vehicles were underwater.
        Mr. Bentsen. When did they find out? Was it not until
    October? Was it not until November? I guess my question is
    because during that period of time the employees and the public
    and the investing public were being told things were never
    better, the stock was under value. Now obviously, some of that
    is a game face that you put on and spin, but it kept going on.
    Options were issued or granted to employees. I mean, was this
    going on? The board still didn't have any idea what their
    balance sheet looked like, what their liabilities looked like?
        Mr. Powers. Well, I think the board was not aware that
    these vehicles were underwater until Lay came back in as the
    CEO, and then they did restructure them.
        Mr. Bentsen. Lay came back as the CEO after Skilling
    resigned in August. I have something here where they issued a
    grant of options on August 27 and Lay says ``one of my highest
    priorities is restoring investor confidence in Enron.'' This
    should result in a significantly higher stock price. And as
    late as September 26, Lay told the employees that the stock was
    under value, that the company's prospects were never better. At
    that point in time, did the chairman and CEO, did the board of
    directors, did the auditing committee of the board understand
    what the true financial condition of the company was?
        Mr. Powers. Well, a lot goes under the true financial
    condition of the company for reasons that were beyond the
    vehicles we were looking at. We were not able definitively to
    ascertain how much Lay knew about these individual vehicles and
    he denies that he did. Skilling, in the interview, denied that
    he had much involvement with them, and therefore doesn't say
    that he told Lay. We were not able to ascertain with that
    precision exactly what Lay or Skilling----
        Mr. Bentsen. Well, my time is up, but Mr. Chairman, it is
    like three blind mice running around and their fingerprints are
    all over the place. The board agrees to the parts and
    everything else. Either nobody was looking at the sum of the
    parts or everybody was looking the other way.
        Mr. Powers. Well, we would agree that people were not
    minding the store. I just can't say with certainty what Lay or
    Skilling knew at that point about the particulars of those
    transactions.
        Mr. Bentsen. Thank you, Mr. Chairman.
        Chairman Baker. The gentleman's time has expired.
        Mr. Royce.
        Mr. Royce. We have talked a lot about systemic failure. In
    1999, an SEC blue ribbon panel commission recommended that
    audit committees be made up solely of independent directors,
    each of whom would be financially literate with at least one
    having either financial expertise or accounting expertise.
    However, under the rules implemented by the New York Stock
    Exchange, directors on the company payroll are permitted,
    former employees and their families are allowed after 3 years,
    and audit committee members with a significant business
    relationship are also acceptable if the board determines that
    their ties won't interfere with their judgment.
        My question to you, based upon your observations, if the
    SEC's recommendations had been adopted verbatim first, fully
    half of Enron six-member committee would probably have been
    barred from service. In your opinion did the close relationship
    between Enron's audit committee and the company impair or
    compromise its judgment or its objectivity in any way?
        Mr. Powers. We didn't have reason to believe that the audit
    committee didn't have objective judgment in the sense that they
    were complicit in these transactions. But they did understand
    and approve the overall use of Enron's own stock as a hedge
    which should have, in our view, raised red flags.
        Mr. Royce. Did any of those members on the board raise any
    questions about these off-book dealings? You interviewed them,
    I take it, and the committee interviewed them. Are there
    particular individuals who, during these meetings, raised
    objections or raised questions or did they simply nod and
    acquiesce?
        Mr. Powers. They did not raise the right questions.
        Mr. Royce. OK. Do you happen to know how these board
    members were chosen?
        Mr. Powers. I don't.
        Mr. Royce. In your opinion, would an additional assertion
    on the effectiveness of internal accounting controls in the
    management disclosure and analysis section of the annual report
    have brought Enron's troubles to the attention of either senior
    management or the board of directors in a more timely fashion?
        Mr. Powers. I don't know whether it would or not. I'm
    sorry.
        Mr. Royce. Let's go to the question of waivers. Was the
    board fully informed when it granted waivers to Mr. Fastow in
    1999 to engage in these hedging ventures that were very risky
    with these partnership agreements, or SPEs, as we are calling
    them, using Enron's own stock and allowing Enron essentially to
    do business with itself? Do you think the board was fully
    informed when it granted those waivers or do you think there
    was information that was withheld from the board that had they
    known it, they would have been able to exercise a decision here
    more in keeping?
        Mr. Powers. I think there was clearly information about the
    nature of those partnerships including Fastow's compensation
    that was withheld from the board.
        Mr. Royce. And the board members that you interviewed
    indicated they simply weren't given full disclosure? Did they
    ask for more information, do you know?
        Mr. Powers. They were told that it was inappropriate to
    know about Fastow's compensation because these were supposed to
    be arms length independent entities and knowing about his
    compensation would defeat that. They asked about it, were not
    told and were satisfied with that answer.
        Mr. Royce. Were the auditors, Arthur Andersen, involved in
    those discussions at the time that that assertion was made to
    the board members? Do you know offhand?
        Mr. Powers. We don't know whether Andersen was present. We
    have seen some of Andersen's work papers and from what we have
    seen, it doesn't look like they asked about Fastow's
    compensation. But again, there may be papers or Andersen may
    have a different view on that. We have not been able to find
    that Andersen looked into that.
        Mr. Royce. My last question is whether you had an
    opportunity to interview Cliff Baxter at all about the
    circumstances?
        Mr. Powers. That was a tragic--one of the tragedies that
    came out of this. The committee interviewed him. I did not
    personally interview Mr. Baxter.
        Mr. Royce. I thank you very much for your testimony here
    today, and Mr. Chairman, thank you.
        Chairman Baker. Mr. Sandlin.
        Mr. Sandlin. Thank you, Mr. Chairman.
        Thank you, Dean, for being here. My oldest daughter just
    began at the University of Texas as a freshman. Hillary should
    be horrified that I mentioned that here in Congress. It's good
    to have you here. Appreciate the hard work that you have done
    in a short period of time under difficult circumstances, and it
    appears as we go through this and listening to the questions
    that as usual, if you follow the money, you know what the
    incentives are and what's happening. I noticed in your report,
    I was interested in Mr. Fastow that you have been talking
    about. He received off the partnerships $30 million profit; is
    that correct?
        Mr. Powers. That's correct.
        Mr. Sandlin. Mr. Kopper, $10 million; two others got $1
    million each; two more got hundreds of thousands of dollars and
    it was also interesting, Mr. Fastow--he obviously knew that it
    was something to be hidden. I saw in your report, it says, item
    404 of regulation S-K required the disclosure, where
    practicable, of the amount of his interest in the transactions,
    and yet management discussed with him the possibility or way to
    hide that; is that correct?
        Mr. Powers. That's correct. Mr. Fastow did not want to
    reveal that.
        Mr. Sandlin. And on top of that he knew that it should be
    revealed and they were trying to find a way not to; is that
    correct?
        Mr. Powers. That's correct.
        Mr. Sandlin. I was interested in tracking these so-called
    retention bonuses. I saw Mr. John Lavorato got $5 million for
    90 days, and this was after Enron filed for bankruptcy; is that
    correct?
        Mr. Powers. I think it was in conjunction with Enron filing
    for bankruptcy trying to keep key employees that Enron thought
    was necessary to move ahead.
        Mr. Sandlin. You would have been pretty key if you got $5
    million for 90 days work, wouldn't you, especially when you are
    giving the employees the rank and file $4,500; is that correct?
        Mr. Powers. That's correct.
        Mr. Sandlin. Has demand been made upon those folks to
    return that money through the bankruptcy court?
        Mr. Powers. I don't know that.
        Mr. Sandlin. I am sure it is being looked at closely. I
    noticed also that Enron and its advisors, of course, set up
    these off-the-book partnerships that we have been talking
    about, and yet 2 days ago, they indicated they had absolutely
    no information as to who might be the investors. Did you see
    that?
        Mr. Powers. I have heard that. I didn't actually see it in
    the papers.
        Mr. Sandlin. That doesn't seem to be very plausible, does
    it?
        Mr. Powers. We have been unable to get those work papers
    because the partnerships have not provided them. I think Enron
    did not look into who the investors were.
        Mr. Sandlin. You would understand, then, how they can be in
    such a bad financial situation if they entered into these
    arrangements with partnerships, and they don't know who their
    partners are and they don't know what the arrangements are and
    they don't have the documents. It's pretty clear they are not
    doing a very good job, isn't it?
        Mr. Powers. They didn't know the limited partners in those
    and how those limited partners were dividing the profits.
        Mr. Sandlin. They knew who they were doing business with as
    far as dealing with their own executives and people making $30
    million, $10 million and $2 million?
        Mr. Powers. They knew they were doing business with Fastow.
        Mr. Sandlin. I would like to talk a little bit about this.
    Since we are talking about the lawyers, it seems to me the
    ultimate obligation and decision is made by the business
    itself; isn't that correct? Accountants are advisers and
    attorneys are advisers. In your report, on page 183, on related
    party disclosures, you say, ``nevertheless, it appears that no
    one outside of Enron Global Finance, the entity principally
    responsible for the related party transactions, exercised
    significant supervision or control over the disclosure process
    concerning these transactions.'' Isn't that correct?
        Mr. Powers. That's correct.
        Mr. Sandlin. In fact, Enron had several attorneys advising
    them; is that correct?
        Mr. Powers. That's my understanding, yes.
        Mr. Sandlin. And although in your report, you said that
    Andersen did not fulfill its professional responsibilities, you
    did not make that same finding about, say, for example,
    Vincent&Elkins; is that correct?
        Mr. Powers. Again, I stayed away from that aspect of the
    report and I don't remember the exact language that was used.
    It may be different language than was used with Andersen.
        Mr. Sandlin. You may have seen that V&E told Enron that
    some of the partnership deals might have been legal from a
    technical standpoint, but would be portrayed badly--that was a
    quote by the media--or in the event of the lawsuit. Have you
    seen those quotes?
        Mr. Powers. I have seen that in our report.
        Mr. Sandlin. Certainly it was portrayed badly, correct?
        Mr. Powers. It was portrayed badly.
        Mr. Sandlin. I think they were correct in that assessment.
    I think I'm out of time and it's about to blink, so I'll get
    back to the few remaining seconds I have and say thank you
    again for coming.
        Chairman Baker. Thank you, Mr. Sandlin.
        Mrs. Biggert.
        Mrs. Biggert. Thank you, Mr. Chairman.
        Did you say that that you determined that LMJ and Enron
    officials, especially Fastow and Kopper, took deliberate
    actions to intentionally frustrate the efforts of the audit
    staff and attorneys?
        Mr. Powers. Well, they certainly did not want their
    compensation known. And they were effective in not making it
    known.
        Mrs. Biggert. Then what about the issue----
        Mr. Powers. And I add that Fastow especially withheld a
    great deal about these transactions from the board.
        Mrs. Biggert. One of the questions that was asked earlier
    was about the fact that the SEC decided not to perform
    regularly scheduled review of Enron's filings with the
    Commission. Did that come up in your report or did you look
    into that?
        Mr. Powers. I don't believe we did look into that, no.
        Mrs. Biggert. Do you think with all these things that went
    on, the lawyers, the accountants, everything seemed to have
    failed, if the SEC had looked at that, do you think they might
    have found out about the special entities, or would have
    brought that to their attention?
        Mr. Powers. Again, these are very complex transactions, and
    one has to be able to really dig into the papers to find out
    about them. More people looking at these might have revealed
    them, but I can't say for sure whether the SEC could have found
    this.
        Mrs. Biggert. You didn't check into it?
        It all seemed to be so many things that happened; what
    would have triggered a stop on this so we could have found out.
    There's been so much in the press and every time we pick up a
    newspaper, and particularly the financial papers, but also the
    financial sections of every paper, there seems to be a lot of
    talking about Enron. Has the financial press helped or hurt or
    had any impact on your investigation?
        Mr. Powers. I don't think they have had any impact on our
    investigation. We may have learned a few things from press
    reports, but most of it was--well, it had a very small impact
    on our investigation.
        Mrs. Biggert. Thank you. Thank you, Mr. Chairman.
        Chairman Baker. Thank you, Ms. Biggert.
        Mr. Sherman.
        Mr. Sherman. Thank you. I am outraged by the retention
    bonuses, outraged by the self-dealing, but I want to focus on
    those aspects that are not unique to Enron, but may be systemic
    problems in the future. American culture says, as long as you
    adhere to the rules, you can go out and maximize profit. And
    it's certainly easier to change the rules and make sure that
    they cause people to adhere to good, socially acceptable
    standards, than it is going to be to change the culture.
        Mr. Ackerman asked a question a lot of us are asking, and I
    think, Dean Powers, that your statement may serve as the
    answer, and I would like to get your response. How did they
    miss this? How did the board not know? The analogy I've used
    before is that the accounting rules allow the car to go at 100
    miles an hour. It's legal. It's wrong, but it's legal. And the
    only reason that car isn't on the road today moving quickly
    toward accounting fantasy land is that they went at 101 miles
    an hour, and that what people didn't focus on was the last mile
    an hour. They knew the car was going fast. They might have
    known in a moral sense that it was wrong, that it exposed a lot
    of people to a lot of risk, but they thought they were adhering
    to the speed limit.
        I see, Dean, you're nodding, and I want to point out
    particular items in your statement that have kind of led me to
    this conclusion. You quote the corporate secretary, ``Does not
    transfer economic risk, but transfers P+L volatility.'' It's as
    if the corporate secretary thinks wow, we've discovered a road
    that you're allowed to go 100 miles an hour on. Do I have this
    right so far?
        Mr. Powers. I think the corporate secretary is probably--
    she's taking the minutes. Recording something that happened in
    the finance committee meeting.
        Mr. Sherman. And your comment later, is that from the board
    of directors on down, they understood that the company was
    seeking to offset its investment losses with its own stock to
    have transactions that affected the profit and loss statement
    or insulated the profit and loss statement, but transactions
    that didn't have any economic reality.
        Mr. Powers. I think they understood that they were setting
    up instruments that were hedging with their own stock. I am not
    sure everybody appreciated, because of the complexity of the
    transactions that therefore they had no economic consequence.
    We think they had no economic consequence. This was a red flag.
    But we can't conclude that everyone on the board appreciated
    that.
        Mr. Sherman. So they tended to appreciate that they were
    hedging with their own stock, but they didn't know particular
    details or enough about accounting rules to know that this
    thing, which you and I would call wrong, was actually banned by
    the accounting rules.
        Chairman Baker. That's your last question, your time has
    expired.
        Mr. Powers. That's correct.
        Mr. Sherman. Your statement at the beginning says if these
    transactions had been structured correctly, Enron could have
    kept assets and liabilities, especially debt, off its balance
    sheet. Enron did not follow the accounting rules. You're
    implying that if they had just slowed down to 99 miles an hour,
    they'd still be within all the rules and more specifically, I
    gather if they had just had $20- or $30- or $40-million of real
    capital at stake from independent investors, these shams would
    still be legally recognized?
        Mr. Powers. I think you're raising a very crucial issue
    here, but it's important to distinguish between different
    transactions. For example, the Chewco transaction was not a
    hedging transaction. It was buying assets that Enron wanted to
    keep off the books for the reason of keeping debt off the books
    and other reasons. That transaction failed because Chewco did
    not satisfy the 3 percent outside equity at risk requirement,
    and that was because of Barclays Bank, and so forth, and we
    outline that in the report.
        Chairman Baker. The gentleman's time has expired.
        Mr. Sherman. I thank the gentleman for his indulgence.
        Chairman Baker. Mr. Shadegg.
        Mr. Shadegg. Dean Powers, do you want to finish your answer
    to that last question?
        Mr. Powers. If the committee would like me to. That
    violation, if corrected, would have permitted that transaction.
    The hedging transactions, I think, were more fundamentally
    flawed, because they were using Enron's own stock to hedge the
    transactions. I don't think that could have been corrected
    simply by adjusting the transaction to meet the accounting
    rules.
        Mr. Shadegg. Dean, as a recovering lawyer, let me ask you
    some legal questions and see if I can get some background.
    First of all, what is your background in law? Do you have
    background in securities law?
        Mr. Powers. No. I teach torts and products liability and
    legal philosophy. I have taught contracts and some other
    topics.
        Mr. Shadegg. Torts and contracts ought to help here a
    little bit. Did you look into how many off-balance-sheet
    entities there were? I, for example, have read 3,000. I have
    heard there were 3,500. And I compare that with other major
    corporations in America where I have heard there are as few as
    6.
        Mr. Powers. We did not look at that issue. We looked at the
    three entities that were engaged in with related parties, that
    is, with Enron employees.
        Mr. Shadegg. So you did not investigate whether there are
    literally hundreds of abuses by off-balance-sheet entities,
    maybe even thousands of them?
        Mr. Powers. That's correct. We did not investigate that.
        Mr. Shadegg. Are you as mystified as I am by the
    exploitation of off-balance-sheet entities to conceal debt, or
    is that----
        Mr. Powers. I was certainly appalled by what we looked at
    in these entities.
        Mr. Shadegg. Let's go to the issue of the knowledge of
    these board members. We just went through some questioning that
    went at the notion that accounting rules allow them to operate
    at 100 miles an hour. Everybody knows that 100 miles an hour
    isn't safe, but it was only when they went 101 miles an hour
    that we got into this trouble. I'm a little troubled. First of
    all, did you interview all of the members of the board of
    directors?
        Mr. Powers. No. I think we interviewed nine members.
        Mr. Shadegg. It was just with respect to these 3 peculiar
    entities that seem to have been abused?
        Mr. Powers. Yes.
        Mr. Shadegg. Did you find that none of the board members
    were aware of, for example, the compensation packages or the
    conflicts of interest?
        Mr. Powers. Well, they certainly understood that Fastow was
    in LJM, and that he was the chief financial officer of the
    company, and as our report indicates, we think that was a basic
    flaw in setting up these transactions in the first place.
        Mr. Shadegg. Didn't Fastow have to ask for an ethics
    exemption to be able to do that, and did you question them
    about how or why they granted that ethics exemption?
        Mr. Powers. He had to get a finding by the office of the
    Chair, granting this not really exemption, but granting these
    transactions was in the best interest of Enron. That did not
    need to come to the board, but it did actually come to the
    board and made that finding.
        Mr. Shadegg. It did come to the board and they were aware
    of it?
        Mr. Powers. They were aware of it, that's correct.
        Mr. Shadegg. Do you see a need for significant revisions in
    the ethics rules governing officers and their disclosures to
    full board members, including things like the extent of their
    interest in an off-balance-sheet entity?
        Mr. Powers. I think it's questionable whether an officer
    ought to have an interest in one of these transactions at all.
    Certainly if a company were to come to the conclusion after
    this episode, it was worthwhile, you'd certainly want to get
    detailed information about the compensation that officer was
    going to get.
        Mr. Shadegg. Let me go to that point. You have written what
    I think is an invaluable report, which will be a great resource
    to the Congress as we go forward. Are there specific things
    that you have concluded in preparing that report or other
    members of the committee that worked with you that you would
    recommend to this Congress to make sure that this kind of
    incident doesn't happen again, that you can't be ignorant of
    speed limit rules that allow you to go up to the line like this
    or allow board members to be as in the dark as it appears they
    were?
        Mr. Powers. We worked very hard to describe what happened
    and we--and I don't have the background, and we did not come to
    conclusions on what ought to be done, though certainly, that's
    what this subcommittee and other Government bodies will be
    looking at.
        Mr. Shadegg. I appreciate your contribution to the process
    and I yield back the balance of my time.
        Chairman Baker. Thank you.
        Mr. Inslee.
        Mr. Inslee. Thank you, Dean. We appreciate your efforts. I
    am interested--I am from the Seattle area, and I am interested
    in the pricing of electricity issues. And obviously it has
    become apparent that to keep this house of cards propped up,
    Enron wanted to keep the electricity on the West Coast as high
    as possible. We would like to find out what Enron did in that
    regard, particularly in regard to any of the Executive
    authorities, the White House included. And I'm wondering if you
    would send to us any documents pertaining to Enron or their
    representatives, requests of the Administration including the
    Vice President's task force, and the reason I asked you
    because, as you know, the Vice President has been unwilling to
    share those with us. Would you be willing to provide those
    documents to the subcommittee?
        Mr. Powers. I don't think our committee has any documents
    of that sort. As far as providing them, we have cooperated and
    provided many documents with SEC, would cooperate with the
    committees. Documents in the company are not mine to send. The
    company would have to make a decision. I certainly would
    support every document or bit of information within the company
    being provided to the Congress.
        Mr. Inslee. You're a director of the corporation now. You
    are certainly the closest thing we have here as a
    representative of the corporation. Would you recommend to the
    corporation that they honor my request to you to provide all
    the documents which I am now making to you pertaining to the
    communication by Enron with the Vice President's energy task
    force.
        Mr. Powers. Absolutely. I would support that.
        Mr. Inslee. I will communicate with you further to try to
    facilitate that. And the public is very, very interested in
    this. They are very concerned, disappointed that this
    information has not been forthcoming to date. So we will
    communicate further. Let me ask you, too, about an issue
    regarding the futures contracts. I am told that back in 1992,
    the Commodities Futures Trading Commission, then headed by
    Wendy Graham, honored a request by Enron to exempt the futures
    contracts that Enron dealt in from regulation by the
    Commodities Futures Trading Commission. I am told that Ms.
    Graham, 5 weeks after leaving her position as chair of that
    board, went on the Enron board, and that following that and
    since that time, Enron's futures contracts were free of any
    Government regulation at least by that agency, and that those
    contracts were the ones that were involved in this ramp-up of
    costs of electrical prices on the West Coast.
        Did you ask Ms. Graham about her role in that regard to any
    extent?
        Mr. Powers. We didn't investigate that at all.
        Mr. Inslee. Is the failure to cover these futures contracts
    by Enron and others, do you think that could have played a part
    in the problem that Enron experienced and/or the problem that
    consumers experienced in the West Coast? Do you have any
    feeling about that?
        Mr. Powers. I really don't know anything about that.
        Mr. Inslee. Given the nature of this loss, do you think it
    would make sense for Congress to at least reexamine that issue
    to whether the public should have some regulatory control over
    these now unregulated futures contracts that at least played a
    part in these agreements?
        Mr. Powers. Well, certainly Congress should look into those
    issues and make judgments about what the best policy and what
    the law is. I myself don't have enough knowledge about those to
    know whether there's an issue to look into.
        Mr. Inslee. I want to come back to what Mr. Sherman talked
    about on the issue of the 3 percent rule. And I will quote from
    your report. You said, ``there's no question that virtually
    everyone from the board of directors on down understood that
    the company was seeking to offset its investment losses with
    its own stock.'' That is not the way it is supposed to work.
    Real earnings are supposed to be compared to really losses,
    something I really agree with. Even if we fixed the 3 percent
    rule, even if we raised it to 6 percent or 10 percent or 15
    percent, that still wouldn't solve the problem that you are
    alluding to; is that right?
        Mr. Powers. That's absolutely correct. Those are different
    issues and different problems.
        Mr. Inslee. How would we, in your judgment--what would be
    the best way to solve that problem other than just tinkering
    with this percentage equity rule.
        Mr. Powers. It's my understanding that there is a current
    accounting rule and practice that a company cannot recognize
    gains in its stock as income, and indirectly, that's what was
    happening here. So I think there's an accounting rule that
    prohibits this. The problem was the transactions got so
    complicated that people really didn't appreciate, or some
    people may not have appreciated that that's what was going on.
        Mr. Inslee. Just a last question. Obviously, you and many
    of us are concerned about the accounting aspect of this and the
    relationship between the auditing firm and management. Do you
    have any thoughts about--given about what you know about the
    relationship of management with the auditors, if you were going
    to pick a solution to that problem right now on a nationwide
    basis, comparing a requirement that auditors rotate, for
    instance, so that there be mandatory termination of auditors'
    duties at some point or a limitation of functions, be it
    management versus auditing function or a decision that some
    other third party decides who the auditor is, if you were to
    pick amongst those types of solutions, what you know about
    Enron, what would have been most effective?
        Chairman Baker. The gentleman's time has expired. That's
    your last question. Please respond.
        Mr. Powers. I am not an accountant and I don't know which
    of those would be a better solution. I honestly don't know.
        Mr. Inslee. Thank you. And we will talk about these
    records. Thank you.
        Chairman Baker. Mr. LaTourette.
        Mr. LaTourette. Thank you, Mr. Chairman. Dean, I just have
    one question and I will yield the rest of my time to the
    Chairman. And I want to focus on the conclusion of your report,
    and I think you've reiterated in your testimony today, that
    basically, what we find is a culture that has many flaws by
    many people at many levels. You talked about the management,
    the board, the outside evaluators auditors and lawyers. And if
    you read and watch the news, there are also some hints and
    insinuations that this was helped along by governmental
    agencies in attention or favors done by people in Government.
    Did you and the folks that you investigated with find anything
    to substantiate any of those, or is that something you didn't
    look into?
        Mr. Powers. We didn't look into it, but we certainly didn't
    find anything one way or the other on that.
        Mr. LaTourette. There is nothing in anything that you
    uncovered from the limited amount of materials that you had
    available to you that indicated that Enron's failure was
    anything but this culture that was created in Enron, and sort
    of these incestuous relationships that existed, perhaps, with
    their auditors and lawyers and folks like that?
        Mr. Powers. That's correct.
        Mr. LaTourette. Thank you very much.
        Mr. Chairman, I yield the balance of my time to you.
        Chairman Baker. It appears to me that Mr. LaTourette was on
    an analysis course that makes a great deal of sense. Tremendous
    earnings pressures to beat the analysts' written
    recommendations or expectation earnings, and then there's the
    whisper numbers and smart management wants to beat the whisper
    number by 1 penny or 2, not by 3, because then it looks like
    you knew something that you didn't disclose. So that you manage
    from month to month to get the earnings target so your stock
    price continues to rise.
        That creates tremendous managerial pressure to use whatever
    means to keep the revenue stream up so that credit markets
    don't cut off the credit window in this case, which was rather
    significant to Enron's continued success. So you had a very
    smart CFO manipulating revenue streams, hiding debt in order to
    keep the appearances whole so that they could perhaps see a
    turnaround in market price, and thereby truly profit.
        It's not unlike the S&Ls in the 1980s who were buying
    broker deposits and giving away toasters. They were hoping that
    the interest rate market would turn around and everything would
    be fine. So I think I understand the corporate culture that
    drove this, but there is something more insidious that bothers
    me, and that is, all the options granted to the insiders and
    corporate officials, that if the stock price ran up and you
    could exercise your option, then if you had to have a
    restatement position later in driving the price back down
    again, the official profited from the rising price and
    exercised a no-cost option because of his employment contract,
    but then did not have to give anything back when a restatement
    of earnings occurred because of that official's misconduct or
    misjudgment.
        Did you examine any of the relationships between options,
    restatement of earnings and the effect on management?
        Mr. Powers. We did not look into the options and the sales
    of stock by insiders in this situation. And it wasn't in our
    charge and we had a lot on our plate.
        Chairman Baker. With regard to what you did find, your
    statement with regard to Andersen not fulfilling its
    professional responsibilities, give me your top three
    complaints.
        Mr. Powers. Well, it's our understanding, using your own
    stock as a way of, even through a complicated system, to end up
    reflecting earnings on your balance sheet, is not proper.
    That's one.
        Chairman Baker. So your target really is that first
    Andersen should have identified the economic relationship
    between the parent and the SPE as problematic because of the
    financial relationships, and in your opinion, they did not.
        Mr. Powers. There were supposedly controls in place that
    tried to mitigate the danger of that conflict that they did not
    manage as well.
        Chairman Baker. Andersen's view they reported to the audit
    committee, and the audit committee determined it was not
    material to the long-term profitability of the corporation.
    Help me understand here what is wrong with the Andersen
    position.
        I'll restate. Andersen reported to the audit committee, and
    purportedly according to their view of the facts, they had
    concerns about the structure of the SPEs and their financial
    relationship too, and they made a determination that these
    matters were not made of material significance to the
    profitability of the corporation.
        Mr. Powers. We don't believe Andersen complained to the
    audit committee on that, and we weren't able to talk to
    Andersen.
        Chairman Baker. Give me a quick two and I'll come back
    later. What is your second one on your list?
        Mr. Powers. That would be the second. The first one was
    using your own stock to collateralize your earnings. That is a
    more fundamental one. The 3 percent rules and having audit
    procedures in place to make sure those things are met, is also
    a problem.
        Chairman Baker. I will try to come back to you later. I
    have exhausted Mr. LaTourette's time.
        Mrs. Jones.
        Mrs. Jones. Professor Powers, or Chair Powers, who were the
    other--you've identified yourself as the Dean of a law school.
    Who is Raymond--and I can't read this name, Troubh. Who is he?
    What type of job does he have?
        Mr. Powers. He's was a lawyer for sometime in New York, and
    then an investment banker, and now he's on the board of
    directors of several companies.
        Mrs. Jones. And what about Herbert Winokur?
        Mr. Powers. He's the Chairman and CEO of Capricorn
    Investments. He's a member of the board of directors and has
    been of Enron.
        Mrs. Jones. I noticed that in your responses to a number of
    the questions you stopped short--what's the name of the law
    firm that's involved.
        Mr. Powers. Vinson & Elkins.
        Mrs. Jones. That you stopped short in saying why you did
    not do something with regard to the lawyers or investigate any
    further the lawyers. Can you finish that sentence, we did not
    because----
        Mr. Powers. The committee did. Vinson & Elkins has been
    counsel for the law school on major litigation. They are a
    major supporter. And I thought the report would speak better if
    I was not involved in the judgments about Vinson & Elkins and
    let the other members of the committee make those
    determinations.
        Mrs. Jones. So where are the findings with regard to Vinson
    & Elkins?
        Mr. Powers. There are some in the executive summary
    conclusions and some in the disclosure section, I believe, and
    there may be others throughout--I'm not sure I am pinpointing
    every one.
        Mrs. Jones. I didn't find them so I will have to go through
    and look through again. And so, did Mr. Winokur have a
    relationship with Vinson & Elkins as well?
        Mr. Powers. No, other than the fact that Vinson & Elkins
    was Enron's lawyers.
        Mrs. Jones. Tell me, the one transaction or one transaction
    was with California Public Employee Retirement System; is that
    correct?
        Mr. Powers. Yes. That's correct.
        Mrs. Jones. And do you know what caused the California
    Employee Retirement System to jump ship and say ``let me us out
    of this transaction before we're in the process of losing
    dollars for our retirees as well.'' Was there anything in your
    findings that told you something?
        Mr. Powers. CalPERS wanted out of an original investment
    called Jedi I, so they could get into a new investment. Then
    they got into a new investment.
        Mrs. Jones. Did they then lose money in the new investment?
        Mr. Powers. We don't know the outcome of that.
        Mrs. Jones. But it was an investment with the Enron
    Corporation?
        Mr. Powers. And it was--Enron--originally Jedi was a
    combined investment fund that was half Enron and half CalPERS.
        Mrs. Jones. What I'm asking you is they wanted to get out
    of that investment and to be able to get into a larger
    investment. Was the larger investment with Enron?
        Mr. Powers. It was with Chewco, which was this off-balance-
    sheet entity of Enron.
        Mrs. Jones. Did you, in fact, review any securities law
    violations with regard to the work that you did, sir?
        Mr. Powers. We didn't.
        Mrs. Jones. Are you able, based upon the review you've done
    and the statements you've made about the accountants, able to
    say whether you would support the restoration of aiding and
    abetting liability for accountants?
        Mr. Powers. We really have not looked into it, and as I
    said, accounting and regulation of accounting is not an area
    that I've looked into. I have tried to find out what happened
    here, but I really do not have a well-informed opinion.
        Mrs. Jones. You found out that Andersen allegedly assisted
    Enron in covering up the limited partnerships that were the
    real losses for the Enron Corporation; is that right?
