[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
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

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

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

                 RICHARD H. BAKER, Louisiana, Chairman

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






                            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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