        Mr. Powers. They were involved in the structuring of these
    transactions, correct.
        Mrs. Jones. Based on that and based on your statement that
    this is terrible conduct, clearly, wouldn't you think it would
    be appropriate that accountants be held responsible for aiding
    and abetting someone for causing them to lose?
        Mr. Powers. I think accountants should be held liable for
    their misconduct. I don't know enough about the act or how that
    act works. But I agree there ought to be appropriate liability
    under appropriate rules for accountant misconduct.
        Mrs. Jones. Tell us how many people were involved in the
    committee other than your three names on your report.
        Chairman Baker. And that will be the last question.
        Mr. Powers. We had 3 members of the committee and then we
    had lawyers and accountants. I'd say 25 different people
    helping us.
        Mrs. Jones. Mr. Chairman, can I just ask were they firms or
    were they individual professors?
        Mr. Powers. They're firms. The lawyers were Wilmer, Cutler
    and Pickering, and our accountants were Deloitte & Touche.
        Chairman Baker. Mr. Crowley--excuse me, Mr. Moore.
        Mr. Moore. Thank you, Mr. Chairman.
        Dean Powers, I am going to give you just about 2 or 3 dates
    here and some information that I believe is correct, and the
    record will correct me if I am wrong, but I understand and
    maybe you found this out during your investigation, August 23
    of the year 2000, stock for Enron peaked at $90 a share, does
    that sound about right to you?
        Mr. Powers. I don't know independently, but that sounds
    reasonable.
        Mr. Moore. You know in August of 2001, I believe the date
    was August 14, 2001 that Jeff Skilling resigned and Ken Lay
    became the CEO of Enron; is that correct?
        Mr. Powers. Yes.
        Mr. Moore. Maybe the record will reflect my information is
    that the stock at that time was $43 a share. That was a year
    after the peak at $90 a share. A year later, it's $43 a share.
    August 21, just 7 days later, after Mr. Lay became CEO, does
    your information reflect or your investigation reflect that he
    sent an e-mail, memorandum to employees of Enron that said that
    he ``had never felt better about the prospects of the company.
    Our growth has never been more certain.''
        Mr. Powers. I've seen reference to that.
        Mr. Moore. Is that timeframe approximately, correct, August
    of 2001?
        Mr. Powers. I don't have any reason to think that's not the
    right date.
        Mr. Moore. Based upon your investigation, do you believe
    that was an accurate statement that the prospects for the
    company had never been better in August, 2001?
        Mr. Powers. In retrospect the prospects of the company were
    not--the company went down from there.
        Mr. Moore. Is that the best answer you can give me?
        Mr. Powers. As I said earlier----
        Mr. Moore. I am not asking you what was in Mr. Lay's mind.
    I'm asking that, based upon your investigation, do you believe
    in August, 2001, that the prospects for the company had never
    been better based upon--in retrospect right now.
        Mr. Powers. No. I think they had been better. I don't think
    that was accurate.
        Mr. Moore. What is the purpose of an audit? I understand
    you're not an accountant. What is the purpose of an audit as
    you understand it, sir?
        Mr. Powers. To assure the public the best that the audit
    process can; that the financial statements of the company are
    accurate.
        Mr. Moore. And should that audit be ``independent''?
        Mr. Powers. I think that audit ought to be independent.
        Mr. Moore. Did you understand that the auditors gave advice
    to Enron as to how Enron could exclude losses of several
    partnerships from its balance sheet?
        Mr. Powers. Yes. I believe that's correct.
        Mr. Moore. Is it your understanding that last year, Enron
    paid its auditors $25 million for auditing services?
        Mr. Powers. I don't have the exact figures in my head, but
    very substantial amounts.
        Mr. Moore. Is it your understanding, based upon your
    investigation, that last year Enron paid its auditors $27
    million for consulting services?
        Mr. Powers. Yes. I believe that's correct.
        Mr. Moore. In addition to the $25 million for auditing
    services?
        Mr. Powers. Yes.
        Mr. Moore. Does that cause you any concern?
        Mr. Powers. I think one of the things that surprised me was
    that the accountants were providing both consulting and
    auditing services at that magnitude.
        Mr. Moore. Why does that surprise you, sir? I want people
    that are listening or watching this to understand why that
    should cause concern.
        Mr. Powers. Because we want the audit to be independent of
    the people that created the transactions.
        Mr. Moore. What would make you to believe or cause you to
    believe that wouldn't be independent?
        Mr. Powers. If they helped structure the transactions, they
    already are going to have a view on the transactions.
        Chairman Baker. Mr. Gonzalez, Mr. Kanjorski asked unanimous
    consent to intervene for one minute.
        Mr. Kanjorski. I cannot resist, Dean Powers. As the Dean of
    the University of Texas Law School, we have another matter up
    here that may have an ancillary effect on this process.
        We have pending before us bankruptcy reform legislation,
    and the present bankruptcy law in Texas and four other States
    allows for unlimited homestead exemptions. A lot of these folks
    that came up here and lost their retirements may not understand
    that anybody in Texas who puts someone else's money in their
    home and is sued for it, for recovery, can go bankrupt and keep
    all the assets in their home, sometimes to the tune of $10, $20
    and $30 million. It is a peculiar constitutional exemption in
    the State of Florida, in the State of Texas, and elsewhere. In
    this case, I am aware of a number of individuals who are
    parties to the Enron collapse who would have the option of
    escaping liability if sued.
        Could you express an opinion to me, other Members of this
    subcommittee and to the Congress, whether or not it is about
    time we remove that homestead exemption from the Federal
    Bankruptcy Act so that Texans can suffer the same consequences
    as every other American in bankruptcy?
        Mr. Powers. I understand that Texas has the homestead
    provision, and I can certainly see the rationale for uniformity
    throughout the country that it ought to be the same. I am not a
    bankruptcy expert by any means, but I certainly understand the
    concern.
        Mr. Kanjorski. Will you help us with the legal community of
    Texas to change the law properly?
        Chairman Baker. I think he's yielding back his time.
        Mr. Gonzalez.
        Mr. Gonzalez. Dean, let me just help you with this
    homestead thing. Being from Texas, you know we hold that sacred
    and we are in a battle with these guys over it, and the few
    abuses, if there are abuses, but I think in terms of the whole
    picture and what it means to so many families in Texas and have
    been able to salvage their homes in the direst times. But you
    teach torts, you teach products liability and give us a couple
    more sessions, you won't have those courses anymore. And if you
    give us enough time, we will take care of legal philosophy.
        I really want to touch on, and this is an interesting
    aspect, I know you have recused yourself from the Vinson &
    Elkins involvement, and I am going to touch on that, and if you
    feel uncomfortable about that, then I will understand. But
    whether you are a officer, director or accountant or lawyer to
    Enron, to whom do you owe a duty? It's the shareholder, isn't
    it?
        Mr. Powers. Shareholders and unfortunately now the
    creditors.
        Mr. Gonzalez. At the time it was the shareholders' interest
    that should have been paramount. And that's who they owed it
    to, and you touched on this, sometimes you have conflicts and
    objectivity goes out the window because you have a vested
    interest in what you are doing personally and maybe you're not
    the best person at that point in time. So an officer is doing
    something they are not supposed to be doing to protect their
    own vested interest in whatever the entity, SPEs and whatever
    they are and their stock options, then you hope the board of
    directors is going to catch it.
        If the board of directors is too busy or if there's a
    chummy relationship, as Congressman LaFalce portrayed earlier,
    then the accountants and the lawyers really do loom large, and
    they should be the most objective of all the parties that owe
    this duty to the shareholders, wouldn't you agree?
        Mr. Powers. Well, I think the outside professionals need to
    be objective in their advice to the company.
        Mr. Gonzalez. But more than anyone else, they are probably
    in the best position to be objective. And they don't have an
    investment in what's going on with that company to the extent
    that the directors who are deriving benefits from the stocks,
    most of them get paid through stock, and of course the officers
    themselves.
        Tomorrow we'll hear from the accountant and you have
    expressed something we are having difficulties with, they are
    consultants and they're also the accountants. So I would like
    to zero in on the lawyers. The lawyers at Vinson & Elkins had
    as much to do as anybody else in creating these SPEs,
    partnerships, Raptors, whatever they were, is that a fair
    statement?
        Mr. Powers. I don't know that.
        Mr. Gonzalez. Well, you were aware to the extent that they
    had knowledge of a legal--because these things are legal
    entities that a lawyer had to have his hand in it somewhere.
        Mr. Powers. My understanding, and I have read through the
    report, is that the law firm had some involvement in these
    transactions.
        Mr. Gonzalez. Now Enron had in-house counsel. Did they have
    general counsel?
        Mr. Powers. Yes.
        Mr. Gonzalez. Who was a former partner at Vinson & Elkins;
    is that correct?
        Mr. Powers. Yes.
        Mr. Gonzalez. To some extent, you have a relationship that
    was pre-existing and continues to some extent.
        Mr. Powers. To some extent.
        Mr. Gonzalez. You also had former Vinson & Elkins partners
    who had an interest in some of these partnerships. Are you
    aware, and I'm not sure if it was SPE, Raptor or partnership,
    and I'm thinking of one individual who was a former V&E
    partner, and then was also the former head of Enron of Mexico.
        Mr. Powers. I am not aware of that.
        Mr. Gonzalez. Let's just assume what I just stated is
    factual, and I need to be very careful, because these are all
    reports and there's triple hearsay, but in fact, you have these
    pre-existing relationships with the law firm, general counsel,
    for instance, and they are hiring people from Vinson & Elkins
    to come and work at Enron. I think that is true. You have some
    of these individuals who leave the law firm and then become
    partners in some of these other entities that are somehow
    aligned with Enron. Do you see a problem with providing
    objective responsible mature calculated legal advice given
    these relationships?
        Mr. Powers. I don't know those relationships to exist.
        Mr. Gonzalez. Just assume that they do.
        Mr. Powers. I think people can have--law firms have people
    leave the firm and go to be in-house counsel.
        Mr. Gonzalez. There's life after Vinson & Elkins, I'm sure.
        Mr. Powers. And still be in a position to give outside
    professional advice. And it's certainly quite common that
    people from law firms go to companies as in-house counsel, and
    people as in-house counsel go back to the law firms.
        Mr. Gonzalez. Is there the potential--and you don't want to
    limit someone's ability to move onward and upward, but
    nevertheless, is there any problems in any of these
    relationships? Do you see if, in fact--and I'm not real sure
    that any of these Raptors, SPEs, partnerships involved former
    partners at Vinson & Elkins. But someone said that these were
    acceptable, legally speaking, and didn't violate any of the
    duties to the shareholders who are now left holding the bag
    along with the creditors?
        Mr. Powers. Again, I didn't focus on that, so I really
    don't know the answer to your question.
        Mr. Gonzalez. Thank you very much.
        Chairman Baker. Mr. Lucas.
        Mr. Lucas. Thank you, Mr. Chairman.
        Dean, I'll be brief, the hour is late and I find your
    report very enlightening. Just one question. I think I
    understand conceptually how hedges and derivatives work, and I
    understand from your report they are being backed up by
    worthless guarantees in the company. In your view--and I have
    heard an analogy that this is kind of like to keep it very
    simplistic, it's like a ticket scalper.
        Let's say a ticket scalper has a ticket and he wants to
    make something more than $50 and he is left holding the bag and
    the game starts and nobody wants the tickets, and they are now
    worth $20 or $30 or maybe nothing. In your view, had the market
    price stayed up where they didn't get in trouble with these
    worthless guarantees, would the house of cards fallen anyway,
    or as long as the money stayed there, would this thing have
    gone on?
        Mr. Powers. In our view, back in with the company's own
    stock would have still been inappropriate, but if the price of
    Enron stock had not gone down, I think there's a real
    likelihood that these would not have come to the attention of
    the public. I think that's what precipitated the problem. The
    price of Enron stock going down and that even on its terms
    meant that the Raptors couldn't honor their obligation and had
    to be restructured and charges to equity and earnings.
        Mr. Lucas. So we have a systemic problem, Mr. Chairman,
    that had the price stayed up, this maybe would have never come
    to light. So we have, I think, a big problem industry-wide.
    Thank you.
        Chairman Baker. Mr. Ross.
        Mr. Ross. Thank you, Mr. Chairman, the hour is late and
    I'll be brief. You know this has had an impact all across
    America. I represent an area in Arkansas about the southern
    half of the State, a small business within my congressional
    district, total retirement plan is roughly $4.5 million. It's a
    small business. With the collapse of Enron, over a quarter-of-
    a-million dollars in a very small retirement plan, some $4.5
    million.
        If they had had access to half the information that's in
    this report, they would have known that's a stock they didn't
    need to be in. Unfortunately, they didn't and those employees
    now are looking at smaller retirements, much smaller
    retirements. We can't go back and fix what happened at Enron.
    We can find out who's responsible and punish them and bring
    about some justice.
        Have you given any thought to the many, many employees of
    Enron who now are left with no retirement or very little
    retirement or the retirees who counted on that check to assist
    and subsidize their Social Security payment and the people,
    like in my congressional district, that have been hit by this
    through their retirement plan and 401Ks, and so forth and so
    on? Have you given any thought to that and have any
    recommendations from your perspective, having lived through
    this; how we can ensure that something like this doesn't happen
    in the future to where those people see something similar to
    this before it's too late?
        Mr. Powers. Well, I've given a great deal of thought to it
    in the sense this is a great human tragedy. As far as
    recommendations, it seems like a simple idea that the financial
    reporting of a company ought to accurately portray the
    condition of the company so that people can make judgments
    about their investments. I don't have a specific recommendation
    of how to ensure that happens, but that's crucially important,
    it seems to me.
        There are substantial issues that are being raised about
    401K plans, and I think those are crucially important to look
    at. Again, I don't want to sit here and say I have particular
    insights into how to structure 401K plans. We tried to show
    what happened, show what happened such that the value of the
    stock in those 401K plans was destroyed, and I hope we have
    done that. But I don't have particular recommendations as to
    how 401K plans should be structured. It's an astonishingly
    important problem to solve and especially for the people who
    are victims of--in their retirement plans of the collapse of
    the Enron stock.
        Mr. Ross. One final question of you, and that is I got up
    at 3:30 this morning in Arkansas to head up here thinking I was
    going to hear the former Chair of Enron testify and somewhere
    between Arkansas and Washington I learned that he was not going
    to appear before us without a subpoena. Why did you choose to
    appear and why would you appear and he not?
        Mr. Powers. Well, I was not, I'd like to say, involved when
    any of these transactions that took place. I was called in to
    do an investigation. The purpose of that investigation was to
    bring to light what happened. When I started I never for a
    moment thought this would be the result of it, but the task of
    our committee was to find out what happened and tell the story
    and I think that's what we've done, and if I can be helpful to
    the committee in helping to explain that story, that's what I'm
    here to do.
        Mr. Ross. It's frustrating that, you know, we pick up the
    paper and we have committee meetings and we learn where papers
    are shredded and where people refuse to come without a subpoena
    and appear before us which, you know, in Arkansas when people
    do things like that we think they have something to hide, and
    I'm real troubled by the failure of the former Chair of Enron
    to appear before us today.
        I want to thank you for coming and hopefully you've helped
    us have a greater understanding of what did happen so we can
    prevent this from happening in the future. Thank you.
        Mr. Powers. Thank you.
        Chairman Baker. Your time has expired, Mr. Ross.
        Ms. Jackson-Lee.
        Ms. Jackson-Lee. Again I thank the committee for its
    kindness. Dean Powers, welcome and thank you very much.
        Mr. Powers. Thank you.
        Ms. Jackson-Lee. This report is quite filled with enormous
    challenges for what we may have to face prospectively, and I'd
    like to follow the line of questioning that my colleagues began
    with respect to the board's assessment. Might I also say that
    my colleagues I think have very ably suggested that we realize
    that people are innocent until proven guilty, but there is a
    lot here, almost insurmountable information, as to what
    occurred throughout your report.
        What drove the board to develop this committee around 2001?
    What was the driving force that caused them to do so?
        Mr. Powers. OK. Of course I wasn't on the board when it was
    formed, but it was my understanding that questions were being
    raised in the press about some of these entities and the board
    wanted to investigate them, have outside people come in and
    investigate them to, I think, from their hope restore
    confidence that they were proper transactions. That's not what
    turned out to be the case.
        Ms. Jackson-Lee. Something was bothering them, if you will.
    I mean, something was awry and they decided to organize this
    committee, and when did you get involved with the committee?
        Mr. Powers. I was appointed as Chair of the committee and
    placed on the board on, I believe, the 31st of October.
        Ms. Jackson-Lee. So just a few days after? The committee
    came about on the 28th and then you came on on the 31st. How
    large is the board?
        Mr. Powers. I believe the board is, I think, 14 people.
        Ms. Jackson-Lee. And so the audit committee is how many?
        Mr. Powers. Six, I understand.
        Ms. Jackson-Lee. So a good portion of the board is the
    audit committee, almost half if its 14. I noticed that the
    committee noted that it had no power to compel third parties to
    submit to interviews, produce documents, or otherwise provide
    information. Do you think that undermined the committee's
    ability to get more information or find out definitively how
    these employees were involved?
        Mr. Powers. I think that somebody with subpoena and cross-
    examination ability will be able to build on this and get more
    information.
        Ms. Jackson-Lee. So you think that certainly that should
    occur, that subpoena power should be used and employees should
    be able to or a former executive should come in under subpoena
    and be asked more questions? You think that would be helpful?
        Mr. Powers. I think the appropriate committees and
    Government agencies should continue and build on this
    investigation by using their subpoena and cross-examination
    power, absolutely.
        Ms. Jackson-Lee. Was the board aware of the fact, and I
    think you note here in your page 4, that the combination of two
    of these SPEs resulted in a billion dollars write-off to a
    certain extent, that the assets were represented to be a
    billion dollars more than they were around the third quarter
    2001?
        Mr. Powers. Well, there were reports on the financial
    statements that use the term revenues of--very large sums were
    being attributed to transactions that can be traced to these
    Raptor transactions.
        Ms. Jackson-Lee. And there was a loss, in essence there was
    a loss of a billion dollars around the third quarter of 2001?
        Mr. Powers. There were several restatements and losses, but
    the ones attributable to the Raptors, I don't think we know
    exactly what board members knew as to how much was being
    attributed to the Raptors at that period of time.
        Ms. Jackson-Lee. With the board organizing this committee,
    you coming on 3 days later, was there any reason why the board
    didn't see fit at that time to terminate Arthur Andersen, and
    then as well as you were investigating and seeing these
    occurrences, was there not some concern at the board level and
    were they aware of the $100 million that was being utilized to
    give to executives to retain them in contrast to the employees
    getting nothing and, of course, the pensioners as the stock was
    going down losing everything? Did you all not discuss that we
    are in an investigation, maybe we should consider granting this
    large sum of money to executives in contrast to our employees
    who were then laid off on December 3, 2001?
        Mr. Powers. Right. That was discussed. We were very early
    on in our investigation and didn't have the information that we
    now have that we've been able to develop at the time the board
    made those----
        Ms. Jackson-Lee. Do you think it was ill advised by the
    managers at the time?
        Chairman Baker. And that will be have to be your last
    question.
        Ms. Jackson-Lee. Thank you, Mr. Chairman.
        Do you think you were ill-advised?
        Mr. Powers. Absolutely.
        Ms. Jackson-Lee. Thank you.
        Chairman Baker. Thank you, Ms. Jackson-Lee.
        Mr. Shays.
        Mr. Shays. I have what amounts to about 2 minutes worth of
    questions.
        Chairman Baker. I have about 2 minutes left.
        Mr. Shays. Do you want to go first?
        Chairman Baker. No. Please, Mr. Shays, proceed.
        Mr. Shays. My wife thought I should apologize to you; so I
    will apologize to you.
        Mr. Powers. There's no need for that.
        Mr. Shays. I just will say to you that I find your report
    so amazing, so scathing, and I was just trying to understand
    just one little part of it, and on your report on the executive
    summary, in conclusions on page 25, you have a paragraph again
    dealing with Vinson & Elkins and you say ``Vinson & Elkins, as
    Enron's longstanding outside counsel, provided advice and
    prepared documentation in connection with many of the
    transactions discussed in the report.'' Is ``the report''
    making reference to your report?
        Mr. Powers. Yes, I believe it is there.
        Mr. Shays. And then you go on to say it also assisted Enron
    with the preparation, and so on, and then at the end of the
    paragraph say ``it would be inappropriate to fault Vinson &
    Elkins for accounting matters which are not within its
    expertise; however, Vinson & Elkins should have brought a
    stronger, more objective and more critical voice to the
    disclosure process.''
        What I'm interested to know is did you read their report
    that it was in response to Sherron Watkins' criticism? They
    were asked to come in and write a report and they basically, on
    October 15, said the accounting practices do not warrant
    further investigation, they basically discounted Ms. Watkins
    and you really substantiated Ms. Watkins. So I'm interested in
    how you characterized their report.
        Mr. Powers. Again I have----
        Mr. Shays. I'm nicer this time.
        Mr. Powers. I understand.
        Mr. Shays. Let's put it this way. Did their report agree
    with your findings or did it have 180 degrees diametrically
    opposite view?
        Mr. Powers. It did not agree with our findings, but I would
    like to answer, but realizing I will say at the outset I have
    got Vinson & Elkins as a major supporter. I think Vinson &
    Elkins saw as its role asking Arthur Andersen about this and
    some of the people within Vinson & Elkins.
        Mr. Shays. You can basically answer the question this way
    and I will be satisfied with the answer if I get an answer, and
    that is they did a report. Did your report fly totally in
    disagreement with their finding? Their finding was the
    accounting practice did not warrant further investigation, and
    I think your finding is diametrically opposed to that, isn't
    it?
        Mr. Powers. Yes. But their finding was based on the fact
    that Arthur Andersen in their report told them the accounting
    on these was OK. Now, again, I fully agree that's a defensive
    statement for Vinson & Elkins, and that's the reason I stayed
    out of that part.
        Mr. Shays. I really came back to be nicer to you.
        Mr. Powers. You've been very nice, Congressman.
        Mr. Shays. Thank you for giving me that opportunity.
        Chairman Baker. I think you need a couple more minutes to
    work that out.
        Mr. Powers, if I may, I appreciate your long suffering
    willingness to be here. I just have a few more questions with
    regard to the audit function, and I want to make sure I
    understand before Mr. Berardino's testimony tomorrow. He has
    had a rather direct response to the criticism leveled by your
    report, and I'm trying to get at the essential elements of your
    findings that we should address with Mr. Berardino, because it
    is my belief that had we engaged in an independent audit
    function, everything from the 401K concerns to the function of
    the SPEs to the mismanagement of revenue streams to the effects
    of shareholder equity would, to a great extent, if not
    altogether eliminate it, significantly mitigate it, and my
    interest in going forward is to try to understand the systemic
    failure that occurred with regard to the audit function in this
    case.
        Earlier you indicated that you do not believe that Andersen
    did appear before the audit committee and allege their concerns
    with regard to the structure of the SPEs.
        Mr. Powers. That's correct. That's our understanding.
        Chairman Baker. Was there anything you found in the course
    of your work that was a statement of concern by Andersen with
    regard to any of the financial activities?
        Mr. Powers. Well, I think we did come across a statement of
    concern in a meeting Andersen had among its own people.
        Chairman Baker. And the point of that concern in that
    meeting was what?
        Mr. Powers. Well, my understanding was it was generally a
    concern about the accounting structure of some of some of
    these, and I can't be precise here, but other vehicles at
    Enron.
        Chairman Baker. Is it possible for you to have resources to
    provide us with that portion of your inquiry in reference to
    the meeting of the Andersen officials relating to their
    concerns about whatever the subject was for us for tomorrow
    morning?
        Mr. Powers. Our understanding of that internal meeting is
    only what Congress has already released; so we don't have any--
    we didn't gather any independent information on that.
        Chairman Baker. OK. That information came from an interview
    with someone or did it come from a document? I'm not
    understanding how that conclusion was reached.
        Mr. Powers. Our understanding is it's an e-mail that the
    House Energy Commerce Committee released and it's been
    reported.
        Chairman Baker. So it wasn't really a finding of your
    internal work; it was a matter released in a public forum by
    another congressional committee?
        Mr. Powers. Yes.
        Chairman Baker. What I'm trying to get us on track here is
    anything which your group in the course of your work in the
    preparation of the report we are in receipt, is there anything
    else that you can tell me--document, interview, e-mail--
    anything that will help me better understand the concerns about
    the performance of Andersen in the conduct of their audit work
    for Enron.
        Chairman Baker.--beyond the general statement that they did
    not meet their professional responsibility? I want as much
    detail as you can provide on the failure to meet that
    professional obligation.
        Mr. Powers. OK. Can I take just a--.
        Chairman Baker. Absolutely. We don't have anything against
    consultants.
        Mr. Powers. We would be happy to have our counsel talk to
    your staff after the meeting and give whatever information they
    have from their investigation.
        Chairman Baker. That would be terrific and very helpful.
    Our goal here, I believe, is to establish a system in which
    truly independent audits can be engaged not only to tell
    shareholders, but employees and everyone else who has a stake
    in that corporation's future as best we know it the true
    financial condition at the time of the audit, and it's my
    opinion based upon your statements, your study, and the work of
    others that in this case the independence of the audit is
    called clearly into question and, more importantly, the whole
    environment in which the audit was conducted appears not to
    have been in accordance with traditional standard.
        Now, I'm certainly going to explore that in some
    considerable detail with Mr. Berardino tomorrow, but anything
    that might be provided to the committee before the 10:00 a.m.
    hour would be extraordinarily helpful to us in trying to
    understand our responsibilities.
        Mr. Powers. We'll certainly do our best to help if we can
    find something that would be of assistance.
        Chairman Baker. You're very kind. Let me for the record
    include any official record documents forwarded by Mr. Bachus
    relative to his concerns on the 401K plans. The record will
    remain open for all Members to include any extraneous material
    or questions or statements they wish to pose. Obviously, Mr.
    Powers, as we proceed there may be need to forward additional
    inquiries to you to get your particular perspectives on
    resolution of this matter. Our subcommittee will now recess
    until 10:00 a.m. in the morning at which time we will receive
    testimony from Mr. Berardino, the CEO of Andersen consulting.
    We stand in recess. Thank you, sir.
        Mr. Powers. Thank you.
        [Whereupon, at 8:29 p.m., the hearing was adjourned.]

                      THE ENRON COLLAPSE: IMPLICATIONS TO

                       INVESTORS AND THE CAPITAL MARKETS

                                  ----------

                           TUESDAY, FEBRUARY 5, 2002

                 U.S. House of Representatives,
           Subcommittee on Capital Markets, Insurance,
                  and Government Sponsored Enterprises,
                               Committee on Financial Services,
                                                        Washington, DC.
        The subcommittee met, pursuant to call, at 10:15 a.m., in
    room 2167, Rayburn House Office Building, Hon. Richard H.
    Baker, [chairman of the subcommittee], presiding.
        Present: Chairman Baker; Representatives Ney, Shays, Cox,
    Castle, Royce, Oxley, LaTourette, Shadegg, Weldon, Biggert,
    Toomey, Ferguson, Rogers, Kanjorski, Ackerman, Bentsen,
    Sandlin, Jones of Ohio, Capuano, Sherman, Inslee, Moore,
    Gonzalez, Ford, Lucas of Kentucky, Crowley, Israel, and Ross.
        Also present: Representatives Capito, Tiberi, Jackson-Lee,
    and Sanders.
        Chairman Baker. I would like to call this hearing of the
    Capital Markets Subcommittee to order. This is a continuation
    of the hearing initiated yesterday as the committee makes its
    inquiry into the conduct of the audit community in relation to
    the failure of Enron Corporation.
        Pursuant to agreement reached yesterday at the outset of
    that hearing, we were to extend a 30-minute period for opening
    statements to each side today and to recognize those Members
    who did not have the opportunity to make opening statements on
    yesterday to facilitate every Member possible getting an
    opportunity to make the opening statement.
        In summary of activities to date, the hearing of yesterday
    created some issues of import to our proceedings this morning.
    For those who have not participated in the hearing yesterday,
    we did receive insight from Chairman Harvey Pitt of the
    Securities and Exchange Commission, as well as comment from Mr.
    Powers, responsible as a board of directors member of Enron for
    determining the causal effects of the Enron bankruptcy and the
    subsequent financial catastrophe.
        Mr. Powers' Report, although not based on the full scope of
    information necessary to reach final conclusions, has raised
    some very troubling issues that we hope to address in the
    proceeding this morning.
        With that in mind, I would now recognize first Mr. Castle
    as the appropriate Member who was not able to make a statement
    on yesterday. Mr. Castle, under the rule you will be recognized
    for 2 minutes.
        Mr. Castle. Thank you, Mr. Chairman. As more and more
    troubling facts are revealed about Enron's collapse, there is
    one point in particular that many Americans find most
    disturbing, and that is the ability of a group of inside
    players at the top of a corporate structure to work the entire
    system to their advantage while millions of small investors,
    including the ordinary Enron employees and their life savings,
    were, in effect, trapped in this moving vehicle as it headed
    off the cliff long after the drivers themselves had escaped.
        Investors, be they multi-millionaires or individuals and
    small investors trying to make the most of their life savings,
    need to rely on some sort of an objective review of those who
    have control of their money. They need an independent opinion
    and review of the practices and the legality of those who are
    managing their money. We normally expect the independent
    accountants and auditors to provide this function.
        It is very troubling when it becomes apparent that the
    supposed independent auditors at Enron apparently completely
    failed at their assigned task of independently verifying the
    truthfulness of Enron's financial practices. The auditors are
    in the games of the players, but they have the authority to
    call time out and say, these financial practices do not make
    sense and we are not going to endorse them until they are
    clarified. At the very least, Arthur Andersen did not perform
    this role adequately in the case of Enron.
        The worst case scenario is even grimmer. Independent press
    reports, and now the Powers Report, indicate that there was a
    complete breakdown in appropriate corporate behavior that
    extends to Enron's management, to its board, and to its
    auditor, Arthur Andersen. We are trying to determine if
    Andersen and its experienced accountants were duped by Enron
    who were actively involved in constructing their evasive
    financial practices. Thus far, Enron's explanations have been
    incomplete and unconvincing.
        If a group of auditors have let investors down and have
    helped create uncertainty in the entire financial market about
    corporate accounting standards, we are obligated to try to work
    out new procedures, new rules, and a new framework that will
    help prevent this from happening again.
        We are here to help develop the solution to this
    tremendously serious problem in our financial system. We hope
    there are not other Enrons out there, but it is quite possible
    there are. Arthur Andersen has a long way to go to address
    questions about its role in Enron's collapse and to provide
    meaningful proposals to real change in corporate accounting. I
    hope that process can start today.
        I yield back the balance of my time.
        [The prepared statement of Hon. Michael N. Castle can be
    found on page XX in the appendix.]
        Chairman Baker. Thank you Mr. Castle.
        Mr. Lucas is recognized for 2 minutes.
        Mr. Lucas. Thank you, Mr. Chairman.
        Yesterday, SEC Chairman Pitt outlined the steps the
    Commission plans on taking to improve and modernize the current
    disclosure and regulatory systems and I applaud him for those
    efforts. Also Dean Powers' testimony was very enlightening and
    very troubling. We need only to look at the performance of the
    stock market in recent days to see the effects of the lack of
    confidence in the current situation.
        As we search for solutions to the problems that the Enron
    collapse has exposed, we should not rush to judgment, hoping
    only to assign blame. The SEC and Congress must move
    constructively to restore the integrity of our financial
    markets, the soundness of our financial systems, and the
    public's confidence in our markets. I look forward to today's
    hearings in order that we may better understand the breadth and
    depth of this problem.
        I yield back the balance of my time.
        Chairman Baker. Thank you, Mr. Lucas.
        Chairman Oxley, did you wish to be heard, sir?
        Mr. Oxley. Thank you, Mr. Chairman.
        We welcome Mr. Berardino back to the subcommittee. As the
    Chair knows, Mr. Berardino was our witness back in December,
    and it was the first hearing on the Enron situation and we
    welcome him back.
        There are some issues that were uncovered in the meantime
    that Mr. Berardino will be addressing and some questions from
    the panel, but I do want to say that we have appreciated Mr.
    Berardino's cooperation in this matter; that, while other
    witnesses have been unwilling to comply with our request to
    appear, Mr. Berardino has been very forthright in appearing
    every time the committee has requested him, and for that we
    appreciate it. And this gives us an opportunity to explore some
    of the underlying issues vis-a-vis Enron and the auditor that I
    think will be in order to our benefit.
        And with that, I yield back.
        Chairman Baker. Thank you, Mr. Chairman.
        Mr. Crowley.
        Mr. Crowley. Thank you, Mr. Chairman.
        After the stock market crash of 1929, the Federal
    Government gave the accounting industry the valuable franchise
    of auditing public companies. In this role, the so-called
    independent auditors were supposed to be the independent
    watchdog to make sure that financial book-cooking like we are
    seeing today at Enron did not occur. These outside auditors are
    supposed to represent the true oversight role for investors and
    the American public on the internal controls of a company. They
    ought to be the investing public's first line of defense.
        We can all acknowledge that there will always be some bad
    actors in the corporate world, overtaken by power and greed.
    And while they are the exception and not the rule, from Ivan
    Bosky to what appears now after reading and listening to the
    Powers Report, Andrew Fastow, they are out there. But it is the
    independent auditors that are supposed to catch these criminals
    before they can wreak the kind of havoc that we are seeing
    today.
        In a capitalist society this is generally not a role for
    the Government to play, but I am growing more and more
    concerned about the actual independence of these auditors. In
    fact, I am angered by auditors who feign ignorance or claim
    they too had concerns about the partnerships of Enron, but they
    continually signed off on the Enron books, books which they
    questioned privately.
        America's market system is based on both transparency and
    consumer confidence, and we cannot have one without the other.
    Therefore, it is imperative to have truly independent outside
    auditors reviewing the books of publicly traded companies. When
    these outside auditors fail to perform their duties, they
    should be punished and punished hard as an example.
        I look forward to hearing Mr. Berardino explain his company
    and his industry and hope that, working together with this
    committee, the SEC and business can work to provide a truly
    independent auditor for publicly traded companies and ensure
    that another Enron does not occur again.
        And I'm tired of hearing about, borrowing from a phrase
    from football, ``all the end runs around Enron.'' That has to
    end, from the highest levels of Government to the highest
    levels of corporate government as well. No more end runs around
    Enron. People have to step up to the plate and take
    responsibility where it is due. So I do look forward to your
    testimony today.
        Chairman Baker. Thank you, Mr. Crowley.
        Mr. Ney.
        Mr. Ney. Thank you, Mr. Chairman.
        For 70 years we have operated on the principle investors
    making decisions about securities has been based on an honest
    assessment of the company's financial health. This model has
    given us the finest and best-regulated markets in the world.
    Unfortunately, this model is now broken. Investors do not
    believe that they are receiving honest information about a
    company's fiscal position. Investors certainly weren't given
    the truth in the Enron case.
        This has to be fixed. We have got to restore investor
    confidence, especially during this time in our country's
    history and all the trauma we have gone through as a Nation and
    how important it is for our people and for jobs. The image of
    ourselves being a rubber stamp for companies that are cooking
    the books has to be done away with. You can't allow a system
    that breeds such deep cynicism about corporate reporting to
    remain if we're to have capital markets that invest with
    people's trust.
        This subcommittee, of course, is here to explore the best
    way to put integrity into the accounting profession. And that
    doesn't mean there is not integrity within the profession.
    Obviously something has gone wrong. Ideas have been floated to
    have the Government become an auditor for the auditors or to
    take over all corporate auditing. Others have floated the idea
    of a robust industry self-regulator, which we do have examples
    of that in our country that I think have worked.
        In looking at all these proposals, I think we have to ask
    the simple question: Will it solve the problem? And if we go
    upon that course, I think we'll have a better, stronger
    industry.
        We need to ask our witnesses, of course, to tell us what,
    in fact, they think we need to do to make disclosure
    meaningful. I really don't want to see Congress consider
    legislation just to look like we are doing something, and I
    know this is not the intent of the subcommittee or committee. I
    don't want us to make a commotion just so we can say that
    action is being taken. I do want to be able to go home to the
    constituents and say that we, in fact, fixed the problem, not
    that we did something. I want to make sure that the situation,
    hopefully, never happens again so we can restore the confidence
    of investors in our markets. I look forward to exploring what's
    the best way to restore the integrity of our accounting
    profession and our capital markets in the best way possible.
        Again, I want to thank Chairman Baker and Ranking Member
    Kanjorski and Chairman Oxley for holding this hearing.
        Chairman Baker. Thank you Mr. Ney.
        Mr. Moore, you are recognized for 2 minutes.
        Mr. Moore. Thank you, Mr. Chairman.
        I, too, would like to welcome Mr. Berardino here today, and
    I appreciate the fact that he's here, because other witnesses,
    namely Mr. Lay, have refused to appear. I am going to give my
    opening statement from yesterday so it is not necessarily
    directed at the witness here today.
        The healthy function of our capital markets depends upon
    reliable auditing and accounting information as well as
    accurate financial statements. Investors have to be able to
    trust financial statements of the companies in which they
    decide to place their money. Additionally, investors need to be
    able to trust the financial analysts who recommended investors
    buy the stocks of companies like Enron.
        In the case of Enron, as the stock plummeted from its 52-
    week high, about $90 a share, down to less than $1 a share,
    financial analysts continued to urge a ``buy'' or ``strong
    buy'' for Enron stock.
        There are now two separate actions underway relating to the
    way Enron prevented its employees from making changes to their
    pensions. The Department of Labor has launched an investigation
    and a class action suit has been filed on behalf of Enron
    employees. What I am particularly interested in is the new
    policy that Enron instituted on October 26, 2001, effectively
    freezing any employee 401K transactions. Enron ostensibly
    instituted the freeze due to a change in pension plan
    administrators. Unfortunately for Enron's employees, the freeze
    was in place while Enron's stock plummeted, forcing employees
    to sit by as their retirement savings collapsed.
        Enron's unfortunate timing of an employee lockdown, while
    executives maintained flexibility to cash out, is outrageous
    and potentially illegal and an attempt by Enron to manipulate
    the rapidly declining value of its stocks by preventing a mass
    sell-off of the company's stock.
        I am interested to hear today if the witness has any
    comments to make about $25 million in audit fees paid to his
    firm, as well, as $27 million paid for consulting fees, and
    whether there is any conflict there, apparent or otherwise, and
    I think there needs to be some discussion about that.
        In these difficult times, American workers are having a
    tough time saving their money for retirement and Congress needs
    to do whatever it can do to encourage long-term savings. It is
    now the responsibility of SEC, the accounting industry, and
    Congress to prevent a corporate collapse and to protect the
    American people and investors in this country. Thank you.
        Chairman Baker. Thank you.
        I have identified three additional Members on the Majority
    side, Mr. Rogers, Mrs. Biggert and Mr. Ross. I am just making
    that announcement, because it is my intention to proceed with
    the witness.
        Mr. Rogers you are recognized for 2 minutes.
        Mr. Rogers. I have no statement.
        Chairman Baker. Mrs. Biggert.
        Mrs. Biggert. Thank you, Mr. Chairman, I appreciate the way
    that you have handled the hearing yesterday and I applaud you
    for the way that you are conducting these hearings.
        I look forward to hearing Mr. Berardino's testimony. As he
    said in his written statement, there is some explaining to do,
    and I appreciate his candor. I think his testimony will move us
    forward in our quest to solve the problems and to restore
    confidence in the financial system and basically to ensure that
    another Enron does not happen. So I look forward to hearing
    from the witness.
        Thank you and I yield back.
        Chairman Baker. Thank you, Mrs. Biggert.
        Mr. Ross.
        Mr. Ross. Thank you, Mr. Chairman.
        I appreciate the subcommittee convening this hearing today
    to discuss the important issues that have surfaced as a result
    of the collapse of Enron. Like my colleagues, I am disappointed
    that Mr. Kenneth Lay, the former CEO of Enron, chose not to
    testify before the subcommittee, and I would encourage him to
    come to the Congress and respond to the numerous issues
    surrounding the company's demise and his role as its chief
    executive in the oversight of its business operations.
        However, I am pleased that you have decided to join us
    today, sir, and have come to hopefully begin an honest and open
    dialogue to discuss your area of expertise and how we can keep
    something like this from ever happening again. The fallout of
    Enron has had far-reaching effects.
        There are thousands of people unemployed, and many have
    suffered enormous financial loss. While most people are aware
    of the Enron employees' inability to sell their stocks in the
    company and the subsequent losses in the 401K plans, many are
    not aware of the numerous companies who also invested in Enron
    stock. For example, one small company in my congressional
    district back in south Arkansas lost roughly $276,000, a
    quarter-of-a-million dollars, last year on Enron stock in their
    retirement plan for its employees. We are talking about a plan
    that the total plan is $4.5 million. One-quarter million now
    gone. This was $50,000 they lost from all other stocks combined
    during the recent decline in the stock market. This plan serves
    35 to 40 people. Many of them I know. Many are first-time
    investors. They are moms, they are dads, they're trying to
    raise families and build better lives for themselves, their
    children, their grandchildren. And this has had severe
    implications on their future.
        For a district where the average household income for a
    family of four is $19,000, the need for tools to increase
    financial security is essential. If this company had been aware
    of the information surrounding the bleak financial condition of
    Enron, believe me, they would have had an opportunity to make
    the necessary changes to protect their employees' interest.
        That is why the financial disclosure requirements for
    public companies must--and I stress must--be enhanced to ensure
    the accuracy of the information provided.
        Thank you, Mr. Chairman.
        Chairman Baker. Thank you, Mr. Ross.
        Mr. Ferguson for 2 minutes.
        Mr. Ferguson. I appreciate you holding these important
    hearings. I was extremely disappointed to hear that Mr. Lay was
    not going to testify before this subcommittee today. And as the
    committee has indicated, we sought Mr. Lay's testimony in good
    faith we and were assured it was going to be given.
        I believe that this subcommittee and, more importantly, the
    American people, deserve to know what happened in the Enron
    collapse from the people who are most directly involved.
    Regardless of Mr. Lay's appearance before this subcommittee, we
    will get to the bottom of this situation. We are going to
    continue to ask difficult questions and we expect to get some
    answers.
        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. I am most
    disturbed that the collapse has had a substantial impact on
    thousands of Americans across the country who put their
    retirement and other investments into mutual funds and pension
    funds and other vehicles that invested in the company.
        We have a moral obligation to ensure that safeguards are
    established to prevent a disaster of this magnitude in the
    future. While it is near impossible to create a system that
    prevents all failure, corporate America must be made more
    accountable to the employees and shareholders, which will
    require stricter accounting standards and tougher disclosure
    requirements.
        I thank Chairman Pitt for coming before us yesterday and
    offering his views on the current financial reporting and
    disclosure regime, as well as Mr. Powers for discussing his
    findings of his report, reviewing the facts and circumstances
    related to the collapse of Enron. Mr. Powers made several
    statements of particular significance to today's hearing,
    including the fact that he found failures in the performance of
    Enron's outside advisers and that the tragedy could have and
    should have been avoided.
        I also thank Mr. Berardino for returning before the
    subcommittee to clarify his previous testimony in light of
    information that he did not have at the time. I look forward to
    hearing your testimony on current auditor procedures, but I am
    also particularly interested to hear your thoughts on the
    impact that consulting fees have on influencing audits as well
    as to shed some light on the very serious matter of document
    destruction.
        With that, I yield back, Mr. Chairman.
        Chairman Baker. Thank you sir.
        The last Member I have for recognition is Mr. Shadegg for 2
    minutes.
        Mr. Shadegg. Thank you, Mr. Chairman, I will be brief. I
    want to thank you for holding this, the third in a series of
    hearings on this important issue. I, too, want to thank the
    witnesses who testified yesterday. I thought their testimony
    was very interesting, and Mr. Powers' Report was enlightening
    and helpful.
        These hearings are extremely important to the future of
    this country. We must ensure the integrity of our financial
    markets. If we do not do so, then the economy we currently
    enjoy and the lifestyle we have will disappear. It is
    absolutely essential we discover the causes for what happened.
        In going through these hearings Mr. Chairman, it occurs to
    me that one definition of insanity is to do the same thing over
    and over again and expect a different result. One thing we
    cannot do in these hearings is decide that we need just one
    more oversight body or just one more law or one more
    regulation. We have to find exactly what was the cause here and
    get to the bottom of it and try to find a solution which will
    result in the prevention of this kind of a collapse ever
    occurring again, and ensure that Americans and people
    throughout the world can have faith in our markets without
    relying on a regulatory system which will just let us or could
    just let us down again.
        I notice that in a discussion on one of the morning shows
    this morning, the comments focused on the fact that the market
    was down yesterday and that that is as a result of some people
    looking at the Enron collapse and worrying about whether or not
    a similar type of accounting nightmare could exist in a company
    which is still in the market today. And they commented that it
    is the market itself that can correct these kinds of problems.
    That is true, but we have an obligation to ensure that the
    institutions that are supposed to be doing their jobs, that the
    SEC, FASB and the others are doing their jobs. I commented
    yesterday in my questioning about how I have a difficult time
    understanding off-balance-sheet entities as a mechanism for
    disguising debt.
        It seems to me--and I quip that my wife and I would like to
    buy a new home and would like to figure out a way to create in
    our own personal balance sheet an off-balance-sheet entity
    where we could put some of our debt and to be able to qualify
    for a more expensive home.
        It seems to me we have to get to the root cause of this
    problem. It seems to me that there was clearly fraud that went
    on. It seems to me that it is impossible to believe these board
    of director members didn't know and others didn't know what was
    going on. So we have to try to get to the bottom of these
    issues. We have to ensure that we have done everything we can.
        We know at the end of the day the market will do what it
    can to correct, but we also know that it is ultimately the
    individual integrity of the people involved, the members of the
    board of directors, the officers, and the accountants that we
    must rely on for the integrity of the entire system.
        And with that, I yield back.
        Chairman Baker. Thank you, Mr. Shadegg.
        Ms. Jones.
        Mrs. Jones. Thank you, Mr. Chairman.
        Yesterday and today, we have the distinct opportunity as
    Members of this Capital Markets Subcommittee to bring to the
    attention of the public some of the details of what has
    occurred with regard to Enron. As we go through this process,
    it is my hope that we can open some of the doors that have been
    closed to us so we have a better understanding of a process
    that's involved when a company like Enron can go 15 years, from
    nowhere to the seventh largest in our country.
        In Ohio alone, the State's two pension funds for Government
    employees lost $114 million on Enron stock. Interestingly
    enough, fund managers were increasing the weight of Enron
    stock, even when the stock was plummeting, on the belief of
    Enron's long-term potential. Even pension officials felt that
    Enron financials were good enough to invest in.
        Ohio's loss is not alone. Other State pension and/or
    retirement plans were impacted as well. The Florida State Board
    of Administration lost $335 million. The California Pension
    Fund lost $49; Alabama, $47; Texas, $24; Missouri, $23 million;
    and New York City's fund for firefighters, police officers,
    teachers, and other workers lost $109 million. These losses,
    coupled by bank exposure estimated around $4.6 billion, will
    ultimately impact consumers by increased fees and possibly less
    money to lend.
        Never in my years has one such issue or scandal, depending
    on how you look at Enron, had so many tangled webs, from
    extensive political influence that had the White House helping
    setting energy policy, conflicting interactions with Arthur
    Andersen, and on and on and on.
        I have more statement. I will put it into the record, Mr.
    Chairman. I am just hopeful that as the people appear before
    our committee this morning, we can get to some facts. As a
    former prosecutor and judge, we can always wade around an
    issue, but fact is the most important thing we can get for the
    public so they can have a full understanding of what happened
    in this instance, so they can begin to educate themselves and
    never put themselves in a position that these Enron employees
    have been in, and so that we can put ourselves in a position to
    pass legislation that would never allow employees such as these
    Enron employees to not be able to access their funds while the
    money managers were going on down the road with the rest of the
    dollars.
        I appreciate the opportunity to be heard, Mr. Chairman and
    yield any time I have left.
        Chairman Baker. Thank you.
        Mr. Ford, you are recognized for 2 minutes.
        Mr. Ford. Thank you. I won't take all that time, Mr.
    Chairman.
        It is good to see that one of our invited guests made it
    today. Pleasure to see you. I look forward to hearing your
    testimony. But one of the things I hope that we are able to get
    to and one of the things I want to address in my questions as
    the hearing proceeds, Mr. Chairman--I am from Memphis, it's
    hard for me to pronounce these big East Coast last names--but
    Mr. Berardino, is that the correct way? Penn taught me well.
        But I am curious about the destruction of some of the
    documents. And one of the things I hope to sort of speak to,
    and I know some of the steps the company has taken, and we
    applaud the effort to bring on Chairman Volcker, but at the
    same time, I hope that we can get some commitment from you,
    perhaps today or in the very near future, from the company
    regarding mandatory document retention. And perhaps your
    company can take the lead in providing a template for the
    industry to follow.
        I see my good friend, Goody Marshall, in the audience as
    well. Always a pleasure to see you. With that, look forward to
    your comments and I thank you for being here this morning.
        Chairman Baker. Thank you, Mr. Ford.
        That concludes all Member opening statements.
        Mr. Israel, did you wish to be recognized?
        Mr. Israel. I do, Mr. Chairman. Thank you.
        I think it is sadly ironic that Mr. Lay has gone through a
    revolving door at the White House and suddenly he's grown shy
    about coming to Washington, but I do appreciate Mr. Berardino
    visiting with us today.
        I think the real scandal here lies not simply in the
    potential illegalities of this case, but in the fact that so
    much of what was done was legal, offshore special purpose
    entities, fuzzy accounting, lazy and conflicting analysis, lax
    oversight, conflicts of interest.
        Our financial system depends on a series of checks and
    balances to ensure market confidence, and every single step in
    this system, save the short sellers, failed catastrophically.
    This is nothing short of the worst indictment of our entire
    system in years.
        Our job is to work together on a bipartisan basis. Marginal
    solutions are not going to cut it. We need to go back to the
    drawing board and start over. What do we want our regulatory
    system to achieve, what are the best structures to get us
    there, and how do we balance investor protection with clear
    regulation?
        I look forward to working with the Chairman and all of my
    colleagues to restore confidence to our accounting system and
    to our financial entities. I thank the Chairman and yield back.
        Chairman Baker. Thank you, Mr. Israel.
        I do believe now that concludes all Members' opening
    statements. Any Member who wishes to introduce any written
    statement for the record certainly will have that opportunity.
        Mr. Berardino, it's my pleasure to welcome you back. I want
    to say for the public record that this is not your first
    voluntary appearance. It is your second. You were among the
    first to appear before this committee in mid-December and
    present your views of where the Enron matter stood as it
    relates to Andersen. And we appreciate the fact that you have
    made every effort to provide the committee with your
    perspectives in regard to this matter.
        I have been directed by the committee in this proceeding
    with regard to all witnesses before the committee in relation
    to our work in the resolution of the Enron matter to swear
    witnesses in. Do you have any objection to testifying under
    oath?
        Mr. Berardino. No, I do not.
        Chairman Baker. In that light, do you desire to be advised
    by counsel during your testimony today?
        Mr. Berardino. Yes, sir.
        Chairman Baker. In that case, would you please instruct
    your counsel to come to the table and assist you? And I need to
    ask him or her a question as well.
        Mr. Berardino. I am not sure that's necessary, Mr.
    Chairman. And I have my counsel with me and if I need to refer
    to him, I will.
        Chairman Baker. This creates a slight technical thing. We
    need to consult. I am advised that if your counsel wishes to
    give testimony, we would be obligated to swear him in as well
    in conformity with the committee rule. If it is advisory only
    and he will not be making statements for his own perspectives,
    it's my understanding that we would be in conformity with the
    subcommittee direction to only require you to take that oath.
        If that is acceptable to the Members of the subcommittee, I
    shall proceed then to administer the oath. Would you please
    rise and raise your right hand?
        [Witness sworn.]
        Chairman Baker. You are now under oath. Thank you very
    much, sir. Your statement, of course, has been made part of the
    official record. You may summarize it or deliver it as you
    choose.

    TESTIMONY OF JOSEPH BERARDINO, CHIEF EXECUTIVE OFFICER, ARTHUR
                              ANDERSEN LLP

        Mr. Berardino. Chairman Oxley, Congressman LaFalce,
    Chairman Baker, Congressman Kanjorski and Members of the
    committee. Andersen and this committee share common goals to
    get to the truth about what happened at Enron and to help
    develop policies that will improve our capital markets, enhance
    audit quality and better protect the investing public. That is
    why I am back before you today for the second time in less than
    2 months.
        At the outset, let me make a few important observations. It
    is abundantly clear that something very tragic and disturbing
    happened at Enron. All that is involved, in my opinion, has to
    do with three things. First, we must face up to our
    responsibilities. That is what my being here is all about.
        Second, we need to get to the bottom of what happened. We
    know more than we did a couple of months ago and we have
    learned some unpleasant things which we have been
    straightforward in bringing to the public's attention. Our
    investigation is continuing and we will take actions when
    appropriate.
        Third, and this is the main reason I am here today, we need
    to think honestly about changes that need to be made. When I
    last appeared before this committee, I pledged to do just that,
    and I am also here to report to you that Andersen has already
    taken the first steps toward fundamental changes in our audit
    practice here in the United States.
        First, former Federal Reserve Board Chairman Paul Volcker
    has agreed to chair an Independent Oversight Board to work with
    us in the U.S. Mr. Volcker and the board will have free access
    to all information relevant to a full review of the policies
    and procedures of our firm to assure the quality and
    credibility of our firm's auditing process. The board will have
    full authority to mandate changes and such practices. As this
    committee well knows, Mr. Volcker is a man of unquestionable
    integrity. He is one of the most independent thinkers in
    America's finance. Paul Volcker calls it as he sees it and the
    investing public will be well served by his involvement.
        Second, we have taken some immediate steps to address
    concerns about potential conflicts of interest. Andersen will
    no longer accept assignments from publicly traded U.S. audit
    clients for the design and implementation of financial
    information systems. And we will no longer accept engagements
    to provide internal audit outsourcing to publicly traded U.S.
    audit clients.
        Third, Andersen will work with each publicly traded U.S.
    audit client's management and audit committee to establish a
    formal process for determining the company's acceptable scope
    and level of fees for those non-audit services that we continue
    to provide.
        Fourth, Andersen will create a new independent Office of
    Ethics and Compliance to investigate on a confidential basis
    any concerns of Arthur Andersen partners, employees, or
    individuals from outside the firm relating to issues of audit
    or auditor quality, integrity, independence and compliance.
        And fifth, Andersen will establish a new Office of Audit
    Quality comprised of senior partners with the sole mission of
    deriving audit quality.
        These are just the first steps, and I want to stress that,
    first steps in a process that will fundamentally change our
    U.S. audit practice. We look forward to working with Mr.
    Volcker and the Independent Oversight Board as we implement
    these and other changes. However, the forms we are willing to
    implement cannot be the end of the matter within our firm and
    beyond. With the accounting profession in crisis, we all need
    to do something more fundamental.
        Let me offer some observations about some of the areas that
    could benefit from change. Many participants in the financial
    reporting system, including auditors, rating agencies,
    analysts, investment bankers, and other financial institutions
    have a great deal of crucial information about public
    companies, information that can tell us a lot about their
    likely future performance. We now have a system which auditors,
    among others, have what must be considered a very inefficient
    and ineffective conversation with company boards, management
    and shareholders. We need to take a fresh look at how auditors
    communicate the work they perform and the conclusions they
    reach.
        Today the auditor can issue a standard unqualified opinion
    or they can disclaim an opinion if so desired. Financial
    statements prepared by management that satisfy generally
    accepted accounting principles get a pass. Financial statements
    prepared by management that comply with GAAP but push the edge
    of the accounting envelope, and that may pose significant risk
    to the company and its shareholders, will get the same
    unqualified opinion as those representing more prudent
    accounting decisions and disclosures.
        Now, I think we need to keep this in context. Many, many,
    many companies get it right, but there are some pushing the
    envelope, and the investing public does not know which one is
    which. So this system is bad for everyone and for investors
    most of all, and they don't get all the information they need
    or would like to make informed decisions. There is a
    significant danger that they may be led astray by this pass-
    fail grade in our product called the auditor's report.
        Therefore, I would suggest we consider replacing the
    current standard auditor's report with a report that grades the
    quality of the company's accounting practices and business
    risks. This change will give investors important guidance on
    how to assess the company's financial statements, the
    information contained in those statements and related financial
    risks, but it also gives the company an incentive to have
    higher disclosure practices and more prudent accounting.
        But there's much more we need to do. We also need to move
    to a more dynamic and richer financial reporting model. We need
    to provide several streams of relevant information, many of
    which are discussed in some detail in my written testimony. And
    we need to simplify accounting principles. We need reports, in
    plain English.
        We need to further strengthen the role of the audit
    committees by encouraging them to engage manager and auditor to
    ensure that risk is managed and that crucial information is
    communicated to shareholders in an intelligible way. We also
    need to give serious thought to making it a felony to lie or
    withhold information to mislead investors and auditors.
        Let me also say a word about the Enron Special
    Investigation Committee Report that was released on February 2.
    As you well know, that document is more than 200 pages long,
    took more than 3 months to produce, and was released just this
    Saturday night. We have experts in my firm that are now
    analyzing and investigating these findings. The report
    acknowledges the time and resource restrictions that limited
    the scope of the review. It notes a lack of access to people
    and documents that the committee admits may have information
    relevant to their conclusions.
        The committee did not speak to people at Andersen. When the
    committee was formed we offered to assist it, but the company's
    lawyers indicated that they were not ready to discuss anything
    with us. We did provide the committee with our work papers when
    requested. The committee asked to speak with some of our
    people, and we were in the process of working out interviews
    when Enron fired us. We never heard from the committee again.
        I would note that the report cites numerous instances of
    possible additional secret arrangements among the company or
    related party special purpose entities. The report says there
    were indications of hidden inside agreements of non-documented
    transactions between Enron and these SPEs. We need to
    investigate the accuracy of these alleged matters. If people
    withheld information from us, they were withholding it from
    investors, and that can't be tolerated.
        Before concluding, I would like to thank Chairman Oxley for
    the opportunity to clarify my December testimony, which I did
    in a letter submitted to the committee on January 21 and in my
    written statement today. I appreciate the open and forthright
    manner in which Chairman Oxley handled this matter.
        Mr. Chairman, we have an opportunity to make some good from
    what happened here. This is a tragedy on many levels. I am here
    because I want to be part of the solution. At Andersen, we are
    determined to convert our current challenge into an
    opportunity, as difficult as that may be; an opportunity to
    reaffirm the principles that drive our 28,000 people here in
    the United States and 85,000 people around the world in our
    desire to serve our clients and the public that relies on our
    work with candor and integrity. The steps I have outlined today
    start the process. We will work with you in the days and weeks
    ahead to continue it.
        Thank you.
        [The prepared statement of Joseph F. Berardino can be found
    on page XX in the appendix.]
        Chairman Baker. Thank you Mr. Berardino.
        I want to ask the committee's indulgence. I have a series
    of questions I would like to pose to Mr. Berardino that may
    take me a little over the normal 5-minute customary rule, but
    if the committee will provide me with this opportunity, I think
    it extremely important given the fact the committee has under
    consideration legislation to address the concerns that you have
    identified and to adopt some of the recommendations perhaps
    that you have outlined this morning.
        Let me start with the first and most obvious question.
    Without regard to any specific accountant or any particular
    event, in general, what would be Andersen's code of ethical
    conduct requirement for any auditor that finds an activity that
    diminishes shareholder value that is GAAP compliant?
        Mr. Berardino. Mr. Chairman, we have an obligation to speak
    to the shareholders through the audit committee. There are
    professional standards that say when we see accounting that is
    on the edge, major subjective decisions that go in or commonly
    go into preparing the financial statements, we communicate the
    risk, the decision is made by management, and our concurrence
    or disagreement as appropriate, to the audit committee.
        Chairman Baker. In the scope of Andersen's relationship
    with Enron, which was over some multiple years, again not with
    regard to specific meeting, specific transaction, or a specific
    report, to your knowledge in the last 24 months, has management
    of Enron met with the audit team prior to its final report
    being posed to the board or to the audit committee and
    resultingly changed the findings of the audit or modified the
    form in which the audit was to be prepared?
        Mr. Berardino. Mr. Chairman, I frankly can't answer that
    question with authority, because obviously I wasn't there doing
    the work, and if not----
        Chairman Baker. Let me ask you differently. Without regard
    to Enron, as a matter of common practice, does the Andersen
    team, when conducting a corporate audit, meet first and
    primarily with the audit committee prior to the release,
    publication, finalization of the report; and is it customary to
    meet with management prior to having that report approved by
    the audit committee?
        Mr. Berardino. Absolutely. Yes, sir.
        Chairman Baker. So you do meet with management.
        Mr. Berardino. Yes. And the audit committee.
        Chairman Baker. Is it customary to meet with management
    first?
        Mr. Berardino. Obviously we are meeting with management all
    the time as we conduct our work.
        Chairman Baker. And that is my point. Is it common practice
    for management to object to a particular method by which a
    transaction is evaluated or to make recommendations as to the
    manner in which it is reported? For example, as opposed to
    having it in the statement, having it in the footnotes; is that
    a common practice?
        Mr. Berardino. As I am sure you can appreciate, the audit
    is an interim process. We are looking for the facts. We are
    looking to understand management's judgment. Management will
    give us their view. We will challenge their views and we will
    come to a conclusion.
        Chairman Baker. So it would be your opinion, from
    professional conduct of Andersen's general accounting process,
    that even were you to meet with management, were you to make
    changes in the reporting of the financial statement, whether it
    be to put a matter into the footnotes or to reconstruct the
    manner in which a transaction were to be reported, that you
    believe that the audit team can reach a professional conclusion
    in that environment and not have your financial report be
    distorted in any manner that would not reflect the accurate
    financial condition to the shareholder?
        Mr. Berardino. Mr. Chairman this is a very fundamental and
    important question. The financial statements are management's
    and the company's. The only thing we put in that report is our
    auditor's report.
        Chairman Baker. Let me interrupt. It is my view, business
    class 101, that the board establishes an audit committee. The
    audit committee retains the auditor. They do so so an audit can
    be made for the shareholder interest to state publicly the
    value of that shareholder's interest in that publicly traded
    corporation. Management is to run the company. They are not to
    run the audit. Do you dispute that point?
        Mr. Berardino. Not at all.
        Chairman Baker. Then it would be your conclusion, then,
    given the fact that the audit team in Andersen's work, Enron or
    not, conducts its activities independent of interference by
    management to give the true and accurate picture to the
    shareholder?
        Mr. Berardino. That is true, Mr. Chairman. But the point I
    would like to emphasize is that at the end of the day, these
    are the company's financial statements. And this is where we
    get into the issue of companies that report just barely in
    accordance with the rules and those that are more forthcoming.
    We cannot make a company report any more than what the rules
    require.
        Chairman Baker. I understand.
        Mr. Berardino. That's a challenge we need to look at.
        Chairman Baker. And from that, conclude as to the true
    financial condition. And I was trying to help you in saying
    that in all cases, you feel your audit team has taken the
    managerial information and provided an accurate picture to the
    shareholder based upon your findings at the time the financial
    statement was prepared.
        Mr. Berardino. Yes, Mr. Chairman.
        Chairman Baker. In that light--and this is an example of
    what is a very complicated subject. I will move through it
    rather quickly, because I believe you to be familiar with it.
    Enron and CalPers were partners in Jedi. CalPers wanted to
    extricate itself from Jedi. Its stake was worth approximately
    $383 million. Fastow and Kopper formed Chewco to buy out the
    CalPers interest to facilitate their release from that prior
    arrangement. Enron, I am told, arranged for Jedi to loan $132
    million to Chewco, a related party. Fastow and Kopper then
    arranged for Barclays to loan Chewco $240 million and Enron
    guaranteed it on the back side. In order to meet the 3 percent
    minimum investor criteria, the investor had to provide $11.5
    million of equity. Barclays then helped provide the credit to
    facilitate that investor equity position, which later--we are
    skipping a bunch--is now disputed by Barclays as to whether it
    was ever an equity position and may have, in fact, been a loan
    in its entirety.
        Without regard to the specifics or the facts that I have
    just made, was there any indication determined by the audit
    team in the course of their normal audit function that would
    have led any reasonable accountant to look at the transactions
    on the corporate books and conclude it was not what management
    represented to you?
        Mr. Berardino. Well, Mr. Chairman, this is part of the fact
    pattern we need to undertake. I don't know with authority what
    we knew and when we knew it. What we have testified to is that
    information had been withheld from us in that transaction, and
    when it was forthcoming we and the company restated those
    financial statements.
        Chairman Baker. It also is important to note that the sale
    of assets to an SPE, which Enron extended the credit for the
    purchase to be consummated, was then booked as earned income on
    the corporate revenue side.
        My point of these facts, only one limited instance and not
    to take undue subcommittee time, there are many. I am now told
    that the number of SPEs could well exceed 400, of which 30 or
    so are questionable in their construct and operation. I am very
    troubled by the fact that all of these activities require a
    check, the movement of stock, board approval, physical evidence
    of a relationship with a party which is not in the shareholder
    interest, either by failure to make appropriate disclosure or
    by engaging in activity and having the disclosure so convoluted
    a reasonable man could not make a determination as to the
    professional relationship that was being established.
        What can you tell me today, without regard to a specific
    event or activity, with regard to your perspective and
    Andersen's role in getting it right, not with regard to one
    particular quarterly report or one particular financial
    statement, can you now acknowledge in retrospect that the true
    financial condition of Enron was not accurately reported in the
    financial statements prepared by Andersen at the time of their
    preparation?
        Mr. Berardino. Mr. Chairman, in hindsight we could look at
    what happened and I really regret to tell you I can't answer
    your question with authority, because there are several
    unanswered questions: What did people know, when did they know
    it? And as I testified last time, everyone's talked about the
    off-balance-sheet liabilities, but Enron had to move assets off
    the books with those liabilities. And one of the big questions
    I have--and I don't have an answer to--is when did those assets
    go bad and when did people know they went bad?
        Chairman Baker. Even more simple. From the events as now
    determined, in 1999, February, you were the auditor at the time
    of the proposed merger. Published reports which I have read in
    great detail indicate that VEBA's due diligence, using another
    audit firm, determined that 75 percent of equity was impaired
    by off-balance-sheet debts, led to their determination not to
    proceed with the merger.
        If you were the auditor at the time that merger failed,
    described in press reports as a merger of equals and giants, an
    enormously important financial transaction to every
    shareholder, every partner, every consultant, every auditor and
    it failed, how is it possible for Andersen not to have known in
    1999 as a result of such a public meltdown on a proposed
    merger, based on the fact that the accounting practices of
    Enron were being questioned, led to the failure of that merger?
    What's the explanation? How could you not know?
        Mr. Berardino. Mr. Chairman, I wish I could be more
    helpful. I did not do the audit on this company. There were
    many people involved who had intimate knowledge at the time. I
    am not one of them.
        Chairman Baker. I don't want to go to the specifics and I
    don't want to ask who the auditor was or ask what the auditor
    found. My point is I am reading newspaper articles, now 3 years
    old, saying that the failure of the merger was questionable
    accounting practices and off-balance-sheet debt to excess. If I
    were a member of the board, if I were a shareholder, and
    certainly if I were the auditor, I would want to have a
    reasonable explanation on the public record why VEBA's auditors
    were wrong, or I take the matter up with someone.
        I have greatly exhausted my time on the subcommittee, and I
    want to come back if you have time and talk about the solution
    side. But these are very deeply troubling matters.
        Mr. Kanjorski.
        Mr. Kanjorski. Give me an opportunity, Mr. Chairman, to
    raise another issue. Mr. LaFalce, unfortunately, has a personal
    family situation that he has to tend to, and would have liked
    to have been here. But, I will certainly take his time.
        Yesterday, Dean Powers testified before the committee. His
    report concluded, in many instances, that the hedges or the
    derivatives that were established with these special purpose
    entities had nothing to do with setting off the economic risks,
    the normal expected purpose of a special purpose entity. In
    fact, they were a vehicle to take debt off the balance sheet
    and falsely inflate earnings and profits. You have had a chance
    now to examine some of these transactions and these sheets. Is
    his analysis correct or incorrect?
        Mr. Berardino. Congressman, I will answer you specifically,
    but I just want to remind the subcommittee that this report was
    issued just Saturday. It's 200 pages long. We were not
    consulted, had not seen a draft, and there are a lot of
    questions and conclusions that were conjecture, ``appears,''
    ``seems like,'' and so forth.
        But, I want to respond specifically to the issue of SPEs
    and lack of economic vitality, and I'll suggest what I did last
    time, which is that the rules for SPEs were not economically
    driven. Our firm disagreed with those rules because they were
    not economically driven. They were accounting conventions to
    move assets and liabilities off the books.
        The reason we disagreed is you have a 3 percent new money
    coming into these SPEs and the sponsor has 97 percent of the
    risk and awards. We never thought that made any sense. We lost
    that debate in our profession, and the rules, in fact, are
    accounting rules that don't reflect economics.
        Mr. Kanjorski. You blame it on FASB or someone else.
    Somebody has got to stand up here, Mr. Berardino, and say ``we
    allowed this to happen. We participated in misrepresentations
    to investors, shareholders, pensioners, and 401K investors.''
    Somebody has got to stand up. To say, ``well, we just have not
    examined the report, we just do not quite know yet,'' is not
    acceptable.
        It is a simple question. You have examined these
    transactions. Were there any economic risks involved that are
    the normal intention of hedges, or were these transactions
    vehicles to deflate debt and falsely inflate earnings and
    profits? That is a pretty simple question.
        Mr. Berardino. With respect, Congressman, the rules are
    accounting rules, not economic rules. Number two is we are
    finding out things that we didn't know. Why did we not know
    them?
        Mr. Kanjorski. I do not know why you did not know of these
    things. Obviously, you are not the man to testify. As a matter
    of fact, I would make the recommendation to the Chairman we
    start subpoenaing some of the responsible people that did these
    things. But, I do know your company helped set up these
    transactions. You are not some innocent. Coming in here as an
    auditor and having all these transactions that are out there,
    you are not just looking at them. You went through the
    intellectual analysis of how to structure these things.
        When we heard Dean Powers talk about moving $800 million of
    Enron stock over to one of these transactions in which Enron
    was hedging itself, it seemed clear to me his interpretation
    was correct. What strikes me is why it was not clear to a
    trained auditor or accountant. Those hedges were not worth
    anything. There was no recovery. There was no setting-off risk.
    It was strictly a chance to take debt off the balance sheet and
    inflate earnings and profit. It accomplished nothing. If the
    Enron stock went down in any respect, it was a sure loss for
    everybody except the insiders who got their fees up front and
    got their profits. Is that not a reality?
        Mr. Berardino. Congressman, I don't know, because I don't
    have all the facts.
        Mr. Kanjorski. Well, did your company see these things and
    go to the board with them or to the shareholders meetings? Did
    your company do something?
        Mr. Berardino. Congressman, there were many meetings with
    management.
        Mr. Kanjorski. Management, look, we cannot put a lot of
    faith in what we heard about these managers getting $30 million
    incomes for setting up these transactions.
        I understand that you are not in a position to prevent
    greed. But one of our colleagues here, Mr. Shadegg, proposed
    the idea that the purpose of this subcommittee and what the
    Congress' responsibility is, is to see that this situation
    never happens again. We must take positions or pass
    legislation.
        I am just a small-town lawyer, and I am not sophisticated
    with hedges and derivatives, but having listened to Dean Powers
    yesterday I know these instruments are good in the system if
    they are properly used. It seems to me that everything that
    Dean Powers testified to yesterday highlighted in capital
    letters: GREED, absolutely unfettered greed. It is clear to me
    that the public and the shareholders have a right to assume
    that professionals, whether they be in the accounting
    profession or the legal profession or other outside
    professionals, have a responsibility to use their best
    judgment. Are their senses as strong as ours?
        What I am worried about is Mr. Shadegg's intention that we
    cure this problem. I do not know that we can ever develop a
    drug to cure greed, but we can shine light on greed. But, that
    is not good enough, because, after the fact, people have
    already lost. I mean, we are deluding these 401K investors into
    believing that they are going to get everything back. We are
    deluding the pensioners, the shareholders, the people that
    offered credit to this company that they are ever going to get
    anything back.
        But what are we going to do? We are not going to cure
    greed. We are not going to have a drug for it. I have given up
    on that. It is starting to get to the point of ugliness now,
    but we can do something with the accounting profession.
    Something is going to be done with the accounting profession.
        Mr. Berardino, I know you are just a CEO of that huge
    company, but you have got to help us. You have got to identify
    who the people were who put these sham transactions together to
    hide a debt and to expand the appearance of earnings when they
    were not there. You have got to work with us on this problem.
    Identify these people, so we can have them up here and put the
    light on them. We have got to go through their mental processes
    of why this was done and did they understand, for those lousy
    $10 or $30 million in rip-offs by inside people in this
    company, people have paid with their life earnings and
    shareholders have lost billions of dollars?
        That is an economic tragedy that we can survive from. I
    think yesterday's market and the news media is really testing
    the fabric of the strength of the economic system of this
    country, because of activities, that your accounting firm
    either failed by negligence or were culpably a part of the
    inside transactions, that went on to send this company into
    bankruptcy and to shake the trust of the American people, and
    maybe the world, in our financial institutions. Something has
    to be done. I urge you, Mr. Berardino, to cooperate with the
    Chairman and this committee in giving us the proper people who
    we can put the light on to find out what was done, when it was
    done, why it was done and how we can hope to prevent it from
    being done again in the future.
        Mr. Berardino. Congressman, I'm up to that challenge. I'm
    here for the second time, as you well know. We will work with
    this committee in any way humanly possible to achieve that end.
        Chairman Baker. Thank you, Mr. Berardino. The gentleman's
    time has expired.
        Mr. Oxley.
        Mr. Oxley. Thank you, Mr. Chairman and Mr. Berardino.
        First of all, before I ask questions, the comment you made
    regarding the 3 percent rule and the consolidating of financial
    statements, it's interesting back in 1996 Andersen was the only
    company among the accounting firms that actually opposed that
    rule, and your comments were absolutely correct.
        Mr. Chairman, I would like to make a copy of that available
    for the record.
        Chairman Baker. Without objection.
        [The information can be found on page XX in the appendix.]
        Mr. Oxley. Thank you.
        Mr. Berardino, the Powers Report notes that the disclosures
    regarding Enron's transaction with LJM and other partnerships
    were: ``Obtuse, did not communicate the essence of the
    transactions, failed to convey the substance of what was going
    on, sought to disguise their import of these transactions and
    sought to avoid disclosing Fastow's''--who was the CFO--
    ``financial interest.'' The Powers Report states that this
    misleading disclosure reflects an absence of forceful and
    effective oversight by, among others, auditors at Andersen.
        How do you respond to this very disturbing criticism, and
    what steps is Andersen taking to remedy the situation?
        Specifically, I asked Dean Powers, based on that statement,
    that indeed it appeared that Andersen was complicit in
    arranging these special purpose entities and indeed, as I
    indicated and characterized it, was involved with baking the
    cake. If that is indeed accurate, what steps immediately can
    Andersen take to avoid that in the future?
        Mr. Berardino. First of all, thank you for that
    clarification; and I find myself in the awkward position of
    defending something we disagreed with. But to specifically
    respond on the disclosures for Enron, let me just suggest that
    there are no requirements to disclose SPEs unless it is
    probable that these debts will come back on the books. So
    there's a judgment call that the manager makes and the auditors
    make as to the likelihood, probability, or remoteness of these
    transactions coming back on the books.
        That's why I keep saying, at the important time the assets
    that went with these liabilities were increasing in value--and
    then we all know what happened. They decreased, and they
    decreased very rapidly. When that happened, when it was
    probable, whether there were side agreements we weren't aware
    of, these are all questions we still have, and it will be
    relevant to understand what happened.
        Mr. Oxley. Is the assumption, then, always that the assets
    will continue to increase and hold value? Is that the
    assumption that the accountants use in this process?
        Mr. Berardino. The assumption is that the assets will hold
    their value and will support the liabilities that are off the
    books with it.
        Mr. Oxley. And that is a hard-and-fast rule, that assets
    never depreciate in value?
        Mr. Berardino. No. In order to, in the first instance, set
    up the transaction, you need to move enough assets off the
    books to satisfy the liabilities, and you need to monitor on an
    ongoing basis--the company needs to monitor whether or not
    these assets can still satisfy the liabilities at such a point
    that they can't then----
        Mr. Oxley. What is the auditor's role in that?
        Mr. Berardino. To monitor the management's judgment as to
    whether those assets have maintained their value.
        I would also like to correct the record in one respect,
    because people keep saying things like we set these things up.
    Our firm where--the accountants and the accounting advisors'
    management, in conjunction with their investment bankers,
    lawyers and others, would present us a transaction and would
    ask the obvious question, does this pass the rules? And we
    would give our judgment as to whether it would pass the rules,
    and at the end of the day those judgments were rendered.
        Mr. Oxley. Mr. Berardino, that was not the testimony by
    Dean Powers. Dean Powers made it very clear that Andersen's
    accountants were very much involved in crafting these special
    purpose entities, that they were not just checking the box, but
    were, in fact, trying to find ways to make it work.
        Mr. Berardino. Mr. Chairman, there's room for both of us to
    be accurate in portraying what happened. This isn't an indurate
    process. The company is, with their bankers and lawyers,
    designing transactions that are accounting transactions, and
    they ask our advice. So we'll say, yes, this works or, no, this
    doesn't work, that kind of conversation.
        Mr. Oxley. Isn't it a fact that Andersen received $5.7
    million for that advice?
        Mr. Berardino. That is true. I would just amplify and say
    that was over a 5-year period for scores of transactions, and
    again that was what you would expect the accounting firm to be
    doing, is looking at these transactions and giving advice as to
    whether or not they pass the rules or not.
        Mr. Oxley. Is there some evidence from your perspective or
    from what the Dean told us yesterday that there was active
    participation in the crafting of these off-the-books entities,
    that Andersen did play a role in setting these up? That is
    true, is it not?
        Mr. Berardino. We were aware of the transactions.
        Mr. Oxley. You were more than aware.
        Mr. Berardino. We gave judgments.
        Mr. Oxley. Dean Powers was pretty clear in saying that it
    was pretty clear that Andersen's people were involved in the
    get-go in creating these off-the-books entities. Is Andersen
    denying that they were involved in the take-off of these?
        Mr. Berardino. Mr. Chairman, I think we may be talking past
    each other in terms of what involved and what setting up all
    means. This committee did not talk to us, did not get our
    perspective on what our involvement was. I wasn't there. I
    can't tell you how active and what the nature of our people's
    judgments were. Suffice it to say, we were very much involved
    as the company setting up these transactions and giving advice
    on whether they would pass the rules. I'm not sure I'm being
    inconsistent with the----
        Chairman Baker. Would you yield, Mr. Chairman?
        Mr. Oxley. I'll be glad to yield.
        Chairman Baker. I just wanted to suggest that it's
    apparent, as Mr. Kanjorski suggested, that there may be others
    more appropriate to respond to some of these questions; and we
    need to visit about the time and venue in which we might have
    some of those individuals available.
        Mr. Oxley. Precisely. Thank you, Mr. Chairman.
        Chairman Baker. Thank you, Chairman Oxley.
        Mr. Ackerman.
        Mr. Ackerman. Thank you.
        Mr. Berardino, let me tell you first, before I ask you a
    question, what's in my heart. You've come back now for the
    second time to amend some things that you said before that
    weren't necessarily as accurate as you would have liked them to
    be, and we have been listening to you for a while, and we've
    basically gotten nothing, and I'm finding it very difficult to
    believe that a person who has risen to a position of such
    prominence and importance in the financial community can
    present himself as knowing absolutely nothing about what's
    going on in his own business.
        Maybe it's better to be dumb than culpable, but we want
    some answers. And I, for one, am extremely troubled by what I'm
    hearing. Your not knowing what was going on, if that's the
    case, is basically saying that you have squandered the
    integrity of your company. You've enabled the enrichment of the
    greedy at the price of destroying the dreams of so many decent,
    innocent people, and that is totally unacceptable.
        It seems to me that we had some testimony yesterday from
    some folks who spent a mere 3 months looking at what's happened
    and came back absolutely astounded, astounded as are we and as
    are the American people.
        You were asked the question before about the company that
    sought a merger with your company and in 2 weeks said this is
    unbelievable, we can't go through with this deal. Didn't that
    raise a suspicion in your mind that something that your
    prestigious firm was auditing and delving into and looking into
    was off base somewhere if in 2 weeks they could say that this
    is a house of cards, to say something is wrong with my
    auditors, I'm the captain of this ship? And to appear before us
    and say that, well, I was GAAP compliant, and I'm not the
    auditor, and I didn't--it's not acceptable. You're the captain
    of the ship.
        I mean, if they came to you and said we want to rob a bank
    and here's who's going to drive the car and this is what we are
    going to pay for the gun and this is the day and time we're
    going to do it and who are fully disclosing all of this, you
    don't think you have the responsibility to blow the whistle?
        Now I don't even know what my question is. I mean, this is
    so mind boggling. I mean, how do you let this happen, Captain?
    I mean, your ship is going to go down, and you're going to be
    lashed to the mast unless you start talking to us about what
    happened. Maybe you can explain it.
        Mr. Berardino. Congressman, we are still getting facts. You
    want me to give you conclusions without all the facts. The
    special committee----
        Mr. Ackerman. How long have you been the auditors of this
    company and how long have you been their consultants?
        Mr. Berardino. This committee had conclusions that----
        Mr. Ackerman. Could you just answer that question first?
    How long have you been the auditors for Enron?
        Mr. Berardino. Our firm has been the auditor since I think
    the mid-1980s.
        Mr. Ackerman. Since the mid-1980s, and now you're just
    getting the facts. That's very interesting. My kid cousin
    wouldn't use you to do his tax returns if that's what you're
    telling me.
        Mr. Berardino. Congressman, when I was here last I reported
    that, in one instance, we had facts and reached an improper
    professional conclusion and the company restated its earnings.
    I said, in the second instance, information was withheld from
    us; and once we had the information, we required and the
    company restated its financial statements. In this report there
    are allegations that maybe there was some other information
    withheld from us. I don't know if that's true or not. I haven't
    been consulted. We haven't been able to approach the committee.
        Mr. Ackerman. I'm just having difficulty here. I'm not
    making an analogy, but I can't help but think if Hitler was
    brought to the Nuremberg trials and he said ``I didn't know
    what was going on, I was just a president of a small country--
    --''
        Chairman Baker. Your time has expired, Mr. Ackerman.
        Mr. Ackerman. Thank you, Mr. Chairman.
        Chairman Baker. Mr. Ney. And let me, before I recognize Mr.
    Ney, acknowledge that I'm having distributed the article
    printed in the New York Times which I made reference to with
    the proposed merger. I'm the one who's doing that.
        Mr. Ney. Thank you, Mr. Chairman.
        Mr. Berardino, based on what is now known, did Enron
    officials, especially Andrew Fastow and Michael Kopper, keep
    material information about the special purpose entities from
    Andersen auditors?
        Mr. Berardino. I don't know. Apparently in the one
    transaction that was restated, 80 percent of the restatement
    information that was relevant was withheld. Who knew it? Who
    withheld it? We don't have that information.
        Mr. Ney. Are you looking into it to find out internally?
        Mr. Berardino. Frankly, we can't look into it. We are no
    longer the auditors for Enron. We don't have access to their
    people. We don't have subpoena power. We're sitting here like
    everybody else reading this report that was issued Saturday.
        Mr. Ney. I understand you're not the auditors, but you
    still should be able internally to question people that were
    around Enron, your people, and involved with Enron to find out
    if, in fact, to the best of their knowledge was information
    directly kept from them, and maybe they have that information.
        Mr. Berardino. Unfortunately, they don't know what they
    didn't know. OK? There are new facts coming out every day, and
    we don't have an opportunity to respond to them. I wish we did.
    I'd like to have facts. I'd like to give you more definitive
    answers. I just can't.
        Mr. Ney. There's a new report out that Enron management
    might have taken large sums, $15 million in 2000 alone, from
    employee benefits accounts for spending at other departments.
    That's, of course, outrageous. I think we all know that, and I
    feel it's a crime. In fact, Ken Lay should have just had a mask
    and a gun. It would have been much easier than what he did to
    these people.
        Now, the Enron accountant who found it out reported it to a
    senior Enron management official, including Ken Lay himself,
    and Lay supposedly told her to mind her own business. Does
    Andersen have any knowledge of that conversation?
        Mr. Berardino. The first I've heard of it.
        Mr. Ney. Another question I wanted to ask: There has been a
    lot of news about the $25 million paid by Enron for Andersen's
    non-auditing services. But the Andersen/Enron relationship,
    it's been stated, was deeper. A recent news article said that
    Andersen employees were given permanent office space at Enron
    headquarters. They were dressed like Enron colleagues--which I
    wondered what that was--and then they went on to explain they
    wore Enron golf shirts, shared in Enron office birthday parties
    and ski trips to Colorado. Enron employees thought, they've
    stated, that your people were other Enron employees.
        That brings up just, obviously, several issues and
    questions. Didn't that violate the ethical standards of the
    CPAs that you're supposed to be independent in spirit as well
    as, in fact, and are these relationships norm throughout the
    accounting business?
        Mr. Berardino. I don't have any particular insight on that.
    I will tell you absolutely we are to be independent. It is not
    unusual, in fact, it is common that we have offices at our
    clients' headquarters, because we're constantly asking them
    questions and with a company of Enron's size we were
    continually doing our audits. So that would not be unusual.
        These other, you know, social points you raise I just have
    no particular knowledge, so I can't respond.
        Mr. Ney. Would you please be intent for the future to go
    back to your company and say, did this happen? Talk to the
    people who were over there that were your employees to make
    sure that type of thing, if it happened, doesn't happen again?
        Mr. Berardino. Absolutely.
        Mr. Ney. You do have----
        Mr. Berardino. Well, we mentioned in my testimony this
    Office of Ethics, and we are going to make much more considered
    policies and directives to our people so that they understand
    what proper behavior might be.
        Mr. Ney. Last question I have, Mr. Chairman, the Powers
    Report states that the annual reviews of the LJM transactions
    by the Audit and Compliance Committee involved brief
    presentations by Enron management. Andersen was present at the
    audit committee and did not involve any meaningful examination
    of the nature or terms of the transactions. So the question
    would be, why didn't Andersen, which was present, seek further
    information about these transactions which ultimately did
    contribute to the collapse of the entire company?
        Mr. Berardino. I think the record will show in time that
    there were conversations with this audit committee over a long
    period of time where these transactions were on the agenda.
        Mr. Ney. Thank you.
        Mr. Chairman, I hope that we can get down to the bottom of
    these eventually with other witnesses or whatever, because I
    think they're important as to the questions that have been
    raised here to be answered to this issue.
        Chairman Baker. I can assure the gentleman that, with the
    committee's assistance, we will have much more informative
    hearings on the matter to determine as best we can the causes
    for these problems.
        Mr. Bentsen.
        Mr. Bentsen. Thank you, Mr. Chairman.
        One thing I wanted to clarify, and I'm sorry Mr. Oxley has
    left, but he raised an important point. Mr. Berardino, when you
    testified last December before us, I asked this question,
    because at the back of your statement you made the comment, and
    I don't have the transcript in front of me, that at the time
    you didn't think that disclosing that stock values would affect
    the repayment of debt was a material item. I think you said
    something to the effect, and I am paraphrasing here, that the
    perception was the stock was always going on, and it's similar
    to what Mr. Oxley was asking, that asset values were always
    going up. So they weren't necessarily material items. I think
    now they have become very material in retrospect.
        Let me go back to some other questions, though, that you
    raised. Knowing what you know today, would Andersen take on
    Enron as a client? It's a yes or no answer, I mean, I guess.
        Mr. Berardino. Well----
        Mr. Bentsen. In the way that they appeared to have run
    their business.
        Mr. Berardino. We look very seriously at the integrity of
    management, the value of their representations, because we do
    test checks at a company. We don't look at every transaction.
    And I think the report yesterday was pretty direct in some of
    its criticisms about lack of supervision and in some cases
    integrity, and that would prevent us from taking on a client
    where those were real concerns.
        Mr. Bentsen. Let me ask you this. Going back a year or so,
    is there a percentage at Andersen with which clients, long-time
    clients, are reviewed on a periodic basis, semiannually,
    annually? Is there a procedure at the partner level, at the
    management committee level with which you review clients? I
    mean, presumably you review how much revenues you are raising
    from clients and whether or not it's worth keeping or not based
    upon that and your costs associated with that, but did that go
    on with the case of Enron?
        Mr. Berardino. Yes, it did. In fact, there is a February
    memo that has been well reported in the public where that
    conversation was taking place within our U.S. management team,
    and the risks of the company were being evaluated as well as
    the procedures we would undertake to review.
        Mr. Bentsen. Was there ever a time at the partner level
    that questions were raised about how Enron was conducting its
    business? I mean, was there ever a discussion of whether or not
    Andersen might want to fire Enron as a client because of
    concerns about how the business was being run?
        Mr. Berardino. I wasn't part of those discussions. I don't
    know specifically what was discussed other than the general
    process we do go through every year about each of our clients
    as to whether we want to continue and whether or not we have
    the understanding----
        Mr. Bentsen. Board meeting minutes or management committee
    meetings that you've seen.
        Mr. Berardino. Not to my knowledge.
        Mr. Bentsen. Was there ever an occasion at the partner
    level where perhaps a call came--I mean, presumably somebody
    looks at the sum of the parts of all of the profit centers
    within the firm. Somebody has to, I guess, decide how to divvy
    up the profits at the end of the year. But was there ever a
    discussion that was made that perhaps there was something, a
    rather aggressive approach?
        Because you said the books--you're right about the fact
    that the books are the company's books and the accounting firm
    is just really adding its interpretation of the books. But it's
    also for a fee and legitimately, in virtually every case, for a
    fee is putting its imprint on there. It's giving its qualified
    opinion which the marketplace takes as an interpretation that
    things are on the up and up.
        But was there ever a case where you received a call or
    someone at the partner level or management level of the firm
    received a call from the division that was responsible for
    Enron that said, there's a problem with how they want to lay
    out the books, with either SPEs or SPVs or whatever, dilution
    of stock, you name it, some of the stuff that's in the Powers
    Report? Was there ever a call made and the discussion was,
    look, the client always comes first? Was there ever a situation
    in the case of Enron like that?
        Mr. Berardino. I'll make two comments. One is that was not
    brought to my attention, that kind of conversation, until the
    third quarter of 2001 when we had many conversations with the
    company on that report. But I'm Chief Executive officer of our
    firm worldwide. We have a management structure in the U.S. that
    would have those conversations to the extent they existed, but
    I wasn't part of those.
        Mr. Bentsen. For the record, could your firm provide us
    with an answer to that question, whether or not there were
    discussions? Because the perception is out there that while the
    auditing firm looks at the books--and, sure, you've given the
    information, although, as Mr. Ney was saying, you had offices
    there so you can pepper them with questions on a regular basis.
    But when you're sitting down to close a deal--I mean, the
    Chewco deal wasn't fully baked, but they had to get the deal
    done, and so they did it improperly. And Andersen was
    apparently involved to some extent, and they assumed that they
    would fix it between November and December or whenever they
    closed their books, and they would find the other 1 1/2 percent
    equity ownership to make the deal work, make it legal under the
    terms of FASB.
        The question I have is, somewhere in the management
    structure was there a discussion that said, look, this isn't
    quite how it ought to be but, look, they are a good client, you
    know, they're an upstanding company, whatever, let's work with
    them to get this done. Because that's a breakdown in the
    system, and it undermines sort of the old adage of FDR going
    back to the Securities and Exchange Act, that the whole idea
    was to have a level playing field. Part of the level playing
    field is the imprimatur of the auditing firm that the books at
    least have been looked at even with a qualified opinion; and if
    the question is that the client is starting to push around the
    auditor, then we have an unlevel playing field.
        Mr. Berardino. I think that's a fair question.
    Unfortunately, you have the wrong person in front of you to
    give you more specific answers.
        Mr. Bentsen. You are the Chief Executive Officer and
    presumably you have access to the minutes of the meetings of
    the partner committees and whoever has responsibility over the
    U.S. functions, North American functions and could provide
    those for the committee.
        Mr. Berardino. We'd be happy to be helpful if we can be.
        Mr. Bentsen. We would appreciate seeing that.
        Thank you, Mr. Chairman.
        Mr. Berardino. Thank you.
        Chairman Baker. The gentleman's time has expired.
        Mr. Shays.
        Mr. Shays. Mr. Chairman, I would like to just pass for two
    or three rounds and then reclaim any time.
        Chairman Baker. Mr. Castle.
        Mr. Castle. Thank you, Mr. Chairman.
        Mr. Berardino, I have had sort of mixed feelings about this
    this entire morning. It's been interesting. I believe your
    testimony, which I have tried to read in full, well beyond what
    you've said here today, is very comprehensive in terms of what
    should be done. But I consider it sort of a mea culpa
    testimony, if you will, as opposed to something I'd like to
    have heard a year ago or whenever it may be.
        I couldn't find my notes on this, but I recall reading that
    Andersen had done auditing work for, I think, Sunbeam--is that
    correct--in the past?
        Mr. Berardino. Yes.
        Mr. Castle. And Rite Aid, was that not correct? Waste
    Management, all of them had some sort of fundamental non-
    disclosure issues, particularly Sunbeam. That created
    tremendous stockholder havoc out there.
        I mean, my whole bottom line on this is that there's a
    whole series of insiders, of which auditors are one to a
    degree, but there are insiders who are doing these kinds of
    things, most of whom hopefully in this country are operating in
    a perfectly acceptable level. They are the ones who are running
    the companies, and they are the lawyers and the others who are
    giving advice, all the investment counselors. There are
    securities analysts who are giving advice on these various
    things that have some knowledge about what is going on.
        Then there is sort of a filter system, and to me the filter
    system is the auditors, and it's the auditors that have to
    filter to those of us, and in this case there are millions of
    people who suffered huge losses out there. And when I say
    millions, I'm not talking about people who directly own Enron
    stock, but all the pensions plans--not just Enron's either--but
    all the pension plans in this country, and all the major stock
    holdings of a lot of operations and they all lost on it,
    because that filter, in my judgment, among other things, did
    not work. The water was plenty dirty by what happened to all
    the others, but I question, has the filter worked or not?
        I wish the ideas you had in here had been in place in order
    to have prevented this. I know that you want to be a part of
    the solution, and I appreciate that, and I have also listened
    to you, say, three or four times, in various ways, that you did
    not do the audit, meaning you personally did not do the audit
    in this particular case, but isn't there a corporate
    responsibility to know? I mean, is Andersen just too big? Do we
    have a problem with the big five accounting firms or whatever?
    Do we need to do this in a way so that everyone knows what's
    going on at this point?
        It just seems to me unacceptable--and I consider you to be
    a person of integrity, but it's unacceptable that these kinds
    of things are happening in a huge, multi-million dollar, fee-
    based structure for a major corporation in the United States of
    America, and yet you can sit there and legitimately be able to
    say I simply did not know. And not that you would have known at
    the time, because you didn't do the work, but that it would not
    have somehow have gotten to you.
        Just in a broad sense, what are we doing with auditing in
    this country?
        Mr. Berardino. Well, I think that's a fair question, and
    what I came here to do today is to help you with your
    thoughtful deliberations in terms of what we're going to do
    going forward. And I've put some very serious proposals on the
    table that we are just going to do as a firm. We are not going
    to wait for people to tell us what to do, but also that I think
    could be part of the fix.
        The fact is, as auditors, we know a lot more than we can
    tell the public. We tell the public through the audit
    committee, and the question is whether we ought to be telling
    more directly to the shareholders in some way. That mechanism
    does not presently exist. I think there are ways we can get
    better. We are looking at this crisis. It is a crisis. It is a
    tragedy we have. We understand that. Real people were involved.
    But I also understand----
        Mr. Castle. I appreciate what you've said, and I agree that
    your testimony is basically positive and good for us, but still
    I'd like to know a little more about the question of the size
    of auditing firms. In other words, it has just gotten too out
    of hand in terms of the magnitude with a limited number--I
    think I read someplace that basically all the audits for all
    the corporations of the country are done not just by the Big
    Five, but by like about 20 or 25 firms throughout the country.
    I have to assume they're all big. Even the smaller more
    regional ones are pretty large.
        Mr. Berardino. Right.
        Mr. Castle. And we're at the point where we are not getting
    good independent reporting with good oversight of what's
    happening there and you're removed from some of these answers.
        Chairman Baker. That will be the gentleman's last question.
    His time has expired, but please respond.
        Mr. Berardino. Congressman, that's a question I have given
    some thought to. Really, you've got a balance here, and I'm not
    going to say I've got the ultra wisdom here, but one of the
    benefits of bigger firms is you can develop deeper expertise,
    invest more in training, and have people on the cutting edge to
    understand the technology risks, the tax risks, all the risks a
    company has. And, you know, as a public policy statement I
    don't know where that white line is.
        No, I don't think we're too big, but when you've got 28,000
    people just in the U.S. that make judgments every day--you
    know, I can't change human nature. People will make bad
    judgments. We need to limit it. I'm not apologizing for it.
        We are considering every possible avenue to make sure those
    judgments are better and the backbone and the skepticism is
    there to ask the hard questions, and every one of my proposals
    is designed to make sure we're better.
        Mr. Castle. Well, my time is up, as the Chairman has so
    warned me, but I would just comment that the whole structure
    issue of the way the very firms are set up at least concerns
    me. I also don't know if it's right or wrong, but it at least
    concerns me. I hope we add it to the list of things we look at.
        Mr. Berardino. I think it is a fair question.
        Chairman Baker. The gentleman yields back his time.
        Mr. Sandlin is recognized.
        Mr. Sandlin. Thank you, Mr. Chairman; and, Mr. Berardino,
    we do appreciate your coming here today.
        We are disappointed that Mr. Lay has taken the Fifth
    Amendment by absentia, and we do appreciate your willingness to
    testify.
        You remember recently when Arthur Levitt and SEC a couple
    of years ago recommended that accounting firms should separate
    their auditing business from their consulting business? Do you
    remember that?
        Mr. Berardino. Well, if I could just correct you just the
    slightest bit.
        Mr. Sandlin. Well, that's my question. Do you remember that
    happening?
        Mr. Berardino. Yeah, well, no, I don't, because I----
        Mr. Sandlin. And at that time Arthur Andersen opposed any
    required division of auditing and consulting; is that correct?
        Mr. Berardino. That's not correct.
        Mr. Sandlin. And you took the position at the time that the
    industry could police itself?
        Mr. Berardino. If I could just correct you on one small
    matter, Congressman, the question Mr. Levitt put on the table
    was whether auditors could do consulting work for their
    clients, not whether or not they could also be in the
    consulting business and offer those services to non-audit
    clients. So that's the only small exception. I did disagree.
        Mr. Sandlin. And your position at the time was that
    Andersen should audit what Andersen did?
        Mr. Berardino. No, I----
        Mr. Sandlin. Andersen was doing consulting; is that
    correct?
        Mr. Berardino. My testimony----
        Mr. Sandlin. Andersen was doing consulting; was that
    correct?
        Mr. Berardino. Yes.
        Mr. Sandlin. Andersen was doing auditing; is that correct?
        Mr. Berardino. Yes.
        Mr. Sandlin. In fact, on this self-policing on January 2nd,
    about 30 days ago, Andersen was touting this peer review that
    did not identify the systemic failures in Andersen; is that
    correct?
        Mr. Berardino. Yes.
        Mr. Sandlin. And that report was reported after the Enron
    problem, after Chewco, after Jedi, after Fastow took off with
    $30 million, after Kopper made off with $10 million, after
    Lavorato took a $5 million retention bonus, after Louise
    Kitchen took $2 million, after the employees were locked down
    in their pensions. In fact, it was a month after Enron filed
    for bankruptcy and your peer review said there were no systemic
    failures; isn't that correct?
        Mr. Berardino. Yes, that's correct.
        Mr. Sandlin. And the report that came from the independent
    group said, quote; ``Andersen did not fulfill its professional
    responsibilities in its auditing work.''; Is that correct?
        Mr. Berardino. I don't----
        Mr. Sandlin. You don't remember that being in the report
    from the Enron investigative board?
        Mr. Berardino. I don't remember the exact wording, but it
    was something to that effect.
        Mr. Sandlin. I believe it said ``did not fulfill its
    professional responsibilities in its auditing work.''
        And talking about failures, when it appeared that Enron was
    in trouble, the response of Arthur Andersen was to immediately
    destroy evidence and to shred documents; is that correct?
        Mr. Berardino. No, it's not.
        Mr. Sandlin. Did Enron--excuse me----
        Mr. Berardino. Congressman, if I could expand on my answer?
        Mr. Sandlin. Let me ask you this, and you can ask your
    counsel if you need to ask questions. Did Arthur Andersen
    engage in destroying and shredding documents?
        Mr. Berardino. Congressman----
        Mr. Sandlin. Did Arthur Andersen shred documents?
        Mr. Berardino. Arthur Andersen is an institution. There
    were individuals----
        Mr. Sandlin. I think Mr. Andersen is deceased. I'm asking
    if your company and your employees shredded documents after
    knowing about an SEC investigation. Did they do that or did
    they not?
        Mr. Berardino. We, top management in this firm found out
    that people had destroyed documents.
        Mr. Sandlin. Thank you.
        Mr. Berardino. We self-reported to the Justice Department,
    self-reported to the SEC----
        Mr. Sandlin. So the answer is that they did.
        Let me ask you this. Arthur Andersen received $25 million
    in auditing fees, $27 million in consulting fees. Taking into
    account the reports and all the problems that we've had and the
    money that you got paid, would you now support a complete
    division and requirement of a division of auditing and
    consulting services in the accounting business?
        Mr. Berardino. Congressman, we put on the table today some
    very significant suggestions that we think Congress should
    consider that we think----
        Mr. Sandlin. Let me ask--and that's a good point. That's a
    good point. I listened to your five proposals you made, and
    every one of them was to make it better for accounting and for
    Arthur Andersen. I didn't hear one thing about the Enron
    employees. I didn't hear one thing about health care. I didn't
    hear one thing about the pensions. I didn't hear one thing
    about Arthur Andersen contributing money to help the people
    that you helped destroy, the lives that you destroyed. All I
    heard was what can we do to make it better for Arthur Andersen
    so we can go on about our business and make more money in the
    accounting business.
        Now that was the five goals in the five areas that you
    listed. I wrote them down. Now are you willing to do something
    and add a sixth to help the Enron employees, to help the people
    whose lives that you helped destroy? Can you do that?
        Mr. Berardino. Congressman, I'm interested in doing things
    that pass two tests. Test number one----
        Mr. Sandlin. Can you help the Enron employees?
        Mr. Berardino. Test number one is that this has to be
    public's interest to build confidence in our profession in the
    public mind.
        Mr. Sandlin. OK.
        Mr. Berardino. And number two is has to improve the quality
    of auditing.
        The steps I put forward are first steps.
        Mr. Sandlin. Thank you. Let me say this----
        Mr. Berardino. The first steps that I think will help both
    those tests, and there will be more as we have a further
    conversation.
        Mr. Sandlin. That's a very charming story and----
        Chairman Baker. Can you----
        Mr. Sandlin. Yes, sir. That helps the accounting industry,
    but I'm interested in Arthur Andersen doing something and
    taking assets, taking some of those fees and putting them in
    the funds to help the people whose lives you destroyed, not
    just the accounting industry.
        Thank you for coming.
        Chairman Baker. The gentleman's time has expired.
        Mr. Royce.
        Mr. Royce. Yes, sir.
        The Powers Report states that your firm declined to speak
    with the investigatory board chaired by Dean Powers about the
    Jedi-Chewco transaction which was structured, in their words,
    in apparent disregard of the accounting requirements for non-
    consolidation. Now, today you told us that you did not refuse
    to cooperate with the board, and my question would be: would
    you be willing, then, to communicate with the Powers
    investigatory board regarding those questions?
        Because we have two assertions that we have heard, one
    yesterday and the other today, by you. I guess the comment you
    made is, well, we're off the case, we're no longer employed by
    Enron. But that doesn't answer the question as to why you
    shouldn't respond to their inquiries, and my first question is,
    are you----
        Mr. Berardino. Because they didn't make an inquiry. We
    offered to help. We were very available. We begged them to talk
    to us. We never saw a draft of the report. The board fired us
    in the middle of the investigation, and you're asking me to
    respond to things I saw on Saturday night for the first time.
        Mr. Royce. I see.
        Mr. Berardino. To answer your question specifically, we
    have been the most forthcoming firm, the most forthcoming
    profession. We're back here for the second time voluntarily,
    because we want to get it right. We will be happy to talk to
    anybody who's interested in getting to the bottom of this so I
    can answer these questions more specifically.
        Mr. Royce. So if Dean Powers approaches you next week and
    asks to talk to the auditors who were on--site so we might be
    able to glean some information, you would be willing to allow
    them to do that?
        Mr. Berardino. Absolutely.
        Mr. Royce. The second question goes to the issue Chairman
    Oxley raised and just to repeat that assertion, as the New York
    Times put it, Enron's accounting treatments for the
    partnerships LJM and Chewco were determined with extensive
    participation and structuring advice from your company which
    billed Enron $5.7 million above and beyond its regular audit
    fees for this service. Chairman Oxley raised some questions. If
    we put those questions in writing so that you could then go
    back to the auditors who conducted this audit, could we then
    get some answers about that structuring agreement, about your
    participation, your firm's participation arguably in setting up
    those partnership agreements?
        Mr. Berardino. We are here to be helpful any way we can be
    helpful.
        Mr. Royce. All right. Well, I appreciate that.
        The next question that I would have would go to the
    question of the document shredding that's been raised here
    today. What exactly was shredded? Could you enlighten us about
    what we know about those files? What did they pertain to? Was
    it the partnership agreements?
        Mr. Berardino. Well, unfortunately, it's hard to recreate
    shredded documents. You can recreate deleted e-mails. And, from
    the moment we knew about this at the top of this organization,
    we have been trying to recreate whatever is possible to
    recreate, and we're able to recreate a lot of it. We are still
    studying what happened, why it happened, and as soon as that
    investigation is complete, we will make those results publicly
    available.
        Mr. Royce. Could you give us some insight, since you've got
    some of the puzzle pieces together, as to the subject matter of
    what was shredded?
        Mr. Berardino. No, I cannot. I just don't know.
        Mr. Royce. All right. And it's been reported that Arthur
    Andersen cut a deal to handle some of the internal auditing
    work for Enron along with vetting its public reports for the
    trading firm's audit committee. The fact that your company
    audited Enron's internal and public financial data seems to
    pose a serious conflict of interest with Andersen developing
    Enron's internal accounting controls on one hand and then
    publicly attesting to the veracity of the data produced on the
    other. As CEO, did this strike you as a serious conflict of
    interest up until----
        Mr. Berardino. No, it hasn't. And I would say back to the
    debate we had 2 years ago with the SEC, this issue was
    specifically debated and it is permissible for auditors to do
    internal audit work. Now, as you've read in my testimony and my
    spoken testimony as well, we understand that though we may win
    on debating points technically, there is a concern in the
    public interest, and that's why I have those two tests, is the
    public interest being served, does it undermine our credibility
    in the public? In this case, it obviously does, and that's why
    we voluntarily stepped forward and will no longer provide those
    services.
        Mr. Royce. Do you think the entire accounting industry
    should pick up this same remedy in terms of conflict of
    interest and establish it as a reform industrywide?
        Chairman Baker. That's the gentleman's last question. His
    time has expired, but please respond.
        Mr. Berardino. Frankly, given what happened here, the whole
    system needs to be looked at, and we are putting forward our
    ideas on our part in the system, and I think this is part of
    the conversation.
        You've got the benefit of my wisdom. To the extent you
    agree with it or disagree with it, I think we can have a
    healthy conversation and debate and end up in a place where the
    public has more confidence in the profession and where we can
    do even better audits.
        Mr. Royce. I thank you, Mr. Chairman; and I will be getting
    back with the questions that Chairman Oxley asked and that I
    asked so that we could have those in writing so that there
    could be some time for the witness to respond to us, because
    we'd like the specifics. Thank you, Mr. Chairman.
        Chairman Baker. Thank you, Mr. Royce. I'm sure the
    subcommittee will work on a follow-up series of questions on
    the subject you have brought to the attention as well as
    Chairman Oxley and a number of other issues which I think would
    be very helpful for the committee's proceedings.
        Mrs. Jones.
        Mrs. Jones. Thank you, Mr. Chairman.
        Mr. Berardino, I, too, would like to have the benefit of
    your wisdom. Could you tell me how long have you been the CEO
    of Andersen, sir?
        Mr. Berardino. Just over a year.
        Mrs. Jones. What were you doing previously, sir?
        Mr. Berardino. I was in charge of our auditing practice.
        Mrs. Jones. And what's the purpose of an audit, sir?
        Mr. Berardino. The purpose of the audit is to give
    investors an opinion on the fairness of the financial
    statements in accordance with the rules that are established.
        Mrs. Jones. So, based on your audit, it was your opinion
    that Enron was an organization that investors should invest in;
    is that correct?
        Mr. Berardino. We don't make judgments on who should be
    investing or not. It was a public company.
        Mrs. Jones. Excuse me. Let me rephrase my question, then.
    Maybe I should say that, based on your audit, people in
    reliance on the name Arthur Andersen invested in Enron.
        Mr. Berardino. Among other things that they rely on. They
    rely on their investment advisors, and so forth.
        Mrs. Jones. Except that the reason we are seated here and
    you no longer represent Enron and the public is outraged, that
    there was something about this audit that did not represent the
    true financial status of the Enron Corporation. Is that a fair
    statement, sir?
        Mr. Berardino. We're here because a big company collapsed
    very quickly.
        Mrs. Jones. Let me restate my question. The reason we are
    here is because you audited Enron Corporation and the
    representations you made were not, in fact, a true financial
    picture of the corporation such that a lot of people lost
    money, and we're in a public hearing trying to decide whether
    the auditing principles that have governed our Nation for the
    past few years are truly in the best interest of the public. Is
    that a fair statement, sir?
        Mr. Berardino. And I'm here to give you some thoughts on
    how we might go forward with a much better----
        Mrs. Jones. Well, then why don't you give me some thoughts?
    How is it that the public would not have been able--strike
    that. How is it that the public could not see what was wrong
    with Enron based on your auditing practice?
        Mr. Berardino. I don't know how to answer that question.
    The public----
        Mrs. Jones. You're an auditor, though, sir, aren't you?
        Mr. Berardino. Yes.
        Mrs. Jones. So based on the audit that your firm did,
    shouldn't the public have been able to see the problems with
    Enron?
        Mr. Berardino. The public--really, what I can tell you is
    that in the 9 months before any of these accounting issues
    became public, this stock went down 70 percent.
        Mrs. Jones. Let me ask you this.
        Mr. Berardino. A number of----
        Mrs. Jones. Hold up a minute. As the auditor, shouldn't you
    have been able to see the problem with Enron such that you
    could have told the public the problem that was going on?
        Mr. Berardino. I think that's a fair question,
    Congresswoman, as to what our role should be. We audit in
    accordance with certain rules. If the rules are passed, we have
    no ability to say anything beyond what's in the management's
    financial statements.
        I think a fairer question is----
        Mrs. Jones. I'm not asking you to ask the questions. I'm
    asking the questions, sir. Hold on a second.
        Let me say this, then. You, as Arthur Andersen and this
    group of auditors who give consultation to the SEC, and so
    forth, have the ability to lobby as to what are the appropriate
    rules and regulations, do you not, sir?
        Mr. Berardino. Yes, we do.
        Mrs. Jones. In fact, you lobbied very recently just in 1995
    to have some change in the Private Security Litigation Reform
    Act that, as a result of that Act, there have been a high
    number of restatements by many corporations restating what
    their financial picture is, because before they were able to
    camouflage it; is that correct, sir?
        Mr. Berardino. There have been a lot of restatements. There
    have been--we did participate in that bill being prepared. We
    also lobbied against these SPE rules and were unsuccessful.
        Mrs. Jones. Let's stay with what I'm talking about. You can
    talk about SPE rules in your testimony, OK?
        So there have been a ton--not a ton--a high number of
    restatements, and the restatements that were made by these
    public officials speak to what--excuse me--by these corporate
    officials speak to what?
        Mr. Berardino. Restatements happen for one of two reasons.
    One is, there's an honest misapplication of generally accepted
    accounting principles or there is just a difference of opinion
    between the SEC staff and the auditor as to what the result
    should be.
        Mrs. Jones. An honest misapplication of auditing principles
    or a disagreement between the SEC and the representatives of
    Arthur Andersen can cause Enron employees and people across the
    country to be in a financial disaster right now; is that
    correct, sir?
        Mr. Berardino. I don't know.
        Mrs. Jones. Let me ask you this, sir. What is the purpose
    of a consultant? I might be out of time, but answer that
    question for me.
        Mr. Berardino. A consultant is to offer advice to a company
    on areas within whatever area of expertise they might practice.
        Mrs. Jones. So on the one hand you audit and you give
    them--you go through the books based upon representations and
    you represent to the public the financial status of a company
    on the other side and you sit and consult and give them advice
    on how they should answer those questions.
        Mr. Berardino. Well, auditors----
        Mrs. Jones. Yes or no?
        Mr. Berardino. Auditors have tremendous insight into a
    company and how they can be approved.
        Mrs. Jones. But my question was a yes or no answer. Is that
    true what I stated about consulting and auditing?
        Mr. Berardino. Yes.
        Mrs. Jones. Thank you. I yield my time.
        Chairman Baker. The gentlelady's time has expired.
        Judy Biggert.
        Mrs. Biggert. Thank you, Mr. Chairman.
        Mr. Berardino, as you know, Chairman Pitt testified before
    our subcommittee yesterday, and one of the questions that I
    asked him was regarding the SEC guidance that was released on
    January 22, and it involved the special purpose entities and
    the market-to-market accounting and the related-party
    transactions. Have you seen that release of the guidance?
        Mr. Berardino. No, but I'm generally aware of it. In fact,
    we had a conversation with the SEC encouraging just that
    release because of the confusion that was out there in those
    issues.
        Mrs. Biggert. On a couple of the issues, for example, the
    market-to-market accounting, and they were talking about the 3
    percent rule, and I recall in someplace that your firm has not
    been in accordance with the SEC on the use of the 3 percent
    rule?
        Mr. Berardino. Well, when that rule was put in place, we
    disagreed with it, and we're on record as disagreeing with it,
    but other people felt differently.
        Mrs. Biggert. Do you think that--I just wondered if there
    was a change in that rule under these guidance terms.
        Mr. Berardino. Not to my knowledge. I think there is
    suggested additional disclosures which were very unclear in the
    original pronouncement.
        Mrs. Biggert. Does your firm intend to respond to those?
        Mr. Berardino. Yes. Absolutely. I should say our clients
    are, and we are insisting that they do.
        Mrs. Biggert. I noticed that he said that there have been
    no negatives to it so far. But, of course, it's only been 2
    weeks, so that's not a very long time.
        One of the proposals that has been suggested is rotating
    auditing firms every 5 years or so or at least a change in the
    partners in charge every 3 to 5 years. How long was David
    Duncan the partner in charge at Enron?
        Mr. Berardino. I don't know, but I will tell you that there
    is a 7-year policy in our firm and in the profession, where you
    cannot be the signing partner on an audit for more than 7 years
    in a row.
        Mrs. Biggert. The number of corporations that have
    retracted and corrected prior earnings has doubled in the past
    3 years, and I think we have talked a little bit about this
    with Sunbeam and Waste Management, and these were not detected
    by the accounting firms, including yours. Do you think that the
    profession should, you know, maybe consider what are the ethic
    standards to avoid more of these embarrassments?
        Mr. Berardino. This is a very fundamental question, and one
    of the problems we have is these rules are overly complex and
    subject to very different interpretations firm to firm and
    individual to individual. And although these restatements are
    very high, that does not mean companies are doing something
    illegal or immoral. It means that the rules are complicated,
    and we've had disagreements within the profession on how to
    apply them, and that does not do much for the confidence of the
    investing public when they see these restatements.
        So I think there's a real serious question, I allude to it
    in my testimony, as to the complexity of the accounting, the
    legalistic nature of it, a flight to the lowest common
    denominator in financial reporting by some companies that
    really needs to be addressed as part of this conversation we're
    having.
        Mrs. Biggert. Let me just go back to the 3 percent rule
    again. Because it seems that 97 percent of, you know, a special
    entity could be, let's say, Enron and only 3 percent an outside
    company, and that--or investor--and that would be enough--is
    that to cause a whistle-blowing on it or to say that there's
    something wrong with this.
        Mr. Berardino. Well, to try to to defend the other point of
    view, not the one we had, the idea was that if you've got
    certain assets you wanted to move off your books, if those
    assets were sufficient to pay off the debt, an arbitrary bright
    line of 3 percent was brought in to say you need to have some
    outside investor involved.
        We looked at it and said, you know, if you look at the form
    of it, you get to the answer of moving it off the books. But
    when you look at risks and rewards, 97 percent stays with the
    sponsoring company. It just didn't make any sense to us. And
    this is one of the fundamental questions about accounting as to
    what are you trying to accomplish. And in this case,
    unfortunately, the rules were drafted the way they were
    drafted.
        Mrs. Biggert. Thank you.
        Thank you, Mr. Chairman.
        Chairman Baker. Thank you, Ms. Biggert.
        Mr. Capuano.
        Mr. Capuano. Thank you, Mr. Chairman.
        Mr. Berardino, I guess I'm one of the few people who have
    no trouble pronouncing your name.
        But I'd just like to start off--I was just reading in the
    paper today some items on the issue, obviously, and some of the
    comments relative to Mr. Pitt's testimony yesterday and some of
    the concerns about his past association with the accounting
    field, and there was one comment I'd like your opinion on.
    After some of the recommendations you've made and some of the
    comments you made today, do you still think it's a good idea
    for the two open slots in the SEC to be awarded to people who
    are currently working for two of the major--the Big Five
    accounting firms, or do you think maybe we should reach a
    little bit for a little more independence?
        Mr. Berardino. Congressman, you're an expert in public
    policy and oversight, and I'm not. I will tell you this. If you
    look at the accounting profession today, we are the most
    regulated profession you'll ever see. We have State Boards of
    Licensing. We have a Public Oversight Board. We're now putting
    two more Public Oversight Boards----
        Mr. Capuano. Mr. Berardino, excuse me. That is not even
    close to true. I don't mean to be disrespectful, but I'm an
    attorney. I've dealt with accounting firms. My wife is a CPA. I
    know very well how you were overseen, by whom and by what; and
    most of the oversight for the auditing field is done by other
    auditors, as is proven on an annual basis or a semiannual basis
    by a peer review audit.
        You are not the most heavily regulated profession in the
    field. You're not even close. That is one of the reasons, in my
    opinion, why we are here today.
        Earlier, in response to one of the Chairman's questions,
    you said you cannot make clients report more than is required.
    I agree with you. However, you can add comments to your audits,
    which of course in this particular case every written report I
    have seen indicates, or any of those comments were confusing or
    misleading.
        You can also qualify your reports. You can also add a
    disclaimer to your reports and if any of that fails for any
    reason, any partner within the firm can also add a dissenting
    opinion to the work papers for those audits.
        Have any of those occurrences happened relative to Enron
    and Arthur Andersen? Have you had any disclaimers? Have you had
    any dings? Have you had any dissenting opinions in your work
    papers which you would know, because they are your work papers?
        Mr. Berardino. The SEC will only accept an unqualified
    opinion. There is no such thing anymore as a qualified opinion.
    You can disclaim an opinion if you think the company is ready
    to go out of business.
        Mr. Capuano. The problem with a qualified opinion is, you
    can do it, you just won't do it.
        Let me tell you something else. When I was the mayor of my
    city, Arthur Andersen was the auditor of my community. They did
    a good job. As the client, like most taxpayers, part of my job
    is to push the envelope as best I can. I understand that. I
    respect that.
        Do you know how people like me are kept in check? By the
    auditors saying if you do that we have to put a comment, we've
    got to put a ding, we've got to put a disclaimer. And that's
    what stops clients from going over the line. And if you tell me
    that you didn't do it--which I know you didn't do it, you know
    you didn't do it--that doesn't require any legislation, that
    doesn't require any hearings, that doesn't require the SEC.
        That requires Arthur Andersen or any other auditor to look
    in the mirror and say, is this right or is this wrong? If it's
    wrong and over the line I need, I am required--not can--I am
    required to put a disclaimer in there. I am required to walk
    away from this client.
        Arthur Andersen didn't do that. And honestly I am not that
    angry. I am angry, of course, about the whole situation. What I
    am is disappointed. As a professional, I am disappointed that
    another professional organization that holds the belief and the
    trust of the American public in your hands blew it so badly.
        Let me ask----
        Mr. Berardino. Congressman, can I respond to that?
        Mr. Capuano. Sure.
        Mr. Berardino. One of the suggestions I put in the
    testimony I gave you is that we ought to have a formal ability
    to do that in our auditors' report, that we ought to have a
    formal ability to risk-adjust our opinion for those companies
    that barely get over the line of acceptability and contrast
    that with those that are at the gold standard.
        Yet we say no. We say no a lot.
        Mr. Capuano. Mr. Berardino, you do have that ability by
    walking away from a client. You say, excuse me, I love being
    paid, but this company is going to get Arthur Andersen in
    trouble. This company is going to get me in trouble. This
    company is going to render my partners liable for millions of
    dollars of problems in the future, possibly against me.
        You do have that ability. You choose not to use it. I
    respect it. You do have that ability.
        I was also reading about Global Crossing today. You have a
    great distinction of being the auditor on the largest
    bankruptcy in history and now the fourth largest bankruptcy in
    history. And I actually think that this committee should start
    looking into things other than just Enron.
        I think we need to start asking questions; many of the same
    questions relative to this instance may or may not apply to
    other companies. Global Crossing has a lot of questions coming
    up. I am sure you are preparing for it internally because it is
    going to come. That's a problem. You got the first and the
    fourth.
        Nobody saw it coming? Nobody did a disclaimer? Nobody did a
    dissent? That is problematic to me.
        Chairman Baker. You need to wrap up.
        Mr. Berardino. Congressman, with respect, Global Crossing
    stock has been coming down for months and months and months,
    because its business was not succeeding. The prices for its
    product came down precipitously. And I think what we need to
    do--and you know this well, I'm sure--is we need distinguish
    between a business failure--and there will be business failures
    in this country--and an auditing failure.
        And I suggest to you there will be more and more business
    failures, and if we immediately rush to judgment that said,
    where were the auditors----
        Mr. Capuano. You are telling me that some of the news
    reports, which is all I know about Global Crossing, that they
    are all overreacting? There's no problems at Global Crossing?
    Please don't tell me that. I am not looking to catch you up.
    And I don't know anything about Global Crossing except what I
    read in the general media. But please don't say that today
    because you're under oath.
        I am not looking to trip you up. Please don't say that,
    because I really don't want to be back here 6 months from now
    with you in front of us telling us, well, it really wasn't a
    business failure, there were accounting issues as well.
        Chairman Baker. That's the gentleman's time, but please
    respond to his comment.
        Mr. Berardino. Congressman, all I'm trying to do is make
    sure we debate what we need to debate so we can improve the
    system. And I do think there is a misunderstanding in the
    American public between a business failure and an audit
    failure.
        All I am suggesting is we are going to have the debate, and
    I am here because I want to be part of that debate. Let's
    debate the right issues, and I think your comments are very
    understandable and very fair in terms of what the right issues
    should be.
        Chairman Baker. The gentleman's time has expired.
        Mr. Rogers.
        Oh, Mr. Shays.
        Mr. Shays. Thank you, Mr. Berardino, for being here. I
    think it's very clear that the Powers Report basically had an
    indictment practically of every profession. It went after
    attorneys, accountants, regulators, management, the board,
    bankers, analysts and the rating agencies, and it basically
    said, all of them, these independently failed to act properly.
    And you're obviously a major player in this process.
        I give you high marks for coming before the committee in
    both December and now. But I am concerned, frankly, as I have
    been listening that you are deflecting questions by saying not
    enough time and you weren't there.
        Mr. Oxley asked you a softball question. Even though you
    may not like to give it, he said, with hindsight, isn't it
    clear that Arthur Andersen failed to do its job properly? And I
    am going to ask you the same question, because maybe you have
    had more time to think about it.
        Mr. Berardino. Congressman, you put me in a difficult
    position asking that question. It's a fair question, but I do
    think there are a lot of facts we don't know like, were we
    misled, was there information withheld from us, and I just
    don't know the answer to that question. I have admitted early
    on that we made a bad judgment and that caused part of the
    restatement.
        We have also admitted that information was withheld in
    another transaction, and that was restated.
        Mr. Shays. I would have to say to you that the easy answer
    and a simple one would be simply to say, we failed to do our
    job properly. I mean, that is the bottom line. It's what Powers
    has said. It's just basic reading of the documents to see what
    ultimately happened.
        This company went under because it made very risky
    investments, but it was able to conceal these investments. When
    I look at what's available to you--I mean, the memo that was
    sent to Mr. Duncan by Michael Jones is a devastating memo. Did
    you read that memo?
        Mr. Berardino. Is that the one in February?
        Mr. Shays. Yes.
        Mr. Berardino. That was a memo, Congressman, where our team
    was discussing the risks at Enron.
        Mr. Shays. Did you read the memo?
        Mr. Berardino. Yes.
        Mr. Shays. Let me read the paragraph.
        ``Ultimately the conclusion was reached to retain Enron as
    a client citing that it appeared that we had the appropriate
    people and process in place to serve Enron and management in
    our engagement risks. We discussed whether there would be a
    perceived independence issue solely considering our level of
    fees. We discussed that the concerns should not be on the
    magnitude of fees, but on the nature of fees. We arbitrarily
    discussed that it would not be unforeseeable that fees could
    reach $100 million per year.''
        That is an extraordinary--when I look at it, because then
    after February, then you get Raptor and you get exactly what
    happened, the failure to disclose and basically hide $800
    million of liability and losses. So I would think as CEO, as
    president, as chairman, you would look and say, we know we
    failed to do our job; and now, as CEO, I am going to take care
    of this, as chairman, I am going to take care of this and
    correct it.
        Mr. Berardino. Congressman, I put together six bold ideas
    as a first step. I am not sitting here telling you we did
    everything right. I am telling you we can do better. And I put
    some suggestions on the table to provide a good-faith deposit
    with this committee and the American public.
        Mr. Shays. These ideas are very helpful, they truly are,
    both in terms of what you can do for your company and what you
    can do for the accounting industry and the profession at large.
        Let me take your statement and say--this is on page 5: ``As
    every accountant also knows, some companies do the bare minimum
    to meet generally accepted accounting principle requirements,
    while others are much more prudent in their accounting
    decisions and disclosures.''
        And then you go down and say: ``What can an auditor do when
    financial statements prepared by management barely pass the
    current test, when they comply with the GAAP, but push the edge
    of the accounting envelope, when they disclose required
    information, but not other information that would be meaningful
    for investors?''
        What else can the auditor do when a client squeaks by? Our
    only other option is to resign the engagement. Isn't there
    something in between? You know, we have a qualified question.
        Mr. Berardino. That is exactly what I am recommending in my
    proposals here.
        Mr. Shays. But you can qualify it. You have the ability
    now.
        Mr. Berardino. Under our professional guidelines, we can
    issue a standard form report.
        Mr. Shays. But part of that can be qualified. You can
    highlight a question that is of concern; isn't that true?
        Mr. Berardino. I don't think so. And what I'm suggesting
    is----
        Mr. Shays. I need to understand this part. You're telling
    me you either give them an A-plus or nothing or resign? Can't
    you express concerns about transactions? Can't you put
    footnotes in that say----
        Mr. Berardino. We can recommend that and we have those
    conversations with audit committees who stand in the shoes of
    the shareholders because they are elected by the shareholders,
    and that's part of my comment about this quote-unquote
    conversation.
        We report this to the audit committee, we make
    recommendations, but at the end of the day, we only can give
    the standard form report. And what I am suggesting is, you've
    got companies that are gold standard, others something like
    less than that.
        Wouldn't it be helpful for us to have, if you will, a risk-
    adjusted opinion?
        Mr. Shays. It would be helpful, but I would dispute and
    take strong issue that you don't have the ability to highlight
    a concern in a report with a footnote, with a qualified report.
    I, for the life of me, can't believe that you don't have the
    ability to do that.
        Chairman Baker. I think that is what certainly can be
    addressed with legislation the committee is formulating. If
    there is any doubt, I think we can make clear that that is a
    minimum requirement of audit responsibility.
        Thank you, Mr. Shays.
        Mr. Sherman.
        Mr. Sherman. Thank you, Mr. Chairman.
        As the only CPA Member of the committee, I am perhaps the
    most disappointed. I would agree with the witness that, right
    now, your only tool is a nuclear bomb, that is to say that you
    can insist that reclassifications be made and the financial
    statements change. You can insist upon a footnote. If they say
    no, you can nuke them or you can acquiesce.
        By nuking them, that is failing to give them an unqualified
    opinion. If you give them a qualified opinion, the SEC throws
    out the statement and the stock is selling for 25 cents the
    next day. If you give a disclaimer, the stock is selling for 15
    cents the next day. And I do look forward to working with my
    colleagues to give you some conventional weapons.
        I would like to put into the record with unanimous consent
    the New York Times article, January 27, 2002, that deals with
    this failed 1999 merger, because it's been characterized that
    VEBA, the German company, wouldn't go through with the merger
    because the accounting problems of Enron were so obvious.
        I would point out that, at least according to the article,
    it was a clash of management styles plus a belief that they
    were being told it was going to be a merger of equals, but it
    would be like the Daimler/Chrysler merger, in which the merger
    of equals led to the Germans taking over and probably would
    have led to Enron taking over; and only as the third reason for
    the merger not going forward were concerns about aggressive
    accounting principles. And as I understand it, some of the
    people involved on the VEBA side were free to short the stock
    of Enron and none of them did.
        [The article referred to can be found on page XX in the
    appendix.]
        Chairman Baker. Would the gentleman yield on that point?
    Since the discovery of that article, I have pursued some of the
    principles in the German-based corporation. We have talked to
    intermediaries and, for the record, although the article did
    not characterize it in that fashion, I am told by officials of
    the affected merger that that was one of the principal
    contributing factors for their concerns--for the record.
        Mr. Sherman. I'm sure that it was an important
    consideration.
        But I want to go on to Mr. Sandlin's comment, what are you
    doing for those who are hurt, particularly the employees, and
    ask you whether you would be willing to contribute to the
    relief fund, the amount equal to all of the fees you have
    collected from Enron in the last 10 years so long as a
    mechanism was designed so that if you had any liability through
    the legal process that you would get credit for your advance
    contribution?
        Mr. Berardino. Congressman, I am not sure what the legal
    implications of what you suggest are. But I will tell you we
    feel deeply for the people who have been impacted.
        Mr. Sherman. They expect the sympathy. They'd like the
    cash.
        Mr. Berardino. I understand, and we'll take it on board if
    you don't mind.
        Mr. Sherman. I hope that you'll get back to me in writing,
    because many predict that you are going to have billions of
    dollars of liability, whether you do or not. So long as you get
    credit for it when the books are closed, you ought to be
    providing that money now because a lot of people have lost
    their jobs already.
        I've got a couple of questions where I am going to ask you
    to respond in writing because my time is going to expire.
        I'm from the tax world where the IRS auditor and the
    private advisor are two very separate--and nobody goes to the
    IRS and says, can you structure my business deal for me,
    auditor, at the IRS. Now you are going to stop engaging, for
    your audit clients, in certain business consulting activities.
        Can I count on you, or have you decided not to be engaged
    in structuring transactions and providing advice for, then, how
    your auditors will approve those transactions that are going to
    be reported?
        Mr. Berardino. Congressman, I put a few--I said a ``good-
    faith deposit'' on the table in terms of these ideas. We need
    to have a broader conversation.
        Mr. Sherman. Because that is where I see the greatest harm.
    A number of my colleagues have talked about the idea. If you
    get paid for advising on how to set up a SPE and then you come
    in and audit to see whether it's been done right, that may be
    of greater concern, being involved in internal auditing, which
    I wish perhaps you would continue to consider, or we as a
    committee ought to consider, whether that should be an area
    that you're involved in. Because there, at least, you're
    learning something about the company.
        I would like to turn to the Enron transactions, because
    here you had phony transactions with phony entities, and all
    the discussion has been about the phony entities. Let me ask
    you if all the transactions that have been engaged with Jedi
    and Chewco and whatever, if all those transactions had been
    engaged in with legitimate, well-capitalized, genuinely
    independent entities, would Enron statements have to be
    restated in major part?
        Mr. Berardino. I don't know. I am not an expert.
        Mr. Sherman. I hope you address that for the record within
    a month or two. Finally, if the Chair would indulge me, your
    written statement from your last testimony, where you said that
    you passed on $51 million of adjustments on the theory that
    they were immaterial when they were over 8 percent of
    normalized income and over 50 percent, or about 50 percent, of
    actual reported income, can I have your assurance that Arthur
    Andersen will require the restatement of all of its clients if
    there's a matter involving 5 percent of normalized income?
        Mr. Berardino. We have worked closely, 2 years ago, with
    the SEC on the SAB 99 that came after the events in question,
    that have substantially clarified that issue. And we are giving
    our people very clear guidance on having no past adjustments.
        Mr. Sherman. But you did not, when that announcement came
    out, require the immediate change in Enron's 1997, I believe,
    financial statements?
        Mr. Berardino. No, we did not.
        Chairman Baker. The gentleman's time has expired.
        Mr. Shadegg.
        Mr. Shadegg. Thank you, Mr. Chairman.
        Mr. Berardino, I appreciate you being here, and I
    appreciate the tough position you're in. I think on the one
    hand, as Mr. Shays said, you get high marks for coming forward.
    I think your testimony is well done. I think the suggestions
    you have come forward with are appropriate and they are an
    attempt to try to improve the future.
        Clearly, we have to do some things to improve in the
    future. The tough time you are getting here though has to do
    with the past. The analogy that occurs to me, it's like you own
    a bakery shop and it is a big bakery shop, and you discover
    that some baker down in the shop, unbeknownst to you, did some
    things that were inappropriate and now you are being called to
    answer the customer standing in front of you, yelling at you
    about the bad baked goods they got and the consequences that
    came from those, which could be pretty severe.
        In this instance, the consequences are very severe, and I
    don't know how anyone in your position at the top of that
    bakery with thousands of bakers working for him can answer
    every question or solve every problem. I think you can, as you
    have done, come forward with some proposals for the future, but
    that doesn't resolve the past.
        Now, I acknowledge that you can't admit certain things
    here. I'm a recovering lawyer. There are plenty of
    practitioners that are going to be taking a look at your
    testimony, and I don't expect you to make statements that are
    going to hurt your company in the long run.
        I am troubled by a couple of different things. It seems to
    me that on the one hand, if we try to improve the system in the
    way you've outlined, without creating bright lines, hard
    rules--you cannot do this, you can do that--that we are going
    to put people back in this impossible position.
        You talked about the nuclear weapon. You guys are put in a
    position where you have a very profitable account. You lose
    that account. If you give a certain answer, you keep that
    account; if you give the other answer, we are putting people in
    an impossible position.
        It seems to me, we have to come up with hard and fast rules
    that say, for example, you cannot have an off-balance-sheet
    entity under these circumstances; and I think a lot of the
    trouble goes to FASB. A great deal of the fix has to go to
    whether FASB can be fixed or whether this Congress has to step
    beyond FASB and set some hard and fast rules.
        Going, however, to some of the questions that go backward
    to what happened, I am looking at the memo actually of a
    meeting that happened exactly a year ago today, and that's the
    meeting that is documented in this memo where it says we need
    to do certain follow-up. And it appears to me that while you
    have done a good job of saying, here's what we should do in the
    future, I don't know what you have done about Andersen
    internally with regard to these people.
        For example, on the to-dos, ``Inquire as to whether Andy
    Fastow or LJM would be viewed as an affiliate from an SEC
    perspective, which would require looking through the
    transactions and treating them as within the consolidated
    group,'' was that, in fact, done?
        This is clear back to last February and nothing came out
    until October.
        Mr. Berardino. I don't know. I would be happy to get back
    to you.
        Mr. Shadegg. Are you looking at your personnel to see if
    that was done?
        Mr. Berardino. We are looking at everything--not just our
    personnel--our processes, the way we run our firm. That is why
    we brought Chairman Volcker in, because frankly I wanted to get
    some outside perspective, not just have us be thinking in our
    usual paradigm. So I gave you some initial ideas. We will be
    coming forward with more ideas.
        Mr. Shadegg. This memo goes on to say that a special
    committee of the board of directors should be created to look
    at these ethics issues. Have you determined whether that
    special committee was established?
        Mr. Berardino. I don't know. Eventually, as you well know,
    Vinson & Elkins did work more toward late summer.
        Mr. Shadegg. It seems to me that as forthcoming as you are
    being in looking forward and the suggestions you are making to
    go forward, Arthur Andersen has to look at these individuals
    and has to decide whether they acted properly and whether they
    didn't and do something about that.
        That takes me to another troubling instant. This memo is
    written to David Duncan, and he's now been fired; and I have to
    tell you, for the all the world, he looks to me like a fall
    guy. He has now been fired over the issue of shredding of
    documents. And yet there are memos that appear in the popular
    press that I have read that suggest an attorney in your Chicago
    office by the name of Nancy Temple, in fact, pretty much
    instructed him to shred, albeit in a cagey way by saying that
    we have this policy on shredding, and then pretty much telling
    him not to or to stop the shredding. And it seems to me it is
    not doing Arthur Andersen any good or anyone in this
    investigation any good for you to try to create a fall guy.
        Did you do a thorough investigation of both Mr. Duncan and
    Ms. Temple before he was fired? And are you looking yourself
    now in terms of rehabilitating Arthur Andersen and whether or
    not it was appropriate to fire Duncan or whether or not he is,
    in fact, being made just a fall guy?
        Mr. Berardino. Congressman, I personally do not look for
    fall guys. I understand the optics of what we have done. Within
    days of finding out about this destruction, we self-reported,
    publicly reported; and on the preliminary--underline
    ``preliminary''--investigation, realizing there was some
    egregious conduct, we also brought in Senator Danforth to say
    that we are open for inspection and we are completing that
    investigation.
        So from the beginning of January, about a month ago, we
    first found out about this. And we are not looking for fall
    guys; we are looking for the truth, and we will deal with the
    truth when we have all the facts. And many people will second-
    guess what we will do, and they're welcome to, because we are
    not an organization that looks for fall guys. We are looking
    for the truth.
        Mr. Shadegg. Let me ask you two quick follow-up questions.
        Do you agree with me that we need some hard and fast rules
    here, and do you agree with me that FASB has to be a part of
    this overall review in terms of having generalized rules that
    people can bend putting them in an impossible position?
        Mr. Berardino. Congressman, I agree with just about
    everything you said. I think everything is up for grabs and we
    need to look at all these issues, including the ones you
    mentioned.
        And I want to specifically thank you for recognizing the
    hard position I'm in with all the investigations in terms of
    looking backward and admitting or denying or anything else. The
    facts will come out. This firm will be forthcoming. We have
    given every possible signal to our availability for these
    inquiries, through our actions when things went wrong that we
    prefer didn't go wrong, to let people know what the real values
    of this organization are.
        And now we are putting forward some ideas for all those who
    want to come forward as part of the solution to be involved in.
        I fully respect your points of view and I wish I could be
    even more forthcoming.
        Mr. Shadegg. I appreciate your testimony and particularly
    the suggestions you have made.
        I yield back the balance of my time.
        Chairman Baker. The gentleman's time has expired.
        Mr. Inslee.
        Mr. Inslee. Thank you, Mr. Chairman.
        You know, the thing that's most stunning to me in this is
    that as far as I can tell, no one stood up at your firm until
    the very last second of the game and said, ``Houston, we have a
    problem.'' And because no one did that personally--I am not
    talking about institutionally--but, no one took it personally
    upon their shoulders to take that stand.
        You're having a very well-deserved flogging today. But I
    want to tell you that it's not just your firm that was affected
    by Enron--I think you should be aware of this--it's the whole
    Federal Government.
        You know, first Enron captured the Administration's energy
    policy of this country and exposed the western United States to
    enormous increases in their electrical bills. Second, then they
    captured the House that passed a tax cut bill that would have
    given Enron over $250 million worth of retroactive tax relief.
    Back in the 1990s, they captured the Commodities Futures
    Trading Commission, which obtained total deregulation of their
    futures contract that formed the whole basis of this disaster.
        They have captured the Federal Government, not just your
    accounting firm. Now we are trying to do something about that
    by passing campaign finance reforms.
        Mr. Shays has been one of the great leaders on that subject
    in Congress. And we are going to have that up for a vote
    shortly, and I would like to know if you think that it would be
    helpful to regain investor confidence, the public's confidence
    not only in you, but in the Federal Government's ability to
    regulate these industries to pass a campaign finance reform
    bill. Does your company back that?
        Mr. Berardino. Congressman, I am not a politician. I'm a
    citizen. I'm a professional. That is not really my area of
    expertise, and I just really can't offer you a professional
    opinion on that.
        Mr. Inslee. We would appreciate you developing a position
    on that, because you ought to recognize, if anybody does, what
    happens when the Federal Government drops the ball regulating
    private industry. And you need to develop a position on that,
    and Corporate America needs to develop a position on that so we
    can get honest campaign finance reform through here.
        I want to ask you about this FASB situation. This 3 percent
    rule--and I'm sorry to say I was not aware of it until these
    hearings started--is one of the most ridiculous things I ever
    heard of in terms of trying to capture real economic activity.
    You have taken the same position, in essence.
        Looking at the track record of FASB and the lack of a track
    record, do you think at this moment we are going to have to
    assume some decisionmaking by elected officials who are
    answerable to the public to really get some meaningful reform
    to get these rules to really be more reflective of honest
    economic activity?
        Mr. Berardino. Congressman, I think that's a fair question.
    I don't have a strong point of view except to this extent.
        The American public--and I recognize I am speaking with the
    people today--have got to decide what they want from the
    accounting profession, from management, from the whole
    structure that we have. And one of the fundamental problems
    we've got is, nobody knows what these financial statements are
    supposed to do. And as a result, we have evolved to this
    bright-line rule-making.
        There's one opinion on derivatives that's 500 pages long.
    You need to be a rocket scientist to understand it and
    interpret it.
        So are there fundamental problems and questions?
    Absolutely. I would suggest that it starts with an honest
    conversation as to what we're trying to accomplish, and honest
    people can be in different places there. And that, I think, is
    a fair dialogue; and I think FASB and the SEC, accountants'
    offices and others need to be part of that conversation.
        Mr. Inslee. Let me ask you, in your opinion, how much have
    these failures--I will call them failures--been repeated, and
    are they being repeated right now. Let me tell you why I'm real
    concerned.
        You passed, I'm told, with flying colors what was styled as
    a peer review fairly recently. I have to tell you, that is very
    concerning to me to think that given what happened in this
    instance, you were given in a peer review a passing grade.
        How prevalent are the auditing activities that you were
    engaged in, where you essentially allowed a corporation to
    hedge with its own stock over and over and over again? How
    prevalent is that in auditing in our economy?
        Mr. Berardino. Congressman, great question. Two points:
        Number one is, the vast majority of companies wake up every
    day trying to get it right. Some cases, the rules are really
    hard; some cases, the subjective decisions are very difficult.
        Number two is, our 28,000 people in the United States wake
    up every day trying to get it right. I have been going all over
    this country speaking with my clients, and they say, who's the
    real Andersen, the one we read about in the paper or the one we
    see every day that's tough as nails, that's calling it hard,
    that's making us make the changes that are required or the one
    we read about in the newspaper? So I would suggest to you that
    this is big, this is tragic, this is something alarming here.
    But many companies, and our firm, get it right a lot.
        Chairman Baker. This is your last, Mr. Inslee.
        Mr. Inslee. I want to read you something from Mr. Powers'
    Report. He says, ``Let me say that while there are questions
    about who understood what concerning many of these very complex
    transactions, there's no question that virtually everyone from
    the board of directors on down understood that the company was
    seeking to offset its investment losses with its own stock.
    That is not the way it's supposed to work. Real earnings are
    supposed to be compared to real losses.''
        My question is, how many other corporations besides Enron
    would that statement apply to today as far as you know? Is
    this----
        Mr. Berardino. Very, very few. Many companies enter into
    SPEs. That's very common. But I would suggest to you that many,
    many companies, a vast majority, 99 percent, are trying to get
    it right.
        Chairman Baker. The gentleman's time has expired.
        Mr. Ferguson.
        Mr. Ferguson. Thank you, Mr. Chairman.
        Just an introductory comment on some of my colleagues'
    comments before. We have to be very, very careful not to turn
    this into a partisan battle. This is not a partisan situation.
    You know--we are in a fact-finding mode right now; and you
    know, one thing that we do know is that Enron made billions of
    dollars when the Clinton Administration was in power, and when
    the Bush Administration came to power, they went bankrupt. That
    is not a suggestion of anything other than there are certain
    things we need to know and there are certain things we need to
    find out. But one thing that we are realizing very quickly is
    that--as we try to score political points in this situation, we
    realize that the facts simply don't support that.
        Now, in our continuing fact-finding mode, I have some
    questions and I had some questions during my introductory
    comments. I am interested in the use of SPEs; and specifically,
    Mr. Berardino--and I realize that you are in a difficult
    position here. I do appreciate the fact that you're here. I
    realize there have been a number of questions that you have
    been unable to answer, and frankly, I think there are some you
    should be able to answer and I hope you will get back to us
    with some of those answers.
        And what I said in my introductory comments, that we are
    going to ask tough questions and we are going to expect some
    answers, we are going to ask that you get us those answers in
    as quick a manner as possible. We will expect that from other
    witnesses who did not show the courtesy of responding and
    appearing here today, and I appreciate your willingness to be
    here today.
        How many of Andersen's other clients currently use SPEs to
    keep material amounts of debt off the books? Do you have any
    estimation of that?
        Mr. Berardino. No.
        Mr. Ferguson. Can you find out?
        Mr. Berardino. We can try. Yes. Sure.
        Mr. Ferguson. Is that of interest to you? There is a
    catastrophic result in not finding out that type of
    information. In this particular situation, I would think that
    that might be something that you would be interested in finding
    out from some of your other clients.
        Mr. Berardino. As one of your colleagues mentioned, the SEC
    recently put out some clearer rules and guidance on SPEs.
        We have clearly given our people guidance to say that SPEs
    exist, the kinds of disclosures, the kinds of audit procedures,
    the kinds of discussions with boards. I don't know that we've
    accumulated which clients are in that category, but I will give
    this committee every confidence that we're all over this issue
    with all of our clients.
        Mr. Ferguson. Let's talk about credit rating agencies. Do
    you believe these agencies have fulfilled their
    responsibilities to the public?
        I'm not asking you as an expert. I'm asking your opinion.
    You're a CEO of a major company in the financial field.
        Mr. Berardino. Credit agencies--I refer to them in my
    statement; they have unfettered access to all the information
    relevant to the financial health of an organization. They made
    judgments, we made judgments; you can draw your own
    conclusions.
        Mr. Ferguson. Do we need to be considering additional
    regulatory reforms in this regard?
        Mr. Berardino. I think everybody in the system should be
    evaluated, and I would put them on my list, absolutely.
        Mr. Ferguson. They are on my list. I can't speak for the
    Chairman or anyone else in this committee, but we have
    regulatory oversight and legislative responsibility. And this
    is a tragic situation, as others have noted. And in addition to
    the frustration that I feel for those who have lost out, in my
    estimation, to others who have made millions of dollars,
    including Mr. Lay, that is an unbelievable development, in my
    estimation.
        The last question I have is that of the report that Ken Lay
    was given a fully-funded pension of a half-a-million dollars.
    Are you familiar with this? Was it audited? And can it be
    rescinded?
        How can a bankrupt company give a half-a-million-dollar
    pension to an embattled, if not problematic, CEO?
        Mr. Berardino. It's a good question, and I don't have an
    answer. I was not aware of it until you mentioned it.
        Mr. Ferguson. Thank you, Mr. Chairman. I have no further
    questions.
        Chairman Baker. Thank you, Mr. Ferguson.
        Mr. Moore.
        Mr. Moore. Thank you, Mr. Chairman.
        And thank you, Mr. Berardino, for being here. Are you aware
    generally of the timeframe in August of the year 2000 that
    Enron stock peaked at about $90 a share?
        Mr. Berardino. Yes.
        Mr. Moore. Are you aware that in August, 1 year later in
    2001, that Jeff Skilling resigned as CEO and Ken Lay became the
    new CEO?
        Mr. Berardino. Yes.
        Mr. Moore. At that time the stock price was about $43 a
    share; does that sound about right?
        Mr. Berardino. Sounds about right.
        Mr. Moore. That was August 14 of 2001. And 1 week later,
    are you aware that Ken Lay sent an e-mail to employees, touting
    the stock of Enron; and basically said that he, quote: ``never
    felt better about the prospects of the company; our growth has
    never been more certain.''
        Are you aware of that memorandum?
        Mr. Berardino. Yes.
        Mr. Moore. Do you believe that to be a truthful statement,
    accurate statement at that time in August of 2001?
        Mr. Berardino. Congressman, I have no inside information of
    what might have been in Mr. Lay's head.
        Mr. Moore. I'm not asking you about what was in Mr. Lay's
    head. I'm asking you, as the auditors for Enron in August of
    2001, and specifically about August 21, do you believe that to
    be a correct statement that the prospects for Enron were never
    better?
        Mr. Berardino. We audit and don't predict the future. I
    have no point of view.
        Mr. Moore. I am not asking you to predict the future. As of
    August of 2001, I'm asking; at that time in August of 2001,
    specifically the 21st, sometime in August of 2001, was Enron in
    good shape?
        Mr. Berardino. I don't know.
        Mr. Moore. You were the auditor and you don't know if Enron
    was in good shape in August of 2001?
        Mr. Berardino. Our firm was the auditor, and you need to
    talk to people who were closer to the account to get a better
    answer. I just can't answer that responsibly right now.
        Mr. Moore. Would you try to get me an answer for that from
    your firm?
        Mr. Berardino. We will be happy to make whatever
    information we have available.
        Mr. Moore. Would you make that information available to me
    by talking to the people who conducted the audits, and tell me
    if they believed in August of 2001 that Enron was in good
    shape, ``never been in better shape"?
        Mr. Berardino. Congressman, with respect, we do not pass
    judgments on whether companies are in great shape, terrible
    shape, and so forth.
        Mr. Moore. You give a pass and fail, right?
        Mr. Berardino. We give an opinion on financial statements,
    based on their applying the rules.
        Mr. Moore. How many SPEs were associated with Enron?
        Mr. Berardino. I don't know.
        Mr. Moore. You don't have any information as a result of
    being the auditors how many SPEs there were?
        Mr. Berardino. We can try to get you that information.
        Mr. Moore. I would appreciate that, as well. Is there an
    obligation to disclose all SPEs associated with a company such
    as Enron?
        Mr. Berardino. No.
        Mr. Moore. And that's the 3 percent rule; is that correct.
        Mr. Berardino. No.
        Mr. Moore. Correct me then.
        Mr. Berardino. Many companies have special-purpose entities
    where they move assets and liabilities off the books. The
    judgment that has to be made is, how probable is it that those
    liabilities will come back on the books, because the assets
    that had been moved off the books--you know, will it be a self-
    sustaining entity or not.
        The rules are designed for those assets to pay off the
    liabilities. If at any point----
        Mr. Moore. Why would those be moved off the books?
        Mr. Berardino. Because the company wants to show a better
    financial position, perhaps attract a lower cost of capital.
        Mr. Moore. They want to show a better financial position to
    the people who might purchase their stock, correct?
        Mr. Berardino. Yes.
        Mr. Moore. And would the people who might purchase their
    stock be in a position to know about these SPEs when a company
    such as Enron moved these SPEs off their books to show
    themselves in a better financial position?
        Mr. Berardino. The rules at the time--if the assets can
    sufficiently satisfy the liabilities, there was no
    requirement----
        Mr. Moore. I understand what the rules are. I am asking
    you--let's strike that and move on here.
        Would you support a provision for full disclosure of all
    SPEs without regard to 3 percent?
        Mr. Berardino. I support a relook of all the SPE rules,
    because they are mistaken in the first place.
        Mr. Moore. How are they mistaken?
        Mr. Berardino. We ought to use the judgment--the
    authoritative literature should look at the risk and rewards of
    the SPEs which--in this case, we're using the 3 percent--would
    be 97 percent, and therefore many of them should not be moved
    off the books.
        Mr. Moore. Is there any reason that you know of that there
    shouldn't be full disclosure?
        Mr. Berardino. Well, I think it really depends on the risks
    inherent in the SPEs. Many of these are fairly benign where the
    assets will liquidate the liabilities. And you get to the point
    where you give so much information to an investor, it's data,
    it's just information that is hard to sort.
        There needs to be a judgment at the end of the day, and
    that's why I resist some of these bright-line rules, and others
    seem to agree with that, because you need judgment as to what
    would be relevant to an investor.
        Mr. Moore. You told Congressman Inslee there needed to be a
    debate, and the American people need to decide what information
    they need. Do you remember that comment?
        Mr. Berardino. Sure do.
        Mr. Moore. Would you agree that the American people are
    entitled to full information, accurate information, so they can
    make an informed decision before they decide to purchase stock
    in a particular publicly traded corporation?
        Chairman Baker. And that is the gentleman's last question.
        Mr. Berardino. Yes.
        Chairman Baker. Mr. Cox.
        Mr. Cox. Thank you, Mr. Chairman.
        Mr. Berardino, have you read this, apparently, e-mail that
    my colleague Mr. Shays referred to earlier, from David Duncan
    in February of 2001--to David Duncan from Michael Jones in
    Houston saying about the 14-person meeting, some by telephone
    and some in person, and the purpose of that meeting was to
    determine whether to keep Enron as a client? Are you familiar
    with that memo?
        Mr. Berardino. Yes.
        Mr. Cox. Am I characterizing it fairly, that the purpose of
    that meeting, which is recounted in this e-mail, printed in
    this memo, was to determine whether to keep Enron as a client?
        Mr. Berardino. I'd just make a slight modification.
        We have meetings like this regarding every one of our
    clients, to assess the risks of the client in terms of their
    financial viability, the accounting they're using, the people
    we have assigned and, yes, the decision as to whether we would
    retain them or not.
        So I'd suggest, this is part of a process and not a unique
    meeting relative to Enron.
        Mr. Cox. Presumably, in most of those meetings you don't
    have discussions with so many people about the fact that your
    client's month-to-month earnings are, quote: ``intelligent
    gambling,'' which is stated----
        Mr. Berardino. That's a fair characterization.
        Mr. Cox. This is a pretty serious meeting, and it was a
    year ago.
        Mr. Berardino. Absolutely.
        Mr. Cox. Did you write a letter to the audit committee of
    the board on the basis of that meeting?
        Mr. Berardino. Not to my knowledge.
        Mr. Cox. Are you aware that Federal law requires you to do
    so if there's any concern about violation, for example, a
    10(b)(5) violation of the requirement to present fairly the
    financial results?
        Mr. Berardino. We are very aware of those rules, but that
    was not the context of the meeting nor the conclusion of the
    meeting.
        Mr. Cox. I'm referring to in Federal law, Section 10(a) of
    the 1934 Act, as amended by the Securities Litigation Reform
    Act of 1995, Section 10(a) which was added, imposes--and I am
    sure you are familiar with this, because you used to head up
    auditing--imposes a requirement on the auditors that if in the
    course of the audit engagement, they come across any
    information that might be illegal--and ``illegal'' is defined
    as even violating a rule--then they are required formally to
    bring it to the attention of the audit committee. And if the
    audit committee doesn't do what they like, then they are
    required to formally bring it to the board.
        The board gets one business day to notify the Commission,
    and the Commission is supposed to copy you on that letter to
    make sure that you know the Commission got it.
        Did any of those things, at any time in your representation
    of Enron, take place?
        Mr. Berardino. Congressman, I read that memo, and I didn't
    see anything in that memo and----
        Mr. Cox. You resigned the engagement. When did you resign
    the engagement?
        Mr. Berardino. We were dismissed by the client at the end
    of December.
        Mr. Cox. When did that occur?
        Mr. Berardino. I don't remember. December, sometime.
        Mr. Cox. December. At any time during your representation
    of Enron did Arthur Andersen ever follow the procedures
    outlined in Section 10(a) of the 1934 act?
        Mr. Berardino. The only situation that I'm aware of was the
    Watkins memo in late August.
        Mr. Cox. In response to the Watkins memo, did you trigger
    the process described in Section 10(a)?
        Mr. Berardino. The company took it immediately to its legal
    counsel, outside legal counsel, for investigation.
        Mr. Cox. Vinson & Elkins interviewed two Andersen partners
    that were quite sure that Andersen was on notice of everything
    that was going on with that Watkins letter and the Watkins
    meeting with Lay.
        In response to that, did you then start the procedure
    that's described in Section 10(a)?
        Mr. Berardino. I don't know, Congressman. We will have to
    get back to you with that.
        Mr. Cox. Section 10(a) of the 1934 Act also requires that
    you take into account the potential materiality, although it
    doesn't require materiality. The Act explicitly states even if
    it's not material, then you've got to start this procedure; but
    one of the things you are supposed to do in your investigation
    is to determine the litigation effect, the potential damages
    and so on.
        Did Arthur Andersen ever do that? Did you ever figure out
    how much money people might be liable for in a lawsuit as a
    result of--let me make a request; and I have discussed this
    with the Chairman, and with his permission, let me make a
    request that Andersen provide to this committee your work
    papers and any documentation of the tests that you performed
    and the analysis and estimates that you performed under Section
    10(a) of the 1934 Act.
        Mr. Berardino. Well, you know, I don't see any reason we
    couldn't provide that, but we will confer and we will be as
    helpful as we can be.
        Mr. Cox. Let me say in conclusion that your statement, what
    can an auditor do, what is an auditor to do, strikes me as
    amazingly cramped. It's a cramped view of the tools at your
    disposal.
        You don't lose your First Amendment rights to write a
    letter to your client. There's nothing preventing you at any
    time from writing a letter to your client saying ``Today, we
    have issued you a clean opinion. We have done so because
    technically you are in compliance with GAAP. We want you to
    know however, Mr. Client, that we think you are skating on thin
    ice. We disagree with the judgments you have made, and we think
    there is a serious risk that you are misrepresenting to
    investors and to the public and to everybody who depends upon
    these financial statements the results of operations. Therefore
    we strongly recommend that you make different accounting
    choices. Consider this to be an integral part of our opinion
    that we have issued today. Sincerely, Mr. Berardino.''
        There is no reason in the world you can't do it. The 10(a)
    procedure that we added in the 1934 Act to the law that we
    passed in 1995 has a formal way to do that, and it also
    provides whistle-blower protection so that nothing you say in
    such a letter could be used to hold you or any accountant that
    works for you liable in any civil proceeding.
        You are completely free to say whatever you like so far as
    the rules hemming you in: What's an auditor to do? My gosh, we
    would have to resign the engagement or nuke them there or else
    keep our mouth shut.
        There are a lot of ways in between that you could address
    it.
        Chairman Baker. That is a did-you-know, and that is your
    last question.
        Mr. Berardino. Congressman, we would be happy to show you
    whatever documentation we have on the conversations that we had
    with the audit committee. And I will tell you, there were
    meaningful conversations. So I understand your point; I think
    it's a fair point. I just want to let you know that there were
    specific conversations with the audit committee.
        Mr. Cox. I would yield to Mr. Shays.
        Mr. Shays. I think that would be helpful if you could
    submit that to the committee.
        Chairman Baker. I can assure the Members on both sides that
    all issues raised in the course of questions today will be
    summarized in a document by staff and forwarded to Andersen for
    their appropriate response on all matters raised for which
    there was no direct resolution today.
        So this matter certainly will be one of the topics on which
    we will----
        Mr. Berardino. We'd be happy to be as helpful as we know
    how to be.
        Chairman Baker. Mr. Gonzalez.
        Mr. Gonzalez. Thank you, Mr. Chairman. This is a postmortem
    on Enron. And what we're trying to do is identify an
    individual's misdeeds, shortcomings, as opposed to those that
    may be systemic; and it is not the easiest thing to do. And not
    to overreact, overregulate or overlegislate, but we've reached
    a point where something's going to get done. And it's going to
    get done real quick. And when something gets done real quick in
    the legislative body it's not always the best result. So I am
    hoping that we will cautiously proceed.
        I used to be a district court judge, and the plaintiff's
    expert accountant would get up there and evaluate an estate or
    company at $10 million. Then the defendant's expert accountant
    would say it was a minus-$250,000. And I thank God for the
    independent accountant that I would appoint to come in and
    testify.
        Now all three qualified--their credentials, their
    licensing--and they all came down and they would say they all
    applied the generally accepted accounting principles. So what I
    would ask the court's expert, then how can we have such a
    range? And he would say, garbage in, garbage out. And that was
    the quality of the data that was looked at by the experts.
        My question to you really has to do with the quality of the
    data that your people look at that's provided by the client and
    to the extent that you control the quality of that information.
    In your written testimony you say, what can an auditor do when
    financial statements prepared by management barely pass a
    current test?
        When they comply with GAAP that push the edge of the
    accounting envelope, when they disclose required information,
    but not other information that would be meaningful for
    investors, the auditor can go to the company's board through
    its audit committee. You said you conducted meaningful
    conversations--your people had meaningful conversations. You
    did take that step; is that correct?
        Mr. Berardino. Yes.
        Mr. Gonzalez. And you still felt that at that point the
    only thing you could do was give them a passing grade; whether
    they pass or not, you just move them on?
        Mr. Berardino. I am talking about that in the abstract, not
    in the context of Enron.
        Mr. Gonzalez. Well, in the context of Enron, because this
    is an Enron postmortem.
        Mr. Berardino. I can't answer that question specifically on
    Enron, because you are absolutely right about garbage in,
    garbage out.
        But the only thing I would add is, why is it OK to mislead
    an auditor or hold information away from an auditor; and we
    don't know to what extent that happened in this case.
        Mr. Gonzalez. Now the German outfit some time ago had
    enough information, less than what was available to you as the
    auditor of Enron, and came to a conclusion that those books did
    not really tell the true story.
        Mr. Berardino. I don't know what they had, what they didn't
    have, nor the basis of their conclusion.
        Mr. Gonzalez. The New York Times story, January 22, notes
    that as early as November, 2000, Andersen had concluded that
    Enron's internet servicing unit, which the company considered
    crucial to its growth, had such poor controls that there was a
    high risk that its financial results would be misrepresented.
    So you knew there were some problems going on.
        Mr. Berardino. I haven't denied that, and I just responded
    that we had meaningful conversations with the audit committee
    about some of these problems.
        Mr. Gonzalez. What do you do to guarantee the quality of
    the information that you are receiving?
        I agree with you that they have no right to mislead you,
    but you're in a position to know when they're pulling your leg.
        Mr. Berardino. And we have got human beings making judgment
    calls, and I don't know how good or bad those calls were,
    because I don't have all the facts.
        Mr. Gonzalez. Let me conclude with this. This is from your
    written testimony.
        ``In recent days''--it is not; it was a report--``Andersen
    has announced that it will no longer accept new assignments
    related to internal audit outsourcing and the design and
    implementation of financial information systems for its
    publicly traded audit clients.''
        Does that translate to consulting services, and if it does,
    did it allow you to basically design a reporting model that
    determined the quality of the information that was being
    presented out there for public consumption by Enron?
        Mr. Berardino. We did not design any accounting models for
    Enron. What we put on the table here is in response to public
    observations that we will take some of these consulting
    services off the table as it relates to our audit clients,
    because it passes those two tests I mentioned earlier.
        Mr. Gonzalez. Design and implementation of financial
    information systems. What does that mean then?
        Mr. Berardino. We will no longer do that for audit clients.
    And 2 years ago when we had debate with the SEC, we agreed that
    that would be OK to do that.
        Mr. Gonzalez. How did this manifest itself in your
    relationship with Enron?
        Mr. Berardino. We did not, to my knowledge, design systems
    for Enron.
        Chairman Baker. The gentleman's time has expired.
        Mr. Ford.
        Mr. Ford. To follow up where I think my friend was going
    with regard to Andersen's suggestion that you would no longer
    design or implement these financial information systems for
    your future audit clients, aren't these types of consulting
    engagements, Mr. Berardino, a fraction of the consulting work
    that Andersen performs for its audit clients?
        To what extent rather does this represent----
        Mr. Berardino. That information is public knowledge.
        Mr. Ford. That may be true, but just to what extent. I am
    not that bright.
        Mr. Berardino. It's meaningful. It's not 100 percent.
        Mr. Ford. How much of the $52 million in fees you received
    from Enron last year are attributable to this type of
    consulting work that you now propose to discontinue?
        Mr. Berardino. Very little.
        Mr. Ford. Say the system was in place beforehand. To what
    extent--and I know, again----
        Mr. Berardino. The number would not have changed
    significantly, because the nature of the work we were doing for
    Enron was accounting and auditing related.
        Mr. Ford. I would imagine that this controversy in the wake
    of this controversy is what motivated this proposal on the part
    of Arthur Andersen.
        Mr. Berardino. Actually, Congressman, with permission, this
    is not the test case. Enron is not the test case in terms of
    the nature of the work we were doing, being auditing our own
    work. There are many other companies where we do quite a bit
    more either in absolute dollars or percentage-wise.
        The reason we have taken this step is because I think in
    the current context it is important that my firm, my
    profession, builds more confidence in the public in terms of
    potential conflicts of interest and the quality of our
    auditing. And I thought from a public positioning standpoint,
    this would be an appropriate step.
        Mr. Ford. The only reason the public is even interested in
    what you guys do is because of what happened. This case is such
    a high profile. And forgive me for presupposing, but maybe this
    was motivated by the failure of this company.
        So can I take it, perhaps the motivation for this, also,
    that one can glean from this proposal is that this is perhaps
    an admission on the part of Arthur Andersen that maybe you were
    wrong to oppose Mr. Levitt's recommendations?
        Mr. Berardino. Well, you know, frankly, I challenged Mr.
    Levitt on those proposals.
        Life goes on, and I do think it's important that we respond
    to public perceptions, and that's what we're doing.
        Mr. Ford. Is this----
        Mr. Berardino. Let me be honest with you. I don't think the
    fact that we will not do this work will make us better auditors
    tomorrow. I think some of the other proposals they put on the
    table will move us in that direction more clearly.
        Mr. Ford. Of the $5.7 million you received for your
    services, how much of that was for the design and
    implementation of these financial information systems?
        Mr. Berardino. None.
        Mr. Ford. You have suggested withholding of material
    information from an auditor should be made a felony. Are you
    willing to go on record saying that the destruction of audit-
    related documents should also be classified as a felony?
        Mr. Berardino. Congressman, as you know, we put the
    limelight on that issue. I am embarrassed at what happened in
    my firm. And I have been forthcoming in reporting it and
    forthcoming in inspecting it, bringing in Senator Danforth, a
    man by who all reports enjoys many peoples' respect, to help us
    come up with the best possible policy and, hopefully, a model.
        Mr. Ford. But you've taken the bold step of suggesting that
    if your clients withhold this information, that that should be
    classified as a felony. Shouldn't destruction of documents,
    audit-related documents, also in the same vein, be classified
    as a felony?
        Mr. Berardino. I think it already is, Congressman. If you
    purposely destroy documents that you think are relevant to an
    investigation, but, you know, it's inappropriate, it should be
    unlawful. I agree.
        Mr. Ford. We have heard, as I stated in my opening, we've
    heard of other instances of document destruction by auditors in
    the wake of a problem audit. Grant Thornton being an example,
    another big accounting firm, destroyed documents during
    litigation of a failed audit, and it seems that we may be in
    need of industry-wide retention policies that include severe
    penalties for offending accounting firms.
        Your commitment today--I understand that you've been asked
    some pointed questions from my colleagues, and I associate
    myself with what Mr. Cox has requested of the Chairman, and I
    hope that he accommodates him, but would you be willing today
    to support mandatory retention, availability of all audit work
    papers and other audit-related documents so that the investing
    public can look behind those audits and make their own
    judgments about the financial health of companies in which they
    wish to invest?
        Mr. Berardino. I don't know where the white line is,
    Congressman. I am prepared to have that discussion. We've taken
    a public lead there, and so in good faith, we'd be more than
    happy to take whatever advice to get to the right answer, but I
    can't be any more specific than that right now.
        Mr. Ford. Maybe I should--and there's two quick questions.
    You said you'd be willing to cooperate. Are you willing
    cooperate with--to the extent you can with the lawyers for the
    defrauded investors and the lawyers for those investors who
    believe they were defrauded and cooperate with the lawyers for
    the employees at Enron?
        Mr. Berardino. I have a feeling they'll want me to
    cooperate, but absolutely.
        Mr. Ford. Last question. I'm a little--I'm reading through,
    and everyone has sort of referenced Mr. Powers' document here,
    and I think this has been an education for everybody about how
    and what auditors do, and companies like the kind of work and
    the advice that you provide, but I'm slight--my understanding
    of these four words, and I just--I graduated from law school. I
    know I look like I just graduated from law school, but I did
    graduate a few years ago.
        But in page 5 of Mr. Powers' Report, it says in virtually
    all of these transactions, referring to Chewco and LJM, Enron's
    accounting treatment was determined with extensive
    participation and structuring advice from Andersen which
    management reported to the board. What does extensive
    participation and structuring advice mean in the eyes of folks
    in your community, because maybe I don't understand what
    auditors do, but my just sort of initial elementary
    understanding would suggest that extensive participation means
    you did a lot.
        I know we come out with these words dislocation, meaning
    you lost your job or--but extensive participation from where I
    come from means you did a lot, and structuring advice means you
    helped them put the thing together. Maybe you didn't do that,
    but could you respond to maybe what those terms, in your eyes,
    mean, sir?
        Chairman Baker. That's the gentleman's last question.
        Mr. Berardino. We're trying to communicate on this one.
    Investment bankers come up with these ideas, or the finance
    department or somebody other than us. It's not like we are
    running around town shopping these ideas. Our client comes to
    us and says here's the transaction we want to do, we think this
    is the accounting answer. Do you agree? And we say no a lot.
    OK. The company comes back and says OK, will this pass? No. OK.
    They come back. OK, now it passes the test. Now, to some people
    that's called structuring the transaction. To an auditor that's
    called standing up and defending what the right accounting
    should be. And so, I'm not smart enough to know what word to
    use for that kind of interactive conversation, but that's what
    was going on.
        Mr. Ford. But you did eventually say yes after those
    questions that they reported back----
        Mr. Berardino. Absolutely. Yeah.
        Mr. Ford. Thank you.
        Chairman Baker. Mr. Lucas.
        Mr. Lucas. Mr. Berardino, do you think it's possible that
    your people who were on site at Enron were lured into the
    mystique and success and the glamour of Enron, and in my
    vernacular, they were just going along kind of fat, dumb and
    happy sort of in the land of milk and honey and human nature,
    being what it is that your people really lost their
    objectivity, even though they were well intentioned that they
    got involved in the glitz and glamour of the Enron environment?
        Mr. Berardino. Congressman, that's a good question and I'm
    a student of human nature and recognize why you ask that
    question. I certainly hope not. All I know is I've been in this
    business for 30 years. I know our people really well and they
    wake up every day trying to do the right job, trying to make
    the right judgments. Whether or not people went over that line
    or not, you know, I can't tell you.
        Mr. Lucas. It was interesting to me that they said you had
    offices there and your employees wore the Enron shirts, and I
    just wondered if they got wrapped up in the web of that
    culture, and even though they were well intentioned, they lost
    their objectivity. One of the things, I think, Mr. Chairman,
    that we ought to do is if we could talk to some of the folks
    that were on site, and maybe if you have a chief of the audit
    or something and if we could talk to some of those people,
    because I understand you can't answer those questions, but
    obviously, some of the people on the site could. I think that
    would be very insightful. That's all I have.
        Chairman Baker. Thank you, Mr. Lucas.
        And Chairman Oxley and Mr. Kanjorski and I have discussed
    this, and we certainly will try to accommodate the committee's
    interest on those requests.
        Mr. Crowley. Thank you, Mr. Chairman. As low man on the
    totem pole here, it takes a while to get down to someone like
    myself and many of the questions that I intend to ask were
    asked especially by my good friend, Mr. Ford from Tennessee,
    but there are a number of things that still are not very clear
    to me. And Mr. Berardino, your firm acted as an inside
    accountant, an outside auditor, as well as a consultant; is
    that correct, for Enron?
        Mr. Berardino. What was the first phrase you used? Inside--
    --
        Mr. Crowley. In other words, you looked on the outside, you
    did things on the inside in terms of accounting, you did things
    as an auditor looking outside as well?
        Mr. Berardino. We were auditors. People keep saying we did
    internal auditing. At one point we did, but most recently we
    gave an opinion on the internal control.
        Mr. Crowley. When was that done? What would the date on
    that have been?
        Mr. Berardino. It was reported in their year 2000 annual
    report.
        Mr. Crowley. So between 1997 and 2000, you did do internal?
        Mr. Berardino. We may have done some, but it was less and
    less. What happened was that the early years, as they were
    building the company, we did internal auditing, and then that
    declined over time.
        Mr. Crowley. So in your second recommendation that you
    made, and we appreciate the recommendations you made, and I'll
    quote. It says to address concerns about potential conflicts of
    interest, Andersen will no longer accept assignments from
    publicly traded U.S. audit clients for the design,
    implementation, on and on. Do you or do you not admit now,
    after your testimony and hearing from Members of Congress, that
    a conflict of interest does exist, that it's not just a
    potential conflict of interest, that there are serious
    conflicts of interest here?
        Mr. Berardino. I guess I don't agree. I think there is a
    perception that there could be, and all I'm saying is that
    perception is important and we are responding to it.
        Mr. Crowley. Your firm helped to establish, the degree to
    which is arguable, Chewco, LJM1, and LJM2.
        Mr. Berardino. We did not help to establish. We reviewed
    the accounting that others developed.
        Mr. Crowley. Did you consult on those?
        Mr. Berardino. We gave advice.
        Mr. Crowley. You gave advice. In the vernacular I come
    from, giving advice means to help someone, but that's another
    story. We'll come back to that later on. In giving that advice,
    your company profited from that; correct?
        Mr. Berardino. We were doing an audit. We answered
    questions. We said no a lot, and we said yes at the end of the
    day to those transactions. If that's advice or consultation--if
    you think that's what it is, that's fine. In my vernacular,
    it's something different. It's called part of the audit. You're
    always looking at transactions and assessing what the right
    accounting should be; so----
        Mr. Crowley. But you profited from giving that advice?
        Mr. Berardino. Yeah. We received fees for----
        Mr. Crowley. In essence, consent?
        Mr. Berardino. Yeah.
        Mr. Crowley. You consented to it? Through your firm you
    consented to it?
        Mr. Berardino. Absolutely.
        Mr. Crowley. You okayed it? You okayed entities that the
    sole purpose, the special purpose, the only purpose was to
    defraud and to dupe. Your firm okayed that; is that correct?
        Mr. Berardino. I disagree with your characterization,
    because I don't know what was in people's mind when they
    designed the transactions. We saw the transactions. We applied
    the accounting to the extent we thought it was appropriate.
        Mr. Crowley. And as a result of the creation of those
    entities, tens of thousands of people have lost their jobs,
    tens of thousands of people have lost just about everything
    they had ever invested in their lives.
        Mr. Berardino. Congressman, I have stated often my
    sympathy, sincere sympathy to people who have lost their money.
    I will also suggest that this company made bad business
    decisions by their own admission. They made investments that
    didn't pay off. That's what went wrong. How they designed it is
    part of the conversation, absolutely.
        Mr. Crowley. It's not entirely all your fault--it's not
    personally your fault, although there may be some
    responsibility here. What we're trying to get to is the bottom
    of what caused this, the collapse of one of the largest
    corporations in the history of this country, and have really
    left the little guy and gal holding the bag, absolutely nothing
    in it when everyone else gets to walk away with big bucks. And
    the people that I represent and the State that I represent, New
    York, is looking at enormous losses where pension funds, as
    mentioned before, were looking at enormous losses and the
    little guys walked away with nothing because of the accounting
    mistakes that your firm made.
        Mr. Berardino. Congressman, I can't let that stand. This
    company failed. Whether the accounting was appropriate, whether
    we had all the information, these are fair questions that we
    will all get to the bottom of, but at the end of the day, we do
    not cause companies to fail.
        Mr. Crowley. Mr. Chairman, I would just ask that--I believe
    there is more information that is needed and I would ask that
    you issue the requisite subpoenas to individuals that would not
    come forward voluntarily, as you have, and for those documents,
    whatever is left at Andersen, to be brought forward as well
    that would be pertinent information to this committee and to
    the findings that what we are trying to----
        Mr. Berardino. I will remind this committee that there are
    millions of documents that we still have that are relevant and
    we have been nothing less than forthcoming.
        Chairman Baker. I take Mr. Berardino at his word. He has
    indicated his willingness to provide the committee with
    appropriate information under his control and access to
    individuals, and the committee will do so.
        Mr. Crowley. Mr. Chairman, I only make the point that if
    individuals are not forthcoming, that those individuals be
    subpoenaed to come before this committee. That's what I'm
    saying.
        Chairman Baker. As you're aware, we've already taken an
    action with regard to a particular individual and the authority
    of the subpoena has to be specific. As we find individuals
    whose content and information would be helpful to the
    committee, we certainly will act in appropriate fashion. Thank
    you, Mr. Crowley.
        Mr. Sanders, you're recognized.
        Mr. Sanders. Thank you, Mr. Chairman. I'm not a Member of
    this subcommittee, and I appreciate your allowing me to
    participate. Mr. Chairman, if there is--and I don't know if
    there is, but if there is a silver lining in the whole Enron/
    Arthur Andersen disaster, it is that the American people I
    think are beginning to catch on about the need for a wide
    variety of reforms in the way Government does business. For a
    start, if my understanding is correct, Arthur Andersen has
    contributed some $5 million to the political process, Enron
    contributed more, and to a large degree, sad to say, the
    Congress of the United States is significantly controlled by
    big money interests like Arthur Andersen, who contribute huge
    sums of money to end up getting their way and I hope that out
    of this will come strong campaign finance reform.
        Second of all, in terms of the pension situation, I think,
    and I fear that many millions of Americans thought all they had
    to do was invest in the stock market and their assets would go
    up 15 to 20 percent a year and everybody would become rich.
    Well, it ain't that easy. And I know that some people want to
    privatize Social Security, and I think maybe the debacle that
    is taking place might make some people think twice about
    allowing Americans to invest substantial parts of their money
    in the stock market rather than in the guarantees that the
    current Social Security system provides.
        In terms of accounting reforms, let me just mention
    something about Arthur Andersen. You know, sometimes we think
    that gee, isn't it too bad that Arthur Andersen may not have
    done a good job with Enron, but let's look at their track
    record in recent years, and Mr. Berardino, you tell me if I'm
    missing anything here. Just last June, Arthur Andersen was
    fined $7 million by the SEC for fraudulently cooking the books
    of Waste Management. Were you fined $7 million, sir?
        Mr. Berardino. Yes.
        Mr. Sanders. A month earlier, Arthur Andersen agreed to pay
    $110 million to settle an accounting fraud lawsuit over the
    firm's audits of Sunbeam. Am I correct in that statement, sir?
        Mr. Berardino. Yes.
        Mr. Sanders. In addition, your firm was in charge of
    auditing the largest issuer of junk bonds in Asia, a company
    called Asia Pulp & Paper, which is now undergoing one of the
    largest bankruptcies in Asian history and is $12 billion in
    debt. Andersen is being sued for cooking the company's books by
    some $220 million. Is that a correct statement, sir?
        Mr. Berardino. They have been a client, yes, sir.
        Mr. Sanders. And are you being sued?
        Mr. Berardino. I think so.
        Mr. Sanders. OK. In Australia, Andersen has allegedly
    cookayed the books of HIH Insurance to the tune of some $470
    million. This company is now undergoing the largest bankruptcy
    in Australian history. In Britain, because of Andersen's
    involvement in the collapse of the luxury car manufacturer,
    John DeLorean, England banned Andersen for years from bidding
    on Government contracts. This ban was lifted in 1977.
        Bottom line is that it's not just Enron, and it is a scary
    situation. I was a mayor of a city for 8 years. We had to look
    at the judgment of auditing firms to tell us what kind of
    investments were appropriate for the city. Millions of
    Americans look to auditing firms for independent objective
    judgment. Mr. Chairman, I would suggest that Americans now are
    going to look twice before they accept the judgment of Arthur
    Andersen and perhaps some of the other auditing giants in this
    country, and I think it's not just--everybody else here has
    touched on the conflict of interest situation. I absolutely
    agree, but I think it goes beyond that and I think Americans
    now have real doubts about the ability of some of these large
    auditing firms to tell them the truth about the financial
    condition of the companies that they are working for and, in
    fact, what we may need to do is move beyond private auditing
    firms and to some Government agency giving us some type of
    objective analysis about what a company is doing before people
    are going to invest in that company.
        Mr. Berardino, I want to congratulate you because I
    understand that your company was successful in keeping Enron
    from paying taxes for 4 out of 5 years, and they received, in
    fact, $382 million in tax refunds through the creation of
    offshore tax shelters. I wonder if you would be prepared to
    spread your wisdom to the middle class of this country, the
    poor suckers who actually have to work hard and pay taxes while
    you and your friends were able to get Enron to avoid paying
    taxes.
        Now, I wonder--you got some consulting fees at a time when
    thousands of Enron workers have lost their retirement savings.
    I was wondering if you feel any obligation on the part of your
    company perhaps to take some of those consulting fees and put
    it into the fund for Enron employees so that some of them can
    get a few bucks back rather than losing everything they had. Is
    that something that Arthur Andersen might consider?
        Chairman Baker. And that's the gentleman's last question.
    Please respond.
        Mr. Berardino. I responded to that earlier, but I would
    like to just put on the record two things: We have 2,500 public
    companies in this country. We get a lot of it right, almost all
    of it, and from time to time, we've had failures and we're not
    pleased about that. Second we did not design this company's tax
    position----
        Mr. Sanders. You did not work on them with their tax----
        Mr. Berardino. No. Another firm worked with them on their
    tax. We audited the tax expense, which is very different from
    structuring.
        Mr. Sanders. But you apparently thought it was Okay for
    them to set up these offshore companies and not pay taxes for 4
    out of 5 years.
        Mr. Berardino. All I'm suggesting is for the record, we did
    not design those. We audit and report on what the results of
    those entities are all about. Big difference.
        Chairman Baker. The gentleman's time has expired.
        Mr. Sanders. Thank you, Mr. Chairman.
        Chairman Baker. Also with us today is Ms. Jackson-Lee, not
    a Member of the committee, but she has been patient in waiting
    her time and I recognize her for 5 minutes.
        Ms. Jackson-Lee. Thank you very much, Mr. Chairman. And as
    I said yesterday, I thank you for committee's indulgence and
    that of the Ranking Member, Mr. Kanjorski, and of course Mr.
    Oxley and Mr. LeFalce.
        Let me thank Mr. Berardino for his presence here. He is
    here without, as I understand it, being subpoenaed. I am not a
    Member of this committee. Enron happens to be in my
    congressional district, and thereby there is a great deal of
    concern in our local community, and in particular among the ex-
    Enron employees and retirees. Just this morning, one of the
    employees testified before the Governmental Affairs Committee
    on the Senate side and noted language, Mr. Chairman, that I
    would like to include in the record.
        If I have it correctly, it was a theme that was used by
    Enron employees, and I think many of us have been struck by the
    enormous loyalty that these people have had or still have to
    the company and its mission. They use the term ``RICE'',
    respect, integrity, communication and excellence. As I was
    sitting next to one of the employees, they were able to recite
    it for me with great appreciation for what it means. I believe
    that this is what we have lost in light of the facts that have
    been unfolding, and let me just say to provide you the facts.
    You did not recall the dates. Let me say that for the record,
    Enron filed for bankruptcy on December 2, a Sunday, as I recall
    it, 2001, and 4,000, many of whom are my constituents, were
    fired on December 3, 2001. You were not terminated and Arthur
    Andersen, until more than a month later, January 17, 2002.
        So the employees lost all the way around. I am wondering,
    Mr. Berardino, with respect to the question of independence.
    Objectivity, integrity and independence are words that I use.
    What was the responsibility of Arthur Andersen? Did you engage
    in giving advice to the board on the structures, these off-
    line, off-budget companies, and how much of that advice did you
    give?
        Mr. Berardino. Well, this $5 million people refer to over 5
    years, we responded to the structures, the investment bankers
    and the finance department brought to us. We did not structure
    those deals. We gave, as an auditor needs to, an opinion on
    what the right accounting was.
        Ms. Jackson-Lee. Do you believe that you were providing
    advice around 1999?
        Mr. Berardino. I'm sure we were.
        Ms. Jackson-Lee. The Powers Report, which I'm sure you have
    read, has made it very clear that the minutes of the finance
    committee reflect that Arthur Andersen was giving them advice
    on the structures. In particular, they indicate that Arthur
    Andersen provided substantial services with respect to
    structuring and accounting for many of the transactions, that
    it reviewed Enron's financial statement disclosures with
    respect to the related party transaction including
    representations that the terms of the transactions were
    reasonable, and no less favorable than the terms of similar
    arrangements. You had a witness that testified some months ago
    that indicated that you did not have any involvement; yet board
    minutes reflect that you did have involvement in giving advice
    on these structures and transactions. Can you not recollect
    more clearly how intense that advice was?
        Mr. Berardino. I can't right now.
        Ms. Jackson-Lee. Wouldn't you think the board would be
    entitled to rely upon Andersen's involvement and as well would
    reasonably expect auditors to raise questions to their client,
    the audit and compliance committee, if confronted with
    transactions whose economic substance was in doubt? Do you
    think that's part of the responsibility in your role as an
    auditor?
        Mr. Berardino. I'm not exactly sure what your question is.
        Ms. Jackson-Lee. My question is, is it not the
    responsibility of an auditor if you are, in fact, engaged in
    providing advice on these structures and transactions that if
    you see a red flag or if you believe that these transactions
    are, if at best, minimally weak and nonsupportable, to raise a
    flag to the audit and finance committee of the board?
        Mr. Berardino. And as I--the answer's yes and----
        Ms. Jackson-Lee. Did you do that? Did Arthur Andersen do
    that?
        Mr. Berardino. We will supply you with information we have
    on what those conversations were with the audit committee.
        Ms. Jackson-Lee. I am probably more used to seeing
    accountants, though I respect the need for companies to get
    advice with those very thick eyeglasses and being the straight
    and narrow individuals, and I'm sure you have a great deal of
    respected and responsible employees, but sitting at their
    desks, if you will, and looking at the numbers and telling the
    facts, it comes to my mind that Global Crossing, a company that
    you advised, you got $2 million, $2.3 million in auditor fees
    and $12 million for non-audit work.
        I don't know where all this money came from in the
    accounting business now, but how can we look to an objective
    assessment on the auditing feature if you have so much money in
    non-audited responsibilities? Isn't that an enormous conflict?
    Did that not raise a flag in the work you were doing for Enron
    that you would yield to the more important responsibility, I
    believe, of auditing and telling them what's going on with the
    books in order to protect pensioners, retirees and employees as
    opposed to, I guess, falling for this large sum of money in the
    non-audit work?
        Chairman Baker. And that would have to be the gentlelady's
    last question, but please respond.
        Ms. Jackson-Lee. Thank you, Mr. Chairman.
        Mr. Berardino. We take our responsibilities as auditors
    very seriously. I'm trained as an auditor and I'm proud of it.
    It's a hard job and our people are trained to do the right
    thing, to raise the red flags when they see them, and we do
    that day in and day out, but we are human beings and we may not
    get it right every time. I'm not apologizing for that, but I'm
    telling you that we take this role extremely seriously.
        Ms. Jackson-Lee. Mr. Chairman, I thank you very much.
        I don't want you to apologize to me, Mr. Berardino, but I
    do think you owe an apology to the employees and the pensioners
    and retirees. I thank the Chairman very much.
        Chairman Baker. Thank you.
        Mr. Berardino, I have the intent to go a little further. I
    know this has gone on for quite some time, but I think it
    appropriate now to focus rather than on the identifiable
    problems, but more importantly, as to some specific elements in
    addition to your own recommendations of approaches the
    committee might consider in light of the circumstances that we
    have discussed here at length.
        With regard to ethical conduct, as I understand the rules
    at the moment and the discussion you had with Mr. Cox relative
    to provision 10A of the 1995 Act, that if there is a discovery
    by an audit team member of an action which violates the law,
    then there is an obligation to report and a process which is
    followed.
        Is it advisable to have a similar requirement when the
    audit team member discovers an action is to be taken by the
    corporation that would result in a likely deterioration of
    shareholder value? Now, that is a business judgment, and I
    understand the difficulty of second-guessing the management,
    but where there is a strongly held opinion sufficient for the
    audit member to take this to a higher level, shouldn't we
    require that audit member to take that action where, in the
    case of one of the questionable SPE's, he feels uncomfortable
    that the financing mechanisms in place are really to obstruct
    the public view of the risk the corporation really is
    undertaking by its creation?
        Mr. Berardino. Well, Congressman, Mr. Chairman, I think
    this gets to the heart of the matter in terms of our
    responsibilities as auditors. At present, we are responsible to
    go to an audit committee. They are elected by the shareholders.
    Is that enough? I think we need to have a conversation about
    what is appropriate corporate governance and can it be
    improved. These are very difficult judgments and we could be
    accused of prematurely raising some flags that may be
    inappropriate, and so we need to think that through and I----
        Chairman Baker. If you go to the audit committee today and
    you are basically outvoted and the audit committee chooses to
    proceed, at least the audit team then should report to someone
    in management of the firm and a firm determination made as to
    whether you should report your disagreement to an outside
    entity, whether it be an office within the SEC, a specially
    created new committee. I don't suggest we go to FASB, frankly.
    I would like a more timely resolution of these matters, but in
    concept, is that something based on the facts and management's
    ability today?
        And I will relate to your earlier comment, I was giving you
    business school philosophy where the board establishes the
    audit committee who engages the audit and the audit is for the
    benefit of shareholder protection, and your view, and I suspect
    the view of many, is that the audit is the property of the
    corporation as well as the shareholders; therefore there is a
    dual master. Should we not separate that dual responsibility
    and make, first and foremost, the obligation to report to the
    audit committee and have the audit committee report to
    shareholders?
        Mr. Berardino. I think there is a lot to talk about there.
    You know, I think that's a fair point. I would also suggest one
    of points that I put on the table, which is this grading system
    that we might develop so that not all audit opinions look the
    same and that the judgments that companies make from, let's
    say, on-the-line aggressive to very conservative, that there's
    a way of communicating that to the public.
        Chairman Baker. I think it goes to the heart of whether we
    maintain the current corporate audit relationship or whether
    something extraordinarily culturally different is engaged. If
    you're going to be paid ultimately by management and feel a
    responsibility to management where management has a plan that's
    not consistent with appropriate corporate governance or at odds
    with shareholder interest, the auditors should not only have a
    sense of responsibility, but an obligation to make that known
    to someone.
        Now, before it becomes public information, it could go to a
    Government office where a judgment could be made. For example,
    if it were the case where a manager sat across the table from
    one of your audit team managers and said we don't like the way
    you've constructed these footnotes or this financial report and
    unless you change it, we're going to go find someone else, what
    has been suggested so far is a remedy for a bad auditor.
        Let's assume the reverse. Let's assume we have a good
    auditor and a bad manager. Where is your relief? To whom can
    you go other than to be fired? We should have a place where you
    can seek counsel confidentially, beyond public view, and get
    assistance and a determination that your recommendations are
    appropriate and have consequences for management. Is that an
    acceptable structure to consider?
        Mr. Berardino. Mr. Chairman, I think everything should be
    considered and I applaud the direction you're going in. It's a
    little out of the box, but we need some out-of the box
    solutions.
        Chairman Baker. I think we have got some out of the box
    problems is a real observation, and where you have management
    and an audit team that, for whatever reason, views the world
    similarly, then we either have outside folks looking at the
    auditing or have liability on the board and the audit committee
    of the board to have some corporate governance liabilities for
    their failure to act.
        It appears to me in this case that neither the audit
    committee nor the board of directors took action appropriate
    based on the information they should have had access to. I also
    like Mr. Ford's suggestion with regard to mandatory document
    retention. In my modest recordkeeping that the IRS requires of
    me, I have to keep my boxes for 7 years. It seems only fair
    that there should be some statutory requirement for similar
    retention regardless of the matter if it's pertinent or
    material to the financial condition of the corporation.
        Mr. Berardino. I agree.
        Chairman Baker. Another element that I have observed is
    that where no--cost options are granted to insiders or
    executives and by whatever manner the value of the stock is
    enhanced either by the effect of the SPE or some announcement
    which may not be, on all corners, accurate, stock value goes
    up. Six months later there is a mandatory restatement. Stock
    value goes down. But in between, the executive has exercised
    his option. He doesn't have to give his money back. The
    shareholder takes the full extent of the loss. What would be
    wrong with a requirement that if there's a restatement of
    earnings and an official exercises a no--cost option in any
    period preceding that restatement of 12 months that he gives
    the money back?
        Mr. Berardino. I think what you're getting at here, Mr.
    Chairman, is a rethink of corporate governance and incentives.
    I think we need to look at what the incentives are----
        Chairman Baker. Well, here's the incentive.
        Mr. Berardino.----versus what they might be.
        Chairman Baker. If I run this company well, I have an
    option. The value's going to go up. I'm going to make a bunch
    of money. Here's the dilemma. If I run this company poorly and
    obfuscate the facts and inflate the value, I'm going to make
    money. Let's make a penalty. If you don't run it properly and
    you're inflating earnings and stock prices arbitrarily out of
    manipulative reporting, you're going to have to give the money
    back, and if we find that it's fraudulent, you're going to have
    to give back more than just the money.
        Mr. Berardino. And if you mislead your auditor
    intentionally----
        Chairman Baker. I'm for that one.
        Mr. Berardino. ----withhold information, and there ought to
    be a qualitative assessment as to how rigorous the accounting
    is.
        Chairman Baker. I've got that one down. That was my next
    one. Withholding material information from the audit team is a
    felony. I think if we keep the records, we know that there's
    going to be a consequence for withholding. We know there's
    going to be a consequence for artificially pumping up the stock
    price. If we say to the board of directors, you're responsible
    for managing the audit team member, if you're intimidated or
    told by management to do something you think is not only in
    contravention with GAAP, but is materially adverse to the
    shareholders' interest, you have an obligation to report that
    fact to somebody, and we'll create that somebody in some office
    somewhere so you can go speak to them and get advice, and if it
    is not corrected, then they can take action against the
    corporate board. You get your fee, and we get the financial
    statement in the appropriate fashion that it should be for the
    best public interest. Now we're starting to get a legislative
    package that makes some sense.
        Mr. Berardino. Well, Mr. Chairman, and I'd just remind you,
    one of the suggestions I've made for my firm is that if anyone
    is uncomfortable with the decisions being made on the audit
    that there will be a separate office that they could go to on a
    no-name basis to make sure we get to the bottom of it quickly.
        Chairman Baker. I think if we do this in a statutory mode
    in a corporate governance manner, that the consequence of this
    would be to have exactly that occur within that corporation,
    within the audit community, and to have the board of directors
    of a corporation understand their liability should they not get
    it right. I see what has happened here is that a lot of people
    made decisions for which there was no downside risk other than
    the bankruptcy of the corporation. If it is, in fact, true that
    Mr. Lay's pension buildup insulates him from the loss of his
    $475,000 for the remainder of his life and all these
    shareholders and employees lost everything, I have a view that
    resources were being improperly managed for the benefit of a
    handful of people and information flows were curtailed, and it
    may be worse than that.
        So there's one other step. One way to have audit
    independence is to put all these blockages, warnings,
    prohibitions and disclosure requirements. Another way, which is
    not my suggestion, but one I have read and found very
    intriguing, is to have the external audit engaged by the
    exchanges and have the auditor report simultaneously to the
    corporation and to the exchange to be paid by fees collected on
    stock transactions. You are not then engaged by the
    corporation. You are clearly engaged by a third party for the
    benefit of the shareholders who have their investment in that
    corporation. This is a relatively old idea, but I have read
    recently people discussing the advisability of that. Do you
    have a comment about that approach?
        Mr. Berardino. I'd need to think about that a little bit.
    One of the concerns you need to consider is each firm has, over
    the years, developed areas of expertise and whether or not
    you'll be able to make those assignment so that the best
    expertise is available to a client would be one question I'd
    ask, but I think this kind of thinking is appropriate and I'd
    like to give it a little more thought. That would be my first
    reaction, though.
        Chairman Baker. I will include that on the long list of
    inquiries, to get the best professional advice possible on a
    cultural change in the way the corporate/audit relationship is
    structured or the best way if we maintain the current
    methodology to ensure that there is transparency and disclosure
    recordkeeping and most importantly, liability for not
    conducting your professional obligations appropriately. I've
    gone on for a bit, but if your folks are hanging in here, Mr.
    Kanjorski, did you have another series?
        Mr. Kanjorski. Other than those on the list that you have
    already expressed, there are other things that I am certainly
    interested in. In the policy area, Mr. Berardino, I am
    particularly worried about how far the Government should get
    into being the final determiner of how the private market
    operates. Should we be attempting to find some way to put a
    Good Housekeeping Seal of Approval on either audits or company
    activities?
        I am actually more interested in the whole theory of these
    off-balance sheet transactions and how prevalent they are.
    Obviously if they are for the purposes of spreading risk, I can
    see the advantage to operations like these, but are they now
    being misused and abused in your estimation?
        Mr. Berardino. Well, Congressman, I haven't done a study of
    that; so with that caveat, there are billions of dollars of
    off-balance sheet transactions. Most of them are very benign.
    Where there is very little risk to the asset, the asset will
    pay off the liability and many of us could quickly agree that
    it's an appropriate transaction. The question is really
    evaluating the risk of that asset being able to pay off the
    liability and I'm just not smart enough, I don't have enough
    context to tell you to what extent that is a risk out there. I
    think it's a relatively minimal risk, but that's not based on
    any scientific analysis.
        Mr. Kanjorski. How far do you think the Government should
    get into the accounting profession and into corporate
    governance of public corporations?
        Mr. Berardino. Well, I've always come from the camp that
    our profession should be self-regulated, and recognize the need
    to have some outside influence beyond accountants to discipline
    and oversee the profession. No question this body represents
    the people and the people have gotten engaged in this issue in
    a way that they've never engaged before, and I would hope we
    could come out with a better answer.
        I've given you some of my ideas. I worry about the
    Government being too intrusive, because I do think the
    shareholders elect their representatives to sit on a board and
    understand what's going on and to protect them, and upon
    occasion that will not work; and the question is whether or not
    we need more Government involvement to reduce that. But I'd say
    in this context, this is a fair conversation and I'm not going
    to sit here telling you that I've got a firm point of view. I'm
    agnostic. I want a better solution, because I, as I started to
    say earlier, we have lots of different bodies regulating us,
    and I'd like to have one do it right rather than this piecemeal
    patchwork approach that we have now. It's just not helpful. So
    I'm agnostic. I could get to a different answer. I think
    today's conversation hopefully gives us a little more
    information so that we can collectively come up with something
    that makes sense.
        Mr. Kanjorski. Well, do you look at Enron as an aberration
    or is it systemic? I am sure we are not going to see anybody
    else here today who is fully aware of corporate governance
    issues as to what has happened. We are always closing the door
    after the horse has run away. Is there a way that we can close
    the door before the horse leaves the barn, or is that just a
    false hope?
        Mr. Berardino. I think there is some serious corporate
    governance issues in this country. As I said earlier, the vast
    majority of companies and boards get it right. The thing that
    is so shocking about this is its rapid ascent and incredible
    quick collapse on a scale, a magnitude we will hopefully never
    see again. So I would put this in the aberration category, but
    I do think whenever you have a natural disaster, it's an
    opportunity to rethink everything and come up with a better
    solution. I think we can come out of this with a better
    solution and that's why my glass is half full as painful as all
    of this has been.
        Mr. Kanjorski. You are the head of one of the huge top five
    accounting firms. I am also beginning to look at this problem a
    little differently, like whether or not we should tier the
    profession. I think for us to put into place very stringent
    rules and regulations and statutes, that apply across the
    board, may be onerous. It seems to me that not everyone in the
    accounting profession has lost their balance here, not to
    suggest that your firm or others in the Big Five have.
        Mr. Berardino. Thank you.
        Mr. Kanjorski. Clearly, you are in an entirely different
    category of accounting than most accounting operations in this
    country, especially when we are talking about separating
    auditing from consulting. I do not have any doubt as to where
    my vote would be in regard to separating auditing from
    consulting with the major corporate structures in the country
    and the major accounting firms. I just think it is too
    conflicting. But, I will also be very practical. There are
    smaller companies and smaller accounting operations where the
    cost of having separate auditors and separate consultants would
    be prohibitive. In some ways, we would be injuring the middle-
    sized businesses and the middle-size accounting firms. They
    would be paying a terrible price for an aberration. How do we
    get balance there?
        Mr. Berardino. Well, Congressman, I think that's a very
    thoughtful point, because you do have smaller firms working
    with our entrepreneurial small businesses that are very
    different space. But before you go too quickly, let's look at
    these big firms. Let's look at my firm. We are $9 billion
    around the world in revenue. That's awfully big.
        Mr. Kanjorski. $9 billion.
        Mr. Berardino. $9 billion. We've got a billion or so of
    equity in our firm. You're asking five firms with several
    billions of dollars of individual partners equity; right? We
    can't go to the stock market to raise capital. Individual
    partners who grew up with nothing and built these firms to
    underwrite trillions of dollars of shareholders equity.
        And what happens when there's the a next big surprise?
    Who's going to underwrite that? So although we are big in
    absolute terms and although we are bigger than some of these
    middle size firms, when you look at our capacity relative to
    the wealth of this country and the stock market, we're a small
    fraction, and that's a significant concern.
        We've gone from eight firms to five already, because firms
    have not been able to compete and stay in business because they
    weren't big enough. And the question is, do you want to go to
    four, three, two or one, or have the Government take over? I
    think that's a good question. I'm not suggesting that I have
    the answer.
        Mr. Kanjorski. Are there those in the accounting profession
    that think maybe the Big Five are too big? Ought we encourage
    many smaller size firms? I was talking to an accounting firm
    over the weekend in preparation for this hearing. I believe
    they are the 25th largest accounting firm in the country. Their
    entire revenues for the year are not equal to what your income
    was from this one audit report. So, the disparity from the huge
    to the average, or the medium, is gigantic.
        I was thinking in terms of legal firms. I am after all, a
    lawyer by profession. I would hate to think we would have four
    or five huge law firms in the country or in the world that
    handle all the big transactions. It is pretty hard for me to
    understand. One, why that situation does not become a business
    as opposed to a profession. Two, only four or five guys have to
    sit around the golf club to divvy up clients and you have got a
    conspiracy. It just seems to me that the rest have are not
    participating. Whatever happened to the substantial medium-
    sized accounting firms in the world that do good auditing and
    good accounting? Why are they not out there doing it?
        Mr. Berardino. Because they can't compete and they can't
    stand the legal liability when one of their clients goes out of
    business.
        Mr. Kanjorski. Well, if that is true, they cannot compete.
    As one of the firm's partners told me: When the company that
    they were involved with, for about 15 or 20 years, was going on
    for its first IPO, Wall Street said it could not use that small
    accounting firm. You have to use one of the Big Five. Is that
    the pressure that is coming from the investment banking
    community?
        Mr. Berardino. Yeah, absolutely. Absolutely. But I'm
    suggesting if you go from four to eight or ten, you're going to
    dilute competence, you're going to dilute the amount of equity
    in these firms.
        Mr. Kanjorski. Do you think bigness and competence are----
        Mr. Berardino. I'm sorry?
        Mr. Kanjorski. Bigness and confidence are synonymous?
        Mr. Berardino. They don't have to be, but I would suggest
    in a proper profession they are.
        Chairman Baker. Mr. Kanjorski, if I may----
        Mr. Berardino. But these are very fair questions,
    Congressman. I wanted to just not so much challenge you, but to
    give you some context in terms of where this might go. These
    are not easy questions, and the answers will be even more
    difficult, but I think they're fair questions, and I want to
    just make sure you were just aware of where I was coming from.
        Chairman Baker. Mr. Shays.
        Mr. Shays. Thank you. Mr. Chairman, I had wanted to get on
    this committee because I figured that it was probably one of
    the most important committees that I could serve on, and
    particularly it impacts my district and Mr. Berardino, for
    instance, is a constituent of mine. And so in some ways, it's a
    little awkward to be in this position. I want to say that I
    think you've done a very fine job coming before this committee
    in many respects.
        The one area that I'm wrestling with is when you spoke last
    time, I felt you had given the committee the impression that
    the non-auditing side of the equation was a lesser source of
    revenue from Enron, and then I'm realizing that it was pretty
    50/50, and I am somewhat haunted by that memo that makes
    reference to $100 million, and, you know, because it's in a
    memo that says do we continue to do business, and let me just
    be very upfront here. I mean, I was contacted by a number of
    accountants who were saying, you know, we need to be able to do
    consulting work and auditing work.
        And so I wrote a letter to Arthur Levitt saying, you know,
    postpone this decision, give more time, and he called me back
    because he happens to be a constituent. He said, Chris,
    postponement means death. So then I went on the floor of the
    House the next day and said I didn't want anyone to make an
    assumption that this letter asking for a postponement meant we
    should kill this regulation. But I wrestle with this and I'm
    wrestling with this now, because I'm seeing $100 million in a
    document that was basically to decide whether or not to
    continue serving, and then I see this document that then later
    results in--I mean, the real failure was the Raptor and the
    failure to disclose $800 million of liability or overstating
    income by that amount.
        Tell me what this $100 million was all about.
        Mr. Berardino. Congressman, you know, it's very hard to
    answer that question. On the one hand we have very complex
    global clients that have hundreds and hundreds of CPAs on their
    staff that are doing very complex things, and I think you would
    agree you would want us to do a very thorough job and to get a
    fair income from that. Enron was in one of the elitist
    category, seventh largest in the country. We don't have any
    $100 million clients, and Enron never became a $100 million
    client. We have many in the $25- or $50 million range, but we
    are a $9 billion organization.
        All these clients are less than 1 percent of our fees. What
    was in that memo, if you want to take an innocent point of
    view, and you may be critical of this, is a recognition by our
    people that the objects of these fees being so big would be
    problematic as you've just suggested. That's what was written
    in that memo. And what the counter to that was, well, let's
    look at what we're doing, and I'd suggest to you when you get
    underneath the facts on that $50-something million, something
    like three-quarters of that you would only hire your accountant
    to do.
        Mr. Shays. I guess the question that it leads me to is
    basically, the $52 million in the year 2001, $25 million was
    auditing, and $27 million trumped the auditing. It was non-
    auditing fees, consulting, and so on; is that correct?
        Mr. Berardino. I've just had somebody give me the facts.
    Would you mind if I read this quickly?
        Mr. Shays. No.
        Mr. Berardino. The basic----
        Mr. Shays. As long as these are your words, because you're
    the one under oath. No, I'm serious. In other words, as long as
    you believe what you're reading here.
        Mr. Berardino. I would never say anything I didn't believe
    was accurate, plus I'd get back at these guys if I was wrong.
    But anyway, $25 million was the basic audit. $3 million was due
    diligence work where we went in and helped the company
    investigate companies they might buy. $3 million was taxes, $3
    million was reviewing internal controls. $4 million was
    actually Andersen Consulting. That's no longer part of our
    organization; so that $52 really is $48, and the $14 million is
    lots of small special projects and consulting jobs.
        Mr. Shays. But basically the $25 million is the auditing
    and the $27 million is non-auditing?
        Mr. Berardino. I'm not trying to be a pain in the neck,
    honestly.
        Mr. Shays. No, I understand.
        Mr. Berardino. What I'd suggest is a lot of the other work
    you would only go to your auditor for anyway.
        Mr. Shays. Let me ask you, though, how do you then jump up
    theoretically to $100 million? What was being said--but it's in
    a memo that basically----
        Mr. Berardino. Yeah, I understand.
        Mr. Shays. Is it non-auditing?
        Mr. Berardino. Clearly any other work to get beyond this
    number would have been non-auditing services that never
    occurred.
        Mr. Shays. What that says to me in a big way, I mean, I had
    to look myself in the mirror as well and all the other
    accountants who came to me and say this was a figure that was
    being dangled in front of your organization that, in my
    judgment, distorted judgment, and what this says to me is your
    organization had a moment of truth then to say good-bye and
    that was the moment of truth, and I bet that's the moment all
    of you regret, and sadly, the person this memo was sent to is
    the person accused of shredding documents.
        So yeah, I'm a little suspicious, and I have to look at
    myself in the mirror as well. This really is an indictment at
    the non-auditing side of the equation.
        Mr. Berardino. Congressman, I think that's a fair question,
    and I've addressed that in the points I put on the table both
    in how decisions are made to retain clients by bringing in some
    outside advice into our organization so that we can really
    think these through. I will promise you one thing. This firm
    will learn a lot of lessons from this and we will come through
    it stronger, because we are willing to challenge everything
    we've done historically, and I put on the table some initial
    ideas.
        I've heard some other ideas here I hadn't thought of
    before. Mr. Volcker will give me other ideas that I haven't
    thought of before as well as his board, and I just want to
    leave this committee with that impression. We are deadly
    serious. We will take a lead, and as I have talked to many of
    our clients around the country, they have all said we went
    through a crisis and we got through it because we were willing
    to change.
        My profession has put some issues on the table that you
    heard from Chairman Pitt yesterday. Whether that's the right
    answer or not isn't important. What's important is we're
    willing to change and we're willing to work with this
    committee, and I want to thank this committee for its
    thoughtful way--I said this last time. You're trying to
    understand. I apologize I can't answer all those questions
    about what happened, but I'm not going to do that
    irresponsibly. But that does not mean that we're in denial.
    That does not mean that we're not willing to work hand in hand
    with whoever's interested, this committee, SEC, other members
    of the financial appointing process to get to a better answer
    and that's what we all ought to be about, and I want to applaud
    you for that leadership.
        Chairman Baker. Thanks, Mr. Berardino.
        Mr. Sanders wants to be recognized one more round.
        Mr. Sanders. Thank you very much, Mr. Chairman. I think
    that you and Mr. Kanjorski and others are wrestling with the
    nub of the issue and as understand it, this is what it is, and,
    Mr. Berardino, maybe you can help me out here. There are
    millions and millions of investors in this country who need a
    referee, need an objective source to say that which company
    should I invest in? There are trillions of dollars of workers'
    money in pension funds.
        In my small State of Vermont, we lost $4 million in the
    Enron debacle. And it seems to me, Mr. Chairman, that the
    essence of the issue is to whom is the auditor loyal? Where is
    your first loyalty? If firemen in New York City put their
    retirement savings in a pension fund, is it your primary
    responsibility to tell their investment counselors the truth
    about the company, or is it your primary responsibility to work
    with the company to earn as much profit as possible for the
    company, some of which you share?
        And this touches on--I don't want to get back to the
    conflict of interest issue, because everybody has raised it and
    I agree with that, but it even goes beyond that and I think
    maybe the Chairman raised that issue. If you look at a set of
    books by a company and you said, hey, this is a bunch of crap,
    it is not the truth, it is very likely that the company will
    say well, thank you very much for your opinion, you're fired,
    we will find somebody else who tells us our books are very,
    very good.
        And I think that's another conflict situation which
    auditors are in, and I think ultimately the investors of their
    country, the workers of this country who put money into pension
    funds have got to know that there is somebody out there who is
    telling them the truth. Investment is always risky, but at
    least you've got to have all of the facts and----
        Chairman Baker. Mr. Sanders, if I can interrupt on that
    point just because, you know, as friends here know, I think
    there's another element to this that goes to the heart of that
    institutional investor's goal, and to some extent, small
    investors. We all sat around and watched the market go crazy.
    People were getting 20 percent rates of return. Management sits
    there and is told by the board and by shareholders if you don't
    beat the expectations for earnings next quarter by a penny or
    two--if you beat it by 3 cents, that's questionable. Beat it by
    a penny or two, you're smart. And you not only have to beat the
    written analyst estimates of your return, but the whisper
    numbers, that people really say, oh, that's not the accurate
    number.
        The end of the process is that management then is forced to
    take on risk to keep the earnings where they should be to
    enhance shareholder value, and we find ourselves replicating
    the 1980s and S&Ls in Louisiana who were buying broker deposits
    and giving away toasters to have returns look good for
    shareholders.
        So this is a cultural problem. And I don't lay fault on any
    one participant, but I want to respond to you by saying I think
    we should make the audit team, the audit committee, and the
    board of directors responsible first and primarily to the
    shareholders. Once that's done, everything else should flow
    appropriately, and I thank the gentleman for yielding.
        Mr. Sanders. I mean that's kind of the direction that I was
    going.
        Chairman Baker. I hoped.
        Mr. Sanders. And I was going to ask Mr. Berardino this
    question. If there needs to be somebody, some institution that
    the shareholders and the pension funds can look at who don't
    have a conflict of interest who are telling them the truth, who
    are not going to get fired when they tell the truth, who are
    not making money and profits with the company if it is doing
    some of the things that the Chairman indicated, who's going to
    be that institution, and what is the proper role in that
    process for the Government? That's number one, who presumably
    does not get rich or poor, based on the activities of the
    company? And second of all, as I understand it, Mr. Berardino,
    Arthur Andersen has the dubious distinction of having received
    the largest fine from the SEC, which was $7 million with regard
    to Waste Management. You are a company that has $9 billion in
    revenue in a given year.
        So the two issues that I want to know is, number one, $7
    million is the largest fine, and yet compared to the $9 billion
    in revenue, it ain't nothing. If you screw up or another
    auditing firm screws up, is a paltry fine like that enough of a
    disincentive so that you don't do it again, and second of all,
    in terms of the broad issue of conflict of interest so you can
    look your company in the eye and say, sorry, we are not going
    along with that, and what is the proper role of the Government
    in that situation?
        Mr. Berardino. Congressman, I am going to answer that in
    two ways. I don't know what the proper role of the Government
    is. I am prepared to engage you in debate, as we are now,
    because I think a lot of smart people can get to a lot of
    different answers and collectively we get to a better place.
    But I will tell you one thing. All those big numbers were
    floating around. I grew up with nothing. Most of my partners
    grew up with nothing and we only care about our reputation,
    which--we only care about our reputation and we have been
    working as hard as we have been these last 2 months as we have
    been criticized left and right, as things have been leaked and
    put in the news that are half truths. We have been a stand-up
    firm that's gone out time and time again, come to this
    committee, come with ideas, made our people and documents
    available, self report the destruction of documents. This has
    all been very painful. I'm not asking you for your sympathy,
    but I'm telling you the real firm you are looking at is a
    stand-up firm that wants to get it right and any fine that
    impugns our reputation hurts us.
        Mr. Sanders. I take a little bit of offense when you
    suggest that the only thing you care about is your reputation.
    I grew up without any money. You grew up without any money. You
    have a lot of money now. I am sure they are paying you quite
    handsomely. In all due respect, you're in the business to make
    money as well. In terms of the reputation of Arthur Andersen, I
    don't think I'm telling anything out of school here, it does
    not have a good reputation. I listened to you time after time
    after time when your company was either fined or you settled.
    You don't have a good reputation.
        But you see, you are not answering my question. My question
    was I see an inherent problem that if, in fact, and maybe it's
    so and maybe it's not so, based on your track record I think
    Arthur Andersen has had a lot of problems in recent years. But
    assuming you wanted to do the right thing and you also wanted
    to make money, which is fair enough, and you came to a company
    and you said, company, you are not telling me the truth and the
    company says you're fired, I don't want to hear that, what is
    the recourse of that conflict right there? How can you be
    honest and make money at the same time?
        Mr. Berardino. Well, I have given you my ideas and my
    testimony. I think if we have had an ability in our report to
    distinguish gradations of quality reporting that would provide
    incentive for every registrant to have the highest degree of
    standards in its accounting and not achieve the bare minimum
    not to get the clean opinion, let's look at the incentives, and
    I think that is where Chairman Baker is going. Let's look at
    those incentives and challenge whether or not we've got the
    right ones. And I'm not going to sit here and tell you I've got
    all the answers, but I am making suggestions that I think can
    make a difference.
        Chairman Baker. I wish to just get perhaps a little bit of
    balance in the hearing record from your perspective of the
    annual revenues you received for accounting services. Can you
    give me an approximation of the number of clients that
    represents?
        Mr. Berardino. We have 2,500 public companies here in the
    U.S. Worldwide, with all the services we render, we have
    100,000 clients.
        Chairman Baker. So that with 100,000 clients, the reported
    concerned cases are less than 10 or perhaps less than 5.
        Mr. Berardino. And some of the cases that have been cited
    have happened over a long period of time.
        Chairman Baker. We could multiply that by some number of
    years. My point is that the failure rate for corporate activity
    as it relates to accounting standards and professional product
    is less than one--tenth of 1 percent now. There is an egregious
    case with Enron because of its unfortunate demise on many
    fronts. I wish to make it clear I think the accounting
    profession is that, a profession, and that most diligent people
    labor and long to provide an honest service for their clients
    who are trying to run a business honestly.
        What we now find ourselves with, however, is clear
    identification of conflicts and conflicts which are not of your
    own making. We are operating in 2001 with a SEC Code written in
    1933 and 1934. There is an inordinate need for this committee
    to move beyond the current crisis of reforming accounting
    principles and move to the broader question, what is the proper
    governance in today's technological world. When you had
    typewriters and White-Out and people were a great deal more
    contemplative, when I was in the real estate business many,
    many years ago and you had to do a purchase agreement and it
    was with carbon paper and you had to have an amendment to that
    purchase agreement and you had to run it back and forth, there
    was time for people to think about making the deal. Today,
    billions of dollars move by computer transaction in
    microseconds. It's a different environment. However, in this
    environment, or in the old one, there is always the necessity
    for ethical conduct and professional judgment, and what this
    committee needs to do, in my opinion, is to provide the
    accountant who's on the site making the evaluations of the
    financial practices of a corporation, is to report the facts as
    he sees them.
        There's a question in my mind as to whether or not the
    environment today enables that to happen in every case, and I
    want to ensure the members of the accounting profession, who
    are I am sure listening to your testimony quite anxiously
    today, that we will work to achieve professional standards that
    serve the public interest well.
        We do now have a crisis of confidence. There are people in
    my hometown in Baton Rouge this morning who are working at a
    corporation wondering if its books are being accurately
    reflected and is their job at risk. There are people who are
    relying on their pension to pay their monthly living expenses
    wondering if there is going to be a restatement of earnings and
    their stock price is going to deteriorate. There are people who
    hold large investments hoping to buy their first home or their
    child's education. This goes to the core of our capital
    market's structure, and the confidence that people have in the
    ability that they're receiving the facts to make educated
    judgments about their economic future cannot be allowed to be
    put at risk, and that is what the committee will do. That is
    the answer we will seek, and we hope with your good counsel and
    cooperation that we can achieve a remedy within days, if not
    months, that is responsive to this crisis and forever puts it
    in a manner that it cannot reoccur.
        To that end the committee is committed, and I want to thank
    you for your second voluntary appearance. The hearing is
    adjourned.
        [Whereupon, at 2:15 p.m., the hearing was adjourned.]
                                A P P E N D I X

                                February 4, 2002
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                                A P P E N D I X

                                February 5, 2002
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